Regulation and Augur

by Peronet Despeignes

Some people have to sell the drama of "us vs. them" to grab eyeballs, boost website views, sell ads and newspapers, but this can often mean creating false narratives of conflict where none exists or missing the opportunity for groups to work together for mutual benefit and the common good.

Take the way that the relationship between blockchain technology and regulators is often framed: as a tale of anarchist pirates twirling their curly mustaches and slapping on Guy Fawkes masks before diving into (suicidal) battle against The Man, while armchair libertarians and other spectators on the sidelines of the Gladiator pit sip on a cool lemonade, lounging under the vernada, waiting with baited breath for the impending bloodbath.

It's colorful David-versus-Goliath, Game of Thrones imagery and great entertainment (at least for spectators), but it's also pretty inaccurate — simplistic (and callous), to say the least.

For one thing, there's a lot for regulators to love about Augur's system.

Augur is transparent. Transactions are recorded and viewable on the blockchain — a groundbreaking innovation in financial technology that both federal and state-level regulators are beginning to appreciate.

Our decentralized platform runs on algorithmic smart contracts, eliminating the costly principal-agent problem and counterparty risks that have dogged investors for decades and been the bane of financial markets (and regulators) since their modern manifestation.

In Augur, there are no corruptible middlemen who can steal funds. There is no counting on the promises of a third party to properly manage their risks and finances and not ruin yours. Augur is decentralized and peer-to-peer, taking human nature out of the equation. On our system, people will be able to trade and exchange funds without worrying about the risk of a custodian one day saying "sorry for your loss."

That can be a good thing.

Decentralized exchanges are the kind of revolutionary sea change that, if they catch on, can make many types of Wall Street disasters a thing of the past.

Now, it is the case that Augur will be decentralized and, unlike previous prediction markets, isn't run by a company or off a central server. It will be a distributed system without a center that exists "everywhere, yet nowhere," but the requirement for people to comply with their local rules and regulations doesn't just go away. We have been emphatic — repeatedly — that users must comply with local rules and regulations, just as with any computer software or any other tool they use.

As we understand it, in a decentralized system where there is no central node, the burden of compliance shifts away from companies and central servers that dominate the current broken paradigm to the users themselves.

Let's be clear about this: Augur is an open platform for people to create markets, make predictions or simply monitor that speculation to get a read on the odds of different events occurring, but it will remain the responsibility of individuals to make sure they're in compliance.

The bigger picture here is the larger relationship between regulation and blockchain tech and how it is often mispresented as a necessarily antagonistic one, but it doesn't have to be that way.

See the thoughtful comments below of cryptolegal experts Constance Choi, Augur advisor Elizabeth Stark and New York Law School Professor Houman Shadab.

Stark makes the point that new tech can actually help regulators carry out their mission: "The blockchain can be used to much more effectively achieve the objectives for both compliance and policy that regulators want to see...Why is there not a good API that will search the OFAC list (the government's list of bad guys or potentially bad guys) to see if you're dealing with people that are prohibited from dealing with the US ...a lot of this stuff can be automated in terms of solutions and what the community can do. We're technologists. We can build things (to make compliance better and easier)..."

Choi makes a point from the other end that the costs in money and time under current status quo systems are escalating without proportionate benefit: "The level of attention that AML (anti-money laundering measures) is getting at the board level is increasing year after year. The efficacy by just 1 or 2 percentage points despite what the they pour in...if you look at KPMG's Global Annual survey from this year, the stats are pretty depressing. They are really spending hundreds of millions of dollars upgrading their system every year. They know it doesn't work...They even have a section in the report where they say, 'if you're (dis)heartened by the (abysmally low) returns on investment on all this compliance, just think about your reputation and the kinds of unquantifiable harm that can come from (not doing all this stuff). So that's literally their (sole) comfort about the effectiveness of these programs."

In 2011, 8 percent of respondents predicted an over 50 percent increase in (compliance-related) expenditure. In reality 22 percent of respondents increased expenditure by over 50 percent during the three year period from 2011.

KPMG 2014 Global Anti-Money Laundering Survey
(of Financial Institutions)

In other words, from a financial perspective, much of this heavy spending isn't cost-effective at all, and it's escalating — beyond many people's expectations.

Between the growing capabilities of blockchain technology applications and the growing burden (including the opportunity cost) and inefficiency of a lot of compliance-driven spending, there's an expanding, golden opportunity here for regulators and technologists to work together to close the widening gap, as Choi and Stark argue.

Stark makes the specific point that this offers great business opportunities for cryptostartups that help to automate compliance and reduce compliance costs and headaches. She references work being done by Byron Gibson and others for the Crypto-Economy Working Group at the Institute for the Future.

(Editor's note, October 14, 2015: These are the kinds of promising time- and money-saving compliance solutions groups such as Scorechain, which had a successful crowdfund recently, are developing.)

These are some of the key points made by Stark and Choi at the MIT Bitcoin Expo held earlier this year, starting at time segment 2:26:36:

Stark points out blockchain applications that are here today to help regulators and the things blockchain technologists need to talk about to better direct the conversation: "real-time continuous auditing, multisig, (the kind of) Safe Harbor (laws that protected the early development of the Internet) — we need to reshape the conversation into what the community can build and what's possible."

Now, let's take a look at Professor's Shadab's great legal analysis of the issue, "Bitcoin Financial Regulation: Securities, Derivatives, Prediction Markets, and Gambling," released earlier this year with co-authors Jerry Brito and Andrea Castillo of George Mason University.

The key sections are:

pg 67, "B. Decentralized Applications,"
pg. 70, "2. Predictions Markets"
pg. 73, "C. Law and Decentralization"

These are the cliff notes: "This is a new world for policymakers. In the past, to achieve a public policy goal, they only needed to regulate a handful of intermediaries. The perceived benefits of the public policy goal very often outweighed the cost associated with regulating the few intermediaries. If there are no intermediaries, but only thousands or millions of users interacting peer-to-peer, then the costs of enforcement may well outweigh any perceived potential benefits of regulation."

"In this new world, regulators should take into consideration the increasingly high cost of information control into their cost-benefit calculus. Doing so may lead policymakers to conclude that efforts to control only make sense as a last resort...The point is not that policymakers should give up once intermediary control becomes ineffectual; quite the contrary. It is that in the face of a new technological reality that cuts off certain choices, policymakers should be prepared not to fight against the new reality, but instead to discover and pursue strategies consistent with the new reality."

His point? As Bitcoin and related technologies make prediction markets and other types of financial markets decentralized and therefore harder to regulate the old-fashioned way, policymakers might find that being more flexible and adaptive could yield better public policy outcomes at lower economic and political cost, and that the net results could be more desirable anway.

Regulators might find that some of the rationales for regulation no longer apply in a decentralized and disintermediated context. For example, gambling and market regulations are often aimed at protecting consumers by attempting to eliminate or at least mitigate information asymmetries (a fancy way of saying service providers know a lot more than their customers, and can exploit this information advantage at customers' expense, hindering the proper performance of the market), but because decentralized peer-to-peer exchanges have no intermediaries, and because they are inherently public and transparent, there's a lot less asymmetry. Incidentally, George Mason University professors Tyler Cowen and Alex Tabarrok also touch on this in a great piece recently on how online tech of all kinds (not just blockchain tech) is reducing vendor/service-provider information advantages.

In other words, the regulatory challenges introduced by bitcoin come from technological innovations that at the same time open the door to the possibility of a newer, smarter, more flexible kind of regulation that more cost-effectively addresses the problems that led to the creation of many of these regulations in the first place — a new approach would downplay the current pre-emptive, costly, top-down approach and shift toward after-the-fact resilience to shocks and adaptability to change.

Augur doesn't make markets or participate in them. We're making a platform people can use to make the markets they want. It's up to users to make sure that whatever markets they're creating or participating in are legal where they happen to live. It'll be a global platform, so it's not possible for us to evaluate who is and who isn't allowed to use them under what conditions depending on where they live. It's up to users.

We believe the Safe Harbor Rules that helped to protect early innovation on the Internet, such as those which protected YouTube, are what's called for here, but even that comparison to YouTube doesn't really fit. In a decentralised system (think BitTorrent) there is no host. The "hosts" are the users. The users are all equal peers. There is no hierarchy. There is no central authority. There is no center.

We believe regulators understand that this trend toward decentralization is developing on multiple fronts and that new approaches to regulation need to be considered — methods that make practical sense, because the paradigm is here. The technology is here. It is not going away.

We've opened up a good dialogue with past and current regulators and continue to have constructive conversations with them and anyone else interested in discussing the platform and the possibilities for a positive path forward together. We've been engaging people on multiple fronts from the start and will continue to do so. Our door, like our code, is open — to everyone.