Blockchain Neutrality

• Publication year: 2021

Blockchain Neutrality

Samuel N. Weinstein
Benjamin N. Cardozo School of Law

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BLOCKCHAIN NEUTRALITY

Samuel N. Weinstein^*

Blockchain technology is transforming how markets work. Blockchains eliminate the need for trusted gatekeepers like banks to execute, verify, and record transactions. In the financial markets, their disruptive potential threatens both Wall Street banks and Silicon Valley venture capitalists. How blockchain technology is regulated will determine whether it encourages or inhibits competition. Some blockchain applications present serious fraud and systemic risks, complicating regulation. This Article explores the antitrust and competition policy challenges blockchain presents and proposes a regulatory strategy, modeled on Internet regulation and net neutrality principles, to unlock blockchain's competitive potential. It contends that financial regulators should promote blockchain competition—and the resulting market decentralization—except in cases where specific applications are shown to harm consumers or threaten systemic safety. Regulators also should ensure open access and non-discrimination on dominant blockchain networks. This approach will not only serve traditional antitrust goals of lowering prices and promoting innovation, but it also might achieve broader economic and social reform by reducing the power and influence of the biggest financial institutions.

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Table of Contents

I. Introduction....................................................................501

II. Blockchain Technology and Its Applications in Financial Markets........................................................516

A. What Is Blockchain Technology?.......................516
B. Blockchain's Use in Financial Markets.............518

1. Impact on Capital Markets..............................519
2. Impact on Derivatives Trading........................524
3. What is at Risk for Financial Institutions?.....535

III. Blockchain & Antitrust.............................................537

IV. Blockchain Competition Policy.................................542

A. Goals......................................................................543
B. Three Key Challenges..........................................546

1. Competition v. Safety & Soundness.................546
2. How Much Decentralization Should Regulators Promote or Tolerate? ....................................... 551
3. Standardization, Open Access, & Non-Discrimination ................................................ 557

C. Institutions...........................................................561

V. Blockchain Competition Policy for Financial Services..........................................................................564

A. Paid Prioritization...............................................564
B. Blockchain-Based Derivatives Trading.............571
C. Capital Markets & Token Sales...........................578
D. Standard Setting & Intellectual Property-Related Risks........................................................585

VI. Conclusion....................................................................590

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I. Introduction

Blockchain technology has been touted as the next transformational innovation of the computer age.¹ The idea behind blockchain is simple, but it has far-reaching implications. Blockchains are distributed ledgers—decentralized databases that allow communities of users to execute, verify, and permanently record transactions using their own computers.² These networks are consensus-driven; community consent is required to change a ledger.³ Once a transaction is recorded in a block of data and added

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to a chain, altering that transaction record is difficult.⁴ As a result, blockchain could, in principle, reduce or eliminate the need for central "gatekeepers" to provide trusted sources of transactional verification and support.⁵ To many proponents, this feature is blockchain's greatest potential benefit.⁶ Rather than requiring a government to supply currency, a title company to insure and record title to real estate, or a Wall Street bank to provide trusted exchange and clearing solutions for equities or derivatives trades, these services could be furnished by a decentralized, blockchain-based network run by its users.⁷

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Blockchain's use is already becoming widespread. Bitcoin, perhaps the best known blockchain application, is surging;⁸ blockchain-based token sales, including initial coin offerings (ICOs) and initial exchange offerings (IEOs), have raised billions of dollars for companies over the past few years;⁹ and the world's largest provider of derivatives processing services is moving trillions of dollars of transactions onto a new blockchain-based system.¹⁰ A 2018 PricewaterhouseCoopers survey of 600 executives found that 84% of their firms had some form of blockchain initiative underway.¹¹

Broad adoption of blockchain technology may have enormous economic, social, and political ramifications. Entrenched institutions whose power and position are based on providing trusted goods or services might see their roles undermined or fundamentally altered. Governments may discover that blockchain-based Bitcoin or JPM Coin¹² competes effectively with their currencies, and banks may find that many of their trust-based services, such as equities and derivatives dealing, are no longer

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needed. Blockchain promises to usher in changes that could be as sweeping as those the Internet has wrought over the past few decades. Just as Internet-based businesses disrupted long-established industries—travel, publishing, retail, and music and video distribution, to name a few—blockchain may render obsolete whole categories of firms and business models.

The changes promise to be particularly significant in the financial-services sector. Blockchain-based capital markets threaten Wall Street banks' and Silicon Valley venture capitalists' (VCs) market dominance. Equities and derivatives trading and clearing platforms based on blockchain may reduce the role of traditional dealers and big banks in these markets. Significant parts of Wall Street's and Silicon Valley's long-standing business models are at risk.¹³

Although blockchain has significant procompetitive potential, certain blockchain applications also pose serious fraud and systemic risks. Many ICOs have turned out to be fraudulent,¹⁴ and decentralized financial-products trading will make regulators' task of tracking and mitigating systemic risks more difficult. Blockchain's ultimate impact in the financial markets—and in the broad range of other markets it might remake—will depend in large part on governments' competition policy responses.¹⁵ Will regulators create the conditions for blockchain-based businesses to transform markets, as they did for the Internet in the past quarter century, or will they disfavor these new business models to protect gatekeeper institutions? To answer this question, financial regulators must weigh blockchain's potential for increasing competition against its very real risks; so far, they are erring on the side of risk prevention.¹⁶

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This Article argues that emerging blockchain-based financial-services networks offer a rare chance to make the financial sector less concentrated, more competitive, and more democratic. Financial regulators are uncertain stewards for this type of transformation. If the regulatory agencies maintain their narrow focus on fraud prevention and systemic-risk management, they may miss a significant opportunity to help modernize the markets they oversee. Instead, they should seek ways to promote the increased competition that blockchain technology promises to create.

To meet this challenge, this Article proposes a regulatory strategy, modeled on early Internet regulation, to unlock blockchain's competitive potential while mitigating the risk of fraud. It contends that regulators should promote vigorous blockchain competition—and the resulting market decentralization—except in cases where specific applications are shown to harm consumers or threaten systemic safety. To safeguard the full flowering of blockchain competition, regulators also should ensure open access and non-discrimination on dominant blockchain networks. This strategy will serve traditional antitrust goals of lowering prices, increasing output, and promoting innovation,¹⁷ while also potentially achieving broader economic and social ends by reducing the power and influence of the biggest financial institutions. These institutions, especially Wall Street banks, have exercised control over financial-services markets for some time.¹⁸

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Access to capital is dominated by leading Wall Street firms and Silicon Valley VCs; Wall Street also controls most financial products trading.¹⁹ Blockchain-based networks offer the opportunity to release this stranglehold, giving individuals and firms more freedom about how they consume financial services. This shift might serve distributive goals, too. Availability of financial services historically has been limited by class and race.²⁰ By providing widely accessible competitive alternatives to traditional banks and VCs, public blockchain-based networks could broaden opportunities for individuals and firms from diverse backgrounds to raise capital and enter the financial markets.

A burgeoning body of legal scholarship has documented the spread and implications of blockchain, addressing how the technology works and its potential to upend various markets.²¹

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Much of that scholarship has focused on the financial markets, especially the development of cryptocurrencies.²² A handful of scholars have addressed the regulatory challenges blockchain presents, including in the financial services sector,²³ but this literature is still in its infancy. This is particularly true for antitrust and competition scholarship, which is especially sparse.²⁴ This Article addresses that...