Decentralized Markets and Self-Regulation

Abstract

Distributed ledger technology, such as blockchains, is changing financial markets by creating a new foundation for transacting with digital assets. Simultaneously, blockchain-enabled intermediaries—cryptoexchanges—have emerged to trade, broker, and settle transactions with digital assets, including native cryptoassets and other tokenized assets. U.S. regulators seek to place cryptoexchanges within the ambit of existing regulation and registration requirements for legacy intermediaries. A critical underexplored corollary of this approach is converting cryptoexchanges into legacy self-regulatory organizations (SROs) or members of such SROs. Put differently, U.S. agencies are bringing not only conventional regulation but also self-regulation into blockchain-enabled markets. Unfortunately, in imposing the traditional model without reform, policymakers risk ignoring the considerable economic potential of the new technologies. Their approach should also fail to precisely target the risks, transaction costs, and negative externalities of digital asset trading. 

To offer solutions, the Article examines the digital asset market structure and microstructure, its intermediaries, and associated transaction costs. Comparing centralized cryptoexchanges, decentralized cryptoexchanges, and legacy trading venues, the Article explains why cryptoexchanges cannot optimally address the risks of digital asset markets without bespoke regulatory guardrails. Agreeing with the basic intuition to introduce formal self-regulation, the Article refines possible self-regulatory models. The proposed frameworks would aggregate the decentralized knowledge of individual participants in the global blockchain-enabled market to ensure better coordination and well-informed regulation. Building on market expertise, the new SROs would educate the regulators about ongoing market developments and risks, promote regulatory efficiency, and improve digital asset trading. The proposed approach would also reduce the costs of coordination among heterogeneous and globally dispersed participants in blockchain-enabled markets and nudge them toward self-regulatory and technological solutions to transactional problems in a comprehensive manner.

 

Keywords: financial markets, distributed ledger technology, blockchains, securities law, derivatives regulation, SEC, CFTC, self-regulation, SROs, innovation, financial regulation