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Why I think FINCEN will kill blockchain applications in the United States

May 16, 2015

The other somewhat controversial statement that I made was that I think FINCEN will kill blockchain applications in the United States, and this was made in response to a question Tone asked about Ripple.  Let me mention that I’m hoping that I’m wrong here, and I hope that the people developing applications on the blockchain will fight the good fight, and rather than waste time arguing with me, just listen to what I think the regulators will do, and fight back.

But here is the problem……

Ripple is trying to create a network of currency exchangers using the blockchain.  The issue here is that technologically, we don’t need Ripple to create a network of currency exchangers.  You could use the internet to do that.  Technologically, I could put up a webpage saying that I’m willing to convert X to Y, and then we find some other means to figure out who to trust.  So you really don’t need Ripple or blockchain to create a network of currency exchangers.

But there is a problem.  You can’t just put up a sign saying “I will convert your money”.  You can’t because the money transmission police will come in and shut you down.  This happens to be good for existing money transmitters, because they can charge hefty fees.  You can see how much rent money transmitters charge by looking at Hong Kong.  In Hong Kong, lots and lots of people are in the CNY-HKD money transmission business, and so the fees people charge are extremely low because there is no barrier to entry.  In most other places, the regulations keep the barrier to entry high.

Now if someone can figure out a clever way of circumventing regulations, this would be cool, and would dramatically reduce fees. So if someone figured out a blockchain method in which random people can post information that they are willing to exchange currency, and this method is pretty tough for the powers that be to stop, then this would totally change things.  At that point you’d have a network of tiny currency exchangers, and this will push fees down.  But this sort of thing is exactly what FINCEN is trying to prevent.

Unfortunately, if you have a system in which you apply current regulatory structures to money transmission, then what will happen is that ultimately money transmission will be restricted to people that can get money licenses, which will keep the costs high.  Once the costs are high, then there is no reason to use your new system over the old system.  The promise of Ripple is that it allows an open door to money exchange by which anyone can become a gateway, but I think that FINCEN has closed that door.

Now, none of this is a criticism against Ripple, and I would be completely delighted if they could prove me wrong.  They are going to have to make some critical decisions about business strategy, and I wish them a lot of luck and sympathy.  One problem that they are going to face is their funding mechanism.

Ripple gets money from VC’s.  VC’s need a large payout, which means that they have to be nice to big banks and regulators.  The trouble is that means that they have to be nice to the people that want to shut them down.  The last thing that banks want is a better way of transmitting money, and what scares FINCEN is a world in which instead of a few easy to trace people making large transactions, you have a large set of hard to trace people making small transactions.  Depending on the good will of people that want to shut you down makes for a bad business model.

Again all of this is meant to be constructive, and I would be completely delighted if they figured out some way around the issues I’ve presented.

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