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How Regulatory Frameworks Drive Technological Innovations The spirit of regulation is to establish fairness and openness, which encourages better participation among innovators and users.

By Pui Ki

Opinions expressed by Entrepreneur contributors are their own.

Stanislaw Pytel | Getty Images

In many industries, regulation is often viewed as an additional hurdle to overcome. Many businesses tend to think of rules and policies as challenges that require adjustments and additional cost in their operations. However, the spirit of regulation is to establish fairness and even openness. Thus, a better paradigm involves regulatory frameworks being drivers of innovation.

"In the economic sphere, regulations can maintain a certain level of openness or competition in product markets which provides the necessary conditions for research and innovation," states an OECD paper on regulatory reform and innovation.

Regulation is not necessarily a hindrance to innovation, especially when it comes to financial technology. It may appear antithetical to decentralized finance, but there are merits in allowing regulatory bodies some participation in the supposed decentralization of financial transactions.

Why laissez-faire and complete deregulation are ineffective

Cryptocurrency exchange and derivative platforms have lacked compliance. A quick search online shows numerous accusations and drawbacks. In October, BitMEX was charged by the U.S. government with facilitating unregistered trading. It has since been reviewing its account holders and requiring verification of their identities.

The lack of regulation and compliance results in higher risk for abuse. Without regulatory agencies overseeing the legitimacy of transactions, players are free to do whatever they want at the expense of customers. Consequently, as reported by Yahoo, "the Hong Kong government has proposed a new licensing regime under its anti-money laundering legislation, requiring all cryptocurrency trading platforms that operate there, or target investors in the city, to apply for an SFC licence."

In theory, it can also go the other way, wherein the absence of regulation allows companies to explore more creative ways to deliver new products and services. However, more often than not, there is a risk that abuse trumps innovation without regulation especially in the world of fintech.

Related: What Business and Government Should Do When Innovation Outpaces Regulation

Finance and technology, coupled with the ideas of decentralization and democratization, are not easy to comprehend. Case in point: Many have already adopted the use of digital assets, but only a few users have a proper grasp of how this fintech innovation works technically. Without regulatory oversight, it is easy for many to fall for deceptive schemes, and there are numerous scams bordering on exit scams, so-called cloud mining operations and the like.

Many are deceived when baited by ideas such as the high conversion rates and the idea that digital assets are a safe haven in this time of economic uncertainty.

Moreover, deliberate abuse is not the only argument against deregulation in fintech. Security is also a critical concern. Many unregulated companies forego adequate security measures as they reduce expenses to pursue better profit margins. Current regulatory policies include security requirements to protect consumers from various threats, both natural and man-made.

Compliance gives enterprises an assurance

Many enterprises or large businesses acknowledge the advantages of new technologies such as blockchain and the benefits of breaking away from centralized systems. However, they hesitate to consider novel services such as blockchain-backed solutions because of the possible security and legal threats arising from a decentralized system.

As an example, the Autorité des Marchés Financiers (AMF), or the French equivalent of the SEC, approved the token swap offering of iExec, a company that provides a decentralized platform for connecting apps and trusted off-chain computation and data providers. It is essentially a decentralized marketplace for cloud computing.

What the French SEC decision imparts is that enterprises can start exchanging compliant cloud resources, which should assure customers of high-quality and secure services. Businesses that take advantage of off-chain cloud resources due to their competitive pricing and improved privacy can be assured that their options are compliant, especially when it comes to security policies.

This presents a compelling case of regulation serving as a stimulator for innovation and ingenuity. For one, through regulatory compliance, the innovation can be seen as free from the risks associated with money laundering and terrorist funding activities.

In one perspective, regulation has empowered iExec to develop its service taking into consideration the various regulatory regimes, including Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) policies. This makes it favorable not only to small businesses but also to enterprises that require a high level of compliance in order to also address their corporate responsibilities.

Complex regulation-technology relations

Going back to the OECD paper cited earlier, it bears emphasizing that well thought out regulation is not inimical to innovation in industries. It can even serve as a stimulus. "Regulatory reform itself can be a powerful stimulus to innovation in most fields, ranging from banking to environment to retailing," the OECD paper points out.

For platforms and solutions, standardization in compliance mechanisms will encourage adoption, particularly if it will give regulators a high level of comfort that innovations will be done within these frameworks.

"When it comes to crypto assets offerings, very few initiatives from financial regulators have proved to be as relevant as the AMF visa. The AMF visa combines both a high level of standards in order to protect investors and the necessary freedom for innovation," says Gilles Fedak, Chief Executive Officer at iExec. "Enterprises involved in cloud computing care about regulation and being able to offer an AML/CFT compliant version of the RLC token will boost Enterprise adoption, and at the same time reinforcing the iExec ecosystem as a whole."

Regulations help foster competition and prevent antitrust activities that deprive smaller competitors of the chance to get funding and consumer exposure. This is particularly true in the finance and tech industries, where larger companies quickly absorb or compete against smaller ones that threaten their dominant positions with their innovative new products and services.

Governments that pay attention to important industry movements and needs must streamline regulations to help promote innovative solutions. Decentralization does not necessarily advocate a complete decoupling from government oversight. Industries that seek to decentralize also need to understand that consumers view government involvement as a form of assurance. Regulation guarantees the quality of the services they get and provides enforceable recourse options in case businesses renege on their responsibility to customers.

Moreover, regulation facilitates international harmonization. China's decision to issue its state-backed digital asset, for example, may attract foreign investors and promote broader digital currency adoption. However, without corresponding regulatory actions in the governments of other countries, the goal of bringing cryptocurrency to the mainstream may lead to challenges that may end up discouraging consumers from embracing digital currency use.

Related: Tech Entrepreneurs to Face More Regulatory Scrutiny in 2020

The takeaway

Regulatory frameworks may appear limiting, but they set conditions that can be viewed in another perspective as opportunities to develop products that do not only address pressing needs through innovative solutions. Regulations help guide innovation to produce solutions that are not only useful but also dependable, secure, and unlikely to be met with local and geopolitical challenges. Additionally, regulation ensures that competition is not suppressed and the introduction of innovations to foreign markets proceeds in harmony with counterpart regulations and technical conditions.

Pui Ki

Senior Analyst

I cover financial-technology news and entrepreneurship.

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