In this Q&A, Crypto Council for Innovation CEO Sheila Warren offers a primer on newly emerging, complex financial technologies like digital currency and blockchain. A nuanced and informed approach to policymaking and regulation is needed.
FSJ: What do U.S. diplomats working with governments and nongovernment entities around the world need to know about blockchain and digital currency?
Sheila Warren: First, blockchain and digital currencies represent foundational technologies. A digital currency is a form of money that exists only in digital or electronic form. It’s a broad category—including crypto, central bank digital currencies (CBDCs), stablecoins, and other emerging models. It may or may not be underpinned by blockchain technology, which is a form of distributed ledger that has cryptographically secured records. We should be thinking of these technologies much like the internet, as layers that will underpin the exchange of value, interaction with applications, and management of our online identities in the future.
People often get tied up in the technicalities, but those should be secondary. It’s more important to understand the unique properties of these innovations and what they enable. We don’t need to understand the inner workings of the Simple Mail Transfer Protocol (SMTP) to know what value email brings to our lives. The same applies here.
Second, there is a diversity of projects in crypto. Blockchain protocols and digital currencies make different decision choices around governance, economic incentives, and more. Thus, a nuanced and informed approach to policymaking and regulation is needed.
Third, blockchain and digital currencies are not something to fear. Use leads to understanding, and we encourage individuals to “play” with the technology to understand its unique features and applications—doing so doesn’t require monetary investment. For example, creating a wallet, looking at a block explorer (an online record of blockchain transactions), and tracking the provenance of an NFT (a non-fungible token) can all be done without spending a cent.
Fourth, now is the time to get up to speed on the fundamentals. We have seen the devastating consequences of people waiting to see what happens; after-the-fact actions are too little, too late. If we are going to effectively balance consumer protection and innovation, education and comprehension are key. This space moves quickly (even as someone focused on this innovation, I find it can be hard to keep up with all the developments), but a little investment of time will go a long way. Education is also key to differentiating between hype and real value.
Fifth, adoption of the technology varies greatly around the world, driven by different use cases and regulatory environments. Notably, there has been high uptake in emerging markets, places where people are living under authoritarian regimes, and countries experiencing instability and hyperinflation.
FSJ: What are the challenges of cryptocurrency adoption for U.S. national security?
SW: Cryptocurrency’s emergence as a new way to transmit value over the internet adds a new dimension to the U.S. national security landscape. It can give everyday people a way to move and hold digital funds safely without a centralized intermediary; but it can also offer illicit actors a new way to transact for nefarious purposes, making it not unlike other transaction methods that have been co-opted by bad actors for decades.
The permissionless nature of crypto systems can offer users the ability to transact pseudonymously. Thus, when Russian military intelligence officers aimed to disrupt the 2016 U.S. presidential election, in an attempt to shield their true identities, they used cryptocurrency to pay for the online tools, such as Virtual Private Networks (VPNs) and website domains, that they needed. However, the publicly viewable ledger of blockchain transactions for major cryptocurrencies like Bitcoin and Ethereum gives national security investigators a trail of data to track and analyze at all times. In fact, it’s this transparent record that has enabled U.S. law enforcement and intelligence officials to uncover and disrupt illicit operations by many state and non-state threat actors.
There is, in addition, a growing segment of tech firms specializing in blockchain forensics that provide the U.S. government software to support that mission. They use public records to identify bad actors within the system. In February 2022, the Justice Department said they “followed the money” via blockchain to retrieve $3.6 billion linked to the Bitfinex hack, the agency’s biggest financial seizure to date. Going back to 2020, analytics firm Elliptic saw that about $1 billion was moving out of a Bitcoin wallet. As a result, U.S. agencies tracked these illicit funds, helping to lead to the closure of the Silk Road case. Finally, the Department of Justice recovered the $2.3 million ransom paid by Colonial Pipeline in one month in 2021. This case points to the “underlying traceability of crypto, which can be used as a powerful tool and asset against criminals,” according to a risk management expert.
At the end of the day, bad actors typically want to convert out of cryptocurrency and into fiat currency, or government-created currency. To do that, they have to go through a money services business that, according to global regulatory standards, is obligated to identify its customers and monitor for criminal transactions. These “off-ramps” into fiat are heavily monitored, as are the “on-ramps” by which users convert fiat into cryptocurrency. Both are where bad actors are deeply vulnerable.
Cryptocurrencies and their underlying technology are spurring significant innovation globally. The U.S. urgently needs to understand this technology, harness its potential, and cultivate leading expertise onshore to keep pace with the quickly evolving global digital economy. Failure to do so would jeopardize the U.S. position in the highly competitive digital future. Lagging behind other nations in our understanding would pose the biggest threat to U.S. national security.
Japan led the G20 countries in being the first to adopt stablecoin legislation in the summer of 2021.
FSJ: What is Web3, and what do diplomats need to understand about it?
SW: Web3 is an industry term that represents the vision for a “decentralized” internet. Enabled by technical advancements in blockchain technology and crypto, it is a model for our online interactions that aims to shift power from centralized intermediaries back to individuals. Its ambition is broad—using new models for incentives and governance to rethink the fundamental relationships like the customer to the bank, the musician to the streaming platform, or the individual to their identity documents. As I’ve mentioned, the models and advancements in crypto—like NFTs, decentralized finance (DeFi), and self-managed identity, among other cases—are asking us to rethink who controls what data, value, and information, and why.
In the past few years, Web3 and crypto have been ubiquitous topics in conversations around digital innovation—but what are they exactly? Broadly speaking, we can think of Web1 as the “Read” era, Web2 as the “Write” era, and Web3 as the “Own” era. So, in the first iteration of the internet, we could view information from across the world. In the second iteration, we could add to it—largely through platforms and intermediaries. Now, we can own assets and transfer value, without the need for the intermediaries of the past.
From an overarching perspective, Web3 represents a vision for the future; it focuses on creating solutions to issues associated with centralized economies such as lack of privacy protection, data ownership, and misuse of data by intermediaries like social media platforms or financial services companies, which we have seen many examples of in recent history.
At its core, Web3 describes a decentralized future—one where tech serves as a tool designed to empower users to protect our data, along with greater transparency regarding privacy and usage policies within our digital economy.
Crypto factors into this movement, positioning itself as not just another technological advancement but instead seeking to reimagine the relationship we have with technology in general (among many other implications). The Web2 and platform era was based on centralization of ownership and data, while Web3 is focused on putting these aspects back into the hands of the users. Crypto-enabled incentive and governance models are central to that shift. The key takeaway here: Web3 and crypto are intertwined.
In an ever-connected world, Web3 will allow for global seamless value transfer and access across industries and sectors: in creative fields such as music, art, and others; in financial use cases such as cross-border remittance and basic financial access. At its core, Web3 guarantees ownership over digital identity and privacy.
The technological improvements made within the Web3 industry are constantly advancing, as the space seeks to solve some of the most challenging questions in the world of cryptography and mass-scale coordination: technical improvements such as zero-knowledge cryptography or effective and fair ways to align incentives across organizations.
FSJ: What else do you think our readers should know about digital currency?
SW: In 2022 crypto made a huge leap into public awareness as individuals and governments alike considered the implications of digital currency. But—and I won’t mince words—it was an unforgiving year. It’s easy to take notice of numbers, but we must not forget that there are people behind them. Sadly, those affected by unethical decisions made at the highest levels felt them most acutely.
Many have, understandably, asked whether the risks of crypto outweigh the benefits. We need to be clear: People were at the center of the negative press, not the technology involved. And the alleged bad acts committed mirror similar bad acts that have happened throughout the course of history: fraud, misuse of assets, and egregious breaches of trust. Keep in mind that crypto emerged out of the financial crisis. It was designed with these very human failures that come with centralization in mind. While we still have a way to go, it’s important to highlight that the technology is designed to avoid these types of events. This is why so many remain excited about its potential. At its best, the technology mitigates centralization risks, and it provides a much-needed option in vulnerable contexts (like hyper-inflation, authoritarianism, and high-friction financial markets).
As the crypto market continues to survive through numerous headlines, both good and bad, it’s clear that governments are taking digital currencies seriously. They have been slowly waking up to the undeniable reality of crypto being here, and their recent focus on policy and regulation is a sign that they acknowledge its potential.
Japan led the G20 countries in being the first to adopt stablecoin legislation in the summer of 2021 and in 2022 announced investment into NFTs, the creation of a decentralized autonomous organization (DAO) for Web3 exploration, and overall investment in services that utilize the metaverse.
The European Union followed by endorsing its landmark legislation, Market in Crypto Assets Regulation (MiCA). This is the first time a major player moved to legislate digital assets and the wider crypto ecosystem. This regulation will have global implications because a majority of the companies in this space are headquartered outside the region.
G20 countries are also coordinating on the regulation of crypto assets through the Financial Stability Board (FSB) and other international standard-setting bodies in financial regulation. The FSB proposed nine recommendations that provide oversight, supervision, and regulation of stablecoins. On the technical side, the Bank for International Settlements (BIS) partnered with four central banks around the world on Project mBridge to explore digital currencies as a more efficient mechanism for cross-border payments.
In the United States, President Joe Biden’s Executive Order on Digital Assets led to the release of several reports and a framework. On the legislative front, crypto saw broad, bipartisan support throughout 2022. Notable bills include the Bipartisan Responsible Financial Innovation Act from Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.), and the Digital Commodities Consumer Protection Act. Although the new Congress brings different actors and priorities, the trend overall demonstrates the growing importance of the sector and the interest from across the political spectrum in securing the future of the U.S. digital economy.
Digital currencies—in some form or other—are here to stay. The crypto space is firmly on the global radar, and these examples represent a handful of the activities that happened around the world in 2022. Worldwide, governments have realized that the technology is not going away. They are making investments in the technology and are making moves to protect consumers with sound regulation. To ensure that the U.S. continues its role as a leader in innovation, government officials and diplomats should pay close attention to this quickly evolving space.
When sharing or linking to FSJ articles online, which we welcome and encourage, please be sure to cite the magazine (The Foreign Service Journal) and the month and year of publication. Please check the permissions page for further details.