An American Diplomat’s Web3 Warning: The U.S. Is Already Losing Smart Technology Allies It Needs

All around me, I see the next wave of the internet taking form, but I have a hard time talking about it in the office. That’s because my colleagues tend to dismiss digital assets as 21^st century “tulips,” one of the most famous market bubbles in history. Many refuse to discuss blockchain or crypto assets in any formal setting at all.

If I worked at a Silicon Valley startup, this would mainly be a problem for our shareholders. But I work for the U.S. government as a foreign service officer, and I believe this is a problem for all U.S. citizens.

I have a warning for them: Too many inside government are clinging to the past. Because of this, the U.S. is at risk of blowing its approach to the next generation of the internet. When it comes to formulating digital asset policy, we need to embrace the internet’s inevitable evolution. We need more technologists, fewer lawyers, and less bias in favor of financial sector incumbents.

As it stands, China’s government is working to capture huge swathes of economic activity within its closed, authoritarian but fast-growing internet infrastructure. At the same time, much of the rest of the world is adopting open blockchain networks, while U.S. government indifference and hostility towards open network blockchain technology is squandering the potential for Americans to benefit from it.

I’m basing this conclusion on first-hand experience. I’ve spent the last five years working as a diplomat in Colombia, Indonesia and now Japan. I took a sabbatical in the middle to work at ConsenSys, a U.S.-Swiss software company that was an early comer to digital assets.

In that time, I’ve helped build a digital asset remittance business for a bank in Manila, visited hacker houses in Seoul and met with crypto custody providers in Singapore and Hong Kong. I’ve also heard Papua New Guinea’s science minister extol blockchain’s recordkeeping benefits and watched the Japanese government experiment with a blockchain-based decision-making mechanism for the country’s rural regions using a digitally native entity called a DAO, or decentralized autonomous organization.

Yes, “crypto” has brought plenty of scams and hype.

But count me among the believers in this emerging suite of next-generation internet technologies, dubbed Web3 in the industry, who argue it has already expanded the number of things that people can do without government or private-sector intermediaries. These go beyond money and digital-property ownership to realms like real-estate recordkeeping, royalties for artists, corporate governance and social organization. As rocky as the crypto road has been lately, Web3 is still a competitive area of technological progress around the world.

Meanwhile, U.S. national-level banking and technology regulations are becoming more obsolete by the day.

To our peril, almost none of this is registering in D.C. even as the world is changing before our eyes. Whether official Washington recognizes it or not, a digital land rush is on. The U.S. risks losing influence over the next era of the internet by ignoring it.

Consumers globally now can choose where and how to save digital assets. They can avoid banks and store them in “self-custody” digital wallets instead. Inventors and artists no longer need national patent authorities: They can preserve their creative output with non-fungible tokens, or NFTs, designed specifically to protect intellectual property. Property exchange and lending don’t need intermediaries if they take place over this emerging network of networks.

The Chinese Communist Party is not making the same mistake.  

While the U.S. has made it a priority to check the spread of Chinese 5G hardware, Chinese efforts to spread their versions of soon-to-be-critical financial and internet software infrastructure have flown under the radar.

In part, that’s because China’s expulsion of Bitcoin miners in 2021 left many in the West with the impression that the country had turned its back on blockchain technology. It didn’t. In fact, during my time in Asia over the past four years, I’ve watched Chinese financial technology projects get a head start on U.S. companies thanks to funding from Beijing.

In particular, there’s the Blockchain-based Services Network, a government-backed suite of software tools launched in October 2019, the same month that President Xi Jinping called on the country to become a leader in blockchain technology Users of the service can, for example, build “smart contracts,” self-executing agreements coded in software, to facilitate exports to China or for supply chain-tracking purposes. In effect, the closed network amounts to a state-backed competitor to open blockchain systems like Bitcoin, Ethereum, or Solana.  

On this network, the Chinese government has the power to shut out people, companies or countries that lose its favor. And the data Beijing gathers from it offers an intelligence trove far more consequential than anything it might gather from Americans watching TikTok videos.

Beijing is also aggressively promoting its central bank digital currency, the digital yuan or eCNY, which has raised privacy concerns and furthers China’s ambitions to displace the dollar as the global reserve currency.  

Meanwhile, the Chinese fintech company AliPay is using its private blockchain to push aggressively into Pakistan and the Philippines, where U.S. rivals PayPal or Coinbase have no operations.

Late last summer, the People’s Bank of China partnered with the central banks of Hong Kong, the United Arab Emirates and Thailand to facilitate 160 cross-border payments totaling over $12 million in value on the “mBridge Ledger,” a blockchain system that uses China’s own central bank digital currency for cross border payment.

The dollar’s influence on the digital future is at stake. Just as the dollar has projected U.S. economic power in the analog world, digital assets pegged to the dollar, called stablecoins, project the dollar into the digital economy.
But if, say, an Indonesian natural resource exporter can only get paid on China’s own closed network and cannot be paid in U.S.-dollar-denominated digital assets such as dollar-backed stablecoins, the U.S. financial system will suffer.

Just as capitalist and communist trade blocs squared off in the 20th century, companies wishing to export their goods to select markets will soon have to navigate competing trade blockchains. They’ll have to choose between permissionless — or interoperable — systems built on open blockchains versus firewalled, permissioned closed systems like those preferred by China. Given that China is becoming the largest trading partner for most of the world, many nations will be tempted to opt into its system. If U.S. regulators continue to antagonize open blockchain systems, economic participants will continue to view them as legally risky, making China’s closed alternative that much more appealing by comparison.

So far, the U.S. has not risen to the challenge.  

The September release of the White House’s framework for digital asset development was a step in the right direction, but it was not enough. While the framework calls for U.S. agencies to “message U.S. values related to digital assets” in international forums, it otherwise remains vague on foreign policy.

At best, the United States merely endorses a nebulous paper-based exercise called the “G20 Roadmap for enhancing cross-border payments.” In reality, this amounts to innovation theater. The word “Web3” does not appear anywhere in the latest joint statement from State Department-organized U.S.-Japan “Internet Economy Dialogue.” On the economic policy side, the U.S. posture on digital assets is skewed to benefit domestically oriented financial sector incumbents at the expense of promising innovations. Risk-averse lawyers hold too much sway in the policy debate at the expense of technologists and informed foreign policy hands. Viewed from abroad, the signals from American policymakers suggest that the United States has turned anti-innovation. While digital assets pose real risks, those risks are currently being overemphasized while potential benefits get overlooked. The result is erratic “regulation by enforcement” and onerous tax policies that drive away commerce.

Take “staking.” Staking is a process by which the owners of blockchain tokens temporarily give up control of the tokens as part of a process called “proof-of-stake” that some blockchains use to ensure network reliability. To compensate people who pledge their tokens for staking, these networks provide stakers with fees paid in tokens, something vaguely akin to interest paid on a bond. Because staking requires some technical skill, investors often make use of services that stake the tokens on their behalf.

One benefit of staking is that it serves as a substitute for the energy-intensive “mining” process employed by Bitcoin. But, because nothing quite like staking has existed before, its exact regulatory status remains unresolved.

In February, the Security and Exchange Commission charged the U.S crypto exchange Kraken, saying it had failed to treat its staking service as an investment contract. As a result, the country’s second-largest crypto exchange has stopped offering this service to customers. This means that American investors have lost an important avenue for participating in, and benefitting from the governance of global blockchain networks.

Inevitably, innovative U.S. companies and developers will migrate overseas.

On the present course, U.S. competitors will keep poaching scarce tech talent en masse. Brain drain is already underway: One study shows that the U.S. share of blockchain developers has fallen from 40 percent to 29 percent in five years. Next-generation financial firms like ConsenSys, Polygon and Crypto.com have incorporated in digital asset-friendly jurisdictions such as Switzerland, Dubai, and Singapore. Blockchain software engineers have taken their $700,000 starting salaries with them.

This absence of U.S. leadership contrasts with its success in taking advantage of the internet in the 1990s, or our current promotion of other emerging technologies, like quantum computing. At an international technology summit in 2021, Secretary of State Antony Blinken said U.S. foreign policy should “put forth and carry out a compelling vision for how to use technology in a way that serves our people, protects our interests and upholds our democratic values.”

But if the U.S. continues to resist the rise of digital assets, democratic values may suffer, losing out to the new digital world order being built by authoritarian China.

It’s not too late to change course.

By seeing digital assets as an opportunity, not a threat or a scam, the United States could fill a gap that would otherwise be filled by authoritarian governments abusing digital assets to control and surveil their citizens.

Policymakers should start sending more positive signals toward the blockchain-based, digital asset financial system being built on Web3. Positive signals would attract the world’s brightest technologists to work with the U.S. government to fight emerging threats like North Korea’s digital asset hackers who reportedly stole $1.65 billion worth of crypto-assets in 2022 alone, according to the Korean Broadcasting Service.

Diplomats should talk more about the potential for digital assets to promote open and democratic systems around world, such as using U.S.-registered DAOs and NFTs to provide international financial support and help overcome poverty in post-conflict zones or to fund journalists in repressive regimes.  

And the State Department should consider establishing an office in its Economic and Business Affairs Bureau dedicated to managing Web3 policy, offering digital asset training at the U.S. diplomatic training school, and encouraging diplomats to gain Web3 background via private sector exchanges with digital asset companies.

At the next Asia Pacific Economic Cooperation summit in November in San Francisco, the U.S. should push the other 20 member nations to test the use of blockchain for distributing development aid, saving the 8 percent transaction fees currently being paid.

Congress has a role to play, too. Web3 entrepreneurs have consistently called on U.S. regulators to provide greater clarity, for example by making explicit which digital assets are commodities and which are securities in the eyes of the law. Without greater legal certainty in the U.S., investors and entrepreneurs will gravitate elsewhere. Some products and services will remain unavailable to American customers. Legislation that would address this is already pending, including a bipartisan bill called the Responsible Financial Innovation Act.  

Tax provisions that clarify definitions and provide a de minimis exclusion of up to $200 per transaction from a taxpayer’s gross income for use of digital assets for payment could similarly prevent commerce from fleeing to other nations with more favorable rules. The United States also needs a clearer stablecoin policy and to grant legal standing to DAOs.

Competition for the future of the internet is just getting started.  

As I’ve watched asset management systems convert from analog to digital in countries around the world, I’ve sensed a larger shift afoot: from economies bound by geography to economies now bound by software networks. Outspoken technology forecaster Balaji Srivanasan describes something similar in his 2022 book The Network State. The book predicts that a trio of technological-economic networks will compete for global domination in the near future: A U.S.-aligned network, a Chinese Communist Party-aligned network and a nonaligned network underpinned by blockchains and cryptoassets. Srivanasan, a strident critic of the political establishment, is not popular in Washington, but his rough vision of an emerging tri-partite, web-based order could be prescient. If the U.S.-aligned network is to prevail against Beijing’s authoritarian network, we need buy-in from the emerging non-aligned network and its technologists, and we need it soon. The American establishment cannot afford to alienate the rapidly strengthening global internet, with its army of software and cybersecurity experts and trillion-plus dollars worth of digital assets. We have to be able to call on Indian, Brazilian, Vietnamese and Estonian technologists to support U.S. cybersecurity efforts. U.S. technology and financial companies need to remain appealing to emerging market consumers.

Bottom line: The best defense against digital authoritarianism is a good offense—namely, the open-source blockchain protocols of Web3.

These networks mobilized quickly last year to fund Ukraine’s resistance to the Russian invasion with digital assets. They can also help in our competition with China, providing hard-to-censor digital services. Web3 platforms could also give Chinese citizens an alternative to China’s own technology ecosystem while Bitcoin facilitates capital flight from China.

The nightmare scenario, on the other hand, would be to go it alone.

The United States could suffer from its own “Galapagos effect” of isolation in technical and financial standards, much as Japan did in the 1990s after insisting on sticking with its own technology standards.

Ultimately, national power is inseparable from financial power. As finance and technology converge in Web3, how much digital land we claim, and how many smart Web3 technologists want to partner with us, will affect U.S. power and competitiveness.

It’s time for the United States to unblock blockchains.