By: Hadar Y. Jabotinsky
This Article is the first to examine the question of global coordination in regulating distributed ledger technology (DLT) and cryptocurrencies through the lens of network effects. A network effect, also known as network externality or demand-side economies of scale, refers to the economic impact generated by a user’s utilization of a product on the product’s value to other users. Essentially, as the number of users of a product grows, its value to each individual user increases or decreases. Viewing regulation as a product, this Article suggests a novel approach: it introduces and surveys three unique kinds of network effects which can be created by the adoption of a global regulatory standard for DLT and cryptocurrencies: (a) network effects for society; (b) network effects among the regulated firms; and (c) network effects among the regulators themselves.
The first dimension pertains to overall social welfare. As more jurisdictions adopt a common standard, the benefits to society increase. One such network effect is the mitigation of “forum shopping” by regulated firms. With more jurisdictions embracing the common international standard, it becomes increasingly challenging for firms to engage in “forum shopping” and to relocate to jurisdictions where the standard does not apply. Each instance of reduced forum shopping contributes to the reinforcement of regulatory standards within the market. The second dimension involves the network effects of global cryptocurrencies and DLT regulation benefiting regulated firms through compatibility with counterparts operating under the same standards. In the third dimension, network effects come into play when regulators or local politicians derive benefits from their membership in a network. An example of this type of network effect occurs when a regulator leverages the collective experience of other regulators within their network, thereby reducing the learning costs associated with drafting and implementing new regulatory measures.
This Article reveals that certain network effects yield positive economic outcomes by reducing costs and enhancing utility, whereas others may have adverse effects on global cryptocurrencies and DLT markets. One such negative network effect is the escalating phenomenon of herding, which can result in value destruction. As financial standards are uniformized and local barriers are removed, the market experiences greater integration, allowing herding behavior to extend beyond specific jurisdictions.
This Article concludes by generally describing the expected interactions between States when adopting a global regulatory standard for cryptocurrencies and DLT regulation and discusses how “soft law” mechanisms may diminish the positive network effects identified by it.