Decentralized apps offer the promise of unparalleled innovation in the growing web3 ecosystem

At Coinbase, we’re working hard to help update the financial system by building trusted products that expand the utility and adoption of crypto because we believe crypto and blockchain technology can increase economic freedom and opportunity around the world. Coinbase chose to become a public company in the US because we believe the US would best be served by embracing this fundamental innovation, but we’re also focused on international markets, many of which are moving forward with strategies to become “crypto hubs.” We would like to see the US take a similar approach, but a regulation-by-enforcement approach in the US is instead leading to a disappointing trend for crypto development in the US. One of the many innovations that holds enormous promise but faces regulatory uncertainty in the US are decentralized apps, or “dapps.”

To the user, dapps look and function like typical websites or smartphone applications. They can enable popular web3 use cases such as decentralized finance (DeFi), NFTs, and gaming. But on the back end, they rely on blockchain, smart contracts, tokens, and digital wallets. 

This difference in how dapps function on the back end provides a host of benefits that can empower creators, protect privacy, and spur new innovation. Specifically, some of the benefits of dapps include:  

• Built-in verifiability and trust. The smart contracts that form the backend of dapps are free for anyone to view and audit. This offers complete transparency of terms and conditions. For example, a smart contract for an NFT marketplace might specify royalty amounts, protocol fees, and terms of auctions.    

• User privacy. While traditional apps raise concerns about the information they track, like location data, health history, and personal photos, dapps typically don’t collect such information. Many also require minimal information to join—users simply connect their digital wallet, and can disconnect at any time. 

• Permissionless and censorship-resistant. Traditional apps are vulnerable to control by corporations and governments, which can deplatform users or even redirect them to sites more favorable to the government. But dapps can be accessed without anyone’s permission, and users can interact directly, peer-to-peer.  

• User governance. Dapps embrace the web3 vision of user ownership and are typically governed collectively by their members, often in the form of decentralized autonomous organizations (DAOs). By selling native tokens and issuing them as rewards, DAOs let token holders participate in dapp governance and vote on proposals related to protocol changes, funding, branding, and more.

• Constant innovation. Because the code underlying dapps is open source, developers can access, improve, and build on top of dapp protocols, encouraging collaboration and accelerating innovation.  

To be sure, dapps have their limitations. They face significant start-up costs and delays, and some have been vulnerable to high-profile scams and hacks. But dapps are innovating rapidly to solve these problems, and many of the uncertainties surrounding them—such as the application of federal law, disclosure requirements, and tax treatment—could be overcome with appropriate regulatory clarity that fosters innovation while protecting consumers. For this reason, it is important for policymakers to understand dapps and the regulatory areas they implicate. 

Policy areas that would benefit from regulatory clarity include: rules for digital asset securities, the applicability of AML/KYC and sanctions-related requirements, and the tax implications of DeFi and NFT transactions that take place using dapps. The current lack of regulatory clarity has increased operating costs for dapps in the U.S. and hampered institutional adoption.

Any regulatory framework for dapps must ultimately preserve their innovative potential and acknowledge their functional benefits over traditional apps and webpages. In an on-chain world, transparency and trust are built into the products themselves, and these protections have tremendous potential to grow as the technology develops, to the benefit of consumers. Crypto can improve on traditional systems by encoding trust on-chain in a cryptographically provable way. Regulators looking at crypto should therefore focus first on centralized actors, where additional transparency and disclosure can benefit consumers.  

Specifically, regulators could embrace innovation and protect consumers by developing a comprehensive regulatory regime for crypto assets generally. Congress could further support innovation around dapps by passing legislation that recognizes and protects their decentralized structure.

For a closer look at dapps and their benefits, take a look at the Coinbase Institute’s new primer, which is part of an ongoing series to explain “why crypto” is a technology that policymakers should care about. Coinbase is committed to building the most trusted products, services, and tools, and we look forward to further exploring this topic with policymakers.