Defending American Leadership: The National Security Case for Crypto and Blockchain

Introduction

Technology and national security have long been interconnected. During World War II, America protected its citizens and ideals in large part through its technological dominance, which not only generated more effective weapons but also ushered in the age of the digital computer. And while the Soviet Union no longer exists, the technologies the U.S. developed to compete with the Soviets in space are everywhere. As these innovations have resulted in the stunning, nearly continuous expansion of the country’s economy over time, today, two of the United States’ key competitive advantages―economic strength and power on the world stage―are rooted in over a century of technological leadership.

Because it is impossible to know which technologies will take root and which are just “flashes in the pan,” it doesn’t pay for government to pick winners and losers. Instead, American technological leadership has been at its strongest when government has thoughtfully encouraged and incentivized the development not just of a specific technology or set of technologies, but the creation of an innovation-friendly culture. The U.S. didn’t invent railroads, automobiles, telecommunications or the Internet―but its entrepreneurial spirit is what allowed these technologies to succeed. In retrospect, the transformative potential of technologies like these seems obvious, but at the time each came on the scene, it was called a fad or unfavorably compared to some other emerging innovation (often one that has been forgotten by history).

Nevertheless, the U.S. provided the ideal environment for each technology to flourish precisely because the government took a welcoming posture toward innovation while managing risks, rather than attempting to set in stone old ways of doing things. Maintaining this position as the global innovation incubator has had profoundly positive consequences for U.S. national security, both from the direct application of technologies and by supporting economic growth and productivity. This achievement is particularly impressive considering how much the world has changed during this time.

Now, a new set of technologies―cryptocurrency (“crypto”) and the blockchain―‌is on the horizon. While the U.S. government’s reaction to date has ranged from ambivalent to adversarial―with current efforts in some parts of government focused on regulating via enforcement instead of legislation―the future of the country’s global leadership depends on its willingness to embrace its leadership in technology. Right now, the U.S. faces unprecedented threats to this leadership position, and one of battlefields is crypto and blockchain. There is a national security imperative to embrace these technologies consistent with the interests of the U.S., its citizens and the country’s tradition of innovation. There is no doubt that this is possible. History proves that when the U.S. commits to leading in a particular area, it has always succeeded.

America at a crossroads

Throughout history, countries have faced a crossroads when deciding whether to embrace or discourage new technologies, sometimes simply allowing them to linger in a legal gray area that undermines consumer confidence. To its enduring benefit, the United States has historically provided sound regulation that, while not perfect, has benefitted both the public and American businesses. 

Recalling recent history: the growth of the Internet

For instance, in the 1990s, the Clinton administration confronted the emergence of the digital infrastructure that ultimately underpins e-commerce today. In a decision that proved deeply consequential, the administration opted to pursue a pragmatic regulatory approach. Recognizing the “breakneck speed of change in the technology” and admitting that “government attempts to regulate are likely to be outmoded by the time they are finally enacted,” Senior White House Policy Adviser Ira Magaziner advocated for an open framework for global e-commerce:

“For electronic commerce to flourish, the private sector must lead…The genius and explosive success of the Internet can be attributed in part to its decentralized nature and to its tradition of bottom-up governance. Accordingly, the regulatory frameworks established over the past 60 years for telecommunication, radio and television may not fit the Internet. Existing laws and regulations that may hinder electronic commerce should be reviewed and revised or eliminated to reflect the needs of the new electronic age.”

This philosophical approach increased consumer choice, created multiple new industries in the U.S., and secured a leadership position in e-commerce that no other country has matched.

Historical examples: on the road and in space

A century earlier, the U.S. took a similar approach to that era’s transformative technology: the automobile. Instead of taking a fully hands-off approach―or attempting to apply the regulations of the horse-and-buggy era to the horseless carriage―state and federal entities focused on addressing safety concerns through incremental legislation. Since then, the country has long been a global leader in the automotive industry and is well placed to drive the next phase of automotive innovation: electric vehicles. Contrast this approach to that taken in the United Kingdom, which once all but banned vehicles through its “Red Flag Act,” requiring self-propelled vehicles to be driven at a walking pace and led by an individual carrying a red flag.

History also offers examples of the U.S. fortifying its technology leadership following threats from adversaries. For instance, in 1957, the Soviet Union beat the U.S. as the first country to enter space with its Sputnik satellite. That single event sparked the founding of DARPA, the Defense Advanced Research Projects Agency, an agency whose work has resulted in the development of tectonic change in military technology and advanced the development of the internet, automated voice recognition and GPS. At the time, it also accelerated a push for greater education in what are now known as the “STEM” fields in American schools.

More recently, U.S. companies fell behind in the development of advanced semiconductors and manufacturing capabilities after other countries started making substantial investments in both next-generation designs and the capacity to build them at scale. As a result, the world has seen the highest value-add semiconductor production concentrated in a few countries, including and especially China, creating myriad risks to the global semiconductor supply chain (including, but by no means limited to, international political disputes, natural disasters and internal strife). Under severe pressure from the industry to catch up after years of underinvestment, the U.S. responded by enacting the CHIPS Act, a generational investment in a domestic semiconductor supply chain. With $53 billion in funding, the program acknowledges that advancing U.S. global leadership in the technologies of the future is critical to our long-term economic competitiveness and our national security.

Unfortunately, the example of cellular communications demonstrates that pioneering a technology is no guarantee of continued leadership; right now, the U.S. remains far behind China and its state-controlled corporations in developing the most advanced telecom technologies. This lagging position has had and will continue to have dangerous implications for American national security, even as the U.S. has recognized the threat and scrambles to catch up.

The importance of crypto and blockchain

To understand why crypto and blockchain present both a rich target for our adversaries and consequently, a national security risk, it is necessary to understand the potential utility of these technologies across a variety of industries. At its core, blockchain is a breakthrough technology that addresses a basic but important challenge: digitally transferring information or value without relying on verification by an intermediary. By removing the need for an intermediary, the blockchain has ushered in a multitude of use cases focused on the technology’s significant efficiency, transparency, and accessibility benefits.

Use case: Finance

The most obvious use case is in the financial system. This includes, but is not exclusive to, crypto. Today’s mainstream digital payment technologies are still dependent on intermediaries and outdated payment infrastructure, making the promise of instantaneous, inexpensive transfers elusive. Blockchain technology presents an opportunity to make meaningful improvements to this system, which 80% of Americans believe unfairly favors powerful interests. Integration of blockchain into global payment rails means that users would not need bank accounts or even banking relationships to participate in the digital economy, lowering costs and broadening access to this ecosystem to the historically underbanked. Without appropriate regulation, however, the risks of the technology’s downsides—including facilitating illicit transactions and tax evasion—will grow.

Use case: Defense supply chains

The use of blockchain itself can enhance defensive capabilities, both for the U.S. and our adversaries. Incorporating blockchain into defense supply chains can mitigate risks and vulnerabilities. For example, the U.S. government prohibits U.S. contractors from using certain suppliers in order to prevent counterfeit components from entering the chain. Blockchain technology could enable these companies, and the U.S. government, to track and verify the path of contractor components and assemblies, thereby mitigating the risk of counterfeits.

Use case: Big data

More broadly, blockchain has promising use cases for data management, both inside and outside the government. The Federal Data Strategy, released in 2019, requires agencies to adopt data management standards that would make their internal data more readily accessible and usable across the U.S. government by 2030. Digital access to data remains a challenge across many parts of government. During the COVID-19 pandemic, for example, health departments received data about the spread of the virus from digital sources—but also by phone, email, physical mail, and fax. Integration of blockchain across federal agencies would allow for more seamless and secure data sharing. The technology could also transform data management in healthcare and other industries that handle large amounts of sensitive data.

Increased global competition

Right now, recognizing the enormous potential of crypto and blockchain―as well as the competitive advantages for first movers―the United States’ adversaries and allies alike are embracing crypto. 

In April 2023, the European Parliament passed legislation creating a new crypto licensing framework for the 27-member European Union. The Markets in Crypto-Assets (MiCA) legislation covers issuers of unbacked crypto-assets and so-called “stablecoins,” as well as trading venues and wallets that store crypto assets. This regulatory framework will protect investors and preserve financial stability across the EU while continuing to foster innovation.

Switzerland, which is not an EU member, adopted its Blockchain Act in 2021, which provides a regulatory framework that offers fintech, exchange, investment fund and banking licenses, and the Swiss Financial Market Supervisory Authority (better known as FINMA) has licensed token trading under securities regulations. Today, the country hosts many prominent industry players, including Ethereum Switzerland GmbH. The United Kingdom has also seen rapid adoption of crypto, with 22% of UK adults currently owning digital currency and the government working towards launching its own regulatory regime for digital assets. The UK announced efforts around a crypto assets framework in February 2023, demonstrating its intention to rival the EU as a home to digital innovation. 

In late November 2022, reports surfaced that lawmakers in Russia are working to launch a national crypto exchange, an effort reportedly supported both by the country’s Ministry of Finance and the Central Bank of Russia. After a prominent Russian legislator suggested in June 2022 that a national crypto exchange in Russia could be launched as part of the Moscow Exchange, the exchange drafted a bill on behalf of the central bank in September to allow trading in digital financial assets.

In June, legislation in Japan will go into effect that permits and regulates stablecoins after the country had long banned them. 

But no country has been as aggressive in promoting blockchain as China. Recognizing that the future direction of crypto and blockchain are difficult to predict, the country has hedged its bets with sizeable investments in the next generation of “traditional” fintech, broader investments in blockchain and a targeted push in crypto. Building on its already strong, if not dominant, positions in areas like 5G, global infrastructure projects and the entire lithium battery value chain, China has drawn an aggressive roadmap in recent years via its Made in China 2025 strategy, with stated ambitions to have the world’s most advanced blockchain technology by 2025. China’s promotion of crypto and blockchain comes as the country has already built among the world’s most mature fintech ecosystems, with its Alipay and WeChat Pay platforms boasting over 1 billion users each across multiple countries. Platforms like these constitute a parallel set of payment rails that China―and its allies like Russia and Iran―can use to bypass Western-dominated and -regulated banking infrastructure that the U.S. uses for a variety of foreign policy purposes, including enforcing sanctions.

In April 2020, China launched the Blockchain-based Service Network (BSN), a global framework for a broad range of blockchain applications that lets developers effectively build next-generation decentralized apps under one uniform environment. The ambition of the BSN suggests that the Chinese government sees decentralized blockchain infrastructure as the backbone of a potential new phase of the global Internet. This centralized, top-down approach to crypto and blockchain is diametrically opposed to the fundamental vision of the technology―decentralization―as well as to the American commitment to individual economic freedom.

The contrast becomes even more stark considering that the Chinese government has banned crypto trading for mainland Chinese citizens while allowing the industry to take root in Hong Kong, a key global banking hub known as one of the world’s freest economies. It also makes clear that China’s crypto push is outward-looking, with the country viewing crypto as a vehicle by which to promote its ambitions around the world. To date, these efforts have often succeeded because China can offer solutions ranging from low-cost consumer goods to foreign direct investment in developing countries to tech platforms like TikTok. These solutions are compelling to people and countries around the world because of the convenience they offer, despite the obvious risks of dependency on China they pose. At a time when the U.S. and its allies are urgently seeking to reduce their economic dependency on China, the U.S. must provide robust alternatives of its own.

As a whole, these efforts appear to be part of a long-term strategy not only to accelerate the decline of the U.S. dollar as the world’s reserve currency, but also to circumvent transaction networks that rely on U.S. regulation―a clear example of the nexus between economic strength and national security. The U.S. has enjoyed the benefits of the dollar functioning as the de facto reserve currency for the globe since the creation of the Bretton Woods system in 1944, including lower transaction costs and easier borrowing by the U.S. government and its citizens. Key to diminishing the U.S.’s relative power in global affairs is diminishing its relative economic power.

Crypto and blockchain are just another weapon in China’s “de-dollarization” arsenal as its government works to dethrone the dollar as the world’s reserve currency in favor of the Chinese yuan. Following sanctions that resulted in its removal from the SWIFT banking network, Russia has moved to settling international trades in Chinese yuan, rather than the U.S. dollar. Bucking precedent, a state oil company conducted a natural gas transaction in yuan on a Shanghai exchange. Efforts like these have resulted in a drop in the share of U.S. dollars in global central bank reserves from roughly 70% twenty years ago to 60% today, as shares of both Euros and yuan have increased. 

Smart regulation and the role of the United States

Facilitating the growth of crypto and blockchain in the United States does not mean abandoning attempts at regulation. In fact, regulation that ensures predictability and safety will encourage increased adoption. For instance, the U.S. is the world’s premier investment destination, hosting the world’s two largest stock exchanges by market capitalization; this is due in large part to the existence of clear and consistently enforced securities regulations that give large and small investors alike peace of mind and recourse in the event of fraud or malfeasance. Likewise, Delaware is a top destination for corporate entity formation because its laws and regulations are well-known, rigorously enforced and highly predictable, decreasing uncertainty for corporations and their customers. On a more mundane level, the widespread adoption of the automobile in America could not have taken place without the introduction of traffic controls (lights, roadway markings, signs and laws) and a commitment to enforcing them nationwide.

Furthermore, bringing crypto under the “regulatory tent” can make other aspects of law enforcement easier, such as collecting taxes and preventing illicit activity. Even if the U.S. were to prohibit the use of crypto entirely, it would not disappear. Rather, its illegality would force the industry offshore, leaving domestic users without the protection of U.S. laws and regulations. Consider how the Prohibition experiment did not end the production or consumption of alcohol, but rather forced it underground, making it less safe and far more profitable for criminal organizations (at the expense of tax revenue). Today, some states have learned from this experience in legalizing recreational marijuana, which allows those jurisdictions to regulate psychoactive content, collect taxes on the drug and cut off a major revenue source for criminal organizations. Similarly, the recent legalization of sports gambling in many places has allowed states to collect revenue and place guardrails on an age-old practice.

Regulation is not the enemy. Rather, the problem lies with unwarranted prohibition and the application of rules ill-suited to new technologies. Crypto now sits in a regulatory limbo in the U.S. Since its emergence, government entities have declined to engage―despite many opportunities―and to clarify how existing regulatory frameworks such as those applying to securities might apply to crypto, much less engage in the fresh thinking necessary to tailor regulations to crypto’s unique qualities. This is a missed opportunity. Tailored regulation can increase confidence, prevent fraud, and ultimately help the U.S. control the future of this compelling technology.

Secure the U.S. by securing U.S. technological leadership

And make no mistake; it is utterly critical that the United States takes such a leadership role, for the sake of our power on the world stage and our economic prospects. Ceding ground in crypto could be akin to the ground the United States ceded in both 5G and semiconductor technology.  If we continue to destroy―either by prohibition or neglect―the homegrown crypto industry, the U.S. will likely find itself at a devastating disadvantage against other countries, including our adversaries, as the technology matures and becomes more important. Crypto is here to stay. It’s time for government to create the regulatory infrastructure necessary for it to serve American economic and security interests before our adversaries turn it against us. The good news is that the nation’s history of economic freedom and commitment to fostering technological innovation provide a solid blueprint for rapidly building a formidable leadership position in emerging technologies.

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