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Native assets under regulatory pressure

Published 14.8.2023

Regulators are concerned with how to properly regulate the blockchain industry. They strive to have at least partial control over how people use decentralized networks. Cardano has a native assets feature. A third party cannot prevent Cardano users from spending their assets in any way. That's great. But is this really the best path to success for the project?

Who should adapt?

So far, most people have only heard of cryptocurrencies and do not actively use or work with them. We do not know what demands they will have on the functioning of decentralized services. Will it be decentralization, a certainty that they are not breaking the law, or economic incentives? It will most likely be a mix of multiple features. Chances are we'll find out soon.

The good news is that there is a gradual convergence between the blockchain industry and the traditional financial market. However, with this comes the demands of regulators, which are not in line with the principles of decentralization. It is very difficult to estimate how regulations can change the blockchain industry.

Should the blockchain industry meet the demands of the regulators, or should the regulators adapt to the principles of decentralization?

If you think you know the answer, wait a little longer. The answer may not always be completely clear. If the blockchain project complies with the regulations, its adoption can increase by leaps and bounds. Investors can legally purchase the project's native coins. Users can use DeFi. Banks and companies can start building new services on such a blockchain. If a project does not comply with regulations, its adoption may be slower and more difficult.

Every technology needs users. Blockchain networks will only be economically sustainable in the long term if people pay usage fees. Adoption within a few decades is essential for the success of the blockchain. A blockchain that will not be used by millions of people every day will collapse, probably due to low security and decentralization.

Insistence on the principles of decentralization and unwillingness to comply with the states' demands can be seen as a fight for the right thing. What has the power to change the world is nothing less than decentralization, the autonomous algorithms of their behavior cannot be changed, privacy, the impossibility of censorship, the right to use the service without permission, and similar things that cannot be ensured today through the client-server architecture.

Unfortunately, the fight for a better world has its limits, and that is primarily the long-term economic sustainability of blockchains. People must want to change the world and start actively using blockchain services. And not only that, they must at least to some extent understand the basic principles of decentralization and self-custody must be the default choice for them.

Cardano is following the harder path of decentralization

Decentralization and Peer-to-Peer (P2P) communication are a priority for the IOG team. Native assets are one example in addition to the high decentralization of the Cardano network. It can be said that Cardano is taking the more difficult route to success.

Native assets separate token issuers from token holders. The token issuer cannot in any way restrict the token holder from using the tokens he issued. The token holder can spend the tokens at any time according to their will. If you have native tokens in your own Cardano wallet, their properties are very similar to those of ADA coins.

From a decentralization perspective, this feature is amazing. At the same time, however, someone may perceive it as a limitation. Cardano tokens are less programmable in the context of what Ethereum can do, for example. The lower programmability of tokens essentially prevents the implementation of behavior that will allow compliance with regulations.

If the regulators in the USA allow USD to be tokenized on the blockchain only if the token issuer can censor transactions or freeze the account, this means that no one can legally mint USD-backed stablecoins on Cardano.

I believe that in the foreseeable future, people will send stablecoins and other tokens through blockchain networks (and L2 networks) much more than native (volatile) cryptocurrencies. Cardano can thus lose fees while other networks can prosper economically.

Can Ethereum be seen as a project that succumbed to pressure from regulators and sacrificed decentralization for commercial success? Can it be said that Ethereum is basically just a better database because the token issuer can retain control over the stablecoins similar to the banking system? No, it's not that simple. Ethereum offers higher programmability of tokens. This will make it possible to mint such tokens where the token issuer will not have any control over their transfer. Ethereum allows the creation of tokens with the same characteristics as Cardano. It cannot be said that Ethereum is worse just because it is more universal.

In other words, Ethereum will make it possible to create tokens that comply with regulations, but also tokens that respect the principles of decentralization. This can cater to different user groups, which is beneficial for adoption.

It is also possible to add functionality to Cardano that would allow tokens to be minted through a smart contract. The token issuer could have similar control over the tokens as in the case of ERC-20 tokens. But should Cardano go down this path?

Decentralization only makes sense if it allows users to interact Peer-to-Peer. If there is to be any intermediary between Alice and Bob, namely a token issuer (deployer of the smart contract), decentralized networks lack their main purpose of existence.

My concern is that if a blockchain project allows for tokens to be issued that comply with regulations, people will adopt them to a much greater extent than decentralized alternatives. Although I think that all centralized projects collapse sooner or later for some reason (higher fees, abuse of the power of the middleman, etc.), it can take a long time.

Cardano should never compromise on the principles of decentralization. Even at the cost of the fact that it is currently not possible to issue USD-backed stablecoins on Cardano. There are other options. Someone may be able to convince the regulators to allow stablecoins to exist on Cardano. In that case, it would be a win, as native assets will always have lower fees than tokens, their transfer is controlled by a smart contract. We'll see if Emurgo (USDA) or the Mehen project (USDM) succeed.

Another option to get USD-backed stablecoins on Cardano is through bridges or projects like Indigo. We must not forget the overcollateralized DJED stablecoin. We can find many types of stablecoins in our ecosystem.

Cardano does not allow Tether and Circle to mint USDT and USDC directly on the blockchain. But I don't think it's necessary if we can have these stablecoins through bridges. Bridges pose a certain risk, but that is mainly technological. Sooner or later there will be decentralized and reliable bridges. I don't think it is possible for Tether, Circle, PayPal, and other companies to make sure that their stablecoins are not used in other ecosystems and a wide range of second layers without their consent (that is, the possibility of control over them). Let's wait and see how this option develops.

Cardano can be one of the few blockchains where it will be true that if you have stablecoins in your wallet, no one can take them from you or limit your use of them. This is a revolution. Not stablecoins that are controlled by Tether and Circle.

Conclusion

It is very difficult to build decentralized networks. Even more complicated to build DeFi services. There is no point in making such a huge effort just so that institutions can ultimately retain control over users' assets through smart contracts or block producers. Blockchain and DeFi must differentiate themselves from traditional banking services, and this is possible through one single feature, namely decentralization. That's why I think Cardano is moving in the right direction. Let the regulators understand native assets and adjust the rules accordingly, or let's look for other ways.

I consider native assets to be one of the significant and at the same time underappreciated advantages of Cardano, as they combine decentralization with the efficiency of sending tokens. There is no more efficient form of sending tokens than directly at the protocol level without using a smart contract. However, it is necessary to achieve meaningful tokens on Cardano, and stablecoins are the best we can have.

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