Crypto challenges some core tenants of state sovereignty. But is there a way this can be reconciled? Or could crypto even strengthen nation states?

On the face of it, crypto and nation state sovereignty are mutually exclusive. Their logic and rationale are inconsistent: one is based on the idea of a dominant central authority, while the other is build on a consensual network of decentralised users.

Given that sovereignty has become an increasingly important part of political discourse over the last decade, particularly in Europe, and crypto adoption is faster than that of the internet, it is a contradiction that is likely to come to a head.

Governments and international institutions are already beginning to grapple with the issues. The UK Government recently announced that it will recognise stablecoins (a digital currency pegged to a stable reserve asset such as the US dollar) as a valid form of payment; the EU is deliberating over regulation in its Market in Crypto-Assets (MiCA) framework; the White House released an Executive Order on developing digital assets; the OECD is working on a new tax transparency framework; and the IMF dedicated a section of its Spring Meetings report to explaining the pros and cons of decentralised finance (DeFi).

But the real question is whether it’s possible for crypto and sovereign states to live together, and if so, how. In this article, we run through:

• what state sovereignty means;

• why it has become an important narrative in western political debate;

• the philosophical underpinnings of crypto and its core features;

• the extent to which crypto can be ‘sovereign’;

• whether crypto challenges the notion of state sovereignty; and

• whether these challenges can be reconciled, with crypto providing a route to strengthen state sovereignty.

It sounds a little dry... but bear with it: we also talk about Cypherpunks, the extent to which states can own crypto infrastructure, and whether DAOs make parts of our legal system defunct!

According to the Stanford Encyclopedia of Philosophy (SEoP), sovereignty can be defined as a “supreme authority within a territory”. There are consequently three parts: authority, supremacy and territory.

A holder of sovereignty derives authority from some mutually acknowledged source of legitimacy — natural law, a divine mandate, hereditary law, a constitution, even international law. In the contemporary era, some body of law is ubiquitously the source of sovereignty. (SEoP)

There is no written constitution in the UK, although it is considered to be made up of the laws and rules that create and regulate state institutions, and the interactions between those institutions and citizens. In the US, this is codified into a formal constitution that has been amended 27 times (and which 17k people recently tried to buy a copy of as part of a DAO!), while EU members states – alongside national constitutions – are governed by the EU treaties.

But in addition, the sovereign entity must also hold supreme authority. So in the UK, Parliament in Westminster is superior to the Greater Manchester Combined Authority. In the EU, by pooling sovereignty, in areas where it has been agreed that the EU institutions have competence over domestic law, the EU is supreme; as is the European Court of Justice in interpreting that law.

Finally, territoriality, which means that subjects are defined by geography rather than their identity.

The borders of a sovereign state may not at all circumscribe a “people” or a “nation,” and may in fact encompass several of these identities, as national self-determination and irredentist movements make evident. It is rather by simple virtue of their location within geographic borders that people belong to a state and fall under the authority of its ruler. It is within a geographic territory that modern sovereigns are supremely authoritative. (SEoP)

The notion of state sovereignty dates back to the Peace of Westphalia in 1648, when European states formally consolidated around such an idea. The principle was then enshrined in the United Nations Charter, which was signed on 26 June 1945 after the Second World War. Human rights as a concept in international law was also developed and the Universal Declaration of Human Rights was adopted by the UN General Assembly in 1948. While this did not encroach on state sovereignty, it did define international norms and limits on what was acceptable behaviour by states over their subjects.

Having established the principle of state sovereignty over many centuries, what does this authority, supremacy and territory allow sovereign states to do? There are generally three functions that differentiate sovereign states from other sovereign entities.

• First, make and enforce law. The UK Parliament and the US Congress’ primary function is to pass legislation that makes up the body of law governing their territories; while their respective Supreme Courts’ are the final arbiters of those rules. These rules include property rights.

• Second, control money. Sovereign states ultimately control money. In the UK, the central government ‘owns’ the Bank of England, even though it operates independently to deliver its mandate of price stability. This role defines what is considered to be legal tender in a country and provides an important role in the macro economy, including through controlling monetary policy (mostly) via interest rates.

• Third, tax citizens. A core function of sovereign states is to tax citizens in order to provide public goods and services such as roads and healthcare. The idea is that in return for paying taxes, individual citizens in sovereign states are provided with security, public goods, the rule of law and law enforcement, which is often referred to as a ‘social contract’.

The importance of these functions is reflected in the emergence of political narratives around sovereignty, particularly in Europe.

Sovereignty has long been a topic of debate among political philosophers. But it has also featured heavily in modern political debate.

The protagonists for Brexit in the UK Parliament had long argued against pooling sovereignty, as is required by EU membership in order for a supranational institution to function. And the idea that supreme authority should reside in the European Commission and European Court of Justice in Brussels and Luxembourg respectively was antipathetical to their world view. There were of course other reasons that voters chose to leave the EU, but for the purists, sovereignty was chief among them. Lord Frost, the UK’s former chief negotiator, consistently stated the UK’s objectives to be a “friendly relationship between sovereign equals”.

For very different reasons, the concept has also been relevant on the European continent.  In 2019, European Commission President Ursula von der Leyen said “we must have mastery and ownership of key technologies in Europe. These include quantum computing, artificial intelligence, blockchain, and chip technologies”. Meanwhile, the French President has focussed on pursuing a notion of ‘strategic autonomy’ and taking over the EU Presidency rotation in January 2022, Macron’s 13 page speech referenced the words sovereign or sovereignty sixteen times, suggesting that he wanted to “define a strategic European sovereignty” and establish “genuine technological sovereignty”. Many people have also talked about ‘digital sovereignty’, enabling people to control their own data, and which is an important principle behind a number of legislative provisions e.g. GDPR, the Digital Markets Act and the Digital Services Act.

Behind this idea of technological sovereignty or autonomy is the concern at being reliant on other states’ technology and intellectual property (IP). In Europe, it often means reducing dependence on US or Chinese technologies. Whether that means the ability to develop and manufacture vaccines, concern over data stored in servers on other continents, telecoms hardware installed by foreign companies, AI algorithms taking decisions via code on issues that matter to voters, designed and controlled by foreign companies, or having the capacity to produce semiconductors that are used in all our electronic devices.

Enabling specialisation and economic integration which has resulted in these interdependencies seems reasonable or sensible in a globalised economy. But in a more fragile environment, with higher tensions between states, a US less willing to act as a power broker and the world’s policeman and greater cyber security threats, some politicians have decided that this balance has gone too far. The result, alongside a number of other factors, mean that commentators like Chris Giles at the FT and Larry Fink, the CEO of Blackrock, have both discussed a new trend towards deglobalisation.

So where does crypto fit?

So we’ve set out the broad parameters of how to think about sovereignty. But what about the historical context of crypto.

Many people consider its ideological origins to relate directly to libertarianism in the 1970s and the work of Friedrich Hayek, who argued for the privatisation and “denationalization” of money.  This was a movement that was explicitly against the state, taxation and the role that central banks played in controlling (or not controlling) the money supply.

This ideological view that there should be no role for the state, particularly vis a vis money, led in part to the Cypherpunk movement in the early 90s. This was a group that believed that with strong online privacy and strong cryptography it might be possible to change how people interact and critically, that this interaction would take place outside the nation state system.

The global financial crisis provided another spark for the movement, with concerns over bank bailouts, quantitative easing and central banks ‘printing money’ to stimulate the economy, and for some, deflating the value of fiat currencies. This contributed to a narrative around a lack of trust in the state, and public (e.g. central banks) and private (e.g. commercial banks) institutions.

In 2008, an anonymous person or a group of people under the pseudo-name of Satoshi Nakamoto published the Bitcoin whitepaper. The first bitcoin ‘block’ was ‘mined’ on January 3 2009. This ‘genesis block’ contained a message in the raw data: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. This referred to the headline for an article in The Times that the then UK Chancellor Alistair Darling was considering a second bailout of the British banking system. While no-one knows for sure the meaning of this reference in the genesis block, many believe it to hint that bitcoin was designed to be different to the existing financial system that needed to be, and could be, bailed out by governments.

Crypto has now evolved beyond bitcoin and its libertarian roots. With the rise of Ethereum and many other protocols, the focus is less on notions of private currencies and more on how the technology can be used for different applications. So while decentralisation remains an important component, the wider community is less maximalist about it and the trade-offs are becoming more sophisticated.

There are three important features of crypto networks: they are decentralised, global and pseudonymous.

Cryptocurrencies are based on blockchain technology. This is a decentralised database where a network of computers confirm through consensus that each ‘block’ of data is correct and receive a reward for doing so. There are two types of consensus:

• Proof of work → “Proof-of-work blockchains are secured and verified by virtual miners around the world racing to be the first to solve a math puzzle. The winner gets to update the blockchain with the latest verified transactions and is rewarded by the network with a predetermined amount of crypto.” (Coinbase)

• Proof of state → “Proof of stake blockchains employ a network of “validators” who contribute — or “stake” — their own crypto in exchange for a chance of getting to validate new transaction, update the blockchain, and earn a reward.” (Coinbase)

Due to the importance of consensus, decentralisation is a core part of the underlying technology.

There is said to be a blockchain trilemma around the balance between decentralisation, security and scalability. A protocol that is very decentralised tends to be more secure, as there is a stronger consensus for each new block. However, greater decentralisation is also more expensive, with more rewards to pay, and slower, as it takes longer to reach consensus. Blockchains like Ethereum, Solana and Avalanche make different trade offs here, and are likely to be used differently – for instance, a gaming application might not need as high security as a financial services application.

The nature of a decentralised network means that it is global by nature. This means that ‘miners’ or ‘validators’ that provide consensus on each new block can be based anywhere in the world, although some countries have made it illegal (e.g. China). Proof of work consensus miners tend to be based in geographies with low energy costs and colder climates, as they require large amounts of energy to power servers and moderate temperature. Proof of stake validators are more mobile, with the value of their stake the critical dimension.

The third feature is pseudonymity. This applies to both those providing consensus i.e. miners or validators, but also the users of cryptocurrencies or applications. The only requirement for providing consensus is the hardware and software, and no personal details are needed. And while some centralised crypto exchanges like Coinbase do require AML/KYC checks to use their exchanges and buy tokens using fiat currencies, most decentralised applications do not. This means that crypto is in theory inherently pseudonymous.

However, it is also transparent. Every transaction is stored on a blockchain, which is publicly searchable. Every wallet can be searched and the contents visible. So while users can remain private, their transactions and ownership cannot.

This technology has enabled a number of new applications. For instance:

• decentralised finance (DeFi) → replicating many of the functions of traditional finance without using central intermediaries like banks;

• non-fungible tokens (NFTs) → enabling digital scarcity and ownership of any piece of data that is recorded and tracked using a blockchain as the database of record; and

• decentralised autonomous organisations (DAOs) → enabling communities to manage economic activity and capital on chain, with decisions executed by smart contracts.

Some of these building blocks, and many others, are enabling projects in a wide variety of sectors, including gaming, marketplaces, investment, publishing and music.

You can read more about why we think web3 is going to be a new paradigm for the internet and what it might feel like in the real world too.

So can crypto itself be ‘sovereign’ in the pure sense? Spoiler - not really. But there are a few parts to consider.

First, each block of data is stored across a network of computer nodes i.e. it is decentralised, rather than on a single server. This might be considered to be counter to the objectives of technological sovereignty, but it also ought to give states more comfort over security and control than data being hosted on a server in a single state.

Second, the technology is not ‘owned’ by anyone. Much like the protocols that underpin the internet (e.g. TCP/IP and HTTP) and email (e.g. SMTP) are open – so that you can decide which browser to use or keep the same email provider but access it through different systems – blockchain protocols like Ethereum are the same. The underlying code is open source and can be used for different applications.

Third, who owns the infrastructure? There are different ways to think about this. On one level, the core infrastructure is decentralised and reflected in the blockchain protocols like Ethereum or Bitcoin. No-one owns the public code. However, in order for these protocols to function, the miners and validators that enable consensus to be reached and new blocks of data be added to a chain are rewarded with new tokens. Every transaction – whether exchanging tokens, smart contract execution or minting an NFT – requires validation, for which a fee is paid to the miners/validators. In 2021, more than $9bn of these fees were paid out on the Ethereum network. The mining and validators are therefore a core part of the ‘infrastructure’.

Top 10 Ethereum miners

As Andrew Beal wrote in his blog 30,000 foot view:

The companies on the Top 10 [miner and] validator lists ...  plus the large crypto exchanges, will be the next generation Fiservs and FISs, controlling the world’s transaction processing. And they will get a piece of EVERYTHING - cryptocurrency transfers, DeFi activity, NFT activity, Metaverse activity…everything.

This is important because it relates to control. If sovereign states want to ‘control’ or have autonomy over blockchain technology, they need to have some control over mining and validation – this might mean incentivising it to take place domestically, with a view to taxing it later (and gaining the upside vs other nations) when it is embedded.

The next question is who owns web3 protocols and companies? This really comes down to how decentralised the projects are, which relates to token ownership and decision making.

Token ownership is about stock and flow. Some projects set a cap on the total number of tokens (e.g. Bitcoin at 21m), while others don’t (e.g. Ethereum). Many provide a certain number of tokens at a project's launch to their core team, investors and their community, while enabling others to be earned. The chart below highlights how diversified different projects were at their launch.

Many projects have the objective of becoming more decentralised over time. Some of this is about diversifying token ownership, which can be difficult (or impossible) to control, but it can also be achieved in a different way through decision making.

Decision making refers to whether a central group run and manage the project, or whether decisions are taken via a DAO. In the former, there is a central entity that can take decisions on strategy, token distribution or code changes. In the latter, token holders propose and vote on decisions relating to the project in a decentralised manner, with the outcomes often executed automatically via code in a smart contract. Some projects say they want to move to a DAO structure when they are sufficiently established.

There has been much debate over ‘who owns web3’. This tends to relate to the extent to which web3 companies are really any different to web2 companies given the extent to which Venture Capital firms (and by extension their Limited Partners) invest and own tokens. One conclusion is that web3 projects have the potential to be more decentralised, even if they don’t start out very different from a traditional web2 startup.

However, perhaps the more interesting questions are a) who can own tokens and b) who controls the protocols. For web2 projects, it is difficult to access ownership until companies go public, and even then, many stock exchanges are not available to people everywhere in the world. In web3, tokens can generally be brought or exchanged by a more diverse group of people and much earlier (i.e. immediately after launch). Control of protocols is a function of how they are managed and what decision making structures are in place. The more decentralised a protocol, the less decision making can be manipulated or enforced by a central entity or government.

So to bring this together:

• blocks of data are decentralised and do not sit on a single server;

• the technology or code isn’t owned by anyone;

• some parts of the infrastructure can be owned and controlled; and

• the extent to which a project is decentralised determines its ownership and decision making.

It all means that crypto can’t be completely ‘sovereign’ (i.e. centralised, supreme or territory specific) – that is inherent in its design. But, importantly, there are ways that governments can seek to benefit from the technology and control elements of it, should they want to.

But are they going to want to?

So if crypto can’t be in and of itself sovereign, does it challenge state sovereignty? And might this lead to greater government oversight and control?

There are three ways that crypto might be thought to challenge state sovereignty.

Control over currency

The most obvious point is that crypto has enabled the proliferation of private currencies. While fiat currencies like the Dollar and Pound are issued by central banks, private currencies are issued by corporations or individuals. Private currencies do exist outside of crypto – for instance, the Brixton Pound was launched in south London in 2009 and accepted by a number of local businesses (and is exploring becoming a digital currency); and loyalty points are sometimes considered to be a form of currency. However, blockchain technology has enabled anyone to issue a token which, to greater and lesser extents depending on the token in question, have similar properties to money i.e. a store of value, a medium of exchange and a unit of account. This has implications for states’ ability to control the macroeconomic environment and respond to economic shocks, as well as maintain financial stability.

For example, while crypto currently constitutes around 0.4% of the global financial system, that number is likely to grow. As it does, and absent regulation or central bank digital currencies (CBDCs), central banks influence over economic activity will fall. Currently, by setting interest rates they can (dis)incentivise economic activity via commercial banks, but with private currencies, this transmission mechanism will be less direct. And should confidence fall in a particular stablecoin (as it did in May with UST, which we wrote about here), their ability to prevent a ‘run’ could in some cases be impossible, as such institutions may not fall neatly within a particular jurisdiction – see below.

Limits of jurisdiction

The global nature of crypto means that it is not always clear where jurisdiction lies. While people can be placed in jurisdictions, it’s less straightforward for code to be.

For example, a DAO might be established by a global community. The DAO issues a token on Ethereum, the funds from which sit in the DAO treasury i.e. a smart contract. The Ethereum network is decentralised, with miners (and soon validators) operating around the world. If a regulator in the UK decided that it wanted to close that DAO down, with no central authority managing the DAO and decentralised members, it is unclear if it would be able to. The regulator would need to gain (or confiscate) enough of the governance tokens to propose a change and force members to vote for it. If the network was decentralised enough, this seems implausible. And even if there was a central entity managing the DAO that the regulator instructed to act in a certain way, that entity may not be able to implement that instruction, given that the code is stored and run on decentralised systems. This final point is an important differentiator between a DAO or protocol and a multinational corporation (MNC): the DAO may not technically be able to implement action demanded by a government, court or regulator; a MNC may not want to, but can always technically do it.

This implies that there might be a point at which a certain level of decentralisation of a project or protocol makes it near impossible to regulate. A new startup with a core team based in a particular location could be forced to act in a certain way by regulators; an established and fully decentralised protocol with no central authority managed entirely by a DAO might not. There are now digital property rights that extend beyond the purview of states.

The power to tax

There is a high level point about clarity over tax treatment, but this can be solved. Governments can set out how they think tokens should be treated for tax purposes in different situations e.g. income tax or capital gains.

In addition, there are also some potentially positive implications for tax collection, as we’ve written before about here.

But there is a broader, more difficult issue. The decentralised and pseudonymous nature of crypto means that it is often not clear who should be taxed, and once established, enforce this. It means the responsibility to comply can rest, in some circumstances, entirely on the individual.

For example, a DAO might be created by a community that is based around the world and is governed by code. If that DAO buys a set of NFTs, then sells them to make a profit, in what jurisdiction does the DAO sit and who has the claim on that tax? Should the DAO pay ‘corporate tax’, and if so, to who; or when members of the DAO are paid out, is it income tax or capital gains tax? And what if those individuals are pseudonymous? It is unclear that states are able to enforce this tax liability.

This implies that a state’s authority, supremacy and territoriality are all challenged by crypto, even if indirectly. The authority and supremacy over money, tax and law enforcement; and the decentralisation of users with respect to clarity over territoriality and jurisdiction.

But going one step further, it’s possible to think of blockchains themselves as nation states.

Indeed, with a slight squint, the social structures of blockchains also resemble those of nations. When a country first forms, it is a blank canvas with unlimited potential but no real economic value other than “future option value.” But over time, as a society builds roads, schools, and other businesses, a country begins to grow its GDP and tax revenues. The same is true of a blockchain as it moves from early formation and speculative value to a thriving metropolis with apps and transaction revenues. Validating nodes “elect” the government and the rules by which society functions. Miners and stakers serve as the military, providing security to defend the nation from potential attackers. However, with enough of the military defecting, blockchains can suffer brutal civil wars. Chains support diverse economies with goods (NFTs) and services, plus deep decentralized financialization and trade routes (bridges) to connect it all. Much of the activity takes place in the nation’s native token, which is the primary medium of exchange of value. This token is also used to pay gas “taxes” that support public goods that serve everyone who uses the chain. (Nick Hotz, Arca)

The analogy extends further, and Natasha Che points to blockchains implementing ‘industrial policies’, much like nation states – for instance, with subsidies for developing in their chains; or attracting FDI from other chains.

The idea goes that this will provide optionality for users to move between these digital nation states. Spending money, building companies and cultivating communities in the most attractive domains. It’s free movement in its purest sense, without the geography. These blockchains are competing directly with nation states – it is monetary competition.

To summarise:

• State sovereignty means monopolistic control over money → crypto directly challenges this.

• State sovereignty means the ability to tax subjects → the decentralised and pseudonymous nature of crypto makes this more challenging.

• State sovereignty means the ability to make law → while crypto doesn’t challenge this per se, it challenges the extent to which that law is applicable and the extent to which economic activity falls neatly within certain jurisdictions.

These issues have not gone unnoticed by nation states and the different institutions within them. They also mean that it is inevitable that crypto will become more heavily regulated over time as states seek to address and manage these inconsistencies. But there is a spectrum of approaches  being taken around the world from very strict bans to very loose regimes.

• Some states see crypto as a direct challenge to their authority and have taken steps to ban it e.g. China.

• Some states are focussed on a regulatory regime to counteract these and other perceived risks e.g. the EU.

• Some countries are more interested in balancing a regulatory regime with ensuring that innovation can take place e.g. the UK.

No state has yet articulated a clear framework for how to think about crypto and its place within modern economies and regulated structures. But we think that it is possible.

There will need to be a number of components.

1. Legality. Clarity that the underlying blockchain technology is legal and should be developed to realise its benefits.

2. Regulation. Set out the principles that should determine any future regulatory framework. It is clear that some areas of the sector will be scrutinised by regulators – for instance, stablecoins and exchanges. Andre Cronje has written about two approaches to regulation: a) crypto regulation – which would aim to prevent activity and innovation, and in some cases as discussed isn’t likely to be possible; and b) regulated crypto – which would aim to enable activity within regulatory frameworks and systems – for instance, using licences to operate. The latter would be better for everyone.

3. Clarity. A process should be set out to explain to users how to comply with existing rules and regulations. This is particularly true for taxation, where it remains unclear for many causal users how to comply, and for larger projects, where rules may need to adapt. But it also true for issues like when KYC checks need to be carried out and whether/when a token might be considered a security.

4. Adoption. Governments should embrace some elements of this technology, exploiting the efficiencies and benefits it can bring. For instance, it is a good thing that the UK is planning to regulate the use of stablecoins, which enable them to be used more widely and more safely. Adoption could also take the form of a CBDC, enabling sovereign currencies to be used in existing web3 ecosystems; or new ecosystems be built around them.

5. Adaption. There may be some areas where regulators and legislators need to adapt rules to enable web3 to function in an appropriate way. For instance, enabling DAOs to be legal entities (as is the case in Wyoming in the US) would go a long way to simplifying some of the tax and liability issues identified in this article.

6. Education. Support should be given to explain how the technology works to a wider audience. Web3’s adoption rate is faster than that of the internet and, as in any sector, there are risks to manage. But much of this can be achieved through campaigns to explain to users how to use the technology safely and protect consumers from false advertising and scams.

We will be developing a White Paper to set out what the principles should be for each of these, and possibly other, components of a thoughtful crypto framework. We would welcome contributions from our community: if you want to be involved or speak further, please reach out to us.

Beyond this core policy and regulatory framework, there are also a number of broader ways that crypto and web3 could support and strengthen nation states, and in so doing, their sovereignty.

Democracy

Democracy and effective governance are under threat from rising partisanship, a lack of trust in democratic institutions and the disempowerment (both real and perceived) of disparate communities. Our systems of government and models of citizenship have not evolved to cope and in many cases, are built on pre-modern foundations. New web3 tools could enable wider participation, engagement, verification and trust-building for every citizen. And as we wrote about in Vellir #6, crypto could help protect freedom of speech and promote the rule of law.

Globalisation vs localism

Chatham House define deglobalisation as:

a movement towards a less connected world, characterized by powerful nation states, local solutions, and border controls rather than global institutions, treaties, and free movement.

On the face of it, mass adoption of web3 could be the catalyst for another wave of globalisation. Data is stored in networks around the globe; people contribute to economic communities from all over the world, and share in the economic value created; and capital flows become easier and cheaper. But for those that see deglobalisation as a positive development, with potentially greater domestic control over supply chains and a focus on local issues, web3 could help here too. In part through enabling more direct participation and community building at very local levels.

Digital sovereignty

Patrick Hansen wrote with respect to the EU that:

Not only do Web3 values perfectly align with the sought-after notion of digital sovereignty, crypto would also make the EU more financially independent from the US and offer a unique economic opportunity to revive its struggling economy in the Web2 era.

He explains how ownership of data and assets that are inherent to crypto could support the EU’s ongoing aims around digital sovereignty.

Strengthening democracy, retaining the benefits of globalisation while also promoting localism, as well as improving digital sovereignty sounds a heady mix. But all would strengthen nation states.

Sovereignty is an important political concept. It has driven political processes and outcomes over many decades, and is a core narrative in western political debate today.

At its heart, the principles that underpin crypto seem inherently inconsistent with the notion of sovereignty: this is a design feature not a bug. However, it does not mean that these challenges can’t be reconciled.

In fact, with a policy framework designed to support the development of web3, it is possible that crypto could support and strengthen nation states and liberal democracies. Taking the opposite approach, with aggressive action that seeks to close down crypto rather than make it safe, would only drive the technology to become more decentralised and the tensions with state sovereignty less likely to be reconciled.

It is possible that some protocols and projects will always want to operate in a fully decentralised way, intentionally outside of the state system. But it’s likely that many others would prefer to operate within it – gaining the potential benefits of blockchain technology, while limiting the legal, compliance and regulatory risks that are currently associated with the sector.

Getting it right could be the difference between being at the centre of the next wave of internet innovation, or still stuck talking about technological sovereignty in 10 years time. The prize for the state that gets this balance right could be massive.

We’ve gone down the slightly academic route this week, but sometimes these topics need exploring in depth! If you made it this far – thank you!

And please sign up to the community to get all our updates and future posts.

This article was first published on 24 May on www.vellir.xyz.

Crypto challenges some core tenants of state sovereignty. But is there a way this can be reconciled? Or could crypto even strengthen nation states?

On the face of it, crypto and nation state sovereignty are mutually exclusive. Their logic and rationale are inconsistent: one is based on the idea of a dominant central authority, while the other is build on a consensual network of decentralised users.

Given that sovereignty has become an increasingly important part of political discourse over the last decade, particularly in Europe, and crypto adoption is faster than that of the internet, it is a contradiction that is likely to come to a head.

Governments and international institutions are already beginning to grapple with the issues. The UK Government recently announced that it will recognise stablecoins (a digital currency pegged to a stable reserve asset such as the US dollar) as a valid form of payment; the EU is deliberating over regulation in its Market in Crypto-Assets (MiCA) framework; the White House released an Executive Order on developing digital assets; the OECD is working on a new tax transparency framework; and the IMF dedicated a section of its Spring Meetings report to explaining the pros and cons of decentralised finance (DeFi).

But the real question is whether it’s possible for crypto and sovereign states to live together, and if so, how. In this article, we run through:

• what state sovereignty means;

• why it has become an important narrative in western political debate;

• the philosophical underpinnings of crypto and its core features;

• the extent to which crypto can be ‘sovereign’;

• whether crypto challenges the notion of state sovereignty; and

• whether these challenges can be reconciled, with crypto providing a route to strengthen state sovereignty.

It sounds a little dry... but bear with it: we also talk about Cypherpunks, the extent to which states can own crypto infrastructure, and whether DAOs make parts of our legal system defunct!

According to the Stanford Encyclopedia of Philosophy (SEoP), sovereignty can be defined as a “supreme authority within a territory”. There are consequently three parts: authority, supremacy and territory.

A holder of sovereignty derives authority from some mutually acknowledged source of legitimacy — natural law, a divine mandate, hereditary law, a constitution, even international law. In the contemporary era, some body of law is ubiquitously the source of sovereignty. (SEoP)

There is no written constitution in the UK, although it is considered to be made up of the laws and rules that create and regulate state institutions, and the interactions between those institutions and citizens. In the US, this is codified into a formal constitution that has been amended 27 times (and which 17k people recently tried to buy a copy of as part of a DAO!), while EU members states – alongside national constitutions – are governed by the EU treaties.

But in addition, the sovereign entity must also hold supreme authority. So in the UK, Parliament in Westminster is superior to the Greater Manchester Combined Authority. In the EU, by pooling sovereignty, in areas where it has been agreed that the EU institutions have competence over domestic law, the EU is supreme; as is the European Court of Justice in interpreting that law.

Finally, territoriality, which means that subjects are defined by geography rather than their identity.

The borders of a sovereign state may not at all circumscribe a “people” or a “nation,” and may in fact encompass several of these identities, as national self-determination and irredentist movements make evident. It is rather by simple virtue of their location within geographic borders that people belong to a state and fall under the authority of its ruler. It is within a geographic territory that modern sovereigns are supremely authoritative. (SEoP)

The notion of state sovereignty dates back to the Peace of Westphalia in 1648, when European states formally consolidated around such an idea. The principle was then enshrined in the United Nations Charter, which was signed on 26 June 1945 after the Second World War. Human rights as a concept in international law was also developed and the Universal Declaration of Human Rights was adopted by the UN General Assembly in 1948. While this did not encroach on state sovereignty, it did define international norms and limits on what was acceptable behaviour by states over their subjects.

Having established the principle of state sovereignty over many centuries, what does this authority, supremacy and territory allow sovereign states to do? There are generally three functions that differentiate sovereign states from other sovereign entities.

• First, make and enforce law. The UK Parliament and the US Congress’ primary function is to pass legislation that makes up the body of law governing their territories; while their respective Supreme Courts’ are the final arbiters of those rules. These rules include property rights.

• Second, control money. Sovereign states ultimately control money. In the UK, the central government ‘owns’ the Bank of England, even though it operates independently to deliver its mandate of price stability. This role defines what is considered to be legal tender in a country and provides an important role in the macro economy, including through controlling monetary policy (mostly) via interest rates.

• Third, tax citizens. A core function of sovereign states is to tax citizens in order to provide public goods and services such as roads and healthcare. The idea is that in return for paying taxes, individual citizens in sovereign states are provided with security, public goods, the rule of law and law enforcement, which is often referred to as a ‘social contract’.

The importance of these functions is reflected in the emergence of political narratives around sovereignty, particularly in Europe.

Sovereignty has long been a topic of debate among political philosophers. But it has also featured heavily in modern political debate.

The protagonists for Brexit in the UK Parliament had long argued against pooling sovereignty, as is required by EU membership in order for a supranational institution to function. And the idea that supreme authority should reside in the European Commission and European Court of Justice in Brussels and Luxembourg respectively was antipathetical to their world view. There were of course other reasons that voters chose to leave the EU, but for the purists, sovereignty was chief among them. Lord Frost, the UK’s former chief negotiator, consistently stated the UK’s objectives to be a “friendly relationship between sovereign equals”.

For very different reasons, the concept has also been relevant on the European continent.  In 2019, European Commission President Ursula von der Leyen said “we must have mastery and ownership of key technologies in Europe. These include quantum computing, artificial intelligence, blockchain, and chip technologies”. Meanwhile, the French President has focussed on pursuing a notion of ‘strategic autonomy’ and taking over the EU Presidency rotation in January 2022, Macron’s 13 page speech referenced the words sovereign or sovereignty sixteen times, suggesting that he wanted to “define a strategic European sovereignty” and establish “genuine technological sovereignty”. Many people have also talked about ‘digital sovereignty’, enabling people to control their own data, and which is an important principle behind a number of legislative provisions e.g. GDPR, the Digital Markets Act and the Digital Services Act.

Behind this idea of technological sovereignty or autonomy is the concern at being reliant on other states’ technology and intellectual property (IP). In Europe, it often means reducing dependence on US or Chinese technologies. Whether that means the ability to develop and manufacture vaccines, concern over data stored in servers on other continents, telecoms hardware installed by foreign companies, AI algorithms taking decisions via code on issues that matter to voters, designed and controlled by foreign companies, or having the capacity to produce semiconductors that are used in all our electronic devices.

Enabling specialisation and economic integration which has resulted in these interdependencies seems reasonable or sensible in a globalised economy. But in a more fragile environment, with higher tensions between states, a US less willing to act as a power broker and the world’s policeman and greater cyber security threats, some politicians have decided that this balance has gone too far. The result, alongside a number of other factors, mean that commentators like Chris Giles at the FT and Larry Fink, the CEO of Blackrock, have both discussed a new trend towards deglobalisation.

So where does crypto fit?

So we’ve set out the broad parameters of how to think about sovereignty. But what about the historical context of crypto.

Many people consider its ideological origins to relate directly to libertarianism in the 1970s and the work of Friedrich Hayek, who argued for the privatisation and “denationalization” of money.  This was a movement that was explicitly against the state, taxation and the role that central banks played in controlling (or not controlling) the money supply.

This ideological view that there should be no role for the state, particularly vis a vis money, led in part to the Cypherpunk movement in the early 90s. This was a group that believed that with strong online privacy and strong cryptography it might be possible to change how people interact and critically, that this interaction would take place outside the nation state system.

The global financial crisis provided another spark for the movement, with concerns over bank bailouts, quantitative easing and central banks ‘printing money’ to stimulate the economy, and for some, deflating the value of fiat currencies. This contributed to a narrative around a lack of trust in the state, and public (e.g. central banks) and private (e.g. commercial banks) institutions.

In 2008, an anonymous person or a group of people under the pseudo-name of Satoshi Nakamoto published the Bitcoin whitepaper. The first bitcoin ‘block’ was ‘mined’ on January 3 2009. This ‘genesis block’ contained a message in the raw data: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. This referred to the headline for an article in The Times that the then UK Chancellor Alistair Darling was considering a second bailout of the British banking system. While no-one knows for sure the meaning of this reference in the genesis block, many believe it to hint that bitcoin was designed to be different to the existing financial system that needed to be, and could be, bailed out by governments.

Crypto has now evolved beyond bitcoin and its libertarian roots. With the rise of Ethereum and many other protocols, the focus is less on notions of private currencies and more on how the technology can be used for different applications. So while decentralisation remains an important component, the wider community is less maximalist about it and the trade-offs are becoming more sophisticated.

There are three important features of crypto networks: they are decentralised, global and pseudonymous.

Cryptocurrencies are based on blockchain technology. This is a decentralised database where a network of computers confirm through consensus that each ‘block’ of data is correct and receive a reward for doing so. There are two types of consensus:

• Proof of work → “Proof-of-work blockchains are secured and verified by virtual miners around the world racing to be the first to solve a math puzzle. The winner gets to update the blockchain with the latest verified transactions and is rewarded by the network with a predetermined amount of crypto.” (Coinbase)

• Proof of state → “Proof of stake blockchains employ a network of “validators” who contribute — or “stake” — their own crypto in exchange for a chance of getting to validate new transaction, update the blockchain, and earn a reward.” (Coinbase)

Due to the importance of consensus, decentralisation is a core part of the underlying technology.

There is said to be a blockchain trilemma around the balance between decentralisation, security and scalability. A protocol that is very decentralised tends to be more secure, as there is a stronger consensus for each new block. However, greater decentralisation is also more expensive, with more rewards to pay, and slower, as it takes longer to reach consensus. Blockchains like Ethereum, Solana and Avalanche make different trade offs here, and are likely to be used differently – for instance, a gaming application might not need as high security as a financial services application.

The nature of a decentralised network means that it is global by nature. This means that ‘miners’ or ‘validators’ that provide consensus on each new block can be based anywhere in the world, although some countries have made it illegal (e.g. China). Proof of work consensus miners tend to be based in geographies with low energy costs and colder climates, as they require large amounts of energy to power servers and moderate temperature. Proof of stake validators are more mobile, with the value of their stake the critical dimension.

The third feature is pseudonymity. This applies to both those providing consensus i.e. miners or validators, but also the users of cryptocurrencies or applications. The only requirement for providing consensus is the hardware and software, and no personal details are needed. And while some centralised crypto exchanges like Coinbase do require AML/KYC checks to use their exchanges and buy tokens using fiat currencies, most decentralised applications do not. This means that crypto is in theory inherently pseudonymous.

However, it is also transparent. Every transaction is stored on a blockchain, which is publicly searchable. Every wallet can be searched and the contents visible. So while users can remain private, their transactions and ownership cannot.

This technology has enabled a number of new applications. For instance:

• decentralised finance (DeFi) → replicating many of the functions of traditional finance without using central intermediaries like banks;

• non-fungible tokens (NFTs) → enabling digital scarcity and ownership of any piece of data that is recorded and tracked using a blockchain as the database of record; and

• decentralised autonomous organisations (DAOs) → enabling communities to manage economic activity and capital on chain, with decisions executed by smart contracts.

Some of these building blocks, and many others, are enabling projects in a wide variety of sectors, including gaming, marketplaces, investment, publishing and music.

You can read more about why we think web3 is going to be a new paradigm for the internet and what it might feel like in the real world too.

So can crypto itself be ‘sovereign’ in the pure sense? Spoiler - not really. But there are a few parts to consider.

First, each block of data is stored across a network of computer nodes i.e. it is decentralised, rather than on a single server. This might be considered to be counter to the objectives of technological sovereignty, but it also ought to give states more comfort over security and control than data being hosted on a server in a single state.

Second, the technology is not ‘owned’ by anyone. Much like the protocols that underpin the internet (e.g. TCP/IP and HTTP) and email (e.g. SMTP) are open – so that you can decide which browser to use or keep the same email provider but access it through different systems – blockchain protocols like Ethereum are the same. The underlying code is open source and can be used for different applications.

Third, who owns the infrastructure? There are different ways to think about this. On one level, the core infrastructure is decentralised and reflected in the blockchain protocols like Ethereum or Bitcoin. No-one owns the public code. However, in order for these protocols to function, the miners and validators that enable consensus to be reached and new blocks of data be added to a chain are rewarded with new tokens. Every transaction – whether exchanging tokens, smart contract execution or minting an NFT – requires validation, for which a fee is paid to the miners/validators. In 2021, more than $9bn of these fees were paid out on the Ethereum network. The mining and validators are therefore a core part of the ‘infrastructure’.

Top 10 Ethereum miners

As Andrew Beal wrote in his blog 30,000 foot view:

The companies on the Top 10 [miner and] validator lists ...  plus the large crypto exchanges, will be the next generation Fiservs and FISs, controlling the world’s transaction processing. And they will get a piece of EVERYTHING - cryptocurrency transfers, DeFi activity, NFT activity, Metaverse activity…everything.

This is important because it relates to control. If sovereign states want to ‘control’ or have autonomy over blockchain technology, they need to have some control over mining and validation – this might mean incentivising it to take place domestically, with a view to taxing it later (and gaining the upside vs other nations) when it is embedded.

The next question is who owns web3 protocols and companies? This really comes down to how decentralised the projects are, which relates to token ownership and decision making.

Token ownership is about stock and flow. Some projects set a cap on the total number of tokens (e.g. Bitcoin at 21m), while others don’t (e.g. Ethereum). Many provide a certain number of tokens at a project's launch to their core team, investors and their community, while enabling others to be earned. The chart below highlights how diversified different projects were at their launch.

Many projects have the objective of becoming more decentralised over time. Some of this is about diversifying token ownership, which can be difficult (or impossible) to control, but it can also be achieved in a different way through decision making.

Decision making refers to whether a central group run and manage the project, or whether decisions are taken via a DAO. In the former, there is a central entity that can take decisions on strategy, token distribution or code changes. In the latter, token holders propose and vote on decisions relating to the project in a decentralised manner, with the outcomes often executed automatically via code in a smart contract. Some projects say they want to move to a DAO structure when they are sufficiently established.

There has been much debate over ‘who owns web3’. This tends to relate to the extent to which web3 companies are really any different to web2 companies given the extent to which Venture Capital firms (and by extension their Limited Partners) invest and own tokens. One conclusion is that web3 projects have the potential to be more decentralised, even if they don’t start out very different from a traditional web2 startup.

However, perhaps the more interesting questions are a) who can own tokens and b) who controls the protocols. For web2 projects, it is difficult to access ownership until companies go public, and even then, many stock exchanges are not available to people everywhere in the world. In web3, tokens can generally be brought or exchanged by a more diverse group of people and much earlier (i.e. immediately after launch). Control of protocols is a function of how they are managed and what decision making structures are in place. The more decentralised a protocol, the less decision making can be manipulated or enforced by a central entity or government.

So to bring this together:

• blocks of data are decentralised and do not sit on a single server;

• the technology or code isn’t owned by anyone;

• some parts of the infrastructure can be owned and controlled; and

• the extent to which a project is decentralised determines its ownership and decision making.

It all means that crypto can’t be completely ‘sovereign’ (i.e. centralised, supreme or territory specific) – that is inherent in its design. But, importantly, there are ways that governments can seek to benefit from the technology and control elements of it, should they want to.

But are they going to want to?

So if crypto can’t be in and of itself sovereign, does it challenge state sovereignty? And might this lead to greater government oversight and control?

There are three ways that crypto might be thought to challenge state sovereignty.

Control over currency

The most obvious point is that crypto has enabled the proliferation of private currencies. While fiat currencies like the Dollar and Pound are issued by central banks, private currencies are issued by corporations or individuals. Private currencies do exist outside of crypto – for instance, the Brixton Pound was launched in south London in 2009 and accepted by a number of local businesses (and is exploring becoming a digital currency); and loyalty points are sometimes considered to be a form of currency. However, blockchain technology has enabled anyone to issue a token which, to greater and lesser extents depending on the token in question, have similar properties to money i.e. a store of value, a medium of exchange and a unit of account. This has implications for states’ ability to control the macroeconomic environment and respond to economic shocks, as well as maintain financial stability.

For example, while crypto currently constitutes around 0.4% of the global financial system, that number is likely to grow. As it does, and absent regulation or central bank digital currencies (CBDCs), central banks influence over economic activity will fall. Currently, by setting interest rates they can (dis)incentivise economic activity via commercial banks, but with private currencies, this transmission mechanism will be less direct. And should confidence fall in a particular stablecoin (as it did in May with UST, which we wrote about here), their ability to prevent a ‘run’ could in some cases be impossible, as such institutions may not fall neatly within a particular jurisdiction – see below.

Limits of jurisdiction

The global nature of crypto means that it is not always clear where jurisdiction lies. While people can be placed in jurisdictions, it’s less straightforward for code to be.

For example, a DAO might be established by a global community. The DAO issues a token on Ethereum, the funds from which sit in the DAO treasury i.e. a smart contract. The Ethereum network is decentralised, with miners (and soon validators) operating around the world. If a regulator in the UK decided that it wanted to close that DAO down, with no central authority managing the DAO and decentralised members, it is unclear if it would be able to. The regulator would need to gain (or confiscate) enough of the governance tokens to propose a change and force members to vote for it. If the network was decentralised enough, this seems implausible. And even if there was a central entity managing the DAO that the regulator instructed to act in a certain way, that entity may not be able to implement that instruction, given that the code is stored and run on decentralised systems. This final point is an important differentiator between a DAO or protocol and a multinational corporation (MNC): the DAO may not technically be able to implement action demanded by a government, court or regulator; a MNC may not want to, but can always technically do it.

This implies that there might be a point at which a certain level of decentralisation of a project or protocol makes it near impossible to regulate. A new startup with a core team based in a particular location could be forced to act in a certain way by regulators; an established and fully decentralised protocol with no central authority managed entirely by a DAO might not. There are now digital property rights that extend beyond the purview of states.

The power to tax

There is a high level point about clarity over tax treatment, but this can be solved. Governments can set out how they think tokens should be treated for tax purposes in different situations e.g. income tax or capital gains.

In addition, there are also some potentially positive implications for tax collection, as we’ve written before about here.

But there is a broader, more difficult issue. The decentralised and pseudonymous nature of crypto means that it is often not clear who should be taxed, and once established, enforce this. It means the responsibility to comply can rest, in some circumstances, entirely on the individual.

For example, a DAO might be created by a community that is based around the world and is governed by code. If that DAO buys a set of NFTs, then sells them to make a profit, in what jurisdiction does the DAO sit and who has the claim on that tax? Should the DAO pay ‘corporate tax’, and if so, to who; or when members of the DAO are paid out, is it income tax or capital gains tax? And what if those individuals are pseudonymous? It is unclear that states are able to enforce this tax liability.

This implies that a state’s authority, supremacy and territoriality are all challenged by crypto, even if indirectly. The authority and supremacy over money, tax and law enforcement; and the decentralisation of users with respect to clarity over territoriality and jurisdiction.

But going one step further, it’s possible to think of blockchains themselves as nation states.

Indeed, with a slight squint, the social structures of blockchains also resemble those of nations. When a country first forms, it is a blank canvas with unlimited potential but no real economic value other than “future option value.” But over time, as a society builds roads, schools, and other businesses, a country begins to grow its GDP and tax revenues. The same is true of a blockchain as it moves from early formation and speculative value to a thriving metropolis with apps and transaction revenues. Validating nodes “elect” the government and the rules by which society functions. Miners and stakers serve as the military, providing security to defend the nation from potential attackers. However, with enough of the military defecting, blockchains can suffer brutal civil wars. Chains support diverse economies with goods (NFTs) and services, plus deep decentralized financialization and trade routes (bridges) to connect it all. Much of the activity takes place in the nation’s native token, which is the primary medium of exchange of value. This token is also used to pay gas “taxes” that support public goods that serve everyone who uses the chain. (Nick Hotz, Arca)

The analogy extends further, and Natasha Che points to blockchains implementing ‘industrial policies’, much like nation states – for instance, with subsidies for developing in their chains; or attracting FDI from other chains.

The idea goes that this will provide optionality for users to move between these digital nation states. Spending money, building companies and cultivating communities in the most attractive domains. It’s free movement in its purest sense, without the geography. These blockchains are competing directly with nation states – it is monetary competition.

To summarise:

• State sovereignty means monopolistic control over money → crypto directly challenges this.

• State sovereignty means the ability to tax subjects → the decentralised and pseudonymous nature of crypto makes this more challenging.

• State sovereignty means the ability to make law → while crypto doesn’t challenge this per se, it challenges the extent to which that law is applicable and the extent to which economic activity falls neatly within certain jurisdictions.

These issues have not gone unnoticed by nation states and the different institutions within them. They also mean that it is inevitable that crypto will become more heavily regulated over time as states seek to address and manage these inconsistencies. But there is a spectrum of approaches  being taken around the world from very strict bans to very loose regimes.

• Some states see crypto as a direct challenge to their authority and have taken steps to ban it e.g. China.

• Some states are focussed on a regulatory regime to counteract these and other perceived risks e.g. the EU.

• Some countries are more interested in balancing a regulatory regime with ensuring that innovation can take place e.g. the UK.

No state has yet articulated a clear framework for how to think about crypto and its place within modern economies and regulated structures. But we think that it is possible.

There will need to be a number of components.

1. Legality. Clarity that the underlying blockchain technology is legal and should be developed to realise its benefits.

2. Regulation. Set out the principles that should determine any future regulatory framework. It is clear that some areas of the sector will be scrutinised by regulators – for instance, stablecoins and exchanges. Andre Cronje has written about two approaches to regulation: a) crypto regulation – which would aim to prevent activity and innovation, and in some cases as discussed isn’t likely to be possible; and b) regulated crypto – which would aim to enable activity within regulatory frameworks and systems – for instance, using licences to operate. The latter would be better for everyone.

3. Clarity. A process should be set out to explain to users how to comply with existing rules and regulations. This is particularly true for taxation, where it remains unclear for many causal users how to comply, and for larger projects, where rules may need to adapt. But it also true for issues like when KYC checks need to be carried out and whether/when a token might be considered a security.

4. Adoption. Governments should embrace some elements of this technology, exploiting the efficiencies and benefits it can bring. For instance, it is a good thing that the UK is planning to regulate the use of stablecoins, which enable them to be used more widely and more safely. Adoption could also take the form of a CBDC, enabling sovereign currencies to be used in existing web3 ecosystems; or new ecosystems be built around them.

5. Adaption. There may be some areas where regulators and legislators need to adapt rules to enable web3 to function in an appropriate way. For instance, enabling DAOs to be legal entities (as is the case in Wyoming in the US) would go a long way to simplifying some of the tax and liability issues identified in this article.

6. Education. Support should be given to explain how the technology works to a wider audience. Web3’s adoption rate is faster than that of the internet and, as in any sector, there are risks to manage. But much of this can be achieved through campaigns to explain to users how to use the technology safely and protect consumers from false advertising and scams.

We will be developing a White Paper to set out what the principles should be for each of these, and possibly other, components of a thoughtful crypto framework. We would welcome contributions from our community: if you want to be involved or speak further, please reach out to us.

Beyond this core policy and regulatory framework, there are also a number of broader ways that crypto and web3 could support and strengthen nation states, and in so doing, their sovereignty.

Democracy

Democracy and effective governance are under threat from rising partisanship, a lack of trust in democratic institutions and the disempowerment (both real and perceived) of disparate communities. Our systems of government and models of citizenship have not evolved to cope and in many cases, are built on pre-modern foundations. New web3 tools could enable wider participation, engagement, verification and trust-building for every citizen. And as we wrote about in Vellir #6, crypto could help protect freedom of speech and promote the rule of law.

Globalisation vs localism

Chatham House define deglobalisation as:

a movement towards a less connected world, characterized by powerful nation states, local solutions, and border controls rather than global institutions, treaties, and free movement.

On the face of it, mass adoption of web3 could be the catalyst for another wave of globalisation. Data is stored in networks around the globe; people contribute to economic communities from all over the world, and share in the economic value created; and capital flows become easier and cheaper. But for those that see deglobalisation as a positive development, with potentially greater domestic control over supply chains and a focus on local issues, web3 could help here too. In part through enabling more direct participation and community building at very local levels.

Digital sovereignty

Patrick Hansen wrote with respect to the EU that:

Not only do Web3 values perfectly align with the sought-after notion of digital sovereignty, crypto would also make the EU more financially independent from the US and offer a unique economic opportunity to revive its struggling economy in the Web2 era.

He explains how ownership of data and assets that are inherent to crypto could support the EU’s ongoing aims around digital sovereignty.

Strengthening democracy, retaining the benefits of globalisation while also promoting localism, as well as improving digital sovereignty sounds a heady mix. But all would strengthen nation states.

Sovereignty is an important political concept. It has driven political processes and outcomes over many decades, and is a core narrative in western political debate today.

At its heart, the principles that underpin crypto seem inherently inconsistent with the notion of sovereignty: this is a design feature not a bug. However, it does not mean that these challenges can’t be reconciled.

In fact, with a policy framework designed to support the development of web3, it is possible that crypto could support and strengthen nation states and liberal democracies. Taking the opposite approach, with aggressive action that seeks to close down crypto rather than make it safe, would only drive the technology to become more decentralised and the tensions with state sovereignty less likely to be reconciled.

It is possible that some protocols and projects will always want to operate in a fully decentralised way, intentionally outside of the state system. But it’s likely that many others would prefer to operate within it – gaining the potential benefits of blockchain technology, while limiting the legal, compliance and regulatory risks that are currently associated with the sector.

Getting it right could be the difference between being at the centre of the next wave of internet innovation, or still stuck talking about technological sovereignty in 10 years time. The prize for the state that gets this balance right could be massive.

We’ve gone down the slightly academic route this week, but sometimes these topics need exploring in depth! If you made it this far – thank you!

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This article was first published on 24 May on www.vellir.xyz.