Regulation
Decoding Crypto Currency and Regulating Artificial Intelligence
Sarah Hammer discusses emerging policy issues surrounding advances in artificial intelligence and cryptocurrency.
In a discussion with The Regulatory Review, Sara Martelloan executive director at the Wharton School of the University of Pennsylvania and managing director of the Wharton Cypher Accelerator, offers his thoughts on new regulatory guidance for digital assets and artificial intelligence (AI).
New generative AI programs and the growing popularity of cryptocurrencies raise important regulatory questions for policymakers, especially in the wake of the FTX fraud and internal controversy at OpenAI. Hammer analyzes these emerging technologies and shares his perspective on their effective regulation for consumer protection.
Hammer argues that regulators should adopt new “crypto standards” to prevent investors from engaging in predatory digital currency practices. He recommends a three-pronged approach to improve consumer protection while maintaining industry innovation: a strong national regulatory system; communication and collaboration with regulatory bodies; and strong industry standards focused on interoperability. In the AI space, Hammer recommends institutions invest in data protection, properly training AI models, and treating customers fairly.
In addition to his current position at Wharton, Hammer serves on the board of trustees of the International Telecommunications Union (ITU) at the United Nations and advisor to the World Economic ForumTHE Dubai International Financial Centreand the Central Bank Digital Currency Digital Dollar Project. Prior to assuming his current position at Wharton, Hammer served as Acting Secretary of the Department of Banking and Securities for Pennsylvania. Previously you were CEO of Center for Innovation in Finance and Senior Director of the Alternative Investments Program at Wharton. Additionally, Hammer served as Acting Deputy Assistant Secretary for Financial Institutions and Director of the Office of Financial Institutions Policy at the U.S. Department of the Treasury and held various leadership positions at Vanguard Group, PIMCO, J.P. Morgan Chase, BlackRock and Tudor Investments.
Regulatory Review is pleased to share the following interview with Sarah Hammer.
TRR: Your research focuses not only on the pillars of financial regulation, such as banking capital, liquidity and capital markets regulation, but also on emerging technologies such as artificial intelligence and digital assets. What are these emerging technologies and what benefits could they offer the financial sector?
I have focused on understanding emerging technologies to the extent that they have a significant impact on the financial sector. I wrote one of the original articles on the blockchain ecosystem in 2018, but the space has evolved significantly since then. I became interested in blockchain technology, the “engine” that powers cryptocurrency, thanks to my experience as a derivatives trader and credit and fixed income portfolio manager. While working in this space, I have noticed the need to settle and settle financial transactions faster and more efficiently. It currently takes a day or two to settle trades, creating counterparty credit risk and systemic risk. Blockchain technology offers the potential to reduce the settlement period to minutes, reducing risks and significantly improving these processes. As a result, financial institutions are now leveraging blockchain in several ways. Similarly, generative artificial intelligence, the technology behind ChatGPT and other applications, has the potential to improve how we manage financial infrastructure and address cybersecurity. Digital assets are complex technologies, so there are many considerations, of course.
TRR: In your recent item on the regulation of digital assets, you advocate the implementation of centralized “cryptographic standards.” What key elements are needed for effective regulation of digital assets?
At a high level, three things are needed for a comprehensive approach to regulating digital assets. First, the industry needs strong national regulation with uncompromising consumer protection. Secondly, due to the inherently cross-border nature of digital assets, we recommend collaboration and communication with relevant international standard-setting bodies. Finally, we support the establishment of strong and responsible industry standards, with attention paid to important technological issues such as interoperability. Establishing industry standards, coupled with a regulatory mandate, would add strength and enforcement capacity.
In particular, the current consumer protection framework for digital assets is very complicated. Several federal financial regulatory agencies are involved, in addition to the Federal Trade Commission, the Department of Justice, the Consumer Financial Protection Board, and state authorities. Due to the complexity of the topic, interagency regulation may be appropriate in some cases.
It is worth noting that we have taken a very thorough approach in our consumer protection recommendations. In the course of writing our article, we examined many of the major legislative proposals related to consumer protection for digital assets. From this, five key areas for consumer protection are derived and outlined. These five key areas include: requiring cryptocurrency issuers to act honestly, fairly and professionally and to prevent, manage and disclose conflicts of interest; establish and maintain information regarding rights, risks, reserves, refunds, recommitment, policies, fees and redemption processes; maintenance and dissemination of governance processes; clarify how customer assets will be treated in the event of insolvency; and provide transparency in the technology regarding changes to the source code of materials.
TRR: What challenges do you see regulators and legislators facing in implementing a centralized cryptocurrency scheme?
One of the challenges is the complexity of our national and global regulatory frameworks. Digital assets move across jurisdictions and therefore require global coordination. This is why I advocate a collaborative process. Another challenge is trying to understand the incredible pace at which technology is developing. I believe that, as politicians, we are obligated to remain at the forefront of innovation. Understanding technology and its rapid developments allows us to establish robust and strong regulatory frameworks, while supporting responsible innovation.
TRR: What are some potentially harmful uses of emerging cryptocurrency technology? How can policymakers address these uses?
Without a doubt, criminal activity in the cryptocurrency industry has been pervasive. Examples of this include allegations relating to the FTX fraud and bankruptcy, the collapse of the Terra Luna cryptocurrency, and the enforcement action against Binance for anti-money laundering and violations of our sanctions laws. Other examples of dangers include cybercrime such as theft, scams, or exploitation of security vulnerabilities. Such unacceptable activities have been, and must continue to be, addressed with fast, secure and powerful enforcement based on clear and comprehensive cryptographic regulations.
TRR: You serve on the Oversight Committee of the International Telecommunication Union at the United Nations, where AI for Good is based, and also lead the AI in Finance for AI for Good and expert workshops on generative artificial intelligence at the United Nations in Geneva. What are the potential AI regulation issues you are focusing on, and how should regulators address them?
In my observations At the AI for Good Summit in Geneva last July, I noted that AI holds great promise while posing unprecedented challenges. To name just a few, institutions must ensure that their interfaces are secure, that sensitive data is protected, that AI models are properly trained, and that customers are treated fairly and ethically. Furthermore, artificial intelligence is advancing at a tremendously accelerated pace. For AI in finance, I proposed a tripartite framework to accommodate the potential of AI while protecting society and maintaining financial stability. The framework I have proposed is based on national laws, international coordination and the definition of industry standards.
TRR: Are there any downsides to implementing regulation so early in the AI innovation lifecycle? Have you encountered alternatives to regulation that could avoid a potentially harmful dampening effect on the AI sector?
I believe that policymakers should be at the forefront of AI innovation developments. They should be informed about technological developments as they occur and continuously learn so as to shape public policies. There are some areas where strong regulation is immediately needed, for example to protect citizens from criminal activity. In other sectors, a more principled approach may be appropriate to protect society while promoting responsible innovation.
The Sunday Spotlight is a recurring feature of The Regulatory Review that periodically shares conversations with leaders and thinkers in the regulatory field and, in doing so, shines a light on important regulatory topics and ideas.