Shoosmiths explore the need for regulation in the evolving landscape of Web 3.0 and the Metaverse, focusing on recent approaches to regulating emerging technologies, and the importance of striking a balance between flexibility and effective safeguards.
At a Web 3.0 Symposium hosted by the Digital Regulation Cooperation Forum (“DRCF”) in October 2022, one of the questions posed for UK regulators was “how can we best encourage responsible innovation in relation to decentralisation and / or distributed ledger technology applications?” Encouraging “responsible innovation” in Web 3.0 and metaverse technologies is a thornier topic for regulators than it might at first appear. It requires trust in regulators from stakeholders and the general public, but a prerequisite for building this trust is an effective and transparent regulatory framework. Such regulation should help protect individuals while fostering innovation in a safe and sustainable manner, thereby establishing trust at the public and industry level in a natural way. But getting to this point poses many challenges.
This article will explore in more detail why regulation of the Web 3.0 and metaverse spaces is required, how it might best be implemented, and will look at the risks around a regulatory regime that could be too prescriptive (thereby potentially inhibiting innovation) or too flexible (thereby potentially not addressing the risks).
The Role of the Regulator
Regulators are supposed to be makers of participant-agnostic policy responsible for setting, monitoring and enforcing standards designed to achieve objectives in a particular area. The DRCF notes how the role of the regulator is changing amid developments in new technologies; “our roles as regulators are becoming increasingly important to ensure that consumers’ and citizens’ interests are at the heart of digital innovation”. In the context of Web 3.0 and metaverse technologies, regulators will need to strike a balance between preserving the flexibility for innovation – by allowing companies and individuals to harness the benefits of decentralisation, new markets and technological advancements – and minimising the potential risks, including of data breaches, fraudulent activity and market volatility. To do so, regulators must keep pace with rapidly emerging technologies, and create regulatory frameworks that support this balance.
Navigating Regulatory Challenges
Regulation is required
Regulators looking to regulate emerging technologies face a constant dilemma around how to balance encouraging innovation with minimising harm. While a flexible approach is often welcomed by developers, the success of emerging technologies can be predicated on there being sufficient trust in regulators among consumers and stakeholders. In recent times we have seen how this trust can be eroded. For example, the FTX collapse (termed by Damian Williams as “one of the biggest financial frauds in American history”), resulted in a significant loss of confidence in emerging digital markets and reduced appetite for investment. One of the key issues this scandal highlighted was the need for stakeholders and consumers to consult with regulatory bodies to develop effective regulatory frameworks. Without consultations, regulators risk creating frameworks which are not fit for purpose, or which negatively impact confidence in these emerging technologies. Conversely, if following any such consultation, consumers or stakeholders wish for these markets to not be regulated, they must satisfy themselves with the risk that without effective regulatory frameworks they will not be afforded any protection when another scenario like the FTX collapse emerges. The more frequent the scandals become, the more likely the trust in these emerging technologies will be eroded.
Regulating emerging technologies like those in Web 3.0 and the metaverse is crucial but doing so in an effective manner presents a tricky balancing act. As the FTX collapse shows, rules are needed to ensure “bad actors” are deterred from exploiting new and innovative technologies to engage in illicit or criminal activities, leading to innocent users being left to deal with the consequences (financially or otherwise) without any support. However, overly strict regulations, as may potentially be the case with the EU's AI Act, can spook developers and investors and potentially restrict innovation.
More flexible approaches, like the one taken by the UK's DSS, seem to strike a better balance. The DSS’s approach allows for testing and adapting regulations as the technology evolves and has been praised for its potential to support innovation without stifling it. However, it remains to be seen whether the actual implementation and use of the financial market infrastructure sandboxes under the DSS garners the same positive support. We are hopeful that this shall be the case.
Ultimately, for Web 3.0 and the metaverse to really take off as viable technologies at scale, it is essential that developers, regulators, and other stakeholders are able to build a sufficient level of trust in them. This will require implementation of effective, adaptable regulation that both adequately protects the public, while at the same time continuing to encourage innovation. Finding the right balance is challenging, but vital for the safe and sustainable growth of Web 3.0 and Metaverse technologies in the UK and beyond.