When disruption meets regulation

January 30, 2014
Nick Dunbar has a fantastic post today headlined “Disruptive Business Models, Uber and Plane Crashes”, talking about how “the latest flurry of innovation” is being concentrated in regulated industries.

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Nick Dunbar has a fantastic post today headlined “Disruptive Business Models, Uber and Plane Crashes”, talking about how “the latest flurry of innovation” is being concentrated in regulated industries. Dunbar concentrates on non-financial companies: his examples are Uber, Airbnb, and a small company called Manx2, which was an airline in much the same way that Uber is a taxi service or Airbnb is a hotel company. Manx2 no longer exists, in the wake of a plane crash which killed two pilots and four passengers.

What Manx2 actually did was sell tickets. For each particular route, Manx2 then contracted with a plane operating company to fly the passengers…

The Spanish regulator that oversaw Flightline had no clue that the crew who had trained and been accredited in sunny Spanish climes were working remotely for Manx2, flying to fogbound Irish airports. And the passengers who bought tickets from Manx2, which the report says was ‘portraying itself as an airline’ had no clue about the risks they were taking by flying in such a plane run by a freelance operator. Reading the report, it’s hard not to get the impression that the virtual airline business model of Manx2 was partly to blame for what happened.

All regulated industries are inefficient: regulation cannot help but add a layer of bureaucracy to any organization, and no one ever hired a compliance officer as a way of boosting productivity. This creates a natural inclination, on the part of entrepreneurial types, to want to disrupt the industry in question. They look at it, they see all that inefficiency, and they know they can produce 90% of the output with 10% of the overhead.

The problem is that from a societal perspective, sometimes 90% — or even 99% — just isn’t good enough. Airlines are a good example: thanks to regulation, they’re incredibly safe. And when a company like Manx2 manages to slip through the regulatory cracks, the consequences can be disastrous.

The anti-Uber lobby is making similar claims about taxicabs: that they’re licensed for a reason, and that Uber’s attempt at doing an end-run around taxicab regulations is going to endanger passengers and other road users. When you get in a cab, you’re placing your life in someone else’s hands, and you really don’t want that person to be a violent criminal, or have a history of nasty traffic accidents. What’s more, the government is generally better at checking on such things than private companies are.

The main reason why local governments mistrust Uber, however, has nothing to do with public safety: it’s simply a fiscal matter. Both hotels and taxis are important revenue sources for municipalities, which is why city governments tend to be unenthusiastic about Airbnb and Uber.

From the point of view of Silicon Valley libertarians, the idea that they’re disrupting a long-established flow of public monies is a feature, not a bug. If you threaten their disruptive business models, you’re threatening their freedom! That’s the message being sent quite explicitly by the mild-mannered Fred Wilson; his west-coast counterparts, like Balaji Srinivasan and Peter Thiel, have a tendency to go even further.

In finance, regulation is very important indeed — if you want to prevent everything from terrorist finance to global financial meltdown, central authorities need to be able to keep tabs on all financial flows. Finance startups generally operate in a lightly-regulated grey area, just because compliance costs tend to be prohibitively high if you want to, say, start a bank. That explains why Simple isn’t a bank; why most microfinance shops don’t accept deposits; why Apple didn’t storm into the payments space years ago; why it’s so difficult for startups to compete with PayPal, which has spent many years and hundreds of millions of dollars on global compliance; and so on and so forth.

And so when states like New York and California try to gently embrace bitcoin, bringing it into the regulatory fold while not stifling it entirely, the result is always going to be a little bit messy. Bitcoin is built on libertarian mistrust of regulations; indeed, much of the enthusiasm surrounding it comes precisely because it is such a powerful and elegant means of circumventing government control.

I can see the argument for lighter regulation of microfinance institutions: if your depositors have just a few dollars in their accounts, you can’t be expected to spend $50 per customer per year on know-your-customer operations. But in the case of bitcoin, the scoundrels have the head start, and the regulators are never going to be able to catch them. As a result, the entire bitcoin edifice is probably going to end up being shut down by the Feds at some point. It might well get replaced by some other cryptocurrency, but in the case of bitcoin, the regulatory arbitrage is already far too advanced. Which means that if the bitcoin economy continues to grow, the world’s financial regulators will eventually have no choice but to kill it.


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