States Can Attract More Entrepreneurs by Sharing Sandboxes
As more states experiment with “regulatory sandboxes” to give innovators whose products don’t fit within old policy models a proving ground, one critique has been surfacing: Participation varies widely. Wyoming has struggled to recruit a single applicant despite its prolific success in creating a crypto-friendly jurisdiction. In comparison, Hawaii’s Digital Currency Innovation Lab has admitted at least 12 participants in its first cohort and 15 in the second, Prominent digital currency companies such as SoFi, BlockFi Trading, Gemini Trust Company, and Robinhood Crypto are among the participants. For a more drastic comparison, look across the Atlantic, where the U.K.’s sandbox has received over 550 applications since its 2016 launch.
Why are some states more successful in recruiting sandbox applicants than others? How might they attract more entrepreneurship?
Since 2018, regulatory sandboxes have created safe harbors for entrepreneurs to temporarily test new business models and novel products and services without incurring significant regulatory compliance costs or bearing the risk of noncompliance. Since 2018, 11 states have established them using one of two different models. The “industry-specific” model focuses on regulatory relief for businesses in distinct industries, typically cutting-edge fields like fintech or medical digital innovation. The “universal” model is all-encompassing and offers potential regulatory relief for any type of business in any industry.
Seven of the 11 states allow for reciprocity, arguably the most important provision in regulatory sandbox legislation: Arizona, Florida, North Carolina, Nevada, Utah, West Virginia, and Wyoming. However, Kentucky, South Dakota, Vermont, and Hawaii do not. Reciprocity allows for sandbox-based businesses to transact in other participating states through temporary regulatory waivers.
With statutory reciprocity, the benefits of a sandbox can be multiplied. Participants can engage in experimental business activity across multiple states, opening the door to a more diverse and larger market for startups seeking to test their unconventional ideas. Startups can access geographically diverse markets that they otherwise might not consider or be able to reach at an early stage. They can learn how consumer preferences vary across regions and gain access to valuable data and business insights.
Digital asset businesses, which quite often face regulatory uncertainty, may find this multijurisdictional sandbox relief attractive and cost-effective. Other hybrid tech industries, such as AgTech and MedTech, also stand to benefit.
Reciprocity offers several other specific advantages. It could mean relief from cumbersome state licensing requirements, such as money transmission laws, which regulate the sending and receiving of money. The universe of money transmissions law is notoriously difficult and expensive to comply with because each state has its own set of rules — one reason why there have been numerous calls for uniform state money transmission laws or even a federal alternative.
It also alleviates the cost of researching and understanding the different laws and regulatory requirements of various states, which can be significant. Startups can focus on innovation rather than regulatory uncertainty, which might otherwise come at the expense of their bottom lines.
Because cryptocurrency payment platforms and trading exchanges, for example, often need money transmission licenses to legally operate, multistate regulatory waivers could result in significant cost savings for startups. Hawaii’s program has already demonstrated the demand for this type of regulatory relief. While beautiful beaches and warm weather certainly don’t hurt, the popularity of its sandbox is likely because of the simplicity of its sandbox model, the absence of residency requirements, and the speed and ease of getting a waiver. Other states should emulate this simplified model, and with the benefits of reciprocity they can become even more attractive options for startups.
Reciprocity also encourages regulators to place less emphasis on overly burdensome residency requirements. Wyoming’s participation drought is reportedly due to strict requirements that a startup’s physical presence be more than just a registered office or agent. Requiring residency in multiple states may inadvertently favor large companies over startups, but negotiating a residency waiver as a condition of reciprocity could level the playing field. Such an agreement could also be a competitive alternative to other regulatory relief initiatives, such as the Catawba Nation’s Digital Economic Zone, which allows digitally native web3 or blockchain startups to legally register entities that are entirely virtual.
Some states could benefit from sandbox reciprocity more than others. Startups are incentivized to target large consumer bases in densely populated markets, like California and New York. It is no coincidence, then, that these wealthy states do not have sandbox initiatives while more rural ones, like South Dakota, Wyoming, Kentucky, and West Virginia, do. With reciprocity, rural, less populated states could form a “super sandbox” or “regional sandbox” as a competitive force to challenge the economic dominance of larger states who may be resting on their legacy reputations.
Despite these advantages, reciprocity is not a panacea for sandbox success and states should work to understand what additional changes could foster business dynamism, which has been on a downward trend in recent decades. Furthermore, the use of reciprocity in this space is not well understood. States seem to recognize the benefits, but could do more to create bridges for interstate and even federal participation. Nevada, for example, is already working with the federal Consumer Financial Protection Bureau’s Office of Innovation, which manages a No Action Letter and Compliance Assistance Sandbox program. However, to date, no state has formally announced any cooperative agreement with another.
The availability and advantages of existing reciprocity agreements are also not well communicated to the public. These details are rarely listed on state sandbox websites and are often buried in dense legislative text. This important information needs better outreach and marketing, two underutilized strategies for attracting applicants and economic activity to a given state.
Whether or not regulatory sandboxes ultimately diversify state economies and create more high-paying jobs, reciprocity can signal that states are in the business of cooperation and business creation.
Agnes Gambill West is a visiting senior research fellow with the Mercatus Center at George Mason University.
