Nothing shows insurgent distrust of our federal institutions quite like the state level nullification of cannabis prohibition. The federal government criminalized Marijuana in 1970, deeming it a Schedule 1 drug and a threat to society. Since then, a growing body of evidence has shown that the prohibition on cannabis was inspired by racial animus, not scientific evidence, and has achieved its intended devastating impact on communities of color. These realizations have shifted public opinion on cannabis legalization past the point of no return.
A Pew Research Poll in 2018 found 67% of adult Americans support marijuana legalization–a stark increase from 1969 when only 12% believed the drug should be legal. Thirty-three states and D.C. have already taken action to allow for medical access to the drug. Of the 11 states that have legalized recreational use, every state besides Illinois used ballot measures. Clearly, the shift towards legalization is derivative of the democratic process, and reflects a larger cultural shift.
Legalization has largely been an experiment in democracy. Every state that legalized medical and/or recreational marijuana had to determine and update the rules of this new space as it has formed and grown. Each additional state sets an example for the states that follow.
"It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country." - Justice Brandeis
This makes the emerging cannabis industry ripe for Regulatory Entrepreneurship. It’s already clear that change won’t come anytime soon from the federal government. Even if it did, long-standing political figures, many of whom strongly opposed marijuana in the past, do not have the faith of the people to decide how this industry should be regulated. As states continue to open up medical and recreational marijuana markets, the best practices are developed through market driven Darwinism. Coalitions of policy makers and industry leaders have shaped mostly functional but ever evolving regulatory frameworks to govern cannabis.
The industry’s regulatory uncertainty gives entrepreneurs and investors the opportunity to assume great risk to win the market in each state. Through regulatory entrepreneurship, these market leaders can lead cannabis from a legal grey area to piles of green.
Regulatory Entrepreneurship (Revisited)
As I’ve written upon previously, Regulatory Entrepreneurship is a strategy to secure influence over the market and update the public policy with which people engage. This strategy is most effectively employed before politicians or competitors take action. This variant of permissionless innovation occurs when changing policy is part of an entrepreneur’s business plan.
This strategy has been successfully implemented in the ride-sharing, housing, and electronic vehicle spaces. Each took a similar form in how they accomplished this. First, regulatory entrepreneurs identify a leverageable legal grey area. Then they work on developing a passionate following of consumers before policy makers attempt to interfere. Finally, regulatory entrepreneurs build coalitions of industry stakeholders to advance regulations around their product. By implementing regulatory entrepreneurship, well-known tech start-ups–like Uber, Airbnb, Tesla, and DraftKings–have unlocked new opportunities in their respective markets and acquired legally protected stakes in them.
Looking forward, the cannabis space presents great opportunities for regulatory entrepreneurship. Cannabis companies, and everyone that comes into contact with them, operate with an exorbitant amount of regulatory uncertainty. As the end of marijuana prohibition accelerates at the state level, the standards of the cannabis industry will take time to fully form–leaving room for regulatory entrepreneurship.
In 420-friendly states, market entrants have already began developing loyal followings. These players have a great opportunity to capture the market and set the standards of the cannabis industry as it continues to expand into new states. Simultaneously, there are emerging opportunities for entrepreneurs to fill in the gaps where federal policy makers have yet to take charge. With the foundations of regulatory entrepreneurship already building up, the cannabis industry will feature the next wave of entrepreneurs who succeed at shaping future policy.
The Grey Area
Nebulous regulations prime the cannabis industry to be influenced by regulatory entrepreneurship.
As state legalization of cannabis first gained traction, the US Department of Justice originally outlined the type of operations that would and would not be prosecuted–setting a playbook for state’s to evade federal interference. However in 2018, these guidance documents were rescinded. Since then, United States Attorneys have had the sole discretion of what cases are prosecuted, adding uncertainty to the market.
In addition to the looming possibility of prosecution, cannabis companies stakeholders miss out on important federal rights and protections affecting their ability to contract, access banks, be paid fair wages, and file for bankruptcy. Each of these legal obstacles are rooted in the struggle between state autonomy and federal control. The struggle to legalize and regulate cannabis is the most pressing issue in federalism of our time.
State Non-Cooperation
By legalizing marijuana within their borders, states made a historic move of non-cooperation with the Federal Government’s Controlled Substance Act. State non-cooperation is a rare occurrence in American history. One of the significant cases of state non-cooperation comes from the 19th century. Similar to the cannabis prohibition, it was also racially charged.
Prigg v. Pennsylvania (1852) arose over the conflict between the Federal Fugitive Slave Act–which demanded that slaves be returned to their owners in the South–and a series of Pennsylvania laws–which imposed criminal penalties on anyone who assisted the return of an escaped slave. The Supreme Court struck down Pennsylvania’s law for interfering with the national government's policy for the recovery of property (read: slaves). However, the court also noted that the national government could not compel state actors to enforce the Fugitive Slave Act. This opened the door for state non-cooperation.
In the aftermath of this decision, northern states went on to refuse to lend their own agents to enforce the Fugitive Slave Act. As this movement grew, the federal government was compelled by the South to increase its own enforcement measures to attempt to keep the union intact.
Centuries later, state non-cooperation with the prohibition on cannabis has initiated a historic resistance against racially tinged federal laws. Mass Incarceration and the War on Drugs are infamously known as the third wave of institutional violence against people of color in the United States. As time has progressed, none of the promised benefits have been realized. The ramifications, on the other hand, have only perpetuated social ills. While white and black people use marijuana at the same rates, black people are over three times as likely to be arrested for marijuana possession.
In response to this disparity and widespread acceptance of marijuana use, states began taking the first leap against the Controlled Substance Act by either repealing or refusing to enforce state level criminalization of marijuana offenses within their own borders. This has opened up a new revenue generating industry while initiating the expungement of marijuana convictions and release of many non-violent offenders.
The increased enforcement efforts to prop up the struggling 19th century slave trade are unlikely to occur in today’s political climate. First, the Justice Department has unofficially avoided intervention. More importantly, the Federal Government does not have the same time or resources to devote to enforcing the marijuana prohibition the way it enforced the Fugitive Slave Act. In 2007, less than 1% of all marijuana arrests were led by federal agents. Without a compelling interest, the federal government is unlikely to find support for the increase in funding that would be needed to stomp out pot.
As de facto federal legalization of cannabis evolves into official national policy, the most pressing issue is how the regulatory environment will evolve.
Insights from the Hemp Industry
Established regulations and norms within the hemp industry provide a window into the future of cannabis. The CBD industry was opened up by the 2018 Farm Act which legalized industrial hemp by declassifying hemp as a Schedule 1 substance. The timing of this comes as no surprise to anyone who has visited a wellness store or gym in the past year and noticed the smorgasbord of CBD tinctures, creams, supplements, and gummies. In the first year after the 2018 Farm Act, an estimated $2 Billion of hemp product sales were made. The industry is projected to reach $16 Billion in revenue by 2025. This growth is enabled by the Federal rights now guaranteed to hemp businesses, which cannabis businesses can expect to have in the future.
The main current issues in hemp law surround the content of CBD products. First, the federal government still has a strong interest in preventing the black market diversion of hemp. For this reason, THC derived CBD products cannot be sold if they have more than 0.3% THC. If cannabis were legalized, the diversion of hemp products would be less of a concern. However, even in states where cannabis is legal, governments have enforced strict inventory management regulations to prevent black markets of legally produced pot from sprouting up.
Additionally, the FDA has oversight over ingestible CBD products. While the FDA requires products with therapeutic claims to be approved, CBD companies have circumvented FDA rules by marketing their products as supplements, and ignoring a few warning letters. While many of their health claims are not proven, public health experts expect that the FDA will not succeed at taking CBD products off the shelves–even if the safety of the products is called into question. Similar to loyal consumers of tobacco products, CBD consumers’ value for their freedom to choose outweighs their faith in the government to determine what they should and shouldn’t consume. Particularly since the government has not engaged in a serious good faith effort to evaluate these products.
The FDA will certainly have oversight over edibles and other cannabis consumables. However, in addition to the general interest in free choice, cannabis consumers are weary of the government’s motives to steer them away from using marijuana. Many of the sinister health claims made about cannabis during the War on Drugs were over exaggerated, and as a result much of the cannabis using community is deeply skeptical of any research on cannabis. In addition, the cannabis industry has grown accustomed to living outside of the bounds of traditional legality; plenty of cannabis users embrace the risk and illegal image promoted by cannabis brands. As legalization spreads, the government will have less influence over consumer behavior than the brands powering the cannabis industry.
Hybrid Regulation
However, beyond the areas specific to federal control and the protections opened up by federal legalization, we can expect the government to defer to the states to regulate the cannabis industry. In Hybrid Marijuana Federalism, Susan F. Mandiberg outlined multiple models of collaborative governance to be applied to the cannabis industry. The most functional regulatory framework would begin with floor regulations, set by the federal government, that each state must meet to have a legal cannabis market. Then, the states would be given the power to set and enforce more strict guidelines around the production, transport, and use of cannabis. This projection for the cannabis legal system works because it does not require increased enforcement efforts from the federal government. In addition, it defers to the expertise states have been building to effectively regulate cannabis within their borders.
The current ability of states to experiment and innovate around methods to cultivate safe and viable cannabis markets has opened up the first opportunities for regulatory entrepreneurs to influence policy. States have already been working closely with industry stakeholders to guide how the industry operates in each state. Simultaneously, entrepreneurs have begun to identify best industry practices while developing solutions to fill the current regulatory gaps. As the trend towards legalization continues, cannabis entrepreneurs have the opportunity to acquire major economic and political power.
Securing Market Power through Policy Coalitions
One proven strategy for regulatory entrepreneurs is to leverage political coalitions to build policy around the entrepreneur’s company. Tesla notably accomplished this by securing specific carve outs to state dealership requirements. Similar examples have already bubbled up in the cannabis space.
Tethering regulations, for instance, have enabled dispensaries to escape competitive market forces. Until 2020, medical marijuana patients in Montana were tethered to their dispensary. Patients were bound to the one dispensary they chose to purchase from when they first obtained their medical card. While this improved the state’s ability to oversee cannabis operations, it largely eliminated competition between dispensaries. Surviving dispensaries happily avoided the fierce competition over price, quality, and aesthetic in states like Colorado, where there are more dispensaries than Mcdonalds and Starbucks combined.
Looking forward, vaping presents a thrilling use case for regulatory entrepreneurship. This past summer, fears broke out over a “vaping epidemic” after a spike in vape-user hospitalizations and deaths. As of December 2019, 55 people have died from lung injuries caused by Vitamin-E acetate in their vape cartridges. The calls for safe vaping inspired some political leaders to come out in support of cannabis legalization. Beyond just opening up more legal markets, concerns over the safety of vaping could transform the cannabis market and award a few existing players a competitive advantage.
In an article on Vape Manufacturing Challenges, David Galvez, Ph.D. outlined the relationship between public health concerns and vaping business interests. The dosage/draw amount, capacity, pressure, content, and packaging of vape pens all have implications to the health of the user and the cost of the supplier. Setting standards for each of these attributes could restore the image of safety to the vaping industry.
Pax Labs, a vape manufacturer, is one company that could take on this task. Shortly after the vaping crisis made national news, Pax formed a health advisory board to advise on the health applications and implications of vaping. If Pax’s leaders and health advisory board worked with policy makers to advance consumer and public health, they could set regulations that align with the health standards Pax holds itself to. This would simultaneously kick unsafe products off the market and create a barrier-to-entry, warding off cheater brands. While this could seem out of reach for small vaping companies, Pax has already developed a passionate following who could rally for strict health vaping regulations the same way Uber’s fans took on city halls across the nation to welcome in the ride-share service.
Remedying Policy Failures
While forward thinking regulatory entrepreneurs work to shape cannabis policy, others focus on remedying current policy failures through the market. A main obstacle for stakeholders in the cannabis industry is their inability to access banking services. Because banks are accountable to federal law, working with cannabis companies would make them liable for money laundering into the cannabis market. Congress has stalled on the Safe Banking Act, which would permit banks to handle marijuana transactions. When discussing the cannabis industry on the Firewall Podcast, Jordan Nof, who invest in startups in heavily regulated industries through Tusk Venture Partners, predicted that hesitancy from the Banks would prevent Congress from making much headway with the Safe Banking Act in 2020.
“[r]ather than protect state interests, [the difficulty of enacting federal law] privileges the legal status quo—whether that status quo be state law or federal.”
Carlos Vasquez
Congress’s indolence has unlocked opportunities for technologists to develop solutions to the credit woes of cannabis companies. Hypur, WAYV, and Alt Thirty Six have all developed digital payment platforms for cannabis merchants. While Alt Thirty Six works over blockchain to enable regulatory compliant payments, WAYV and Hyper have created a line of credit from seed to sale to increase predictability of payments. As these companies reach scale, they gain the power to establish monetary policy in the cannabis industry, such as payment norms. Serving as a first use case for emerging fintech, these players could pioneer new investment and payment structures to be adapted on a broader scale.
The difficulty of compliance in the cannabis industry reaches beyond banking. In order to prevent any black market diversion, the cannabis inventory management regulations are incredibly strict and quickly enforced. METRC became the “the de facto track-and-trace system” enabling the government to track cannabis from seed to sale. However, marijuana businesses who fail to fully comply with METRC requirements quickly lose their licenses to operate.
Distru was developed to integrate METRC with supply chain management software and provide a compliance advantage to the marijuana businesses it works with. Distru’s software could have broader applications, as the hemp industry faces similar compliance challenges to monitor the amount of THC in hemp plants. By developing technological solutions to problems created by the regulatory uncertainty of the cannabis industry, Distru and similar regulatory entrepreneurs diminish the need for federal intervention. This is what is truly powerful about regulatory entrepreneurship in the cannabis industry.
Regulatory Entrepreneurship shifts the locus of governance to stakeholders with industry expertise who face private market feedback where failure is unsustainable.
The evolving nature of the cannabis industry has unlocked bountiful opportunities for states and entrepreneurs to take action where the federal government has refused to. Regulatory Entrepreneurs have the opportunity to shape the future policy and industry standards of the cannabis industry while creating solutions to current policy failures. If entrepreneurs and states to succeed at building safe and viable cannabis markets, the federal government will continue to defer to them. As the power to govern is further localized, politicians can update policy and introduce innovative governance structures faster. Moving towards boots-on-the-ground governance would make public work more visible and responsive. The effects of this work will be much greater than profits for dispensaries. Regulatory Entrepreneurship in the cannabis industry has the potential to affect democracy as a whole.
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