Brace for impact: Cryptocurrency industry faces heavy regulatory blow
How immutable and censorship-resistant will Bitcoin be when people really try to mutate and censor it?
- A sweeping set of stringent regulations is likely to impact cryptocurrency.
- Digital currency services may be required to identify users and start freezing transactions.
- Bitcoin's censorship-resistance and immutability might actually be put to the test.
In October 2018 the Financial Action Task Force (FATF) promised some more uniform regulations around cryptocurrency. In December that year the G20 agreed to comply with the regulatory decision passed down by the FATF.
Then on 22 February 2019, the FATF published a draft of recommended cryptocurrency regulations.
It sought industry feedback on 6 and 7 May this year, and has now closed its door to further industry feedback.
Thou shalt/shalt not
The rules apply to all Virtual Asset Service Providers (VASPs). According to the FATF draft, a VASP is almost any business in the digital currency line of work. This broad term covers exchanges, wallets and businesses which use digital currency in their own right, such as cryptocurrency lending platforms.
It recommends that countries ensure their VASPs comply with a strict set of rules, including:
- Registration or licensing for all VASPs.
- Conducting customer due diligence for all transactions over US/EUR 1,000 in value.
- Effective punishment for VASPs that fail to comply with their obligations.
- Identifying and knowing who the sender and receiver in a transaction is.
- Being able to collect the relevant information from or freeze assets when needed.
The suggestion is that any digital currency transaction should be de-anonymised and centrally controllable.
Imagine all wallets, exchanges (both fiat to crypto and crypto to crypto) and any other cryptocurrency-related business needing to comply with these.
If it rolled out overnight in its current form, it would upend the entire industry and spark digital riots.
But it's not rolling out overnight, and it's theoretically not set in stone yet.
However, attendees at the FATF discussion have expressed the opinion that these regulations will be applied in their current form, and that it could have a disastrous impact.
Peripherally, FinCEN (the USA's anti-money laundering agency who's responsible for carrying out the FATF's will in the States) published an interpretive guidance document (PDF) on 9 May, which goes into some detail about how VASPs could be expected to comply.
It's not directly related to the FATF proposal, but the timing is likely not coincidental and it similarly suggests that cryptocurrency should be hobbled with an expensive identification and transaction-censoring layer, similar to the SWIFT network.
How bad is it?
By all accounts, it's pretty bad.
Even among the crypto organisations which have committed to facing regulatory inevitability with a happy face, there's an ominous vibe around the proceedings.
"One of the recurring messages [in Game of Thrones] is winter is coming," said Arnold Spencer, general counsel of CoinSource and former Assistant United States Attorney. "I don't like to think of regulation as the White Walkers, but regulation is coming... one thing I think you will see build consistently is the regulatory environment, so get ready for it."
"How are you going to identify an illicit transaction. How are you going to freeze that?" Spencer asks. "That answer is going to vary from country to country depending on what banking systems they have in place. But there is an expectation, a requirement, at the FATF level, that countries develop systems to both identify these illicit payments and then freeze them, then subsequently investigate the players behind illicit transactions."
To recap, it looks like a wide range of cryptocurrency exchanges, wallets and other services will be required to:
- Identify illicit transactions.
- Freeze those transactions.
- Identify the people responsible for those transactions.
Long term plans
Winter is coming, even if it is moving at a glacial pace.
"What the FATF is doing is over a series of years... is really building up a protocol for cryptocurrency regulations for their member countries," Spencer explained. "They're trying to develop a protocol for their member countries to develop regulations, in this case specifically the cryptocurrency industry."
It is the catalyst for change."
"In this case the FATF, back in February, has issued certain standards that they want countries to abide by with regards to regulating crypto and really limiting the amount of money that can be laundered through the crypto industry, and any sort of terrorism financing that flows through the crypto industry."
"It is the catalyst for change," Spencer noted. "But it's a series of dominoes, if you will. The FATF dominoes will first fall, which will then cause each of those individual countries to start to study their own regulatory frameworks, and then they will adopt new regulations and new requirements, and then the next domino to fall will be the company, the industry players who now have to conform to and obey these new laws."
Essentially, it looks like we now know that the regulatory rollout is inevitable, that it's probably going to find its way to a wide range of service providers, and that it looks like it's going to upend the industry.
Where the dominos fall
One critical part may be that these requirements will apply to all VASPs, and that even if it's going to move slowly, the objective here appears to be the elimination of some of the things that make cryptocurrency useful.
If all wallets need to reserve the right to freeze funds, and have to conduct AML/KYC checks on their users, you're losing an intrinsic part of Bitcoin and other cryptocurrencies.
An equally mortal threat might be the sheer cost of compliance seemingly set to fall on the cryptocurrency industry.
A large part of the industry is dependent on the ability of entrepreneurs to more easily enter the space, and for developers to get started with small teams and minimal budgets. But when any startup that even thinks about touching digital currency has to wade into the same compliance morass as a fully fledged bank, a lot of innovation in the space will disappear.
And as costs drive away the compliance-minded VASPs, you risk leaving the door wide open for the less-compliant and less-reputable actors.
It's difficult to see too many digital currency services could find an exemption.
"It is certainly true that it will apply to wallets and exchanges," Spencer noted. "My company runs Bitcoin ATM machines, so we're not an exchange, we just sell bitcoin on an indivudal peer to peer basis. But it will apply to us as well."
"It will apply to custodians, it will apply to crypto lending businesses, crypto insurance businesses. Depending on how the countries frame the regulations it will apply to a broad category of different industries."
end beginning of an era
"Worldwide, internationally, there is a recognition of the importance of regulation and that most countries will be moving towards regulatory frameworks that are consistent with the FATF protocols," Spencer notes.
They're ten years behind us, but they're catching up."
"There will be rogue states that still allow illicit transactions, and I think the rest of the world will isolate those rogue states."
From one angle, this is the death of the industry. Immutability, decentralisation, privacy and many of the things Bitcoin was all about are apparently on the chopping block.
From another angle, this is the start of a grand new era in digital assets, of institutional involvement and appropriately-taxed Lamborghinis.
"I don't think this is an issue of saving the industry," Spencer muses. "It's just evolving."
"The first ten years of this industry have been dominated by entrepreneurs and developers, creating terrific new products. The next ten years... the industry is going to be dominated by more traditional economic players, by companies, central banks, major financial institutions, and then most importantly by regulators. They're ten years behind us, but they're catching up."
"What I think you're going to see in the next 10 years is a whole series of regulatory reforms, and I think the FATF is out in front of that. For someone in an FATF countrry, I would read the regulations and understand what's coming. Your country may not have specifically adopted these regulations yet, but they're coming."
"And if you want to develop a long term business you need to understand what the regulations are. You're going to need to comply with these regulations."
"As a lawyer it won't surprise you to hear me say my advice is to hire lawyers. But the reality is, if you want to build a solid foundation for long term business, you don't want to be at odds with the government."
What happens next?
It might be that the world will find out just how immutable and censorship-resistant Bitcoin and other cryptocurrencies really are.
May the odds be ever in your favour.
Disclosure: The author holds BTC, BNB, ATOM at the time of writing.