Blockchain Bites: The Fight for Private, Digital Cash

Hey, what a week. Coinbase sent a signal of its intent to go public. Block.one revealed it has more than its purported 140,000 BTC war chest. And bitcoin is still above $20,000 – everyday adding a new notch to its longest streak. 

Crypto experts
FinCEN is hiring two policy officers to help draft regulations related to the “threats” posed by the cryptocurrency space, advise financial institutions and collaborate across government and the private sector on crypto policy. Earlier this month, rumors swirled that Treasury Secretary Steven Mnuchin would rush out self-hosted wallet regulations many think would harm the crypto industry. The Block reported this may require crypto companies file a “currency transaction report” on crypto transactions over $10,000 involving a self-hosted crypto wallet. (More on this below.)

Coinbase IPO
Coinbase filed preliminary paperwork to go public, beginning the long road to what could be the first major Bitcoin company trading on U.S. stock exchanges. This summer, rumors swirled that the firm, last valued at $8 billion, would pursue a “direct listing” rather than the bank-heavy traditional route of an initial public offering – though Thursday’s “confidential” filing offers few clues. Messari estimates the firm could fetch $28 billion on the open market. 

State of the chain?
Compound Labs released a white paper Thursday detailing its plans to create Compound Chain, an application-specific blockchain that can provide money market services across multiple networks. The DeFi protocol is looking to beat Ethereum’s high gas costs, lack of chain interoperability and other technical challenges – though there’s no timeline for launch. Perhaps most important, it’s looking to target the nascent field of central bank digital currencies.

Digital cash
Two weeks ago, Coinbase’s Brian Armstrong threw the crypto community into a tizzy when he spoke of rumors of a potential Treasury Department measure meant to introduce oversight of “self-hosted wallets.” The term wasn’t exactly well-known (Armstrong even included a rough definition in his late-night tweet thread) but the possible repercussions were immediately intuited. The markets – then on a month-long climb – faltered.

Self-hosted crypto wallets are a key part of blockchain technology, and what many crypto purists would call the only acceptable way to store your coin. Also known as non-custodial wallets or self-custody wallets, they allow users to interact with a blockchain network and store crypto without relying on a “third-party financial institution,” to use Amstrong’s term. (“Unhosted” was coined by the Financial Crimes Enforcement Network [FinCEN] in 2019, to compare to wallets hosted by intermediaries.)

“This proposed regulation would, we think, require financial institutions like Coinbase to verify the recipient/owner of the self-hosted wallet, collecting identifying information on that party, before a withdrawal could be sent to that self-hosted wallet,” Armstrong tweeted at the time.

It was a broad understanding of what could have broad, irreparable harm for a young industry. Everything from hard wallets to open finance (DeFi) protocols could conceivably be affected. “It would force corporations to know every counterparty to their users’ crypto transactions, keeping logs, tracking movements and verifying identities even before a transfer could take place,” my colleagues Danny Nelson and Sebastian Sinclair wrote.

Last night, The Block gave a peak under the hood to the still murky regulation. According to an anonymous source, Treasury’s Steven Mnuchin is looking to implement a transaction reporting rule for money services businesses (MSBs) that interact with unhosted crypto wallets. The fine details, like if there is a transaction reporting level, are unknown.

Also still dark: When such a regulation might go into effect – from today on, reportedly – and whether there will be a period for public comment. What’s important to note is the rule doesn’t seem to be an outright ban on unhosted wallets.

These so-called currency transaction reports (CTR) institutions may be required to file are a way to bring the type of guidance and oversight to blockchains as had existed in much of the traditional financial system. But many argue it goes a step too far. For years, most oversight of crypto came in the form of on-ramps, such as know-your-customer (KYC) requirements at exchanges. Though the FinCEN has pushed forward a “travel rule” adopted by most jurisdictions that introduces reporting requirements for “virtual asset services providers” (VASPs).

As such, whatever regulation the Treasury may hand down is part of a greater trend towards financial oversight. As CoinDesk’s Ian Allison reported, blockchain analytics companies have long flagged funds moving to and from private crypto wallets. Now, self-custody is “the next fault line for crypto regulations,” he said.

“Policymakers fear that full maturity of these decentralized protocols could foreshadow a future without financial intermediaries, which would significantly inhibit law enforcement’s ability to identify, prosecute and otherwise disrupt illicit financial networks in an environment when the effectiveness of these tools is already being challenged,” Head of Risk, Compliance and Regulatory Policy at cLabs Jai Ramaswamy wrote for Coin Center.

What’s troubling, however, is these new rules are introducing an unprecedented level of oversight over our financial lives, the argument goes. As the Blockchain Association points out, in enabling peer-to-peer transactions, self-hosted wallets are a necessary tool in maintaining a digital equivalent of cash. Cash has no identity requirements. Cash is also used by nefarious actors. But allowing people to engage in commerce and exchange freely is a net benefit for society.

In treating all digital commerce as suspect, or “high risk,” is unnecessary and misguided the Blockchain Association argues.

“The issue at hand is nuanced, the potential implications are far-reaching, and numerous valid but sometimes competing interests, such as empowering law enforcement while protecting citizens’ fundamental rights, must be considered and balanced,” the association writes.