Recent weeks have seen a lot of movement surrounding regulatory developments for cryptocurrencies and the deployments of such, from reports of an upcoming bill in Spain, a full regulatory cryptocurrency framework released by the U.S. Department of Justice, a crypto derivatives ban in the UK, and serious enforcement actions against Bitcoin derivatives platform BitMEX.
According to an analysis by lawyer Jake Chervinsky, the timing for the developments is not coincidental. In a twenty-part Twitter thread, he confirmed that based on statements and regulatory trends, it is clear a war is being waged "over self-custody & privacy."
At current, the process of self-custodying cryptocurrencies with fiat is actually rather simple: users can sign up for an exchange, deposit funds, purchase bitcoin, then withdraw it to a personal wallet. Once the funds are in a user's non-custodial wallet, they can do with them as they please.
But as Chervinsky explains, this is changing. Traditional anti-money laundering (AML) frameworks "break down" when Bitcoin is involved, he explained, referring to Bitcoin's nature as a bearer asset that can be transacted without an intermediary.
With no intermediary to deputize, gov'ts are less able to detect transactions, identify counterparties, determine sources of funds, conduct censorship & seizure, etc. This is true for both paper cash & electronic cash.
In the past, it seemed most regulators were fine with regulating on- and off-ramps. But as cryptocurrencies are growing into their own enclosed economy, Chervinsky noted, regulators are beginning to try and implement AML rules more vigorously, while "also attacking privacy more aggressively."
This much was made abundantly clear when the U.S. Department of Justice, together with representatives of six other nations, recently published an open letter urging technology companies to work with the government to introduce backdoors to services using end-to-end encryption. In regards to cryptocurrencies in particular, the DoJ released a framework highlighting how Bitcoin's pseudonymity and privacy-enhancing technologies in the space can perpetuate crime.
The cryptocurrency-focused lawyer feels that these moves, coupled with reports released by Europol the Financial Action Task Force that seemed to target privacy-enhancing technologies such as Bitcoin mixers, are the beginning of the end of legal self-custody and digital asset privacy:
I fear we're heading for a world where withdrawing crypto from exchanges to self-custody is restricted as a means of attacking privacy. We'd have two separate crypto markets: one of "clean" custodial coins & another of "dirty" self-sovereign ones, with no bridge between.
As morbid as this may sound, what he fears has begun to come to pass. Reuters reported on October 13th that Spain's minister of finance is pushing for legislation that would require all cryptocurrency holders in the country to identify themselves and their holdings to the government. Should it pass, this would be "mandatory," not optional.
The recent actions by the U.S. Securities and Exchange Commission, the U.S. Justice Department, and FATF, amongst many other regulatory bodies, clearly represent the harshest stance regulators have ever taken towards cryptocurrencies.
This raises the question of why there has been such a reversal, or at least such a rapid uptick in regulatory action.
Chervisnky points to two trends: Bitcoin gaining "geopolitical significance," and the parabolic explosion in the growth of fiat-backed stablecoins.
Although Bitcoin isn't actively discussed in Congress, for instance, it has seen a strong uptick in adoption and attention amid the pandemic.
Namely, a number of large corporations and institutional investors have begun investing heavily in the space as a narrative has developed surrounding Bitcoin's ability to hedge against risks in the fiat system. The project has garnered attention from firms like Fidelity Investments and Microsoft, while investors like Paul Tudor Jones have allocated capital to Bitcoin.
Stablecoins in particular have seen a rapid uptick in adoption in 2020. Coin Metrics data indicates that the value of all U.S. dollar stablecoins in circulation recently passed $20 billion, after starting 2020 closer to $7 billion. Reasons for this growth include a U.S. dollar liquidity crisis, growth in so-called decentralized finance, and the ease in e-commerce enabled by stablecoins.
Regulatory agencies acting so severely after such growth in Bitcoin and stablecoins suggests there are serious concerns that sooner or later, fiat systems may lose dominance over Bitcoin.
Regulatory trends lend to Chervinsky's fear that self-custodying bitcoin may become illegal in the future.
Not all hope is lost, however, he explains: if industry representatives successfully "convince policymakers why it's a terrible idea" to act against withdrawals to non-custodial wallets, such a "worst-case scenario" does not have to be the outcome.
Cryptocurrency advocacy group CoinCenter, for instance, released a famous paper in 2019 outlining why electronic cash technologies like Bitcoin should be "fostered and celebrated," not feared by regulators.
What has become apparent is that cryptocurrencies are taking a seat at the table when it comes to financial regulation, and whether open conversation is initiated between the tech industry and regulators, we may need to prepare for more legal frameworks to be released in the foreseeable future.