Cryptocurrencies were designed to be anonymous or pseudonymous, so there is an inherent tension when protocols come up against jurisdictional authorit
Cryptocurrencies were designed to be anonymous or pseudonymous, so there is an inherent tension when protocols come up against jurisdictional authorities.
In the United States, the blockchain and cryptocurrency sector has jousted with regulators over the need to comply with Know Your Customer (KYC) and Anti-Money Laundering (AML) rules, and even over adherence to economic sanctions regimes.
Most recently, a top U.S. Commodity Futures Trading Commission (CFTC) official suggested in a speech that it behooves the industry to verify the digital identity of its users. The CFTC has historically been friendly to the crypto sector — at least when compared with other U.S. agencies like the Securities and Exchange Commission — so its views might be worth considering.
However, is it possible “for all crypto companies to distance themselves from [digital currency] mixers and anonymity-enhanced technology,” as CFTC commissioner Christy Goldsmith Romero urged in an April 25 speech?
What about decentralized exchanges? Romero said central parties maintain them, and they could do KYC and AML if they wanted to. But would forcing compliance risk driving decentralized finance (DeFi) innovation abroad?
“Sure, it’s possible for companies to distance themselves from anything they want — software does what we tell it to do,” Preston Byrne, a partner at the law firm Brown Rudnick, told Cointelegraph, adding:
“The real question is whether the United States, as a policy matter, wants to cut off its companies from DeFi when DeFi growth overseas is exploding.”
Whether crypto protocols have to comply with AML/KYC rules and other aspects of the U.S. Bank Secrecy Act (BSA) depends on whether they are “money transmitters” or “money services businesses” under the applicable state and federal laws, according to John Wagster, who heads the technology industry team at law firm Frost Brown Todd. But whether they can comply is another matter. He told Cointelegraph:
“Centralized protocols clearly have the ability to implement AML/KYC compliance, albeit at the risk of losing crypto idealists who will only use products that allow permissionless, anonymous access.”
What about DeFi projects? “Decentralized protocols can implement BSA compliance, but the individual steps must be approved by the protocol’s DAO — or another governance mechanism — and some aspect of the implementation will likely need to be performed by community members or service organizations authorized by the DAO,” Wagster added.
But the BSA isn’t the only potential challenge for crypto firms looking to set up business in the United States; it might not even be the most serious.
All companies must comply with the Office of Foreign Assets Control (OFAC) “to ensure their platforms are not being used by individuals from prohibited jurisdictions,” like North Korea and Iran, or by specially designated nationals, said Wagster. However, “some aspects of OFAC compliance can be implemented autonomously through the use of third parties like Chainalysis, which provides access to its OFAC API free of charge.”
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In August 2022, OFAC sanctioned digital currency mixer Tornado Cash, which the agency accused of laundering more than $7 billion of digital currency since its creation in 2019. This included over $455 million stolen by a North Korean state-sponsored hacking group. Mixers like Tornado facilitate anonymous transactions “by obfuscating their origin, destination, and counterparties, with no attempt to determine their origin,” according to the U.S. Department of the Treasury. OFAC has since prohibited U.S. firms and individuals from doing business with Tornado Cash.
Some believe that decentralized exchanges can also shut out mixers if they set their mind to it. “When the whole Tornado Cash debacle happened, decentralized exchanges like Aave and dYdX actively blocked addresses that interacted with mixers,” Justin Hartzman, CEO and co-founder of Toronto-based cryptocurrency exchange CoinSmart, told Cointelegraph. As Hartzman further explained:
“While mixers do tend to protect user identity, it is fairly easy to tell which addresses have interacted with these protocols, thanks to blockchain’s transparency.”
Still, even if crypto firms can resist anonymity-enhanced technology, would that be beneficial? Perhaps preserving privacy coins and anonymous crypto is important globally as a counterweight to growing government surveillance.
“The answer to this question is in the eye of the beholder,” said Byrne, adding that the desirability of privacy-enhancing technology is a political question. “I think the point of crypto is to make this technology so commonplace that it ceases to be a political question because its existence must be assumed.”
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cointelegraph.com