The cat’s out of the bag on crypto regulations, forcing some companies to choose between their principles and their profits.
Crypto was taking off, and governments were finally starting to act like it. In 2013, when a young writer and software developer named Vitalik Buterin wrote an impassioned screed defending the blockchain gospel for his publication, Bitcoin Magazine, cryptocurrencies were still a niche curiosity. But a series of regulations was spooking the nascent industry, threatening the sort of anti-government ethos that has always been core to the project. For Buterin the panic felt a little overblown. Crypto, he argued, couldn’t truly be regulated. After all, this was the whole point of the new system: an internet with no masters, no mediators, and no guardrails. “The future of crypto-libertarianism is fine,” he wrote. “Stop worrying.”
This is the promise crypto advocates have sold consumers and politicians over the past decade, as crypto has blown up into a trillion-dollar behemoth—in the process making Buterin, now best known as the founder of the Ethereum network, very, very rich. (Buterin’s Ethereum Foundation did not respond to a request for comment.) Even as crypto has wormed its way into the mainstream, the argument goes, the tech was constructed in such a way as to prevent meddling on the part of banks and governments. For example, Jesse Powell, CEO of the Kraken exchange, has referred to crypto networks as “censorship-resistant rails of last resort.” And the venture-capital powerhouse Andreessen Horowitz, now the foremost backer of crypto start-ups, has invoked that same idea in promoting its multibillion-dollar funds.
But what might have rung true in 2013 doesn’t hit quite as hard in 2022. Thanks in part to its attempts to garner mainstream recognition, crypto is now rubbing up against renewed governmental scrutiny. In recent weeks, a subtle yet significant move from the Treasury Department has exposed some of the rhetorical misconceptions at the heart of the industry, suggesting that the tech can be meddled with after all.
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For all the talk of crypto as a slick new alternative to a corrupt and outmoded banking system, companies have now found themselves backed into a corner: Either they can comply with regulations that could essentially defang the promise of the technology, or they can stay the course, at great cost to their bottom lines. And for the most part, companies look to be choosing the easy way out, principles be damned. It’s a sign that crypto is growing up from its youth oriented around building a new financial system, instead evolving into something like a new wing of Big Tech. The more crypto matures, and the more it integrates into the existing scaffolds of American capitalism, the more it strays from its core ideals.
The panic began in early August, when the Treasury Department decided to sanction a program called Tornado Cash, essentially forbidding any person or business in the U.S. from interacting with it in any capacity. Tornado Cash is a tool that makes Ethereum transactions more or less untraceable, scrambling the paper trail on a famously transparent blockchain. It’s great for well-meaning privacy enthusiasts worried about prying eyes, but it’s also great for cleaning up dirty money: State-backed North Korean hackers reportedly used the program to launder more than half a billion dollars’ worth of Ethereum in April.
Tornado Cash isn’t all that popular of a program, but the implications of the sanctions are far-reaching. It threatens to affect how the entire Ethereum blockchain—now the second-largest crypto network after bitcoin—functions in practice. Permit me a moment of crypto-splaining: When you ask your computer to send some Ethereum to a friend, you need to wait for another computer in the network to verify the transaction, ensuring that you have enough money to send and that it’s going to the right address. Without that go-ahead, the money is stuck in limbo.
Right now, that happens through a process called “mining,” though Ethereum plans to replace its miners with a new, more energy-efficient system of “validators” later this month. Technically anyone can be a validator, but because validation requires having lots of crypto on hand, it’s mostly companies that do this work, pooling together customer funds and taking a cut of the profits. According to Decrypt, more than 60 percent of the validation will go through four companies. And if the computer doing the validating belongs to an American company (even if you yourself are not based in the U.S.), it will need to abide by the sanctions, making it harder for anyone anywhere in the network to use Tornado Cash.
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The end result risks what crypto has always wanted to avoid: censorship. Because the companies behind these validators are subject to punishments for violating the sanctions, the reality is that your money can be effectively frozen by a watchful government. It’s a small dent in the armor that is Ethereum’s resistance to censorship, and one that may not necessarily affect more casual users—but the fact that the armor can be dented at all is telling. Who knows what the Treasury might decide to sanction next? “It reveals what was true all along,” Angela Walch, a law professor at St. Mary’s University who studies crypto, told me. “The cat’s out of the bag for both regulators and the crypto sector that [censorship resistance] is kind of a myth.”
American validators have no good options here. If they choose to comply with the sanctions, they’re conceding that governments can meddle in transactions after all, and potentially allowing innocent bystanders to get caught in the crossfire. If they don’t, they risk violating Treasury Department guidelines—a move that’s not particularly sustainable for a growing industry.
In practice, companies will need to either comply with the sanctions and renege on their Don’t Tread on Me roots, or simply halt their validation businesses altogether, skipping out on gobs of money in the process. “For crypto companies, this is where the rubber is meeting the road,” Walch said. “Their talk about this being a democratizing force, and ‘neutrality is important,’ and ‘everyone should have the ability to freely transact’—okay, are you going to follow the law, or are you going to follow the purported ethos of the space? We’re hitting the point where you’re not going to have it both ways anymore.”
No one should be surprised that the denizens of crypto Twitter—that twisted artery through which all blockchain-related discourse seems to flow—are lobbying for the latter option. To the faithful, the choice of how to respond to these sanctions is almost a moral issue. If you’re willing to comply with the Tornado Cash sanction, the thinking goes, maybe you never really cared about what made the blockchain special to begin with. A crypto YouTuber suggested that if Ethereum validators capitulate to the sanctions, the whole system would be “for beta males.”
A few crypto leaders are not backing down. Buterin, more a technologist than a company man, is on record as saying he would opt to punish validators who comply with the sanctions. Coinbase CEO Brian Armstrong, arguably the most influential executive in the American crypto sphere, has said the same of his company’s validators; yesterday, the exchange announced that it’s bankrolling a lawsuit against the U.S. Treasury over the sanctions. When Ethereum upgrades later this month, Coinbase will control an estimated 15 percent of the market for the network’s validation process, making it one of the most powerful individual actors in the system. Shutting down a portion of a business that’s poised to create major gains for Coinbase, especially on the heels of a particularly bad quarter, would be borderline disastrous. (A spokesperson for Coinbase pointed me to a webinar it hosted to discuss the fallout of the sanctions, but declined to comment further.)
But by and large, most companies have so far stayed mum on this question. For some, the silence could represent genuine confusion as to how exactly they’re meant to conform to the sanctions. For others, though, it may be just a way of passing the buck: The industry seems to be more concerned with enshrining its place in the American financial system than with taking an ideological stand at the expense of profit, and it’s possible an official statement to that effect would only inflame the community. Last week, a spokesperson for Kraken, which runs an Ethereum validation business alongside its exchange, said in an email that the company is “carefully monitoring the discussion on the potential implications of Tornado Cash sanctions for validators,” but refrained from expanding on how it plans to comply with the new sanctions. A 2018 mission statement from Jesse Powell might give you a hint as to where the company is headed, however: He wrote that his “ideological motivation” to build a world-class exchange was entirely dependent on “working with regulators.” Lido Finance, another prominent source of validators, didn’t respond to multiple requests for comment.
That companies are finally confronting these issues is a sign the industry is maturing, for better or for worse. Crypto was originally conceived as an alternative to traditional finance, a way of sidestepping the big banks. But what happens when the new system grows into the old one? When Buterin wrote his blog post a decade ago, a single bitcoin cost $120. At the heart of last year’s surge, that price hit $69,000. In 2022, venture-capital firms and investment banks are putting billions into the idea that crypto will have some role in the future of global finance. Blackrock has a private Bitcoin trust for its clients, and JPMorgan Chase, Morgan Stanley, and Goldman Sachs all have dedicated crypto divisions.
In this new era, companies will have to decide: accept the reality of regulation and continue to grow their businesses, or find some way of skirting the new rules entirely. At least, they’ll finally have to pick a side.
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