In the past, cryptocurrency regulation in the US has been severely fractured. Federal agencies not only failed to cooperate but openly contradicted each other and cajoled each other in a turf war to control our nascent industry.
But recent signals from regulators suggest a move.
Earlier this month, the SEC and CFTC released a Memorandum of Understanding to address past errors and improve coordination for greater regulatory clarity. Even more importantly, the two agencies issued joint guidance last week on how securities and commodities laws apply to crypto assets.
This is outstanding progress and a useful step in bringing crypto innovation back to the country. Still, there are other critical areas where disagreements between agencies create unnecessary uncertainty for American businesses and consumers. First are the rules on financial privacy.
The United States does not have a single privacy regulator. Instead, financial privacy is affected by the actions of the Treasury Department, the Department of Justice (DOJ), and the SEC, just to name a few. And when those agencies diverge, uncertainty arises.
Treasury’s 2019 guidance on non-custodial crypto services was later contradicted by the Department of Justice’s enforcement of the law against the creators of privacy software Tornado Cash. Only recently has the Justice Department softened its position, while the Treasury has reopened the conversation through a request for comment. A subsequent Treasury report noted potentially valuable and legal uses of privacy-protecting technology like mixers, even as it raised the possibility of rescinding its own 2019 guidance. Separately, several SEC commissioners have lately questioned whether the mandatory data collection regime imposed on financial institutions has outlived its useful life.
This is a lot of back-and-forth with potentially significant consequences for software developers and anyone who wants privacy for personal or financial reasons. But while the stakes are high, this entire government re-examination is long overdue. For many years, we normalized mass data collection stemming from the Bank Secrecy Act of 1970. The logic was simple, but persuasive: why be afraid if you have nothing to hide?
But there is a growing recognition that our extensive financial surveillance regime has become a government panopticon at odds with our democratic values. Banks and other financial institutions are obliged to spy on customers and hand over their data to the government at the slightest suspicion. After decades of excessive enforcement and sanctions, many institutions have learned to err on the side of excessive disclosure.
Financial institutions in the United States and Canada spend billions of dollars annually on compliance. But that’s just the tip of the iceberg. The even greater cost of this surveillance is the loss of privacy deadweight: economic and social activity that never occurs because participants are forced to make a false choice between revealing everything or not participating at all.
This effect is visible throughout the financial system. Consumers and merchants continue to pay high fees to use credit cards, even though blockchain-based payment systems could perform the same function at a fraction of the cost. Financial institutions rely on a settlement infrastructure designed decades ago, with all the costs, delays and errors that come with manual processing from the pre-Internet stone age days.
These outdated systems persist because we have not yet created a financial privacy framework for the digital age. When a system requires full exposure, rational actors choose not to do so. Banks, asset managers and market makers will not move their operations to a system where own strategies, client positions or portfolio construction are revealed to everyone.
The good news is that we have the technology to solve all of these problems. Modern cryptography, like zero-knowledge proofs, allows participants to demonstrate compliance, creditworthiness, or eligibility without revealing underlying data. As a result of these advances, fully private transactions can be carried out on fully public blockchains.
If we can do it for securities and commodities laws, we can do it for financial privacy. Much of our legislation already recognizes that financial privacy is not only an important civil liberty, but also an essential economic good. Software developers and market participants do not need loopholes; They need to know what the law requires of them. Because if the last few years have taught us anything, it is that markets don’t fail only when the rules are incorrect. They also fail when uncertainty prevents participants from showing up.
