The cryptocurrency-regulated cat and mouse game is fully upgraded. Who will be the final winner?

About the author: Michael J. Casey is chairman of the CoinDesk Advisory Board and a senior consultant for the blockchain research at the Massachusetts Institute of Technology (MIT) Digital Currency Initiative.

There has been a ruthless cat and mouse game between regulators and cryptocurrency developers. This time, "cats" will add some powerful firepower in the form of a global alliance.

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However, if you think that the “know-your-customer (KYC) compliance standard that the upcoming Financial Action Task Force (TATF) is about will mean the end of the mice, then you It’s a big mistake. The FATF's move is expected to be released next month, and if there is any impact, it will prompt developers to accelerate the development of unmanaged exchanges and other tools, making it easier for end users to work outside of regulated intermediaries. Trading.

As CoinDesk executive editor Marc Hochstein explained last week, the new rules may require exchanges and other escrow entities that are responsible for hosting cryptocurrencies to obtain identity information about the parties to the transaction before allowing transactions through their platform.

Much like the FATF's “Travel Rule” for correspondent banks, the new regulatory approach will be supported by the unique powers of the special working group's member institutions, and if these institutions are judged to be non-compliant, the FATF has the right to include the entire country in “grey”. The list" and eventually blacklisted.

When combined with the EU's forthcoming AMLD5 anti-money laundering regulations for cryptocurrencies, this new framework is reminiscent of a comprehensive global system of cryptocurrency transactions in which no single user can escape regulatory requirements.

Has Nakamoto's vision been ruined?

Critics of cryptocurrencies have deep-rooted liberal ideas that they see as a damn monitoring system that violates the anti-censorship principles established by Bitcoin.

From a practical point of view, the new rules will be a heavy burden on the custody of the exchange. This may spur industry consolidation as smaller participants may find compliance costs too high. In a report to the FATF, blockchain analysis firm Chainalysis pointed out that the new rules are impractical and will drive more cryptocurrency activities into the service sector, making it more difficult for authorities to track illegal activities.

Regrettably, these regulations may also exacerbate the “de-risk” problem of excluding billions of unidentifiable people in developing countries from the global financial system.

But not all things are like this. In most countries, it is not illegal to hold and keep cryptocurrencies. Moreover, as the guidelines issued by the Financial Crime Enforcement Network (FinCEN) recently stated, at least for now, global regulators will not implement the same KYC requirements for self-hosting wallet software vendors.

Then, beyond the ecosystem of the custodians regulated by the FATF, what may arise is a completely independent economic system in which peer-to-peer exchanges are conducted between those who control their own cryptocurrencies.

If you are hosting through Coinbase, you will no longer be able to send or receive cryptocurrencies if you pass the KYC program, including receiving currency from any old Bitcoin address. Once you transfer your funds to an unmanaged account, you are free to send them to any self-hosted address, but if you have never officially associated your identity with that address through a supervised entity, you will not be able to contact the Coinbase address. Or trade at an address managed by any other regulated hosting provider.

However, the key is that this strict regulatory framework still leaves room for Nakamoto's vision of the p2p payment system. As more technical and business model development work progresses, the system is likely to become quite large.

In fact, the new rules may prompt developers to address core technology and liquidity challenges more rigorously, limiting the use of self-hosted cryptocurrency wallets. These challenges are divided into three categories: security, market coordination and the French currency channel. Currently, the three categories have made significant progress.

safety

One of the key motivations for people to hold cryptocurrencies through hosted services such as Coinbase is that they are not willing to risk placing their private keys in the wrong place or stolen. Stories about hacking and loss of cryptocurrencies abound, and for a long time, these stories have been preventing newcomers from "keeping their own cryptocurrencies."

In recent years, secure hardware wallets such as Ledger and Trezor have made it easier for people to control their cryptographic assets without exposing their private keys to cyber hackers. But security experts claim to have discovered the vulnerabilities. And for people who don't understand, the user experience is still very inconvenient.

However, the new generation of smartphones with military-grade security and end-to-end encryption technology should make it easier for users to securely store cryptocurrencies on a local device that can easily connect to the Internet for global payments. HTC is ahead of this technology. Samsung is catching up.

Mobile phone manufacturers are using complex, locally stored biometric identification to link users to control in ways that are tamper-proof. When combined with multi-signature technology, a humanized key recovery solution (such as seed phrases saved with trusted partners) and some education, the risk of loss can be reduced to a negligible level.

Other changes in the ecosystem, such as decentralized insurance plans, and more aggressive measures that require mobile operators to take responsibility for “SIM card exchange” attacks (such as causing Michael Terpin to fight a hacker and AT&T) Long-lasting legal warfare events will also enhance people's confidence.

As time goes by, more and more people will feel more at ease with their own private keys.

Market coordination and legal currency channels

The next challenge is to reduce the general reliance on host-based exchanges.

Users of cryptocurrencies need to buy and sell effectively, and so far they have to rely on centralized exchanges, and centralized exchanges are the main goal of the new regulations.

The answer lies in the rapidly growing decentralized exchange (DEX) sector. In this area, trusteeship is reserved by investors, while technologies such as atomic exchange allow seamless point-to-point asset transfers, and neither party can deceive the other party.

As an emerging technology, it is currently difficult for DEX to achieve the same level of liquidity as larger centralized exchanges, which makes them less attractive. However, with the release of a DEX beta, the field is likely to grow rapidly.

At the same time, Boston-based startup Arwen launched an agreement that allows investors to access the matching engine of a large centralized exchange, but allows them to retain custody through a smart contract solution, so they can keep their own encryption currency. KuCoin has integrated the beta version of the technology into its exchange.

Even if decentralized exchanges and self-hosted transactions can help the currency transactions move away from the regulatory network, they cannot solve the problems associated with the legal currency channel. Currently, this service is almost exclusively provided by regulated centralised exchanges.

The solution lies in a series of new stable coins, of which the dollar-linked tokens, such as MakerDAO's algorithmic solution Dai, are competing with the reserve-backed stable coins such as Gemini and Paxos and the consortium led by Circle and Coinbase.

In theory, there is no technical means to prevent these stable value tokens from entering and exiting unidentified self-managed wallets, which provides a way to solve the problem of the legal currency channel, enabling people to obtain de facto dollars (if not actually Dollar). Only when users convert them into actual dollars through the company that issued the tokens will they enter a regulated environment and must indicate their identity.

Facebook fights against banks?

Now all of these services must be supported by real legal currency resources, which means that stable currency providers and DEX software vendors still need bank accounts. Given that banks have been reluctant to support cryptocurrency operations, access to bank accounts may be a potential barrier for start-ups looking to develop in this ecosystem.

In this way, banks may continue to be the wedge for regulators to impose restrictions on the unregulated cryptocurrency industry.

However, as I pointed out elsewhere, banks are increasingly interested in the development of other blockchains, such as the development of token-based stock and bond issuance markets, which will encourage them to support token-based payments. This will ultimately require a more friendly approach to some of these service providers, especially stable currency providers.

Most banks are reluctant to hand over the future of legal currency payments to competitors such as JPMorgan, and are not willing to turn Facebook into more than 2 billion active users into an instant global payment network that bypasses banks. The irony is that this may bring them closer to these rebel suppliers who support self-hosting services.

In other words, the cat and mouse programs will continue, don't change channels.

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