United States Senators have cast their votes, and the contentious HR 3684 infrastructure bill cleared in the upper Congress chamber. The House of Representatives now has the massive document of nearly 2,700 pages, which amounts to almost $1 trillion, and the provisions expanding the definition of cryptocurrency broker. This is to increase crypto and decentralized finance tax compliance (DeFi). It’s not possible for $1 trillion to be made from nothing, right?
Although the bill is in fact a follow-up to Financial Action Task Force (FATF), doomsayers already believe the end is near, haunted now by the fear of the dreaded Internal Revenue Service coming after their money. They are wrong as usual.
Not everyone is a broker.
For critics, one of the key points of contention is that Section 80603 of the bill defines “brokers” as anyone who is “regularly providing any service effectuating transfers of digital assets on behalf of another person.” Even this incredibly unclear language comes from an amended version of the bill, with an earlier one featuring an even broader definition. It could be even clearer. Although the bill requires brokers to report client information to IRS, critics worry that a broad definition could include everyone from miners and node operators to liquidity pool providers.
A compromise amendment was supposed to explicitly exclude blockchain validators from the definition, but it did not survive a vote, sunk by a defiant Senator. It is difficult to imagine how the original language could be used to the wider crypto ecosystem even if it is not amended by the House. “Effective transfers” on behalf of another person is not what miners and holders do. The entities that transfer value between users in the cryptoverse are decentralized and centralized exchanges. They are the market makers. Both types of brokers can introduce compliance tools to their platforms through software updates.
In the legal debates on content piracy back in Aug. 2007, BitTorrent wasn’t found liable for the enormous amount of copyrighted songs and videos shared freely via its peer-to-peer (P2P) protocol. Those leveraging the P2P protocol weren’t as lucky — Lime Group, with its LimeWire web service, was deemed liable for “contributory infringement” in 2010. It was the way they approached searches that made the difference. BitTorrent allows you to create a tracker of any file and then share it on a third party website to make it move bit-by-bit around a network. LimeWire supported file transfers via intrinsic search queries. LimeWire had a recommendation system. If LimeWire saw that you were downloading Spider-Man, it would recommend you download the movie. Similar to BitTorrent, miners facilitate generic transactions, but not necessarily value transfers. The party who coordinated the transaction facilitates the value transfer. This includes matching buyers and sellers with pricing information.
Another point is that DEXs often are not required to file tax information with the IRS. CEXs already have this capability. Why isn’t DEXs held the same standard as CEXs or other services that facilitate transfers of value such as PayPal? It is morally just and fair to bring them under the same umbrella as CEXs and other services that facilitate transfers of value, such as PayPal. For those who claim such entities don’t have a central administration to enforce anything, remember that DEXs often still have an owner whose wallet is generating the profits and that the majority of updates for open-source project projects come from the same entity. There’s always a way.
Innovation is not about packing up
Critics also warn that the bill, if approved, could drive the crypto community out of the U.S., which would dent the country’s potential for innovation. Fear not, there is no place to run. The crypto provisions in the infrastructure bill, as noted, are based upon the most recent standards issued by FATF (a global organization fighting money laundering). These standards are generally applied around the globe, though they may not be implemented in the same timeframe.
FATF first put its sights on cryptocurrencies in 2019, urging nations to tighten up the regulations on crypto exchanges. Numerous exchanges around the globe have been closed down since then for not complying with FATF standards. The latest guidelines target DeFi and nonfungible tokens (or NFTs), so it is not surprising that decentralized finance is a major concern for U.S. regulators. The process goes beyond the United States: Europe is also moving to tighten up crypto regulations, consistent with other laws controlling value transfer.
The playbook will become the same in all places sooner or later. The majority of the community knows this and would struggle to succeed if their businesses were banned.
There won’t be private data honeypots
Another concern is that brokers will have to file client data to the IRS. This will make it more difficult for them to create databases with private information about clients, which could be a honeypot — an attractive target for hackers. This does not take into account the effectiveness of crypto and DeFi communities that use secure cryptographic algorithms.
Consider the zero-knowledge proof: A cryptographic concept that zooms in on how to prove to a third party that you know the value of a specific variable without saying anything other than you know it. Users who keep their authentication data private can sign in to Zero-knowledge authentication without having to reveal any sensitive data. This algorithm is used for DeFi and can automatically generate all necessary forms and send them to IRS without the DeFi service needing to store the data. Similar to suspicious transaction reports, they can be automatically generated and sent to the regulator without needing to notify other entities.
The surveillance and privacy point also requires another parallel, with the social contract, written rules for value transfers and disclosure of financial services, and written rules. While spending $100 at your local shop, you can remain anonymous. You will need to provide more details about yourself to transfer $3,000 to a friend. If you wish to send $100,000 abroad the bank or customs entity may ask more questions. The money will also leave a more detailed financial trail. DeFi is no different.
Adapting is the key to success
We can see that most of the outcry over possible regulations does not stem from any legal or logical reasoning. The crypto ecosystem faces more compliance, which is a problem because it takes time and money to create the protocols and algorithms that make it work. Yes, there will be some people who have their income stolen from other illicit transactions, but not enough to make up a substantial portion of the crypto ecosystem.
Despite the fact that it might seem offensive to crypto-purists. More compliance equals more mainstream adoption. And more mainstream adoption equals more growth. Blockchain-based financial applications and services have the potential to revolutionize finance and bring real value for billions of people. It is not too expensive to comply with the law.
