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, the original author: Jai Ramaswamy, compiled by Odaily translator Katie Ku.
Over the past year, governments around the world have raised concerns about the risks of illicit financial activity, including money laundering, terrorist financing and evasion of international sanctions due to the use of non-custodial wallets. Such applications allow anonymous and private transactions of crypto assets over the internet, bypassing financial intermediaries.This concern is articulated in a recent study published by the Financial Action Task Force (FATF), an intergovernmental body established by the G7 countries in 1989 to issue and promote global action against illicit financial activity. Adoption of Regulatory Standards. The report acknowledges that non-custodial wallets currently pose limited risks compared to traditional financial channels, but nonetheless urges global regulators to consider various restrictive measures amid increased adoption.Measures suggested for consideration include transaction restrictions on non-custodial wallets, limiting the ability of regulated financial institutions to transact with them, and licensing or even banning platforms that support them.
The report echoes the concerns of U.S. policymakers about personal crypto transactions, and the U.S. has been at the forefront of eliminating and cracking down on illicit financial networks.
These proposals represent a clear shift in the field of global regulatory targeting.Similar proposals originated 50 years ago in the US when the Bank Secrecy Act (BSA) passed the worlds first Anti-Money Laundering (AML) regime. The BSA aims to address the illicit financial risks of cash (an earlier, more popular technology that enabled private transactions between individuals), curb the growth of organized crime and the rate of international narcotics trafficking. Despite the increased risk of illicit financing from cash,
Policymakers have traditionally avoided steps that separate private transactions from formal financial channels. Instead, they favor an approach in which financial intermediaries perform the critical aggregation and settlement functions that are key to providing financial intelligence to assist law enforcement investigations.
The BSA imposes recordkeeping and reporting requirements on financial institutions, which primarily require reporting suspected criminal activity to law enforcement agencies and maintaining customer acknowledgment information and KYC records, which law enforcement agencies can obtain by subpoena or other means or other laws program. The purpose of this is to prevent financial institutions from exploiting customer privacy to conceal their own and customers complicity in illegal activities. Financial intermediaries in Swiss banks and other banking secrecy jurisdictions have used this tactic in the past.
Although not always recognized, all AML regimes involve trade-offs between financial integrity, financial privacy and equally important social values of financial access or inclusion. AML is no exception, reflecting choices about acceptable levels of illicit financial activity, balancing the goals of financial inclusion and financial privacy. On the one hand, it accepts the risks posed by private financial transactions given the countervailing benefits to financial privacy and economic opportunity. At the same time, it implicitly accepts the tangible costs of record-keeping and reporting requirements that increase financial transparency but adversely affect access to financial services. Not ignoring the intangible costs of mandatory third-party surveillance in terms of financial privacy, but limited to preventing government abuse of it in criminal proceedings. Customer records are protected by statutory financial privacy rights, except for disclosure of suspected criminal activity to law enforcement agencies. However, fines and possible prison terms, including in connection with criminal proceedings and other legal proceedings, prohibit the publication of so-called suspicious activity reports (SARs). SAR itself cannot be used as evidence; instead, law enforcement agencies must obtain evidence through other legal means, including subpoenas.The principles of the original AML regulations have been globalized through a series of recommendations issued by the Financial Action Task Force in 1990 and have evolved over time to include responses to terrorist financing, international sanctions and other Measures for Emerging Threats. The recommendations include basic obligations such as identifying customers, KYC requirements, the so-called travel rule, and suspicious activity reports, which require disclosure of possible criminal activity. Although FATF recommendations have evolved over time, they still reflect
The fundamental principle at the heart of AML that financial transparency through intermediary regulation is the most effective means of combating illicit finance consistent with the values of financial privacy and financial inclusion.In 2013, the Financial Crimes Enforcement Network (FinCEN), the agency within the U.S. Treasury Department that oversees anti-money laundering, issued guidance for applying these basic principles to the nascent cryptocurrency industry. FinCEN’s guidance states that only financial intermediaries acting on behalf of clients should be subject to AML recording and reporting requirements as a “money services business” (MSB), consistent with its core principles, excluding “users” of cryptocurrencies outside its scope.The FinCEN guidelines were then incorporated into the revised Financial Action Task Force recommendations released later that year, which have become the basis for laws passed around the world to mitigate the risk of illicit financing posed by crypto-assets. They are committed to lowering standards across all jurisdictions by extending existing recordkeeping and reporting requirements already imposed on traditional financial institutions to cryptocurrency exchanges, custodians and other “virtual asset service providers” (VASPs). to minimum. The scope has now been expanded to include financial intermediaries serving the developing crypto ecosystem.
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Shifting regulatory priorities in response to the rise of Libra and DeFi
The Financial Action Task Force report released earlier this year presented the results of a year-long study to monitor the progress of jurisdictions in adopting its recommendations and reflected a trend of increasing anxiety in the cryptocurrency industry over the past year , which could upset the consensus balance between the cryptocurrency industry over the past 50 years on competing issues of financial transparency, financial privacy, and financial inclusion. This anxiety is fueled by the industrys rapid innovation, often led by startups facing structural constraints to profitable growth.
The release of the Libra white paper changed perceptions of the industry overnight, raising the possibility that global tech companies with large user bases could drive adoption of crypto assets to levels comparable to traditional money flows. Furthermore, although Libra itself has withdrawn plans to develop a fully distributed blockchain network to support non-custodial wallets, rapid innovation will lead to a large number of distributed protocols allowing non-custodial wallets to run on mobile devices to support stable value All of these have the potential to increase mainstream user adoption of personal cryptocurrency exchanges.
Viewed in this light, personal cryptocurrency transactions appear to combine the benefits of cash with the convenience of electronic payments, but without the physical constraints of the former and the risk controls of the latter, leading some to describe non-custodial wallets as Swiss personal bank accounts enhanced for global reach via the Internet, a risk highlighted by the Financial Action Task Force over the past five years. Policymakers worry that the full maturity of these distributed protocols could herald a future without financial intermediaries, which would severely limit law enforcements ability to identify, prosecute, and disrupt illicit financial networks.However, there are also good reasons to believe the opposite is true, namely that individual crypto transactions pose less risk of illicit financing than is commonly believed. A wallet without custody is more like a personal wallet than a Swiss bank account. Unlike cash, cryptoassets are not legal tender and therefore still not universally accepted for goods and services in the real economy. Although certain exceptional circumstances, such as hyperinflation or severe currency devaluation, give cryptoassets certain attributes in specific regions or darknet markets where illicit goods and services are priced in cryptoassets and payments, but these are unlikely to lead to sweeping and global changes in consumer behaviour.In fact, even illicit actors (similar to legitimate businesses or individuals) must eventually convert between crypto assets and local fiat currencies to meet basic needs and operate their businesses.
It is theoretically possible to imagine a world in which crypto assets could serve this purpose, however, the future remains uncertain. For entrepreneurs launching crypto projects, this reality has long been clear. They are challenged on a daily basis how to grow organically without responding to liquid fiat currency up and down. Despite the proliferation of other crypto assets over the past decade and the growing market share of fiat-backed stablecoins, Bitcoin has continued to maintain market dominance. The important reason is that Bitcoin can be converted into fiat currency through regulated intermediaries.
Perhaps most importantly, policymakers must adapt to technological change to fuel the rise of decentralized blockchain protocols. These changes have the potential to alter the architecture of the internet, break down the distinction between communication and settlement of value on the network, and reinvent some of the way we think about financial services, particularly in terms of driving financial inclusion. Crucially, these were primarily technological advances, leading to financial innovations. Therefore, policymakers who want to ban or limit their development and use should make it clear that the momentum of cryptocurrency development is unstoppable.
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Demystifying Blockchain TechnologyAlthough originally associated with Bitcoin, blockchain is more than just a financial technology. They are an emerging family of cryptographic protocols that solve a fundamental problem that generations of computer scientists avoided before the original Bitcoin white paper, namely, how to create a resilient network that is free from single points of failure.
Blockchains avoid relying on a central server as a single source of truth in favor of consensus among a distributed network of computers, and they do this by allowing anyone who wants to participate in the operation of the network to download and run open source code, which results in stored A redundant copy of the public ledger on every networked computer. This distributed ledger is public and viewable by anyone, increasing community trust in its content. New information is recorded in the ledger only when a majority of computers agree with the captured information. Consensus-based mechanisms help to better defend against malicious attacks than server-based networks, making the network more resilient, since successful attacks require acquiring or compromising a majority of networked computers, rather than a single central server. Resilience increases as the network scales, as it becomes increasingly difficult for malicious attackers to gain control. Distributed web-based applications are in their infancy but are beginning to be used for a variety of functions not limited to financial services, including network security, secure file storage and private web browsing that can support Web 3.0 development.
Blockchain protocols stimulate economic incentives to overcome collective behavior problems inherent in consensus-based computer networks that do not know or have reason to trust each other. They reward consensus users by using cryptographic assets that can be freely sent between network users. These cryptoassets are actively traded in secondary markets, and their prices appear to reflect the scale of network usage, giving holders an economic stake in the integrity of the network. Being a network-based technology effectively opens up network operations to dynamic groups of user-operators whose composition can change over time and share the economic benefits of network success, potentially mitigating the current concentration of economic power in networks Degree is very important in establishing secure ownership of encrypted assets.
Ownership is recorded on the distributed ledger by associating a network users unique identifier (their public address) with the cryptoasset belonging to them. However, the transparency of the ledger exposes holders of crypto assets to potential risks of theft and fraud. Therefore, encryption algorithms built into the protocol address this vulnerability by allowing users to create private keys known only to them, which generate a public address, which cannot be reverse engineered. Since assets can only be sent from public addresses by the holder of the private key, users can not worry about sharing their public wallet addresses, unlike bank account numbers, allowing them to be used as secure pseudonyms for blockchain transactions. Private keys are the fundamental functionality that enables users to interact on a blockchain network, and the ability to generate private keys can be accessed through a native command-line interface included in the open-source protocol. After generation, users need to keep their private keys properly. Theft or loss of private keys will lead to permanent loss, thus making encrypted assets a digital carrier tool owned by the private key holder.
In contrast, what regulators call “custodial” wallets are not real wallets at all. They are internal accounting systems maintained by virtual asset service providers who actually hold one or more cryptographic key pairs that they use to aggregate their clients assets. Clients have contractual rights to some of the assets held by the virtual asset service provider. “Custodial wallets” replace the inherent transparency of blockchains with the artificial opacity of private ledgers. Importantly, transactions via “custodial” and “non-custodial” wallets are indistinguishable on the blockchain, and they both appear as pseudonymous encrypted transactions on the public ledger.
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Restricting individual cryptocurrency transactions is impractical and ineffective
Since personal cryptocurrency transactions are an inherent property of blockchain technology, rather than an incidental feature enabled by non-custodial wallets, restricting their use would require prohibiting the development of the blockchain protocol itself, or requiring the protocol to only support custodial wallets, which is equivalent to Same thing, something that is actually very difficult to accomplish. Most blockchain technologies are open-source and freely available to anyone with an internet connection who chooses to connect to the network. Restricting the release of open source software faces constitutional and policy hurdles, at least in the United States, and will likely require some level of repression anyway, raising fundamental questions in any open and democratic society. Perhaps more importantly, the practical experience of countries that have attempted to impose formal or informal restrictions on cryptoassets has demonstrated their ineffectiveness. Despite attempts to limit or limit its general usability, blockchain technology and crypto assets have grown rapidly in countries like Lebanon, South Korea, which eventually abandoned the approach.
Regulating the use of open source software by establishing licensing requirements for software agreements or mandating the inclusion of certain features in them is less likely to succeed than attempts to ban open source use.
First, financial regulators should carefully consider whether they have sufficient knowledge and experience to manage the technical decisions of software developers. Although financial regulators have extensive experience in regulating the risk management practices of financial institutions suppliers, these efforts have focused on assessing the effectiveness of controls put in place to minimize disruption to core operations, rather than assessing and managing Technology development, regulators wisely do not do. Regardless, the successful implementation of such a licensing or regulatory regime is likely to prove a difficult victory. Open source protocols are inherently developed by a community of developers spread across the globe, and thus are not subject to the regulatory regime of any single country or region. Licensing restrictions will not have any impact on the development of the technology, it will only push it to countries that do not have similar requirements. Unless accompanied by repressive measures to restrict the flow of information, such restrictions will not affect its usability in these jurisdictions, especially for illicit actors seeking to misuse the technology.
Global policymakers are also considering more targeted approaches, such as requiring virtual asset service providers to verify the identity of non-custodial wallets their customers transact with. However, this approach does more harm than good and ultimately fails to mitigate the risks of illicit financial activity. They effectively established KYCC (know your customer/counterparty) requirements that have traditionally been rejected by financial regulators. Unlike KYC requirements arising from a direct customer relationship, KYCC unreasonably requires non-customers to transact with a virtual asset service provider/money services business they do not know or deal with, and whose security and privacy practices they have not assessed VASPs/MSBs provide personally identifiable information simply because they happen to transact with one of their customers. Collecting identity information from individuals who are not customers will also pose challenges to virtual asset service providers and may limit access only to legitimate customers, especially those who benefit most from financially disadvantaged communities because of illegal Actors would simply use so-called money, or use stolen and synthetic identities, to break that requirement, as is done with KYC requirements today. The result would be to further exclude financially marginalized populations and hinder innovation that could address their needs without materially impacting illicit financial activity.Banning or restricting individual cryptocurrency transactions is not only impractical and ineffective in stopping illicit financial activity, but would also undo the efforts of previous efforts in the fight.
The most likely outcome of these and other efforts to regulate, limit, or prohibit the development and use of open source software will be to drive private cryptocurrency activity away from regulated, transparent financial intermediaries that can report to law enforcement Provide actionable information. Law enforcement and regulators will find themselves playing whack-a-mole to solve the problems they create. In summary, restrictions or bans on blockchain protocols ultimately result in less efficient use of law enforcement resources.
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Cryptocurrency is the solution, not a problem to be solved
Paradoxically, the most effective way to minimize the misuse of blockchain technology for illicit financial activities is to embrace the industry trends driving decentralized protocols, rather than attempt to inhibit or limit their development and use. While policymakers often openly acknowledge the regulatory benefits of transaction traceability, they have struggled to truly appreciate how the inherent transparency of blockchain could change the way we think about combating illicit financial activity. In particular, far from being an end in itself, mandatory financial surveillance aims to overcome obstacles to law enforcement investigations arising from the fundamental anonymity of cash transactions and the role of financial intermediaries in aggregating and settling private ledgers. Banks and other traditional financial institutions spend a lot of money implementing transaction monitoring systems that often generate more than 90% false positives and require a lot of investigators to sort through. The government then invests significant resources in its own data analysis tools to eliminate this erroneous data and identify trends and clues to support law enforcement investigations. In addition, subject to legal restrictions, the government strives to share information with financial institutions, which will provide the necessary environment to generate high-value SARs. While public authorities in the US, UK, and elsewhere have had some success in addressing these issues through public-private partnerships that facilitate information sharing, these arrangements face obvious limitations in terms of scalability.secondary title
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