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FinCEN Oversight Hearing: Foster + Davidson Comments
In a hearing last week, Representatives Bill Foster (D-IL) and Warren Davidson (R-OH) both made comments about peer-to-peer transactions and self-custody that warrant a close read and some discussion.
On Thursday, the House Financial Services held an oversight hearing on the Financial Crimes Enforcement Network (FinCEN), the U.S. agency responsible for enforcing anti-money laundering laws. FinCEN’s Acting Director Him Das testified.
Representative Foster noted FinCEN’s “notable success” in using new tools like blockchain analytics to combat illicit activity involving cryptocurrencies. He continued:
However, I worry that we are much less equipped to handle instances where transactions involve self-hosted wallets, or generally off exchanges… if we end up with a regulatory regime where bank accounts are not needed to create or access a digital wallet, what might the regime that works to prevent money laundering, ransomware, and so on, how would you monitor something like KYC compliance if it’s not tied to a bank account?
On net, Foster said that he believes
Ultimately, it seems like what you're going to need is some sort of a internationally operable crypto driver’s license that you attach to every crypto transaction that you can use when you see a crime has been committed, for example, you can go to a trusted court system and get that de-anonymized. And find out When your screen locks up with ransomware, you have to be able to go to a judge and say ‘here’s the proof the crime has been committed and I want to know who owns that wallet.’ And then have the judge in a trusted jurisdiction—that’s an important part. That seems to only work if you have something like a crypto license attached pseudonymously to every transaction.
Later in the hearing, Congressman Davidson responded to Foster’s comments:
Perhaps the most disturbing thing that I've heard is the idea that to access your own money that you need to get some identity, some globalist conforming identity stamp, and then everything that you want to do is tracked and monitored. And then when they want to rewind the tape and figure out who it was, they may not even need to get a warrant… I think that the way we protect our way of life is by being less like China and more like America, because this is exactly what China is in the process of implementing. And when [constituents] hear the things you’re working on, people back home hear that is exactly what you’re part of building, a system—frankly a dystopian system—where the average citizen needs to get permission to access their own money. I think that’s why the self-custody of crypto, basically if you download software and you use it, somehow you could become a criminal under [the Mnuchin Midnight Rulemaking on crypto wallets].
(Congress also remains focused on the potential use of cryptocurrencies and privacy software to evade sanctions, and several democratic representatives asked Acting Director Das for his views on the topic. Das generally reiterated the position of several Biden administration officials, saying that FinCEN is monitoring the situation diligently but that “again, we have not seen large scale evasion through the use of cryptocurrency….”)
What does this mean for DeFi?
Foster’s comments and Davidson’s response to them encapsulate a debate critical to both DeFi and cryptocurrencies: under what conditions citizens may exercise their right to self-custody their own digital assets.
Foster’s curiosity (mixed with some apprehension) is understandable in that the disintermediation of financial services, which gives individuals the ability to directly conduct a range of economic activities online, renders inapplicable many of the tools and tactics regulators have developed to pursue policy objectives in the traditional financial system. In this instance, for example, Foster’s comments related to AML/CFT controls, many of which traditionally are predicated (legally and practically) on the intermediation of financial services. And the same tactic—regulating financial intermediaries to achieve policy objectives—is mirrored across the entire traditional financial regulatory regime.
In this context, one of Foster’s questions is worth a close read: “if we end up with a regulatory regime where bank accounts are not needed to create or access a digital wallet, what might the regime that works to prevent money laundering, ransomware, and so on, how would you monitor something like KYC compliance if it’s not tied to a bank account?”
The first clause of the quoted section, “if we end up with a regulatory regime where bank accounts are not needed to create or access a digital wallet…” (emphasis added) raises a very fundamental question: should a regulatory regime adapt to innovation, or should innovation adapt to a regulatory regime? In other words, should innovation be allowed to threaten the utility of existing regulatory tactics? Yes! We’d be in for a world of hurt if individuals’ creativity and ingenuity—be it in the fields of business, science, or ideas—were limited to the confines of existing regulatory frameworks—which are not known to be terribly fast moving or innovative. Doing so would prescribe the acceptable bounds of innovation to our current understanding and knowledge of the world, meaning not much would be all that innovative.
The two clauses contrast with one another in an important—and revealing—way. First, the Congressman asks, in a digital commercial ecosystem without intermediaries, “what might the regime that works to prevent money laundering, ransomware, and so on” look like? In a way, Foster answered his own question when he lauded FinCEN’s use of new tools , e.g. blockchain analytics, to pursue in cryptocurrency markets its longstanding policy objective of preventing illicit financial activity. None of these tools existed ten years ago, and law enforcement developed them in order to adapt to the ever-changing ways through which people conduct economic activities. (Indeed, FinCEN has long depended on totally different methods to monitor peer-to-peer transactions (like those using cash) and intermediated transactions involving financial institutions.) But back to the quote. Here, Foster’s question is spot on; it’s really *the question* in a lot of ways: how do we adapt our approaches (or create new ones) to achieve our long-standing policy objectives in new systems? This idea stands in contrast to the final clause of Foster’s quoted comments. The question for policymakers and regulators should not be how to apply existing regulations and tactics to innovative systems, which Foster asks: “how would you monitor something like KYC compliance if it’s not tied to a bank account?”
Turning to Congressman Foster’s answer to all of these questions (the digital ID proposal he described), we’ll let Representative Davidson’s response speak for itself.
*All this being said, Congressman Foster is clearly thinking deeply and thoughtfully about questions that matter to the future of the United States. The only way we’ll end up with good policy outcomes for DeFi is a robust competition of ideas, and we appreciate him for being an open-minded participant in the debate.*
OECD Letter
On Thursday, the Blockchain Association and we submitted a joint letter to the Organization for Economic Cooperation and Development’s public consultation on their proposed framework for tax reporting in the digital asset ecosystem. (Broadly when it comes to DeFi, the proposal fits squarely in the “how do we apply existing regulations and tactics to innovative systems” camp/phase.)
Below is the portion most relevant to DeFi, concerning which entities are “intermediaries in scope” and therefore obligated (like brokers) to comply with tax reporting requirements (citations omitted).
“We have significant concerns with the report’s proposal to include non-intermediaries as intermediaries in scope. The CARF defines Reporting Crypto-Asset Service Providers (‘Reporting CASPs’)—entities that would be required to report information to tax authorities—as
“‘any individual or Entity that, as a business, provides a service effectuating Exchange Transactions for or on behalf of customers (which for purposes of this definition includes users of services of Reporting Crypto-Asset Service Providers), including by acting as a counterparty, or as an intermediary, to Exchange Transactions, or by making available a trading platform.’
“The core of this definition is consistent with the obligations of businesses traditionally subject to tax reporting requirements, i.e., businesses that ‘effectuate’ financial transactions ‘for or on behalf of customers.’ As intermediaries, these businesses have access to relevant information about the transactions they effectuate on behalf of their customers, including the transacting parties’ identities and the profit or loss associated with each transaction.
“However, the remainder of the proposed definition designates businesses that do not intermediate transactions and do not ‘provide[] a service effectuating Exchange Transactions for or on behalf of customers’ as Reporting CASPs. For example, the definition would capture entities that ‘mak[e] available a trading platform that provides the ability for... customers to effectuate Exchange Transactions…’ (emphasis added). A transaction that a user effectuates on her own behalf does not involve an intermediating ‘individual or Entity that, as a business, provides a service effectuating Exchange Transactions for or on behalf of customers....’
“Entities that do not intermediate transactions should not be designated as intermediaries in scope. We welcome the opportunity to collaborate with the OECD to clarify which entities will be considered intermediaries in scope while also exploring novel means through which tax compliance can be augmented in disintermediated markets.”