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Wednesday, November 29, 2023

New Regulation Could Cause a Split in the Crypto Community

Big Crypto has arrived. On August 10, following days of wrangling and furious tweeting, cryptocurrency enthusiasts, advocates, and entrepreneurs watched in horror as the US Senate approved a $1 trillion infrastructure bill, complete with an article that many fear might jeopardize the whole American crypto sector beyond repair. The controversial rule would require that “brokers” of transactions in digital assets—i.e., cryptocurrencies—report their customers to the Internal Revenue Service so they can be taxed.

The crypto crowd griped that the bill’s definition of “broker” was so broad it would potentially encompass miners, validators, and developers of decentralized applications—all of which, while playing pivotal roles in the functioning of a blockchain ecosystem, have no way of identifying their anonymous users.

Initially, it had looked like the bill’s language might be tweaked to exempt those categories, as a trio of senators put forth an amendment clarifying the “broker” term. Then a White House-backed amendment appeared, pushing for a less lenient clarification, exempting proof-of-work miners—which use an energy-intensive process to secure blockchains such as Bitcoin or Ethereum—but not many other categories, such as proof-of-stake validators, which carry out the same function without the energy burning. Just as a compromise position was being worked out, the Senate decided to pass the bill unamended. Any change will have to happen at a later stage—and it likely will, given the patent unenforceability of the bill as is.

On the face of it, it's a drubbing for American crypto. But the narrative that has been doing the rounds is quite different: The infrastructure bill is a watershed moment in the history of cryptocurrency. The technology—at its core a crypto-anarchist, anti-bank, borderline anti-government manifesto disguised as code—has finally acquired that great marker of prestige: a lobby. The fact that some senators were ready to fight in crypto’s corner appears to show that the cryptocurrency industry is more than a gaggle of Twitter accounts and some blue-sky venture capitalists. Whatever the reason, it has influence, and—after the infrastructure bill saga—it will be ready to wield it even more deftly.

“We're seeing the formalization, the maturing, of the crypto lobby, and this was the first coordinated effort that brought that to bear,” says Alex Brammer, vice president of business development at Luxor Tech, a bitcoin mining company. “Organizations like the Blockchain Association, the Texas Blockchain Council, or the Chamber of Digital Commerce are certainly going to continue their work.”

Cryptocurrency is usually, and lazily, described as a Wild West, but as a matter of fact the established businesses operating in the sector—from big mining enterprises to Wall Street–listed giants such as Coinbase—tend to crave regulation to define the boundaries of what is acceptable and what might get them into trouble. “Sophisticated players in this space welcome intelligent regulation. It provides clarity and predictability for large operations,” Brammer says. “It provides a set of rules of the road that allow large, publicly traded companies to make sure that they're doing everything they can to be as viable and as profitable as possible going forward.”

But where does that leave the smaller, less established, less corporate players? Bitcoin—an asset owned and lionized by billionaires such as Mark Cuban and Elon Musk—has been growing since 2009 into an industry that carries heft and brand recognition. (Even Ted Cruz is waxing lyrical about it).

The much-contested amendment approved by the White House would have saved bitcoin while throwing much of crypto under the bus. Granted, when that plan emerged, the crypto lobby—or, at least, crypto-Twitter—rose as one against it. Jerry Brito, executive director of cryptocurrency trade group Coin Center thundered against the Senate’s attempt to pick “winners and losers,” while venture capitalist and crypto-ideologue Balaji Srinivasan said that the amendment would eventually open the door to a full-blown bitcoin ban. But it is worth wondering whether, in the long run, a rift might open between a Big Crypto clamoring for clear regulation to achieve peace of mind and the smaller actors of the cryptocurrency community, who might be less well equipped to meet the requirements that regulation would impose.

Patrick Murck, a legal expert and an affiliate with the Berkman Klein Center at Harvard University, says that the infrastructure bill could go down in history as the moment in which a wedge was started to be driven between those two constituencies. “I think there is potentially a schism between the everyday community around crypto coming into conflict with an institutionalized form of crypto,” he says. “I don't think that there's such a desire within either camp, but you can see how increasing scrutiny and regulation could lead to that. The question is, does that put the community in conflict with the players that are being institutionalized?”

One segment of the cryptocurrency industry that seems to be in for a walloping is the so-called decentralized finance, or DeFi, sector. That is a budding ecosystem in which financial services such as loans, savings, or trading are provided by blockchain-based programs as opposed to companies. The requirements stemming from the infrastructure bill's "broker" definition— onerous enough for bitcoin miners and exchanges—would be just as daunting when applied to DeFi, says Lex Sokolin, global fintech cohead at blockchain firm Consensys.

"People that are engaged in decentralized finance—like the lenders and the traders and so on—of whom there are about 2 million and are all over the world and are in large part regular people—,” he says, “those people would be considered the equivalent of the Nasdaq," squashed by an excessive compliance burden. Even if that language were amended at a later stage, the Securities and Exchange Commission has already made it clear that it is poised to crack down on DeFi, which it regards as a high-risk sector, as the agency's chair emphasized in a letter to influential democratic senator Elizabeth Warren.

As a consequence, according to Joe Carlasare, a bitcoin advocate and partner at law firm SmithAmundsen, some developers in the DeFi space might simply up sticks and leave America altogether. "Some people in the DeFi market are going to seek refuge outside of the United States, because it's easier for them with these requirements."

Is the Big Crypto lobby going to spend time and energy trying to protect the DeFi sector? On the one hand, it doesn't need to. "Bitcoin is already well established under US law as a commodity, so I don't think anything changes," Carlasare says. But on the other hand, it might be in its best interest to keep protecting the wider ecosystem, Murck argues. "You want to be making sure that it's really a community effort rather than just sort of an industry effort to fully institutionalize," he says. "Because you don't want regulation driving that wedge between those groups."

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