A Case for Legal Cryptocurrency

ARGUMENT (Declared Bias: Liberal Democrat)

Distributed-ledger technologies have captured the business world’s imagination in the past several years. Their potential applications are numerous, ranging from document storage to voting [1]. Their most widely known use, however, is cryptocurrency, defined for purposes of this article as distributed-ledger-based digital assets used purely as media of financial transaction.

Though recent media coverage has increasingly portrayed cryptocurrencies (particularly Bitcoin) as speculative assets, the prevailing public image of these currencies has long been one of criminality. Many immediately associate them with nefarious settings such as dark-net markets and ransomware that demands payment in Bitcoin while training a pistol made of code on your files. Understandably, many wish to respond to the emergence of these currencies with the most base of regulatory instincts --- a simple ban. In 2014, Senator Joe Manchin’s office called for regulators to “take appropriate action to limit the abilities” of Bitcoin [2]. Bitcoin “ought to be outlawed,” cried Joseph Stiglitz mere months ago [3]. Some governments have already started to crack down. China has shut down its cryptocurrency exchanges and is reportedly weighing a full ban on crypto trading [4]. Bangladesh has outlawed cryptocurrency transactions entirely [5]. Other countries have been friendlier. Japan, for instance, has recognized Bitcoin as legal tender and legally recognized its exchanges [6]. The US would best take something resembling Japan’s approach over that of China to encourage the development of socially beneficial applications of cryptocurrency.

First, the easy task: proving that it can be widely used for socially useful purposes. A prime example is Stellar, a nonprofit that seeks to make international money transfers cheaper and more efficient [7]. Its native currency, the lumen, is necessary to secure the Stellar network against DDoS attacks and to serve as a bridge currency in cases involving fiat currencies that do not have large direct markets [8]. Stellar is also an example of already-realized legitimate potential; it has partnered with IBM to launch blockchain-based banking services in the South Pacific [9].

 Crypto skeptics contend that distributed-ledger technologies have not meaningfully improved over existing financial technologies in any realm outside of illicit transactions [10]. Stiglitz bases his call for the criminalization of Bitcoin on similar grounds [11]. If one assumes that speculation is a socially beneficial application, cryptocurrencies are already mostly used for justifiable purposes [12]. For the sake of argument, however, it can be ignored. Nevertheless, Stellar Lumens and many other cryptocurrencies put the skeptic in a tough position. It becomes even more difficult to deny this when one takes into account that much of the utility of these currencies is unrealized and even unconceived of.

But the crypto skeptic has a fallback position: surely the bad outweighs the good? Surely, he may assert, it is better to outlaw first and ask questions later when enough beneficial uses reveal themselves? But this temporary ban would be self-defeating for several reasons. First of all, the prohibiting jurisdiction (in our case, the US) would be a closed-off market for companies developing legal uses for them, significantly limiting the prospects of mass adoption. Budding developers in this jurisdiction would lose interest in cryptocurrency, depriving these companies of the talent they would otherwise have provided. Furthermore, companies may not necessarily flock back in after cryptocurrency is legalized, especially in the probable case that criminalization is replaced by exceptionally stringent regulation. Many would fear another ban in the future, and they may not find it worthwhile to reenter the market. As long as criminalization is widely debated, the apprehension would not fade.

Many cryptocurrencies are also not as useful for illicit purchases as they may appear. Bitcoin, for example, is arguably less private than cash because the entire transaction history of each Bitcoin public address is easily viewable online and it is surprisingly easy to trace a public address to its owner [13]. But there do exist privacy-focused cryptocurrencies, such as Monero and ZCash, whose transactions are kept under cryptographic wraps. They may invite another fallback position for anti-crypto hawks: outlaw only currencies that seem particularly suited to illicit activity. But it would be difficult to draw a line between legitimate and illegitimate currencies. Governments cannot always distinguish a cryptocurrency that is socially beneficial from one that is not, meaning that the former may sometimes be outlawed.

Even leaving this objection aside, those currencies best suited for criminal purposes are hardly more dangerous than cash. Cash is also hard to trace because it is fungible (unlike Bitcoin) and requires no identification to transact in. Unlike any major cryptocurrency, cash can be counterfeited. An investigation conducted by Europol in 2015, when Bitcoin’s illicit use was already well-known, found that money launderers still mostly use cash [14]. Of course, some regulation is necessary; cash has certain restrictions associated with it. But the regulatory regime for cryptocurrencies should ultimately differ little from that of cash.

"The regulatory regime for cryptocurrencies should ultimately differ little from that of cash. "

Furthermore, there are fair reasons to maximize privacy. Businesses would do themselves no good by exposing their transaction histories for competitors to see. Additionally, not all illegal items necessarily ought to be illegal. Governments will inevitably pass unjust laws, and Monero or ZCash can become tools of civil disobedience in these contexts. Even discounting the instrumental value of privacy, these currencies enable a more free exercise of the individual right to privacy. For instance, data from online purchases are often mined and used in advertisements. There may be significant pent-up demand for the sovereignty over one’s data that privacy-focused cryptocurrencies could offer. In one 2015 survey from the University of Pennsylvania’s Annenberg School for Communication of 1506 American adult internet users, 55% of respondents disagreed that “[i]t’s okay if a store where I shop uses information it has about me to create a picture of me that improves the services they provide for me [15].” Unless one is prepared to argue that consumers should be allowed to be forced to hand over their shopping data, preserving control over personal data is an end in itself.

Even after accounting for these fair uses, a ban may still seem plausible. But it would be futile because they would still be acquirable via hard-to-regulate peer-to-peer (P2P) transactions on overseas exchanges that would have little reason to stop them. Even companies such as Paypal and Venmo, with far more incentive to detect illegal transactions, struggle to police their P2P networks because of the sheer volume of transactions that require vetting and the speed with which they occur [16]. Criminal use would persist, but legitimate usage --- and all the social benefits it would bring --- would be prematurely snuffed out. This point may seem familiar, and that is because it is similar to the argument made by Second Amendment advocates that the problem with outlawing guns is that only outlaws will have guns. Opponents of this argument often assert that there are many dangerous would-be owners who would be deterred by a ban [17]. But cryptocurrency is different.Peer-to-Peer transactions would still be available to those wishing to (illegally) acquire Monero, the extent to which they would be deterred would be similar to the extent to which a torrent user would be deterred from using The Pirate Bay (i.e., rather little). Even assuming for the sake of argument that this deterrence would be widespread among would-be Monero users, the analogy between guns and cryptocurrency falls apart.From the standpoint of someone who wishes to illegally acquire a gun (or, at least, a certain type of gun) for nefarious purposes, the inability to do so is a major handicap. But for someone who wishes to buy contraband, Monero is a means to an end. If he is deterred from using it, he still has older-fashioned means of acquiring it that are not obviously as much of a downgrade from Monero as a knife would be from an AR-15. Of course, none of these arguments imply that a ban would be completely futile. But given the potential for legal and productive use that privacy-focused currencies hold, it is worth asking whether a successful ban is desirable.

In sum, the case for prohibiting cryptocurrencies that seem especially suited for criminal use relies on three questionable assumptions:

  1. Currencies that society would be better off without can be reliably distinguished from those that have legitimate applications, so no socially beneficial cryptocurrency is outlawed.
  2. The prohibition of cryptocurrency can be effectively enforced and would deter those who would use them for morally undesirable purposes.
  3. There do not exist enough morally justifiable applications for these currencies to warrant keeping them legal.

The second and third assumptions also apply to the argument for a total ban. The third is the most obviously contestable, given the rise of Stellar Lumens and many other currencies with promising applications.

As mentioned above, cryptocurrency ought to be regulated like cash. Regulations would largely target fiat gateways --- exchanges and other entities through which one can convert cryptocurrency into fiat and vice versa. Kathryn Hau Rodriguez, an attorney who helped prosecute corrupt federal agents who stole Bitcoin from the Silk Road investigation, has suggested granting the federal government more authority to go after shadowy overseas exchanges that rely on US companies to provide them with server space, software, and other technical resources [18]. These US companies have long failed to comply with search warrants for data stored overseas [19].

The fact that exchanges and businesses (as well as cryptocurrencies themselves) are practically borderless further illustrates why a ban, even a temporary one, would be counterproductive. US-based exchanges and other cryptocurrency-related enterprises are already obligated to comply with AML (Anti-Money Laundering) laws [20]. Outlawing all trading would leave only illegally operating overseas exchanges with no incentive to verify customers’ identities. Chinese exchanges have responded in this fashion after China’s initial crackdown [21]. The development of legitimate usage would be set back because of the lost opportunity to legally enter the American market, but the ease of laundering money and other criminal activities would be largely unaffected. In fact, such activities may become easier because exchanging US dollars for cryptocurrency would occur via harder-to-regulate peer-to-peer transactions rather than direct deposit. This shift toward P2P transactions has already occurred in Chinese exchanges that have moved overseas [22].

We see two possible scenarios in this case:  Transacting in some or all cryptocurrencies is outlawed in the US, where US exchanges move overseas and are left with little incentive to protect against money laundering and other illicit use. The remaining users in the US, now operating illegally, use P2P transactions to move their US dollars out of the country to buy cryptocurrency. If some currencies remain legal, they may be easily exchanged for illegal ones via these networks. Or, US exchanges are well-regulated and the federal government is empowered to go after US companies that support unregulated overseas exchanges. Here, overseas exchanges in countries with looser AML laws may still exist, but they must compete with regulated US exchanges and fear the federal government if they rely on US companies for resources.

The fact that US exchanges would compete with unregulated overseas exchanges in the second scenario is important because it is a reason that outlawing cryptocurrency trading and giving the federal government more legal authority to go after non-complying overseas exchanges and the US companies that support them would not be as effective.

There are also constructive ways to bring firms into compliance. Many non-complying firms are not willfully defying AML laws, but rather lack the financial and legal resources to establish the infrastructure necessary to comply [23]. Appropriately, one solution may involve blockchain technology --- namely, a global KYC (Know Your Customer) registry. Whether blockchain-based or not, it could dramatically lower compliance costs. Consolidation of the licensing of exchanges and other similar firms under a single federal procedure would also reduce these costs. Currently, licensing occurs on the state level [24]. Consolidation would make life easier for firms operating in multiple states (i.e., virtually all of them). These approaches would not only help crack down on criminal use of cryptocurrencies but also encourage adoption among more respectable institutions by reducing their operating costs.

The cryptocurrency sector also regulates itself to a significant degree. Firms have considerable incentive to go beyond government regulations to establish trust and legitimacy among customers. Coinbase, one of the most popular exchanges in the US, has barred white supremacists who rely on Bitcoin for funding [25]. The private sector also develops forensic software for use by law enforcement in tracing illicit transactions [26].

This self-policing is obviously not sufficient on its own, but it complements government oversight to form a regulatory regime that would facilitate adoption by legitimate enterprises while rooting out criminal usage. A categorical ban, by contrast, would strangle the former in its crib while failing to fully curb the latter. There is more to cryptocurrency than reckless speculation and dark-net organ markets. For the sake of technological innovation and economic prosperity, regulators would be wise to understand that.

 

Disclosure: The author has holdings in several crypto assets, but none of those mentioned in this article.

Disclaimer: This article is not financial advice of any kind. No single source should be.

Bruno YounSenior Editor

Edited by Politics Editor Ross Reggio

Sources and Notes

Featured Image: “Bitcoins” by Andreas Trojak — Own work. Licensed under Cc BY 2.0 via Flickr Creative Commons — https://flic.kr/p/Eo34JR

[1] https://www.factom.com/; https://horizonstate.com
[2] https://www.manchin.senate.gov/newsroom/press-releases/manchin-demands-federal-regulators-ban-bitcoin
[3] https://www.bloomberg.com/news/articles/2017-11-29/bitcoin-ought-to-be-outlawed-nobel-prize-winner-stiglitz-says-jal10hxd
[4] https://www.investopedia.com/news/cryptocurrency-exchanges-china-are-officially-dead/; https://www.cnbc.com/2018/01/15/china-is-reportedly-raising-the-bar-on-its-cryptocurrency-crackdown.html
[5] https://cryptovest.com/news/bangladesh-c-bank-outlaws-cryptocurrency-transactions/
[6] https://www.coindesk.com/japan-bitcoin-law-effect-tomorrow/
[7] https://www.stellar.org/how-it-works/use-cases/
[8] https://www.stellar.org/lumens/
[9] http://fortune.com/2017/10/16/ibm-blockchain-stellar/
[10] https://medium.com/@kaistinchcombe/ten-years-in-nobody-has-come-up-with-a-use-case-for-blockchain-ee98c180100
[11] https://www.bloomberg.com/news/articles/2017-11-29/bitcoin-ought-to-be-outlawed-nobel-prize-winner-stiglitz-says-jal10hxd
[12] https://financialservices.house.gov/uploadedfiles/hhrg-115-ba01-wstate-jlevin-20170608.pdf
[13] https://www.technologyreview.com/s/608716/bitcoin-transactions-arent-as-anonymous-as-everyone-hoped/
[14] https://www.europol.europa.eu/publications-documents/why-cash-still-king-strategic-report-use-of-cash-criminal-groups-facilitator-for-money-laundering
[15] https://www.asc.upenn.edu/sites/default/files/TradeoffFallacy_1.pdf
[16] https://www.georgetownlawtechreview.org/breaking-the-law-by-using-venmo-trends-in-p2p-payments-and-u-s-foreign-policy/GLTR-04-2017/
[17] https://www.thedailybeast.com/the-3-worst-arguments-against-gun-control
[18] https://financialservices.house.gov/uploadedfiles/hhrg-115-ba01-wstate-khaun-20170608.pdf
[19] https://financialservices.house.gov/uploadedfiles/hhrg-115-ba01-wstate-khaun-20170608.pdf
[20] https://coinidol.com/bitcoin-exchanges-must-comply-with-us-laws/
[21] http://www.scmp.com/business/companies/article/2117806/china-closes-its-doors-cryptocurrencies-exchanges-shift-their
[22] https://www.forbes.com/sites/kenrapoza/2017/11/02/cryptocurrency-exchanges-officially-dead-in-china/#730a37392a83
[23] https://s3.amazonaws.com/files.cnas.org/documents/CNASReport-TerroristFinancing-Final.pdf?mtime=20170502033819
[24] https://www.coindesk.com/bitcoin-law-money-transmission-state-level-us/
[25] https://venturebeat.com/2017/08/15/another-registrar-rejects-the-daily-stormer-as-coinbase-blocks-transfers/
[26] https://www.inc.com/will-yakowicz/startups-law-enforcement-agencies-catch-criminals-who-use-cryptocurrency.html

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