Is compromising on anonymity the key to crypto adoption in the US? Experts weigh in

In the Brief:

  • US regulators demand crypto KYC/AML compliance, conflicting with crypto's privacy ethos
  • Decentralized exchanges can opt for KYC/AML if desired
  • Tornado Cash faces OFAC sanctions
  • BSA compliance possible with DAO approval
  • Compliance regimes vary in importance
  • Protocols seeking institutional adoption may not support mixer use

3 - 6 minute read

Cryptocurrencies have always been designed to be anonymous or pseudonymous, which has created a tension when it comes to complying with Know Your Customer (KYC) and Anti-Money Laundering (AML) rules, along with economic sanctions regimes. In the United States, the blockchain and cryptocurrency sector has been trying to comply with these regulations, but there is still some pushback from regulators. The Commodity Futures Trading Commission (CFTC), for example, has recently suggested that the industry should verify the digital identity of its users. However, this has raised questions about whether crypto companies should distance themselves from anonymity-enhanced technology while maintaining compliance with regulatory requirements.

While centralized protocols have the ability to implement AML/KYC compliance, it comes at the risk of losing crypto idealists who prioritize permissionless, anonymous access. On the other hand, decentralized protocols can implement BSA compliance, but the individual steps must be approved by the protocol’s DAO. The bottom line is that the BSA isn’t the only challenge that crypto firms face when setting up business in the United States. All companies must comply with the Office of Foreign Assets Control (OFAC) to ensure their platforms are not being used by individuals from prohibited jurisdictions. OFAC has also sanctioned digital currency mixers, such as Tornado Cash, which the agency accused of laundering more than $7 billion of digital currency since its creation in 2019.

Privacy coins and regulations don’t gel, according to some experts. While privacy coins may not go away, their usability will probably remain highly niched and restricted. Anonymizing technology and BSA compliance do not mix. If a protocol is required to be BSA compliant, that protocol cannot permit users to mask their identities.

Some believe that decentralized exchanges can also shut out mixers if they set their mind to it. “When the whole Tornado Cash debacle happened, decentralized exchanges like Aave and dYdX actively blocked addresses that interacted with mixers,” said Justin Hartzman, CEO and co-founder of Toronto-based cryptocurrency exchange CoinSmart. However, while mixers do tend to protect user identity, it is fairly easy to tell which addresses have interacted with these protocols, thanks to blockchain’s transparency.

“The real question is whether the United States, as a policy matter, wants to cut off its companies from DeFi when DeFi growth overseas is exploding.”

The desirability of privacy-enhancing technology is a political question. The point of crypto is to make this technology so commonplace that it ceases to be a political question because its existence must be assumed. Ultimately, some DeFi providers will likely end up adopting AML/KYC procedures, whether they are required to or not, both to avoid unwanted government scrutiny and to attract institutional money. Others will hold true to their ideological preferences because that’s why they got into crypto in the first place.

The Bottom Line

The regulation of cryptocurrencies in the United States is still a work in progress. While complying with regulatory requirements may make it difficult for crypto firms to maintain anonymity, it is important for them to follow the rules and regulations for wider adoption. There is also the issue of creating a specific regulatory framework for cryptocurrencies, and some believe that U.S. regulators may arrive too late to the party to do anything forcible on the anonymity question. Traders should be aware of the potential risks and opportunities as the regulatory landscape for cryptocurrencies continues to evolve.

Disclaimer: The content in this article is provided for informational purposes only and should not be considered as financial or trading advice. We are not financial advisors, and trading carries high risk. Always consult a professional financial advisor before making any investment decisions.

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