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Biggest Challenges Ahead for Crypto as Regulators Declare War on Privacy & Self-Custody

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The start of the new quarter saw a slew of regulatory moves targeting the cryptocurrency space – “we’ve made the world stage,” which Fundstrat Global Advisors LLC believes is good for the overall crypto market because it’s just regulators “clearing up bad actors.”

While the “prevailing bull market trend is intact,” the ideological war over self-custody & privacy means “our biggest challenges still lie ahead,” said Jake Chervinsky, general counsel at Compound Finance.

As the crypto market continues to grow, the change is now coming.

Policymakers have taken a stern approach to KYC and AML on a global scale intended to prevent criminals from abusing the financial system.

With the goal that “crime doesn’t pay,” AML regulations deputize the “gatekeepers” financial institutions to act as government agents such as identify customers, surveil transactions, and file reports with the government.

Although AML regulations break down in the context of cash, which govt. are trying to get rid of it, it has its limitations because cash works only in-person and isn’t easy to move in large amounts over long distances.

As such, regulators are much more concerned about digital transfers.

Pursuing Crypto Aggressively

Up until now, they weren’t concerned much because, in their belief, crypto’s main utility comes from conversion into fiat, they can track crypto transfers via blockchain fairly easy, and there isn’t much criminal activity in crypto.

But, over the last year, as bitcoin gained geopolitical significance & fiat-pegged stablecoin volume exploded upwards, governments are now concerned about both illicit activity & the threat to their monetary sovereignty, noted Chervinsky.

Now, they’re enforcing AML regulations more aggressively.

As we saw in the case of BitMEX, which not only got tagged by CFTC for unregistered derivatives trading as expected, but DOJ also turned the case criminal, which “doesn’t happen often.”

The key takeaways from this action are that not only law enforcement and the regulators are paying attention to what you do, but those non-U.S. entities may also be subject to U.S. laws and willful ignorance or violation of US AML laws is serious, said Phil Liu, chief legal officer at Arca.

The Main Challenge

Last week, DOJ released a framework to cryptos where it described anonymous transactions as “a high-risk activity…indicative of possible criminal conduct” and an ominous warning in the form of “anonymity enhanced cryptocurrencies” for exchanges.

This war over privacy and restricting access to crypto is global as the international standard-setting body for AML regulation FATF said in June that the “lack of explicit coverage of peer-to-peer transactions…was a source of concern.”

“Swiss Rule” is already prohibiting self-custody “in the guise of verifying the owner of a private key.” And just last week, BIS said in its report on CBDCs that “full anonymity is not plausible.”

With FATF red-flagging hardware wallets, Europol prioritizing privacy wallets, and UK’s FCA banning crypto derivatives, the situation is serious.

“I fear we’re heading for a world where withdrawing crypto from exchanges to self-custody is restricted as a means of attacking privacy,” said Chervinksy, which according to him, is the main challenge for the crypto market for years to come.

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