The State of Crypto Regulation | Jake Chervinsky (SotN 8/17)
Primer: The Infrastructure Bill was recently passed by the Senate. It includes some provisions that would negatively affect the crypto industry. Join Jake Chervinsky as he shares his firsthand experience with crypto regulation in this episode of the Bankless Podcast.
Background
General Counsel at Compound Finance
Before that, he serves as Defense Counsel in U.S. government criminal investigation’s Kobre & Kim
Started legal career at Baker McKenzie LLP, focusing on commercial litigation, white-collar criminal defence and internal investigations related to allegations of fraud and corruption
Strategic Advisor to Variant Fund
DeFi Chair at the Blockchain Association
Is Crypto Winning In Washington?
Fighting a war on multiple fronts
Gaining more influence in DC and getting through to a lot of elected officials
Problem is in the Executive Branch and the Treasury, where there is a tough fight ahead of us
Sort of winning and also struggling a little bit as well
The Infrastructure Bill
How Did The Infrastructure Bill Come To His Attention
Those working on the policy gets a heads-up in advance when a major legislation related to crypto is about to be released
They work behind the scenes to influence the legislation before it becomes public
However, this time round, he and the Blockchain Association were blindsided by the Infrastructure Bill. Only knew about it 9 days before release
Was It Snuck In Maliciously?
Possible explanation, but he always tries not to assume malice
A charitable view would be the negotiation over the Infrastructure Bill was very tense and the senators could not come to an agreement
Major piece of legislation. Proposes $1.2 trillion in spending. Hence, they had to raise exactly $1.2 trillion in revenue to offset the spending. Crypto just happened to be caught up in it
Treasury trying to expand its jurisdiction and warrantless surveillance over a P2P financial system
Why Was The Language Troubling?
Tax code imposes reporting requirements on types of US persons called brokers
"Persons" could refer to an individual, company, or an association of any kind
Brokers have to prepare a form 1099 that indicates the amount of taxes someone owes to the IRS
Infrastructure Bill expands the definition of these brokers to include every single actor in the crypto markets:
Miners
LPs in DEXes
DEX users
DeFi developers
DeFi aggregators
Could also impact NFTs and NFT markets. Content creators could end up being defined as brokers under this bill
Fundamentally no way for people to comply with IRS reporting requirements (e.g. miners will not be able to get the KYC information for everyone using a public blockchain)
"I was joking about this on Twitter, but it's almost like the IRS wants you to tell them every time an Axie Infinity is mating. Do you know like, that's how ridiculous this is? Right?"
- Ryan Sean Adams
Start With Overreach And Rolling Back Later
Will have a rulemaking process from IRS to further define who is actually captured by this new broker definition
Will have a notice and comment period
Goal in Congress is to secure as much authority as possible
The IRS is the one who will actually work out who does it apply to
Who Fought Against It
Entire crypto industry got together to fight the Infrastructure Bill
Starts with the policy organizations
Coin Center (Independent Non-profit think tank)
Blockchain Association (Premier trade association for the industry in DC)
Large, well-established crypto companies (Coinbase, Square, etc.)
"And that's something we often see in crypto when there's a real threat, we put aside all of our other disputes about which layer one is going to win the smart contract and fight and Bitcoiners versus Ethereum and all this stuff. And we just focus and get the job done. And I think that really is amazing."
- Jake Chervinsky
Treasury's Concern On DeFi
Treasury trying to figure out how to get jurisdiction over DeFi (who is responsible for reporting DEX transactions and capital gains to the IRS)
Treasury isn't that concerned about Bitcoin as people are trading it through CEXes which is already subject to their jurisdiction
Tried to remove the provision but it was a non-starter because the purpose of the provision was to raise new revenue to offset spending
Lucky to have Senators Wyden, Lummis, and Toomey to propose language that carved out exemptions for market participants that just fundamentally cannot comply with the requirements
Treasury worried that the industry would expand the exemption to DEX LPs, Lightning Network, etc. Hence, the competing amendment that specifically states that the exemption is only for Proof-of-Work miners
Tried to work out a compromise amendment that did cover validators of all kinds. However, it was not successful
Who Is Out To Get Us? What Are Their Motivations?
Congress's job is to write laws and Treasury to enforce it
Congress can consult with an agency with expertise on how the law is enforced
Don't actually know who is out to get us
Conjectured that it might be people within the Terrorism and Financial Intelligence division, FINCEN, OFAC, etc.
Difficult to say what their motivations are. People within the government have different interests
People would think FINCEN would be the ultimate enemy of crypto
However, there are people in FINCEN who have been very supportive of crypto
Some people just want people to pay their taxes
Others want more surveillance over DeFi because they think that it is an illicit financial risk
Most problematic are those who hold that crypto is bad - a financial system with no intermediaries is worse than the current financial system that we have
Anyone Lobbying Behind Closed Doors?
Don't think it is the bank lobby. Think this was more about making the numbers look good on the Infrastructure Bill
Banks would support the provision as they are not our friends. They have been making attacks on crypto as a whole
US Approach To The Digital Currency Revolution
Do not think that there is a strategic plan
During the Trump administration, there was no national strategy. Hence, we have Secretary Mnuchin going after crypto while Brian Brooks at the OCC have been very constructive about crypto
People hoping that the administration would get its act together regarding digital assets in the Biden administration. However, there is no evidence of this yet
Currently, Senator Warren is taking a hostile stance against crypto
Have to position themselves and start speaking from the perspective of the important US interests at stake
Perspective Of How Big The Bill Was
It was a big deal
Crypto entered the public consciousness
Received calls, emails, and texts from people regarding it
Bill was a threat but more importantly it showed that the crypto industry was able to rally and defend itself in DC
"I think a lot of people came away from this investor's thinking, man, the biggest fear I had about putting money into bitcoin or ether or what have you, was regulatory risk, because I thought if the government decided it didn't like this industry, it would just steamroll the industry. And there's nothing anyone could do to stop it. And that is obviously not true. Right?"
- Jake Chervinsky
Era Of Crypto Regulation
Did not manage to get the language amended in the Senate
The crypto industry will have another shot in the House. May be difficult to get an amendment in the House
Could even push new legislation through in the future
Friends in Congress already talking about the next bill where they can provide a fix to this overbroad provision
Will have guidance from Treasury explaining who this really applies to
Developers in DeFi could also end up engineering their way around regulatory issues
On Ryan Selkis' Tweet
Ryan Selkis made the following tweet:
Feels frustrating to have to apologize for everything that is happening in crypto
From the outside, people view crypto more as speculative trading of Dogecoin, memes, and illiquid JPEGs rather than DeF
People are also looking for evidence that DeFi lives up to its promises (e.g. financial inclusion, everyone having access to financial services)
Two Different Crypto Systems?
Thinks that the government views crypto as two separate systems
One is clean, custodial, intermediated, and permissioned while the other is a separate wild west version
"There's so many people who have dedicated their lives to this whole entire revolution, me and Ryan, are 2 examples, you as well. And we have too much at stake both our money and our savings and our jobs to care about anything else."
- David Hoffman
Most Effective Thing To Do As Individuals
Extremely effective is to make calls. The second is to send tweets
Emails are helpful but they will not be read. A staffer will check the inbox every couple of weeks and provide a report on the number of emails they got for a particular issue
For calls, they end up speaking with the staffer and taking up their time. This will end up getting relayed back to the senator
Many politicians have their phones with them. Tweeting at them will blow up the notifications on their phone
If politicians tweet something positive, get them some engagement. They like the dopamine hit as well
Thoughts On Senators
Have to consider what senators are saying and what their actual incentives are
Senator Warren
She is someone who could have been a huge supporter of crypto. Got almost all the way there, but turned in the wrong direction at the last minute. She agrees with the crypto industry on:
The problems of the traditional financial system
Big banks having too much power and influence
Financial system should not be dominated by too-big-to-fail institutions that privatize gains and socialize losses
Looks at the banking problem and finds that the solution is not to get rid of banks but to do a better job in regulating banks
Senator Lummis
Believer in decentralization
Her approach to how government works is consistent with having a robust private sector
Solutions
Need better arguments. Need to marshal the evidence of cases where the technology is genuinely helping people in the world
Need to show financial support for candidates who support pro-crypto policy
Elaborating On His Tweet
Jake tweeted the following:
The Fourth Amendment states that the government cannot search or seize our persons, houses, papers and effects without a warrant
This includes financial privacy
There are exceptions where the government are permitted to warrantless surveillance of financial transactions
The Bank Secrecy Act was passed in the 1970s. Was challenged as a violation of the Fourth Amendment rights. It was left open that there could be some circumstances where rights are violated
Over the last few years, the Supreme Court has been strengthening the Fourth Amendment
3 years ago, in the Carpenter v. United States case, the government was collecting data from cell site towers because people were sharing their location with these 3rd parties. Thus, the government is able to get your location data without a warrant. The Supreme Court said it is unconstitutional and violated our privacy
The same argument can be applied in the crypto context in the event that the Treasury decides to say that they have a right to surveil every transaction on the blockchain because the blockchain is public. He would argue that this is a violation of the Fourth Amendment and the Supreme Court would agree with him
Issues That Governments Will Have With Crypto
Illicit finance risk (e.g. money laundering, terrorist financing)
Monetary sovereignty (e.g. do governments maintain control over fiat currencies, can private sector participants create their own private money)
US government worried about US dollar instruments created by private parties that they don't control (especially stablecoins)
"They do not like the idea of DAI, a decentralized stablecoin, that can be created by any person anywhere without government permission. So with that, I think is really the final boss."
- Jake Chervinsky
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