Do Treasury Secretary Janet Yellen and Chair Gary Gensler of the Securities and Exchange Commission know what you did with cryptocurrency last summer? Before you scream that U.S. regulators would not start major crypto enforcement actions now against the industry, remind yourself of the last horror movie you watched where you were incredulous that some teenager who sadly met an untimely demise, seemed to miss all the signals that danger was nearby.
Yesterday, the U.S. Treasury Deputy Secretary Wally Adeyemo at Consensus 2022, one of the largest crypto conferences in the world, cited in his speech the shutdown of the Russian darknet marketplace Hydra and the virtual currency exchange Garantex sanctioned for enabling ransomware. According to Adeyemo, even though cryptocurrency has not been used in a significant fashion to evade sanctions against Russia, the country is well-known, “…as a hub for cyber criminals that use cryptocurrency in furtherance of their crimes.”
While suggesting that the Treasury Department hoped to work with the cryptocurrency firms at the conference in Austin, Texas as a partnership, Adeyemo definitely insinuated a pattern where he claimed the industry turns a blind eye to illicit finance activities in the digital asset industry. “What stands out about these entities is that their role in financing and facilitating criminal activity was well known, even before they were subject to sanctions. In too many cases, some investors and firms in the crypto ecosystem are willing to look the other way when jurisdictions like Russia offer a haven to criminals abusing digital assets,” said Adeyemo.
Adeyemo then described an interest to promote a partnership between Treasury and the crypto industry, who he also suggested could improve via self-regulation. As a gesture of good faith, Adeyemo mentioned two major areas regarding crypto regulation that would be forthcoming from Treasury over the next few months. First, Treasury would work to strike a careful balance regarding the enforcement of the Travel Rule, a regulation where both the sender and receiver of a digital asset over a certain threshold dollar amount must share personally identifying information with all intermediaries involved in the transfer.
Secondly, the Department of the Treasury would be focused on the unique risks associated with unhosted wallets. Adeyemo pointed out in his remarks, “Because unhosted wallets are effectively just addresses on a blockchain, it can be difficult to determine who really owns and controls them—creating opportunities to abuse this heightened anonymity.” Similar to the need for Treasury to enforce the Bank Secrecy Act (BSA) via the requirements of the Travel Rule, Adeyemo argued that financial institutions need to know who they are transacting and doing business with to make sure they are not making payments to criminals or sanctioned entities that have a heightened level of anonymity as an unhosted wallet.
Of course, the opposite of an unhosted wallet where you may custody your Bitcoin
Crypto Horror Picture Show?
Back to the potential for a regulatory crackdown this summer, Adeyemo confirmed that the effort to push for a self-hosted wallet rule by Secretary Yellen that first appeared in January as part of Treasury’s Semiannual Agenda and Regulatory Plan had in fact made its way to the top of the priority list regarding cryptocurrency. Certainly this concern of how cryptocurrency might be used to evade sanctions due to the Russia-Ukraine war has certainly accelerated the desire by Treasury to ensure all U.S. citizens are aware that cryptocurrencies used in any manner to help Russia evade sanctions is the same as using regular U.S. dollars.
However, this speech yesterday is not the first sign of a major U.S. financial regulator signaling to the industry that regulation by enforcement may be coming very quickly to cryptocurrency. Chair Gensler, who was recently referred to as ‘the number one offender’ by the head of a crypto trade association in D.C. regarding impeding the progress of innovation with blockchain technology, has made no secret about his belief that cryptocurrency exchanges should be coming into his agency to register as an exchange because it is likely that at least one, if not many, of the digital assets that are regularly traded are in fact securities.
While the industry retorts again and again as to how ‘unclear’ the regulatory environment is due to the technological nature of cryptocurrencies and blockchain networks, Gensler has travelled far and wide appearing on numerous media outlets and at speaking engagements saying that in fact, whether a digital asset is a security is in fact clear. Gensler has decried in the past the overwhelming number of blockchain tokens in the ecosystem is no match for the level of staff he has at the SEC to provide effective regulation by enforcement, which was one of the reasons he asked cryptocurrency exchanges to come visit him and register.
However, on May 3, the SEC announced it was doubling the size of his Crypto Assets and Cyber Unit. The press release stated, “By nearly doubling the size of this key unit, the SEC will be better equipped to police wrongdoing in the crypto markets…”. By adding an additional 20 staffers to the enforcement team with a focus on cryptocurrencies, it was clear that ‘spring training’ for the summer would begin in earnest to get these new employees up to speed on how to identify any bad actors in crypto taking advantage of U.S. investors. The release defined the scope of what this enforcement unit would focus on, stating, “The expanded Crypto Assets and Cyber Unit will leverage the agency’s expertise to ensure investors are protected in the crypto markets, with a focus on investigating securities law violations related to: Crypto asset offerings; Crypto asset exchanges; Crypto asset lending and staking products; Decentralized finance (“DeFi”) platforms; Non-fungible tokens (“NFTs”); and Stablecoins.”
Of course, the Terra Luna stablecoin debacle that sent the crypto market downward just a few weeks ago and renewed cries for potential legislation, has put the U.S. regulators in a very difficult position. There is no U.S. regulator assigned to stablecoins at this time, highlighting a gap in the law that Congress would need to fix. However, the algorithmic stablecoin that fell from grace, as well as the founder Do Kwon, highlighted the potential dangers to consumers who could get harmed financially as a result. Very often, a regulatory crackdown will result from the regulator’s perception of the need to act, where although there are laws – whether clear or not – that tell an industry what they can and cannot do, it is not until there is a strong level of enforcement that the actual behavior in the marketplace changes.
In what may be another hint that there is an expectation of a harsh regulatory crackdown coming, Coin Center, a non-profit focused on cryptocurrencies in D.C. announced at Consensus 2022 that they had sued the U.S. Department of the Treasury over “…the so-called 6050I amendment, and it will require individuals and businesses who receive $10,000 or more in crypto to report to the government not just the name of who sent them the funds, but that person’s date of birth and Social Security number as well.” This amendment was part of the crypto tax reporting legislation which became law Infrastructure Investments and Jobs Act (H.R. 3684) that passed last summer. The intense battle on Capitol Hill last summer arguably raised the stakes regarding crypto lobbying in D.C. to new levels, as many were surprised at the level of grassroots pushback from cryptocurrency advocates who called and wrote their representatives to complain about the bill.
Coin Center explains this amendment, “…will require individuals and businesses who receive $10,000 or more in crypto to report to the government not just the name of who sent them the funds, but that person’s date of birth and Social Security number as well.” Coin Center argues this is unconstitutional in part because it, “forcing ordinary people to collect highly intrusive information about other ordinary people, and report it to the government without a warrant, is unconstitutional under the Fourth Amendment…”.
Whether by coincidence or not that Coin Center filed a suit relating to providing personal information to the U.S. Government was connected to the resurrection of the ‘unhosted wallet’ regulation by Treasury, it seems the first skirmish has begun yesterday over what rights individuals who hold digital currencies have. At a minimum, it certainly seems to make for the beginning of a great summer movie.
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