The crypto/blockchain world seems pretty well tuned into regulatory developments, and rumors thereof, coming out of the SEC and the other major regulators of the American financial system. Crypto publications and podcasts, which I’ve been avidly consuming of late, seem to find the contents of Gary Gensler’s consciousness absolutely riveting. That’s fine. That’s great. However, I fear that an excess of SEC Kremlinology and kvetching about the Howey Test may have taken cryptoland’s eye off the political ball, because Congress just beaned it in the noggin.
The $1.2 trillion Infrastructure Investment and Jobs Act, which passed the House Friday night and now awaits Biden’s signature, contains two crypto-related provisions that were added in the Senate, both of which can be expected to have the effect of driving transactions that otherwise would have occurred on a blockchain back onto incumbent, bank- and broker-surveilled payment and exchange systems. That is to say, U.S.-based crypto firms and investors just faced their first big political test and failed miserably.
Crypto players need to get their heads in the game, organize, and start paying attention to the right things. To my mind, the infrastructure bill’s new crypto reporting requirements suggest that the most serious threats to “DeFi” (decentralized finance), and the development of disintermediating distributed ledger technology more generally, are most likely to come from Congress (not executive branch regulators) in legislation aimed at fighting domestic crime, protecting national security, and defending America’s global interests (rather than on consumer/investor protection or the stability of the financial system).
The first of the bill’s crypto provisions redefines “broker” to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” This definition is so vague and broad that miners/validators, node operators, or even Axie breeders—none of whom are brokers in any recognizable sense—could conceivably fall within its scope, which would subject them to nonsensical and potentially ruinous broker tax reporting requirements.
The crypto world noticed and raised a stink about this in August, when the infrastructure bill was making its way through the Senate, and the pressure almost made a legislative difference. Sen. Pat Toomey (R - Pennsylvania), ranking member of the Senate Banking Committee, negotiated a narrower definition deemed acceptable by the relevant parties. Yet the amended language failed to make it into the final bill.
“It was a procedural problem that prevented us from getting our fix adopted. So, that means we still have the opportunity to fix it,” Toomey said. “We’ll have to do it in subsequent legislation if they pass the infrastructure bill in its current form.”
Rather less attention was paid to a different IRS reporting provision that applies to anyone who receives $10,000 or more in digital assets in the course of business. My old buddy Abe Sutherland, a former White House and State Department lawyer, calmly yelled his head off trying to get folks to pay attention to this. I’ll let him describe this law, which takes the form of a deceptively modest amendment to the tax code:
The proposed amendment to Section 6050I states that, in a broad range of scenarios, “any person” who receives over $10,000 in digital assets must verify the sender’s personal information, including Social Security number, and sign and submit a report to the government within 15 days. Failure to comply results in mandatory fines and can be a felony (up to five years in prison).
The proposal relies on a 1984 law that was written to discourage in-person cash transfers and to encourage the use of financial institutions for large transactions. The law’s relative clarity and limited applicability in the case of old-fashioned cash is difficult to apply to the transfer of digital assets, thus making compliance unduly burdensome (as any “receipt” can trigger the reporting requirement, and “digital asset” is defined broadly as any “digital representation of value” using distributed ledger technology, including NFTs). Miners, stakers, lenders, decentralized application and marketplace users, traders, businesses and individuals are all at risk of being subject to this reporting requirement, even though in most situations the person or entity in receipt is not in the position to report the required information
A statute creating felony crimes for users of digital assets should be debated openly, not quietly inserted into a spending bill
Thanks to Abe’s relentlessness, the big boys did finally pay attention. Here’s the CEO of Coinbase, the largest crypto exchange in the U.S., sharing Abe’s latest:
And then… the bill passes 36 hours later.
There are at least two lessons for the cryptoverse here. First, crypto firms have either under-invested in public policy and government affairs or have hired the wrong people. I reckon it’s a bit of both. (Call me, Brian Armstrong! Resume very much available on request.) There’s a lot of work to do.
When Goldman or Exxon are torqued off about a bit of language in a bill that would harm their interests, it generally doesn’t wind up in the legislative text that lands on the president’s desk totally unchanged — especially not when there’s sufficient support for your fix in the chamber. I suspect that, in this case, “procedural problem” mostly means “not a big enough priority to be worth the hassle.” The crypto world certainly has the resources it needs to be treated as a priority in the Senate, to be considered worth the hassle, but it has so far failed to effectively bring those resources to bear.
Policymaker education is key. Given the nature of blockchain technology, the broker and 5060I reporting requirements don’t make sense and can’t really work. This suggests that legislators don’t understand what it is they’re trying to regulate. When folks think of lobbying, they tend to think of hardball influence peddling, backroom deals, and shady quid pro quo. Reality is a bit more mundane. A surprisingly large part of policy advocacy it is simply explaining the basic, relevant facts to policymakers and then what follows from that. Crypto people have a lot of explaining to do if they don’t want this to happen again.
Last point here… The obnoxious tweak to Section 5060I of the tax code really should not have taken Big Crypto by surprise. And it shouldn’t have required a bunch of pro bono work by an altruistic expert in crypto tax law to raise consciousness and rally some opposition. If intra-Democratic negotiations hadn’t been so prolonged, and Abe hadn’t so effectively sounded the alarm, this profoundly misguided provision could easily have slipped into law almost entirely unnoticed and totally unopposed. Instead, it’s about to be signed into law mostly unnoticed and lightly opposed. This doesn’t happen to an industry that’s on top of its political game.
The second tough lesson of the infrastructure bill is that wonky crypto enthusiasts haven’t been thinking hard enough about the extent to which decentralizing and disintermediating the financial system threatens the state’s perceived domestic and international security interests. I think that’s where the motivation to hobble emerging blockchain technologies and services is most likely to originate.
Consider the amendment to Section 6050I of the tax code. Because it requires filing a report to the IRS under certain conditions, it’s tempting to think it’s about taxes. But it isn’t. As Abe notes:
It’s an unusual law -- it’s part of the tax code but it’s not really a tax provision. First, unlike all other IRS information reporting requirements, violations here are felonies. Second, it does not simply add a reporting burden to intermediaries already in the business of collecting and storing customer data, such as stock brokers or centralized cryptocurrency exchanges. It applies to all businesses -- which can include individuals. In fact, the only businesses that are exempt from section 6050I are banks and financial institutions.
The predictable effect of imposing an onerous administrative burden on anyone who receives digital assets worth significant sums in the course of business, and then making it a felony not to meet this burden, is to discourage bigger-than-medium peer-to-peer blockchain transactions and force people back into dollar-denominated exchanges mediated by incumbent financial institutions. As Abe notes, the pre-existing function of 6050I is to discourage large-ish IRL peer-to-peer cash transactions in favor of bank-mediated transactions visible to law enforcement by making it a hassle to deal in cash and a crime not to leave a paper trail.
American law enforcement and foreign policy are heavily reliant on bank-based surveillance/reporting requirements, as well as control over international payments systems. Henry Farrell and Abraham Newman’s work on “weaponized interdependence” effectively explains why you should expect the prospect of hugely scaled-up blockchain-based financial disintermediation to be profoundly troubling to the American state:
National security and economic policy used to be separate spheres. They are now merging, turning the global networked economy into a space of strategic actions, counteractions, threats, targeting, countertargeting and decoupling…
[T]he politics of sanctions and other forms of economic coercion have been transformed by globalization. It used to be that sanctions rested on a country’s ability to prevent outsiders from access to its internal market. Now, however, proper participation in the world economy requires access to global networks such as the dollar clearing system and the SWIFT financial network. We live in an interdependent world, but one where the dependencies are asymmetric. Some countries—most prominently the U.S.—are able to cut businesses or even entire countries out of these global networks, with profound economic consequences.
Crucial global economic networks are not the kind of open-ended networks, capable of overturning power asymmetries and toppling political hierarchy, of which globalizers dreamed of. Instead, they tend to be highly centralized. Networks comprise two basic elements: the nodes, which represent the actors or locations within the network, and the ties, which connect these nodes together. Many world-spanning economic networks evolve so that some nodes become far more important than others, channeling and even directing the flows in the rest of the network; for example, the dollar clearing system, which is crucial to international financial flows, runs through a very small number of key U.S. institutions. Such nodes, in turn, can become vectors for state control. If a state has jurisdiction over the key nodes in an important global network along with appropriate institutions, it can weaponize the network, using it to conduct surveillance or to block others from accessing the network in question.
Peer-to-peer exchange networks enabled by encrypted distributed ledger technologies are “the kind of open-ended networks, capable of overturning power asymmetries and toppling political hierarchy, of which globalizers dreamed of.” That’s why they’re a problem especially for the U.S., which has come to depend on its control over chokepoints in the incumbent system to exert its will internationally. To the extent that new decentralized networks displace highly centralized financial networks under U.S. jurisdiction, the state’s ability to pursue its global interests by “weaponizing” these networks weakens.
The development of decentralized finance and the principles that govern the blockchain infrastructure of “Web 3.0” directly conflict with the American state’s perceived interest in maintaining its tools of economic and financial surveillance and coercion. If emerging crypto interests want to avoid getting strangled in the cradle, they need to defuse the sense of threat generated by the conflict between financial disintermediation and the state’s reliance on bank-based surveillance and “weaponized interdependence.”
I think this means developing the argument that the law enforcement and foreign policy tools threatened by blockchain disintermediation aren’t as valuable and irreplaceable as policymakers think they are; that there are real advantages to be gleaned from complete, transparent public records of transactions; that it’s not as hard as they might imagine to associate wallets with names; and that America’s interests are best served by capitalizing on China’s crypto ban and taking advantage of our leading position in blockchain innovation. It’s not an easy lift, but it’s time for crypto to grow up, face political reality, and start lifting.