United States Senators have cast their votes, and the contentious HR 3684 infrastructure bill cleared in the upper Congress chamber. Now, the gigantic document of over 2,700 pages and amounting to almost $1 trillion is heading to the House of Representatives, including the provisions expanding the definition of a cryptocurrency broker, designed to beef up crypto and decentralized finance (DeFi) tax compliance. The $1 trillion can’t come out of thin air, right?
While the bill in effect simply follows Financial Action Task Force (FATF) guidelines, doomsayers are already declaring the end is nigh, haunted by visions of the dreaded Internal Revenue Service (IRS) coming for their coins. As usual, they’re wrong.
Related: Cryptocurrency mining under proposed US policy changes
No, not everybody is a ‘broker’
For critics, one of the key points of contention is that Section 80603 of the bill defines “brokers” as anyone who is “regularly providing any service effectuating transfers of digital assets on behalf of another person.” Even this incredibly unclear language comes from an amended version of the bill, with an earlier one featuring an even broader definition. And yes, it could still be clearer. The bill demands that brokers report client information to the IRS but critics fear that with a definition this wide, it would encompass everyone from miners to node operators and liquidity pool providers.
A compromise amendment was supposed to explicitly exclude blockchain validators from the definition, but it did not survive a vote, sunk by a defiant Senator. Even if House lawmakers do not amend this, it remains hard to see how the original language could be applied to the broader crypto ecosystem, as “effectuating transfers” on someone else’s behalf is simply not what miners or holders do. In the cryptosystem, the entities that are transferring value between users are centralized exchanges (CEX) and decentralized exchanges (DEX). They are the market makers. Both kinds of brokers are capable of introducing compliance tools through software updates for their platforms.
Related: Broker licensing for US blockchain developers threatens jobs and diversity
In the legal debates on content piracy back in Aug. 2007, BitTorrent wasn’t found liable for the enormous amount of copyrighted songs and videos shared freely via its peer-to-peer (P2P) protocol. Those leveraging the P2P protocol weren’t as lucky — Lime Group, with its LimeWire web service, was deemed liable for “contributory infringement” in 2010. The difference was in how they approached the searches. With BitTorrent, you create a tracker for any specific file and share it on a third-party website to move it bit by bit around a network of users. LimeWire’s network supported intrinsic search queries for audio and video files, thus facilitating the file transfers. LimeWire also had a recommendation system: If it saw you were downloading, for example, Spider-Man the movie, it would suggest you download Superman as well. In the same vein as BitTorrent, miners facilitate a generic transaction, not necessarily a value transfer. The value transfer is facilitated by the party that coordinated the transaction, which includes matching a buyer and seller with associated pricing information for a proposed transaction.
And another point, CEXs are already filing tax information to the IRS, while DEXs mostly are not. Why aren’t DEXs held to the same standard as CEXs and other services facilitating transfers of value, such as PayPal? Bringing them under this umbrella is not only morally fair and just, but it is a sound and uniform implementation of the law. And for those saying such entities have no central administration to enforce anything, consider the fact that DEXs most often still have an owner whose wallet is collecting the profits, and that most updates for open-source projects usually come from one and the same entity. Where there’s a will, there’s a way.
Related: More IRS crypto reporting, more danger
No, innovation is not packing up
Critics also warn that the bill, if approved, could drive the crypto community out of the U.S., which would dent the country’s potential for innovation. But fear not: There is nowhere to run anyway. As noted before, the crypto provisions of the infrastructure bill are based on the latest standards issued by FATF, a global body fighting money laundering. These standards are generally implemented around the world, albeit within different time frames.
FATF first put its sights on cryptocurrencies in 2019, urging nations to tighten up the regulations on crypto exchanges. Since then, dozens of exchanges have been shuttered around the world for failing to comply with the respective local regulations inspired by FATF standards. Its latest guidelines take aim at DeFi and nonfungible tokens, or NFTs, so it’s no surprise that decentralized finance is one of the targets on U.S. regulators’ minds. The process goes beyond the United States: Europe is also moving to tighten up crypto regulations, consistent with other laws controlling value transfer.
Sooner or later, the playbook will be the same everywhere. Most in the community understand that, and would hardly take off unless their businesses were outright banned.
No, there won’t be any private data honeypots
Another very vocal concern is that having to file customer data to the IRS will force the brokers to create databases with clients’ private information, creating a honeypot — a lucrative target for hackers. This idea does not account for the efficacy of the crypto and DeFi communities with secure cryptographic algorithms.
Consider the zero-knowledge proof: A cryptographic concept that zooms in on how to prove to a third party that you know the value of a specific variable without saying anything other than you know it. Zero-knowledge authentication sees users, who hold their authentication data to themselves, sign in without revealing sensitive data to the platform. Implemented for DeFi, this kind of algorithm can generate any necessary forms required and send them to the IRS automatically without the need for the DeFi service to store the data on its own servers. Similarly, suspicious transaction reports can also be generated automatically and sent right to the regulator, with no need to inform other entities.
Related: FATF draft guidance targets DeFi with compliance
Finally, the point about surveillance and privacy also calls for another parallel with the social contract and written rules for other value transfers, especially for disclosing financial services. You can be as anonymous as you want while spending $100 in cash at your local store. To transfer $3,000 to a friend, you will have to share more information about yourself with the bank. And if you want to send $100,000 abroad, the bank or the customs entity will ask you more questions and the money will leave more of a financial trail. So, why should DeFi be any different?
Win by adapting
As we can see, most of the outcry about these possible regulations is not rooted in any real legal or logical reasoning. Yes, more compliance poses a challenge for the crypto ecosystem, as it would take time and money to develop the algorithms and protocols that will make it work. And yes, some people will have to part with some of their income from others’ illicit dealings — not a significant chunk of the crypto ecosystem, anyway.
The truth, as offensive as it may seem for crypto-purists, is that more compliance means more mainstream adoption, and more mainstream adoption means more growth. Blockchain-based financial services and applications do hold the promise of a revolution in finance, bringing real value to billions of users. Basic compliance with the law is hardly too much of a price to pay for that.