The Future For Privacy Tokens
This is an excerpt from our April newsletter.
Neither this post nor any other on cryptofal.com should be taken as financial advice. It is not.
Privacy tokens are something that regulators are both perplexed and frightened by. While many privacy advocates are in support of privacy tokens and their usefulness for a variety of people, governments accuse these projects of being vehicles for money laundering and other illicit activities. With governments having this type of mentality towards privacy tokens, many have speculated whether regulation would eventually lead to an outright ban of privacy tokens in some places.
To understand and potentially predict how privacy tokens may be treated by regulators, we have to understand the attitudes of regulators towards them, the attitudes of the public towards them, and the attitudes of those in the crypto space surrounding these protocols.
It’s not too surprising that both regulators and law enforcement aren’t huge fans of privacy tokens or privacy-based blockchain protocols. Law enforcement has especially been opponents of privacy-based crypto and the broader cryptocurrency space for over a decade now.
In a piece from 2020, Forbes interviewed someone from the Secret Service regarding cryptocurrency’s roles in crime. They found that cryptocurrencies and crime often intersect in cases of money laundering, fraud, or cases where they’re trying to “undermine the integrity of financial and payment systems.” The piece revealed that while they don’t believe these are cryptocurrency-specific problems, there are protections that cryptocurrency can provide for illicit actors that they can’t find in the fiat system. The Secret Service views crypto less as a type of crime and more as a tool that can be used for crime at times.
With this being the view of the broader cryptocurrency space, it’s not too surprising that law enforcement holds unpopular opinions of encrypted iterations of this new tech. Also in 2020, the IRS offered a reward of over half a million dollars to anyone who could trace cryptocurrency transactions, specifically privacy coins such as Monero. Monero allows for private transactions where the users and the transaction amounts are protected and not easily accessible as with public blockchain ledgers like BTC and ETH. The IRS sees crypto, and more specifically privacy tokens, as a potential tool for evading taxes as well.
Like law enforcement, regulators have similar concerns about private cryptocurrencies being used as tools for illicit activities or evading taxes. While most US and EU-based centralized cryptocurrency exchanges are registered, where strict AML guidelines are abided, there are still many aspects of the cryptocurrency space that don’t have that information as readily accessible to regulators. One of the features of the cryptocurrency space that intentionally lacks this information is privacy tokens and blockchains.
Currently, the European Union’s parliament recently held a vote in favor of sweeping regulation on much of the crypto industry, including anonymous transactions. Anonymous transactions (such as those of privacy tokens) would then be restricted from accessing the broader fiat financial system. This would also extend to many self-hosted wallets and non-registered exchanges. This proposal is an extension of AML-based regulatory requirements.
Privacy advocates and opponents of the measure have condemned the new proposal, and believe that it could lead to a “de facto ban of self-hosted wallets.” For privacy tokens and privacy-based blockchain protocols, this could be a huge deal. For this rule to pass, it must be agreed upon by both the EU parliament and its national ministers. Many in the cryptocurrency space are hoping that this does not get passed into law, and have been very outspoken about it. One of the main opponents in the space to this measure is the CEO of Coinbase, Brian Armstrong, who had a tweet thread reacting to this that’s been making the rounds throughout the space.
While this ban doesn’t only encompass privacy tokens, it’s very likely that many other governmental and regulatory bodies will group privacy token bans and/or privacy token regulation with other sweeping regulatory measures.
With regulators and law enforcement framing cryptocurrencies as a tool for fraudsters and criminals, it’s unsurprising that this has tainted the public’s perception of the space. When discussing cryptocurrencies, it should be noted that as of late 2021, only about 16% of Americans are invested in cryptocurrencies or have purchased them before, with only 24% saying they know a lot about cryptocurrencies.
So, when you have regulators and those in power painting these protocols with a very broad brush, it doesn’t fare well for public opinion. This has created a branding issue for the space, with many’s first interactions with the space being a story they heard about ransomware or fraudsters. Many who aren’t as knowledgeable of the space will often falsely assume that cryptocurrencies are inherently private, which is another notion you’ll often hear. This is an assumption that only comes with ignorance and will likely be less prevalent as time goes on. Hopefully, this happens sooner rather than later, because it is very likely that public opinion will be needed in the fight to get proper, and fair regulation (on both privacy coins/protocols and the broader cryptocurrency space). It will likely take a lot of influence from the public if we want to avoid sweeping bans on privacy protocols.
With all that being said, it should be noted that both the number of people aware of the space and the number of people invested in the space has increased dramatically over the past few years.
Those involved in the cryptocurrency space regard privacy tokens much differently. Many see it as a useful tool for those attempting to avoid sanctions or for avoiding the prying eyes of oppressive regimes. Crypto advocates in the US often view it as a right to privacy and see the banning or sweeping regulation of privacy tokens as a violation of such. Either way, support remains largely intact by those in the crypto industry.
Regulation of some sort is likely inevitable for both privacy tokens and the broader cryptocurrency space. Unfortunately, it’s likely that these regulations will be supported by both the miseducated public as well as regulators. The EU proposal that included a wide variety of crypto regulations including the ban on privacy-based transactions, will likely not be the last of its kind. While some regulators will likely attempt to push back, it wouldn’t be surprising if we continue to see reiterations of this ban in a variety of international jurisdictions. Most of these regulations are likely to be focused on regulating people’s access to these protocols through registered exchanges since doing it on an individual wallet-by-wallet basis would be impossible. They may block exchanges from listing privacy-based protocols, or even block registered institutions from hosting wallets for these privacy tokens
The issue is, that there are other ways beyond centralized institutions to use these privacy protocols. Decentralized exchanges and non-custodial wallets will also likely be a challenge to enforce regulations on. Whether or not regulators and governments will be able to regulate these entities remains to be seen.
As governments and regulators learn more about the space, hopefully, they’ll see the benefits of privacy tokens and their positive use-case for many before slapping them with an outright ban.
