Contradictions and Improvements in Regulation
I. Need for Independent Regulatory Bodies
The current cryptocurrency regulation comes from multiple agencies, necessitating a more efficient regulatory framework. Under the existing system, different regulatory agencies (such as the U.S. Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Hong Kong Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority) have unclear regulatory responsibilities for cryptocurrencies, resulting in overlapping, gaps, and conflicts in regulation. It seems that any department can intervene.
As an example, cryptocurrency exchanges must comply with anti-money laundering regulations and also face multiple other regulatory frameworks like securities and commodities laws, increasing compliance costs. The regulation of decentralized finance (DeFi) and non-fungible tokens (NFTs) is even more ambiguous, lacking clear legal basis, leading to ineffective regulation and accumulated risks. The rise and fall of meme coins further highlight the inadequacies of the existing regulatory framework. Regulatory agencies are inexperienced in regulating such new assets and have failed to effectively prevent risks. Inappropriate regulation has led to significant losses in the crypto market, causing distress in the entire industry.
In the first part of this series, “Problems with Cryptocurrency Regulation Part 1,” we discussed the conceptual problems of cryptocurrencies. When the basic concepts are unclear, regulators, judges, and project teams handle matters based on their own understanding. These understandings come from past experiences, and differing experiences lead to a lack of common ground for communication. The views of each party do not constitute a comprehensive consensus, and the lack of an overall perspective in research methods is akin to the fable of the blind men and the elephant—each person perceives a part correctly, but it is insufficient to explain the whole.
Since we believe cryptocurrencies are the future, we must, based on the interdisciplinary nature of cryptocurrencies, have an independent body to manage all aspects related to cryptocurrencies. While checks and balances are correct, the decentralization of regulation has led to multiple authorities, leaving inexperienced entrepreneurs at a loss, so they try to circumvent it. The current chaos in meme coins precisely illustrates the failure of this regulatory approach. If the stubborn issue of chaotic regulation is not resolved, the big trees in the sector will eventually fall, and the grasses will not survive either. Cryptocurrency exchanges should not be the ATMs for regulatory bodies, and project teams should not have to face regulatory hazards while bearing the risks of the entrepreneurial market.
I believe that under the leadership of a new regulatory body, the efficient mechanisms of cryptocurrencies will outperform the current stock trading mechanisms.
II. Policies Infringing on Personal Privacy or Property Rights Must Be Prohibited
The anti-money laundering law aims to combat financial crime, but its implementation increasingly infringes on individual privacy and property rights. The main issues are three folds:
1. Uneven Enforcement and Presumption of Guilt: Some banks excessively scrutinize fund transfers, and even legitimate transactions may be suspected of money laundering if source of funds is not adequately proven, leading to account freezes and infringement of personal property rights. For instance, requiring the disclosure of business secrets to prove the source of funds has occurred in Hong Kong, where a bank required customers to provide contracts to explain the source before allowing corporate account transfers, exacerbating this issue.
2. Over-cautious Banks and Difficulty Opening Accounts: To mitigate risk, banks make the KYC (Know Your Customer) process for opening corporate accounts overly cumbersome, affecting normal economic activities and potentially fostering underground financial activities. Meanwhile, some “enterprising” online banks, to attract customers, lack stringent reviews and become easier targets for regulatory crackdowns.
3. Rigid Regulations Infringing on Privacy: Regulations like banks asking about withdrawal purposes, although intended to prevent money laundering, infringe on individual privacy rights. Such impractical regulations increase the burden and reduce enforcement efficiency.
The frequent appearance of “unfreeze account” tutorials on platforms like Douyin (Chinese version of TikTok) indirectly reflects issues with the execution of anti-money laundering laws. These tutorials indicate that some accounts are frozen without solid evidence, and based on misjudgments or over-interpretations. This necessitates a review of the execution standards and processes of the anti-money laundering law to avoid unnecessary harm to innocent individuals.
The funniest thing is when one withdraws money from a bank, they ask what you need it for. It’s my money; how I spend it is private. Will the reason I tell them be true? I certainly wouldn’t say I’m taking the money to commit a crime. Such absurd regulations are executed seriously, indicating that the laws made lack practicality.
III. No Prosecution without a Complainant
The application of KYT (Know Your Transaction) technology in blockchain provides new technical means for anti-money laundering efforts but also raises issues about personal privacy rights and the principle of “no prosecution without a complainant.”
The so-called loan fraud case of President Trump is very typical; there is no victim, yet a case can be filed and adjudicated. Why can public prosecution be carried out against private enterprises without a complainant?
Traditionally, the principle of “no prosecution without a complainant” has protected citizens’ personal freedom and privacy to some extent. Financial crimes like money laundering using blockchain are highly concealed and transnational, making it difficult for traditional enforcement models to cope effectively. The current KYT technology analyzes on-chain transaction data to address this shortcoming. Its advantage lies in monitoring large-scale transaction data, identifying potential money laundering behaviors, and providing clues easily to law enforcement agencies.
For example, data from a KYT service provider in the industry shows that as of August 2023, it covers more than 170 blockchain networks worldwide, with over 1,000 TB of on-chain data. Among this data, it has compiled a “suspicious address database” with over 3.4 billion address labels and nearly 70 million black and gray address labels. It can help financial regulatory agencies and project teams understand the background and attributes of each address and monitor whether each transaction has risks in real-time, issuing timely warnings and handling suspicious transactions when detected.
The monitoring and reporting system based on suspicious data monitoring ordinary people’s transactions disrupts the public order and customs formed over thousands of years: no prosecution without a complainant.
Where there is a way, there is a way to counter it. This is a dynamic confrontation process. Machines are prone to errors, causing harm to innocent people. There needs to be a complainant for an investigation to be pursued.
Online monitoring has destroyed individual privacy. Legislation is needed to limit this. The current anti-money laundering law does not sufficiently protect users.
IV. Establishing a Transparent Accountability Mechanism through Blockchain
Understanding the previous section makes it clear that the transparency of blockchain far surpasses that of the current financial system.
The dispersed nature of data and the phenomenon of information silos in the existing financial system increase the difficulty of tracking laundered funds. Data from various financial institutions is usually stored independently, and cross-institutional data sharing only exists for specific purposes. In just a few years, data from over 170 well-known blockchain projects have been tracked. Data does not need to be reported to authorities like in the banks because authorities can view on-chain tracking data themselves.
Currently, on-chain data on the blockchain is transparent, but the non-transparent part is the exchanges. Exchange data can actually be checked, but it is only disclosed to law enforcement. When law enforcement tracks a blockchain address to an exchange, they can know the data flow, thereby catching individuals and seizing criminal proceeds. The collaboration of Binance with Western countries during the Russia-Ukraine war demonstrates its capability in this regard. The public, however, does not know the fund flow, making it difficult to find a complete evidence chain to report when asset is lost.
Transparency is the core principle of cryptocurrency. According to this principle, making centralized exchange data transparent and hashing transaction records on-chain can prevent exchanges from cheating. The entire blockchain data flow can be traced, and anyone can view it. This is the principle of transparent centralization advocated and implemented by the Chainless Transparent Centralization Platform. If all cryptocurrency data were transparent, current anti-money laundering measures would be unnecessary. If users are scammed, they can take the complete data to report it, and the public security authorities can verify and file a case within minutes, then notify the project team to seize the funds.
With transparency, crime will decrease, and social management costs will be significantly reduced. This requires regulatory authorities to introduce corresponding policies to promote industry transparency.
V. Regulation Based on Transparency
The article “What is the Internet Era” introduces five characteristics of cryptocurrencies: personal sovereignty, community self governance, transparency, fairness and justice, and tamper-resistance. Cryptocurrency projects should simultaneously meet these five characteristics. Under these conditions, the essence of decentralization is still reflected in transparency—the more opaque, the more regulatory intervention is needed. The more centralized, the easier it is to be opaque, and the more regulatory intervention is required. Regulation based on the degree of transparency is better for policy formulation.
Ownerless Systems Also Need Regulation
The Bitcoin system is transparent and ownerless, requiring no license. If the Bitcoin community mechanism fails, it is impossible for Bitcoin to seek help from regulatory agencies. Therefore, Bitcoin should have a foundation to better integrate with the real world. The foundation will be held responsible to the Bitcoin community and only need to be registered in one jurisdiction.
The Ethereum system is transparent and ownerless, but the Ethereum Foundation is the controlling entity. Ethereum does well with its foundation’s annual report, although the report’s content is not detailed enough. The problem with Ethereum is that the foundation is not constrained by the community and needs additional third-party checks. Regulatory authorities’ regulation of the controlling entity is regulation of the foundation. Key regulatory points include the foundation’s financial status, governance mechanisms, information disclosure, and the planning and execution of project development. An independent audit etc on top of the annual report should be conducted. The regulatory model can refer to listed companies’ regulation to formulate relevant detailed regulations.
Licenses are for Increasing Trust in Opaque Systems
Traditional financial institutions are opaque, and their credibility is questioned. Without supervisory regulations, major problems arise, requiring regulatory constraints and high regulatory conditions and requirements—this is the role of a license. The regulatory authority’s credibility is reflected in the license, thereby endorsing banks and other financial institutions.
For transparent systems like Bitcoin, there is inherent trust, so no license is required.
Decentralized exchanges (DeFi) have Ethereum-like ledger transparency and naturally do not require a license. DeFi has controlling entities, which may or may not have a foundation or community control, and should have management mechanisms similar to listed companies. This management is weaker than license control.
Non-automated Places Require Regulation
The credibility of machines represents the level of automation and transparency of a project. Wherever automation is insufficient, regulation is needed, such as for human operations, rule violations, and nontransparent operations. Specific regulatory provisions are required here.
Project Teams Must Use Real Names
Anonymity represents uncertainty. Currently, the maintenance personnel of the Bitcoin system use their real names. The fact that Satoshi Nakamoto remained anonymous was caused by historical conditions which are no longer applicable today. Real names for Bitcoin maintenance personnel are a progress and represent accountability. Without an ultimate real name, there is no ultimate responsible party, and such projects carry huge risks. The impact of anonymity in blockchain has large impact and must be addressed. Users can remain anonymous, just like using cash, but cash has significant loopholes that can be exploited by criminals.
In normal transactions, users are not afraid of using their real names; excessive anti-money laundering measures have led to a dislike of real names, causing people to remain anonymous. This results in stricter regulations, which is an incorrect regulatory approach.
It is wrong for project teams to remain anonymous, but restrictions and enhanced regulations cannot solve this problem. If it is stipulated that anonymous projects cannot be listed or traded, who would remain anonymous?
Regulation Based on Core Team Commitments
Cryptocurrencies are not entirely successful through iterations; they require thorough pre-design. The white paper must reflect the central idea of the project, akin to a prospectus. The white paper can be modified but such modifications must be announced in advance. If changes are made arbitrarily due to unachievable goals, the team can be sued.
Token Circulation is Equivalent to Listing
The main difference between cryptocurrency exchange circulation and stock circulation is the listing stage; stocks are listed in late stages, whereas cryptocurrencies are listed in early stages. The regulatory requirements for cryptocurrency listings should be higher than for stocks, including that the first listing exchange has regulatory and sponsorship responsibilities, unless the token has a sponsor. This way, exchanges are jointly liable for fraudulent listings. When tokens are listed without a listing prospectus, the exchange bears unlimited liability, whether it is a centralized or decentralized exchange. Investors in various countries can sue exchanges under the universal jurisdiction exercised by the government, and exchanges cannot escape no matter where they are located.
Formulating Practical Listing Rules
Currently, only a few tokens can be listed on compliant exchanges in Hong Kong, which totally lack vitality. Regulators need to have practical listing rules, as current listing rules are clearly impractical. There is significant criticism of Exchange’s listing operations, mainly due to its opaque policies.
Regulation of Project Teams
The management rules for senior executives of listed companies are generally applicable to the regulation of members of cryptocurrency project teams, with team executives subject to local jurisdiction where they are listed.
VI. Regulating Fund Inflows and Outflows
USDT, USDC, and bank fund inflows and outflows can be regulated. The responsibility for KYC (Know Your Customer) real-person verification and AML (anti-money laundering) lies with these institutions, as they are the interface with fiat currency. Regulatory policies for them are already complete, along with practical execution experience. As long as the blockchain is a transparent whole, funds become transparent once entering the blockchain, thus little additional regulation is needed. If the entire financial system is transparently centralized, regulatory costs will be very low. Currently, high-cost regulation is inefficient and plays a cat-and-mouse game with criminals, also harming the innocent.
VII. Same Rules Not Applicable to Different Structures
“Problems with Cryptocurrency Regulation Part 1” mentioned that it was proposed to the Hong Kong Securities and Futures Commission that “same structure” should be added to the principles of “same business, same risks, and same rules”. Despite similar business between cryptocurrency and stock trading, the structures of cryptocurrency trading and stock market trading are entirely different. Applying stock regulatory approach to cryptocurrency is a huge mistake, giving exchanges great opportunities for fraud. Regulatory mechanisms cannot be the same for the same business with different structures, justifying the need for a new unified regulatory body.
In the next section, I will use cryptocurrency trading to illustrate what a low-cost regulatory structure for cryptocurrency trading entails.
