Crypto’s libertarianism goes headfirst into reality
Crypto took off and governments finally started acting like it. In 2013, when a young writer and software developer named Vitalik Buterin wrote an impassioned screed defending the blockchain gospel for his publication, Bitcoin Magazine, cryptocurrencies were still a niche curiosity. But a series of regulations spooked the nascent industry, threatening the kind of anti-government ethos that has always been at the heart of the project. For Buterin, the panic felt a little excessive. Crypto, he argued, couldn’t really be regulated. After all, this was the whole point of the new system: an internet with no masters, no intermediaries and no guardrails. “The future of crypto-libertarianism is bright,” he wrote. “Stop worrying.”
This is the promise that crypto advocates have been selling consumers and politicians over the past decade, as crypto has blown up to a trillion-dollar behemoth — in the process making Buterin, now best known as the founder of the Ethereum network, very, very rich. (Buterin’s Ethereum Foundation did not respond to a request for comment.) Although crypto has wormed its way into the mainstream, the argument goes, the technology was engineered in such a way as to prevent interference from banks and governments. For example, Jesse Powell, CEO of the Kraken exchange, has referred to crypto networks as “censorship-resistant rails as a last resort.” And venture capital powerhouse Andreessen Horowitz, now the top backer of crypto startups, has invoked the same idea to promote its multibillion-dollar funds.
But what may have been true in 2013 doesn’t ring quite as hard in 2022. Thanks in part to its efforts to gain mainstream recognition, crypto is now rubbing up against renewed government scrutiny. In recent weeks, a subtle but significant move by the Treasury Department has exposed some of the rhetorical misconceptions at the heart of the industry, suggesting that the technology can get mixed up with after all.
Despite all the talk of crypto as a slick new alternative to a corrupt and outdated banking system, businesses have now found themselves backed into a corner: Either they can comply with regulations that could essentially defang the promise of the technology, or they can keep, of course, to large costs to their bottom lines. And for the most part, companies seem to take the easy way out, principles be damned. It’s a sign that crypto is growing out of its youth oriented around building a new financial system, rather than evolving into something like a new wing of Big Tech. The more crypto matures, and the more it integrates into the existing scaffolding of American capitalism, the more it deviates from its core ideals.
The panic began in early August, when the Treasury Department decided to sanction a program called Tornado Cash, essentially banning any person or business in the United States from interacting with it in any capacity. Tornado Cash is a tool that makes Ethereum transactions more or less untraceable, distorting the paper trail of a known transparent blockchain. It’s great for well-meaning privacy enthusiasts worried about prying eyes, but it’s also great for cleaning up dirty money: State-backed North Korean hackers reportedly used the program to launder more than half a billion dollars of Ethereum in April.
Tornado Cash is not that popular as a program, but the implications of the sanctions are far-reaching. It threatens to affect how the entire Ethereum blockchain – now the second largest crypto network after bitcoin – works in practice. Allow me a moment of crypto-splaining: When you ask your computer to send Ethereum to a friend, you have to wait for another computer on the network to confirm the transaction, to ensure that you have enough money to send and that it will arrive to the correct address. Without that clear signal, the money is stuck in limbo.
Right now, that happens through a process called “mining,” though Ethereum plans to replace its miners with a new, more energy-efficient system of “validators” later this month. Technically, anyone can be a validator, but because validation requires having a lot of crypto available, it’s mostly companies that do this work, collect customer funds, and take a cut of the profits. According to Decrypt, more than 60 percent of the validation will go through four companies. And if the computer performing the validation belongs to a US company (even if you are not based in the US yourself), it must comply with the sanctions, making it more difficult for anyone anywhere on the network to use Tornado Cash.
The end result risks what crypto has always wanted to avoid: censorship. Because the companies behind these validators are subject to publication for sanctions violations, the reality is that your money can effectively be frozen by an vigilant government. It’s a small chink in the armor that is Ethereum’s resistance to censorship, and one that might not necessarily affect more casual users – but the fact that the armor can be chinked at all is telling. Who knows what the Treasury may decide to sanction further? “It reveals what was true all along,” said Angela Walch, a St. Mary’s University law professor who studies crypto. “The cat is out of the bag for both regulators and the crypto sector [censorship resistance] is a kind of myth.”
US validators have no good options here. If they choose to comply with the sanctions, they concede that governments can interfere in transactions after all, potentially allowing innocent bystanders to be caught in the crossfire. If they don’t, they risk breaching Treasury guidelines – a move that isn’t particularly sustainable for a growing industry.
In practice, companies must either comply with the sanctions and renounce their Don’t Tread on Me roots, or simply stop their validation businesses altogether, skipping loads of money in the process. “For crypto companies, this is where the rubber meets the road,” Walch said. “Your talk about this being a democratizing force, and ‘neutrality is important’, and ‘everyone should have the ability to act freely’ – okay, are you going to follow the law, or are you going to follow the alleged ethos of space? We’re reaching a point where you’re not going to have it both ways anymore.”
No one should be surprised that the denizens of crypto-Twitter—the twisted artery through which all blockchain-related discourse seems to flow—engages in lobbying activities for the last option. For the faithful, the choice of how to react to these sanctions is almost a moral question. If you’re willing to comply with the Tornado Cash sanction, the thinking goes, maybe you never really cared about what made the blockchain special to begin with. One crypto YouTuber suggested that if Ethereum validators capitulate to the sanctions, the entire system would be “for beta men.”
A few crypto leaders are not backing down. Buterin, more a technologist than a businessman, is recorded as saying he would choose to punish validators who comply with the sanctions. Coinbase CEO Brian Armstrong, arguably the most influential leader in the US cryptosphere, has said the same about the company’s validators; yesterday the exchange announced it will bankroll a lawsuit against the US Treasury over the sanctions. When Ethereum upgrades later this month, Coinbase will control an estimated 15 percent of the market for the network’s validation process, making it one of the most powerful individual players in the system. Shutting down part of a business poised to generate huge gains for Coinbase, especially on the heels of a particularly bad quarter, would be borderline catastrophic. (A Coinbase spokesperson pointed me to a webinar it held to discuss the implications of the sanctions, but declined to comment further.)
But by and large most companies have so far remained mum on this issue. For some, the silence may represent genuine confusion about exactly how they are supposed to comply with the sanctions. For others, however, it may just be a way to pass the buck: The industry seems more concerned with cementing its place in the American financial system than taking an ideological stand at the expense of profits, and an official statement in that direction would only inflame society. Last week, a spokesperson for Kraken, which operates an Ethereum validation business alongside the exchange, said in an email that the company is “closely monitoring the discussion of the potential implications of Tornado Cash sanctions for validators,” but declined to expand on how it plans to comply with the new sanctions. However, a mission statement from Jesse Powell from 2018 might give you a hint of where the company is headed: He wrote that his “ideological motivation” to build a world-class exchange was entirely dependent on “working with regulators.” Lido Finance, another prominent source of validators, did not respond to multiple requests for comment.
That companies are finally confronting these issues is a sign that the industry is maturing, for better or for worse. Crypto was originally conceived as an alternative to traditional finance, a way to bypass the big banks. But what happens when the new system grows into the old? When Buterin wrote his blog post a decade ago, a single bitcoin cost $120. At the heart of last year’s wave, the price reached $69,000. By 2022, venture capital firms and investment banks are pouring billions into the idea that crypto will have a role in the future of global finance. Blackrock has a private Bitcoin trust for its clients, and JPMorgan Chase, Morgan Stanley and Goldman Sachs all have dedicated crypto divisions.
In this new era, businesses must decide: accept the reality of regulation and continue to grow their businesses, or find a way to circumvent the new rules altogether. At least they finally have to pick a side.
