KYC: Know Your Cryptocurrency


Government institutions are well-known for their continuing attempts to impose controls on everything they may possibly think of. This is not a modern trend; examples of this kind of behavior are identifiable throughout the whole history of humankind. Government is all about controlling after all, and any such entity, be it in ancient Egypt, the Roman Empire, the lands of Aztecs, or, say, ancient China, does so. Whatever happens, no government will feel like giving up the controls.

The Strange Case of Genova and St. George

One notable example of the contrary can be found in Machiavelli’s Florentine Histories. The government of Genova, following a war with Venice, could not reimburse its citizens for money it had borrowed off them to wage the war. In order to settle the matters, the government assigned some shares of customs fees to the creditors proportionally to the debt. The creditors established a managing board, issued shares corresponding to the amounts of assigned payments, and called their organization St. George. Eventually, when the government needed money, it borrowed it from St. George. A bit later, lands and even cities governed by Genova, became property of St. George, which, while being technically a bank, had an army and a navy at the time. Thus, the Genovian government has lost any control of the country, as St. George became a state within a state, and Genovian citizens trusted the bank more than trusted the government. Any turmoil or revolution in the state became insignificant to the people of Genovia, as their allegiance lain with the bank that stood still, whatever happens.

Machiavelli himself noted:

“That is a truly remarkable example unknown to any philosopher describing courses of a state, real or imaginary. In the very same land, among the very same people, there are freedom and tyranny at once; respect for laws and corruption at once; justice and abuse of power at once. This is the very order that maintains the city’s existence.”

This instance remarks the essence of any government, namely, controlling. If a government behaves like Genovian authorities and gives up its controlling functions, it will essentially lose any reason to exist at all. The same Machiavelli wrote in his famous work “The Prince” that once someone makes it to gain power, this someone will never give it up voluntarily.

Government vs. Cryptocurrencies

This is the philosophic basis for the government rejection of cryptocurrencies, as they, in their turn, are based on the principle of depriving government institutions from their controlling functions. This is the sole philosophy for endless attempts to regulate cryptocurrency markets. Moreover, commonly known experience has proven that the governments mostly lack any proper comprehension of cryptocurrency’s working principles. The statements by numerous politicians across the globe show one thing: without even realizing what it actually is, they call for banning or restricting it, as they feel a well justified threat from the phenomenon.

Financial operations are just too important to let them go decentralized and uncontrollable. The easiest way to control financial transactions is to make them easily identifiable. While justifying themselves with terrorist threats or money laundering risks, government officials of different ranks reiterate the necessity of imposing know-your-customer regulations on cryptocurrencies.

The most remarkable move in this regard is New York’s notorious BitLicense, a set of regulations which had divided local crypto-companies into two. Some of them preferred to abandon the state of New York, while others gladly complied. Another remarkable issue of BitLicense is that it was intended to incorporate proposals from cryptocommunity. While many believe it failed to do so eventually, no one would possibly blame the regulator for not attempting to see into the matter prior to issuing its requirements.

Across the Atlantic, the same approach comes to minds of some politicians.

“It’s easy to fail when you regulate, you can be too early and too late. From the European Commission’ perspective, we are more on the monitoring side. We want to understand better what is happening,” said Olivier Salles, a senior official at the European Commission, at the hearing in the European Parliament in late January 2016.

However, the idea of imposing strict controls on operations with cryptocurrency turned out to be way more attractive. Just a few days after the statement, the European Commission announced it would tighten the regulation grasp over cryptocurrency exchanges.

The note issued by the Commission read:

“As requested during the extraordinary Justice and Home Affairs Council of 20 November 2015, the Commission will work on a proposal for a number of targeted amendments to the Fourth Anti-Money Laundering Directive, on the following points:
– enhanced due diligence measures/counter-measures to be taken towards high risk third countries;
– virtual currency exchange platforms;
– prepaid instruments, such as prepaid cards;
– enhance the powers of EU Financial Intelligence Units and facilitate their cooperation. This entails the further alignment of rules for such Units to the latest international standards,
– provide the Financial Intelligence Units with swift access to information on the holders of bank-and payment accounts, through centralized registers or electronic data retrieval systems at national level.”

The statement has instantly caused some turmoil in the crypto-community. Many would expect to hear such language from witch hunters of the Russian government, but in this case nobody seemed to expect the European inquisition.

New Wine in Old Wineskins

The plans in question are remarkable not only due to their obvious obscurantism. Additionally, they signify the lack of comprehension as to basic principles of Bitcoin. The most popular word in the obscurant language of the naysayers is “anonymity”, while Bitcoin, as everybody knows, may grant mere pseudonymity. The difference between anonymity and pseudonymity is striking enough for some to develop a completely anonymous cryptocurrency like Dash or Z-Cash, while for most users the pseudonymity thing is more than sufficient.

However, the lack of understanding signifies another philosophic pattern unfortunately inherent in modern government paradigm. The officials almost literally attempt to pour new wine in their old wineskins. Cryptocurrency as a phenomenon isn’t in line with the basic paradigm of old financial systems. It is structurally and philosophically different from any financial solution ever available before. The difference is even more striking than that between anonymity and pseudonymity, and that probably is the problem. Such enormous paradigm shift is too powerful for the officials to handle.

While operations with cryptocurrency may be anonymous, the anonymity inevitably ends when a user tries to withdraw the funds or transfer them to a plastic card. In fact, as there are not too many opportunities to spend bitcoins now, the withdrawal becomes the very KYC measure the officials might be searching for. In addition, pseudonymity means that law enforcement still may identify a Bitcoin user if they devote required energies to do so.

There were several serious reports issued in this regard for different government institutions. One of them, released by U.S.-based RAND Corporation, reads:

“The anonymity of using Bitcoin with Tor is the subject of debate, with recent research suggesting that de-anonymizing Bitcoin users employing Tor is possible given the current manner in which Bitcoin is configured.”

In case a transaction has something to do with money laundering or terrorism funding, the de-anonymizing efforts are pretty justified. For instance, a law enforcement agency may monitor the network for suspicious transactions and check them selectively to make sure no drug cartels or terrorist gangs are involved, leaving other users alone.

Moreover, there are some solutions to help the police to track down criminals. For instance, a New-York based startup Chainalysis engaged in AML and fraud countering projects, has announced its forthcoming partnership with Europol, the EU’s top law enforcement agency. Chainalysis software is said to be capable of defining ‘suspicious activity’, and offers investigative tools to law enforcement agencies for cases related to digital currencies.

The Protection and the Stranglehold

However, while all of this would have sufficed to counter criminal activities, governments still insist on imposing KYC measures to any operations with cryptocurrency. The phenomenon of new wine in old wineskins gets combined with the governmental fear of losing control, and, therefore, any reason to exist.

Some of the latest reports point out more or less the same issue, while also supporting the hands-off approach to regulation problems. Thus, a recent report issued for the Commonwealth, reads:

“Any regulatory and legislative frameworks should focus on interactions with fiat currencies and avoid attempting to regulate the underlying decentralised ledger technology. Such frameworks should be technologically neutral and avoid stifling innovation.”

Regulation, as such, is more of a good thing for traditional finance. While placing some obstacles, it still insures customers from fraudulent activities of banks or financial institutions, and even provides them with reimbursement mechanisms. That being said, regulation, while maintaining some protection for customers, is still a loyal friend of any government intending to get a stranglehold on any kind of activity it deems unwelcome. Thus, the Russian government uses regulation to trouble currency exchange for the country’s citizens; the Chinese government imposes restrictions on transferrable amounts of money; and Nigeria has completely prohibited its citizens to use plastic cards for purchases abroad.

However, regulation is futile when it comes to digital currencies. Due to the serious paradigm shift, the traditional approach is hardly applicable. Moreover, as the Commonwealth’s report also suggests, it may stifle innovations without any sensible result on the plus side.

On the contrary, KYC measures may cause some companies to leave local economies for more friendly jurisdictions, just as it happened with New York. Even though the state’s BitLicense is far from being unbearably strict, it still caused many companies, some of which are international, to abandon the state. As was mentioned above, regulation separates the community, with some of its members preferring to go to jail instead of complying with KYC requirements, and others even willing to run a government-approved business. However, if lots of companies decide to leave, it would seriously affect the abandoned region’s economy, as it entails losses of jobs, investment, and taxes as a minimum.

KYC: Know Your Criminals

Regulation for countering crime is also futile. No regulation measures are of any use to prevent criminal activities, when there still are physical cash and corruption. Ironically, cryptocurrencies, and their underlying technology, may help those interested to counter those evils without affecting law-abiding citizens. Moving funds to offshore accounts still occurs every now and then, and no regulation can stop it. Corruptive practices are even more common, and traditional finance’s non-transparency mostly facilitates them. Drug trafficking is thriving, while current financial regulations are as strict as ever. Terrorist activities are closely monitored by intelligence agencies, and most of their financial operations are thoroughly tracked. And again, for security reasons now, the information is classified.

A notable example of KYC’s possible usefulness is taxation. Indeed, a purportedly anonymous, or a plainly pseudonymous system would be a true gift to taxpayers. Companies would be free to evade their corporate taxes just by creating secret non-auditable accounts and underreporting their revenues. The same would be applicable to withholding taxes or personal income taxes. However, regulation in a transformed form might be useful to cover failed budgets and ruined taxation systems. Rearrangement of taxation system, currently unbearably complex and at times unfair in most countries, and essentially senseless in some corrupted nations, would restore the taxation level. In addition, if the imaginary future taxation system would be based on blockchain, it would be completely transparent, and thus way more efficient and less prone to corruption and abuse.

Regulation as a Weapon

Summarizing it all, no regulation in general, and KYC policy in particular, is useful for their nominal purposes. Moreover, regulation of innovations as proposed may hinder the overall progress and affect economies. However, the purposes of regulation may have been misinterpreted. If we suppose that regulation has nothing to do with preventing money laundering, drug trafficking, terrorism, and other serious crimes, it may seem quite useful.

Useful, that is, not for people, but for a government. Regulation, as such, is a perfect tool for maintaining controls. It is a weapon a government uses in the war for existence.

Cryptocurrency, in a way, is a modern version of St. George described by Machiavelli. It is a true and effective alternative for a government. They may co-exist for a while, but as the alternative seems more successful and meets the spirit of times, the government will be gradually losing every speck of reasons to be there. Benefits of digital currencies over those traditional are fairly obvious, and require no reiteration here. Digital currency, alongside with the blockchain technology underpinning it, is not a threat to economy, it is a threat to the current system of government, so the measures undertaken by governments are more than reasonable, at least from their own point of view.

Resistance is Futile

However, innovation as a phenomenon is unstoppable. No matter what the government policy was, innovations were propagating. For instance, in the USSR of 1930’s genetics were considered a pseudoscience, and prominent genetics were sent to labour camps or shot. The government attempted to create ‘the new Soviet man’ and used pseudo-scientific approaches to justify itself. However, this disgraceful and infamous episode never stopped genetics from being developed.

With officials, obviously intending to expand their controls further, and regular citizens minding their own business and wishing the government would try it, too, the struggle between the old and new may take a long time.

As long as there are people preferring imprisonment to complying with senseless regulations, the innovations will go on.

by Jenny Aysgarth

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