The End Of An Unregulated Era: How Regulators Will Control Bitcoin
By Eric Brouwer on ALTCOIN MAGAZINE
By running or contracting others to run full nodes, regulators will collect and analyze data and with that, command governance over the bitcoin end user. It may not be the end of bitcoin, but it certainly represents the end of an unregulated era and the start of a new regulatory saga.
This article does not constitute legal or any other professional advice and is not intended to be relied upon as such.
A New Regulatory Saga
For ten years bitcoin enjoyed unparalleled status as an unregulated technology. Its decentralized architecture disrupted the status quo of regulation predicated on centralization. It represented an era of decentralised governance in the hands of users and not government rules.
Regulators took notice. In an effort to combat the challenge of decentralised systems, they attacked the “on and off-ramps”. This strategy bore great fruit for the regulators with enforcement actions running ubiquitously in the market.
However, it was not enough. Regulators wanted control over the bitcoin network, the one thing that escaped their grasp. They wanted to continue their reign of command control just like they did over the “on and off-ramps”.
And now they have started their journey down that pathway. They have drawn up their battle plans and have decided to run their own bitcoin nodes. They will collect and analyse data, and with that, command governance over the bitcoin end user. It may not be the end of bitcoin, but it certainly represents the end of an unregulated era and the start of a new regulatory saga.
The Status Quo of Centralized Control
When we think about regulation we think about the rules that govern society. They penetrate our minds and have a powerful effect on how we interact and behave with others and the environment. One knows not to intentionally inflict harm on a stranger because we know intuitively that this comes with the risk of criminal sanction in a court of law.
The power of rules are twofold: (1) to change our behaviour to fit a specific objective (in the example above this would be preservation of the integrity of the person) and (2) to punish any behaviour that does not conform to the rule (a fine or jail sentence, for example). With these two effects, rules influence how people and entities engage in the world.
Using rules to change our behavior is the oldest form of regulation known to mankind. This system of governance is what we call “command and control regulation”. It is a framework of legislated rules that aim to change our behavior through the coercion of law. It starts with the legislature producing law and moves to the executive branch enforcing that law, and lastly through the judiciary meting out fines and penalties. This forms the basis of our democratic separated organs of government.
The above command and control architecture of regulation is no stranger to the crypto universe. We have rules that state that you cannot offer unregistered security to the public. We have government agencies that then detect and try to enforce those laws. And lastly, we have the courts that adjudicate any disputes between the alleged wrongdoer and the regulatory agency that may result in fines or sanctions. Sound familiar? This is the bedrock enforcement model for many jurisdictions and is the exact model used to penalize any unlawful ICOs that have violated securities laws.
This model of rules and coercive enforcement relies on the foundation of a centralized actor. The legislation defines who come within its scope and who the rules apply to. The regulatory agency monitors and scans the markets for individuals and entities that transgress those rules. And the courts levy fines and penalties against individuals and entities who breach those rules. At every stage of the command and control process, a centralized entity is the focal point of consideration. A person, corporation, undertaking, etc must exist for this model to work. If you remove that centralized figure the foundation upon which the rules and enforcement rely, fall with it.
That is the major weakness of such a system. It relies upon the proposition that regulation requires a centralized actor. The system works great in almost all cases. Our society is made up interactions between centralized figures whether natural or legal. In such a society, command and control regulation is the primordial form of regulation that any society will need to shape the direction of its people. That is until something comes along that does not fit within that centralized paradigm of regulation.
Bitcoin’s Regulatory Challenge and Intrinsic Value Proposition
That something is bitcoin: A decentralised peer to peer network that relies on cryptography to send codified value across the globe to anyone with an Internet connection without the use of intermediary support. An invention that has no face, no body, no board of directors, no mind soul or cognitive capability. What we are talking about is a thing that that exists nowhere yet everywhere. A thing that is completely decentralized that removes any notion of trust with anyone or any being and instead embodies that trust in a cryptographically secure algorithm. Welcome to the future of finance. A model of trust and governance that removes our typical conceptualization of a person or figure, a centralised entity, and flips it on its head to create a decentralised figure that is made up of the millions of people that use it.
This lack of human quality and legal personality directly attacks the model of command and control governance our society is founded upon. With no individual or entity pulling the strings behind bitcoin, rules have no teeth. Legislation has no effect. Regulatory agencies have no one to investigate. Courts have no lawful jurisdiction. Bitcoin takes everything about a centralized model of command and control regulation and frustrates it. It eviscerates the cornerstone of regulation, the centralized individual.
As rules cannot target bitcoin due to its lack of centrality, regulators cling on to anything that resembles a centralized entity. This should come to no surprise. We have rules that pertain to ICO issuers as a result of having a person or entity that facilitates the issuance of a token to the public. We have rules for crypto exchanges, again, because of the fact that an exchange will normally have separate legal personality. And we have rules for crypto wallet and custodian providers for exactly the same underpinning reason, centralisation. Rules may not find homage with bitcoin, but they surely find a place with the so-called “on and off ramps” between the crypto and legacy financial system.
To me, bitcoin’s intrinsic value is its decentralized censorship-resistant framework. It is its capability to disrupt regulation and to escape every third party’s attempt to govern and control it. It has a hardcoded objective to have 21 million bitcoin in circulation by roughly 2140. No one can change that. This is what people mean when they say that bitcoin is censorship resistant. It is the fact that despite the plethora of rules and regulations that change and influence every aspect of our lives, not one of those rules can influence bitcoin governance or policy. In that sense, it is one of the first truly decentralised democratic embodiments that we have witnessed since the Internet itself. Direction and control are not left to a legislature, but a pre-programmed cryptographically secure algorithm. For that simple reason, bitcoin has a unique intrinsic value proposition of disrupting command and control regulation that derives from its decentralized architecture.
Return of the Regulators
However, that intrinsic value proposition may start to unravel and change. With rules not directly applicable to bitcoin itself, regulators have to think about ways to influence something that they cannot effectively touch or control. Thus far, regulators have not really focused on bitcoin, but rather those centralized entities, the “on and off ramps” as we like to call them, as they can actually exert control in such circumstances. But, if you cannot control bitcoin then what do you do?
Well, as the old adage goes: “if you cannot beat them join them”. And that is exactly what regulators are doing. The Securities Exchange Commission (“SEC”) just recently announced that they will use contractors to run bitcoin nodes. They will use these nodes to monitor risk, and importantly improve compliance. The underlying purpose here is clear. Since they cannot directly command influence over the bitcoin network because of a lack of centralization then at a minimum they can at least collect data on the bitcoin network itself. Using data analytics, they can then try to command control, not over bitcoin per se, but its users.
That is where things get a bit murky for anyone using bitcoin. If the overall objective here from the SEC’s view is to improve compliance, then how exactly do they intend to reach that goal? Well it’s not exactly clear at this point in time, my estimation is that they intend to accumulate as much data as possible to break down the effects of decentralization in order to recalibrate the locus of regulation back onto the individual. Yes, you. They intend to sift through swathes of data and decode that data to identify individual users. Once they have done this, they can focus the rules back on to the centralized individual. This way, they attempt to ratchet in the decentralized effects of bitcoin and reinstate a command and control approach.
With any luck, they will have the data and tools at their disposal to identify individuals that breach the rule of law, say by offering unregistered securities to the public. At least for now that is the most probable scenario as the SEC’s regulatory remit is limited to enforcing securities laws. If, however, we view this as the start of something bigger and a gateway for more regulators to run their own nodes the picture changes drastically. We may shortly have FinCEN running nodes on the bitcoin network and monitoring individuals for specious transactions that offend anti-money laundering laws.
This takes regulatory enforcement to an entirely new level. It magnifies the risk of being caught for anything questionable. Big brother will always be watching at every step of the way. They will know when you use your bitcoin for lawful acts and when you use your funds for nefarious activities. They have taken bitcoin’s transparency and audit trail and used it against the people. They have taken bitcoin’s technological intricacies and gamed it to their advantage to plug the holes in their legacy enforcement model that did not account for decentralised systems. Welcome to the future of regulatory enforcement: A system whereby regulators actively participate in open decentralized networks to collect data, monitor and enforce rules and regulations on end users.
The End is Near
Who knows, maybe the purpose of the SEC running a node is merely to just collect data. That is a possibility but it is wishful thinking. Individuals act with purpose. Their actions reflect a desire to reach some objective. No doubt here, with the SEC, that goal is to find a way to enforce regulation in a decentralized system that answers to no rules or authorities. What better way to achieve this than by actively participating in the system that you cannot directly control.
That is what makes this such a big deal. A regulator like the SEC operates and thinks in terms of risks. Big risks deserve greater attention while smaller risks do not warrant the same amount of regulatory resources. To me, running a node on the bitcoin network places bitcoin somewhere on the lower end of the risk scale with the potential to move up in severity. Right now the focus is on data analytics and learning with the potential for regulatory enforcement on the end user. That is only the beginning, however. As data analytics and technological tools at regulators’ disposal advance, we may start to see regulators pushing more into space in an attempt to grab more power and command and control influence over the bitcoin network, or at least more realistically, its end users.
For some, such a possibility does not really matter. Most do not even use bitcoin as a medium of exchange, but only as a means to “hodl”. For those types of users, the SEC’s experiment in running a node will have little impact. But for other users, the ones that care deeply about their privacy, that view bitcoin as this libertarian panacea that will free them from the grips of big government, have everything to fear. Their paradise of laissez-faire bitcoin economics are no more. Big government has joined the party and is here to stay. That is the new reality of bitcoin. It may have its unique intrinsic value of averting direct regulatory control and having a programmed set in stone monetary policy, but it does not escape regulatory scrutiny. Every transaction is now more thoroughly investigated, analyzed, and logged. It is the start of something big. It represents the end of an unregulated bitcoin era and the start of decentralized regulatory control. And you best be prepared for it.
