Earlier this week the Biden administration took aim at cryptocurrency by announcing they’re preparing an executive order for release early next month outlining the U.S. government strategy on cryptocurrency.

Here’s a handy bullet point list:

The directive would place the White House in a central role overseeing efforts to set policies and regulate digital assets, Bloomberg reported.

• Federal agencies have already been studying or providing regulatory guidance around the digital asset sector for years.
• The Office of the Comptroller of the Currency (OCC), Securities and Exchange Commission and Commodity Futures Trading Commission have issued guidance letters, informal statements and public rule-making efforts to direct how different aspects of the crypto industry should comply with federal law. But these efforts have not been coordinated in a single document or by one agency.
• Biden Administration senior officials have met multiple times to discuss the directive, which will be presented to the president in the next few weeks, according to Bloomberg.

This is naturally the next step in the arms race wherein regulators have finally caught up to the cryptocurrency space, and will enjoy some temporary supremacy until the crypto-space decides its had enough and unveils some new privacy-based technology. Some incorrectly believe this is already at hand – with decentralized finance. But there are a handful of misconceptions about DeFi that should probably be cleared up before we get into the case for privacy.

Misconceptions:

• DeFi is anonymous. It’s not.
• DeFi is decentralized. It’s not and probably will never be.
• DeFi is untouchable by government. It’s not.

Let’s unpack these first.

Decentralized finance isn’t anonymous because the blockchains governing it aren’t. I can think of two companies off hand—Bigg Digital Assets (BIGG.C) and DMG Blockchain Solutions (DMGI.V)— with proprietary tech capable of negotiating the flows of the most dominant blockchains involved in DeFi. Specifically, those products are Qlue, BitRank Verified and for DMG, Walletscore and Blockseer Explorer.

That means all the business transactions involving coins these companies have on their extensive list of options for their products will be subject to scrutiny in the future. The same system devised by Satoshi Nakamoto to bring transparency and trust to the blockchain system will henceforth be used by those in power to ensure their ends are met.

Welcome to the future.

But DeFi is protected due to its decentralization, right? If it were decentralized, this might be true. But it’s not. Decentralization is more of a stretch goal for most of the organization presently developing and developing-in decentralized finance.

Decentralized in DeFi is an illusion. There’s a need for governance that makes some level of centralization inevitable and structural aspects lead to a concentration of power. If DeFi were to go mainstream, its vulnerabilities could theoretically cause financial instability.

These could be severe courtesy of high leverage, liquidity mismatches, the domino effect of built-in interconnections and the lack of shock and risk mitigation offered by banks. At present, existing governance mechanisms in DeFi make pain points for authorities in terms of address issues related to financial stability, investor protection and illegal activities.

The government can and will find its way into DeFi if and when it wants too. Don’t listen to the DudeBros on Reddit who insist that DeFi and crypto are untouchable—they’re not. The decentralized, distributed ledgers, spread out all over the world are de facto untouchable (Bitcoin itself isn’t, which is ironic), but any organization built on the back of the asset is entirely vulnerable.

The Arms Race Continues

If you go back to 2008 in the aftermath of the housing crisis, you can find the growth of the ideological underpinning that would ultimately lead to the creation of the Bitcoin ledger. It was supposed to be a cash alternative—completely transparent (but also private) and anonymous, and not only tamper-proof but regulation proof.

One has to wonder what Satoshi Nakamoto thinks about his invention now, assuming he’s still out there. He’d probably be disgusted at how his initial intention for the technology has been perverted, but maybe not surprised.

If you listen to the pundits go off about blockchain technology you’ll invariably catch wind of a number of their claims: immutable, transparent and with full provenance, the blockchain is the technology of the future. It’s a revolutionary technology that’s going to be the saving grace for the economic system.

It’s perks, listed above, included immutability, transparency, privacy and provenance. Except there’s an inherent contradiction in there. How can something be transparent and private at the same time? As it turns out, it can’t.

It was private only as long as folks didn’t know how to read the long strings of numbers corresponding to various addresses and coins on the blockchain, and when the proverbial cat exited that proverbial bag with the advent of artificial intelligence for rapid-fire collating of hashing information, privacy was for sale. Now governments pay lucrative contracts to publicly-traded companies for the ability to watch the flows on Bitcoin’s blockchain.

So onus for evolution and change is on the developers, and there’s a greater call for actual privacy from some, and there’s also a case that greater privacy could lead to greater disruption and danger. Over the course of this and the next week, I’m going to try and unpack this funky dialectic and find a good place to rest.

For right now, though, let’s go with the Pro-Privacy crowd.

Pro-Privacy

A clarification

The notion of privacy isn’t the same as ‘hiding’ your data. Monero, for example, allows you to selectively reveal your data to whomever you want whenever you want and for how long you want. Hence, if the government shows up at your door and demands via some legal avenue to see your transactions, the option of compliance or penalty is yours.

Three axis of access

Most privacy advocates agree there are three strong camps that the present transparency of the blockchain does not protect you from.

The first is well-meaning but essentially overzealous regulators.

There will be people may not have done their due diligence and miss certain red flags and find themselves run afoul of the minority of actors in DeFi out there trying to scam a quick buck. It will ultimately mean regulators step in and regulate the entire ecosystem, effectively spoiling the whole bunch in the case of a few bad apples.

Here’s a recent tweet from Senator Elizabeth Warren indicating the growing government interest:

Stablecoins pose risks to consumers &
to our economy. They’re propping up one of the shadiest parts of
the crypto world, DeFi, where consumers are least protected from
getting scammed. Our regulators need to get serious about clamping
down before it is too late. pic.twitter.com/hMOT1HIQgn

—
Elizabeth Warren (@SenWarren) December
14, 2021

Is she wrong? No. Not really.

But there’s not really much of a case for government intervention either. Most people who get involved in DeFi aren’t rubes off the street getting involved because Elon Musk and the hype-squad told them too. They’re a crypto-educated crowd interested in better swaps, and maybe finding out if the promises of a passive income from contributing to liquidity pools and staking native coins are smoke and bullshit.

The average crypto-enthusiast isn’t into DeFi. Yet. He or she’s probably curious, but the learning curve is steep and they’re equal parts curious and hesitant.

Can you get scammed in DeFi? Oh yes. The difference between passive income from an investment in liquidity pools and staking and a ponzi scheme is the presence of a behind-the-scenes protocol capable of doing the staking. No tech means a ponzi scheme. And that can be hard to parse for someone getting the information flow on the project from someone interesting in snowing you.

As always, know your risk tolerance or the government will dictate it to you.

The second axis of access is corporate interests.

Remember Cambridge Analytica and Facebook? Where Mark Zuckerberg sold all of yours and my data to Cambridge Analytica, who then proceeded to use it to undermine our democracy? Yeah. That’s the kind of corporation that will keep track of your data from the blockchain. Granted, they won’t have too. If you adventure onto the metaverse in any capacity—keep in mind that all your real estate and NFT sales are codified on a blockchain—you’re basically gift-wrapping your data for whatever company happens to own said platform.

But we digress (but not by much).

There’s more than just financial transactions that go on a blockchain. Consider the following scenario:

In 2022, you decide to go to one of those genetic testing sites to get your genome read. Twenty years later, you’re turned down for insurance because the company has access to said genome readout, and it’s indicated that you’re too high of a risk factor to insure.

Granted, right now there’s regulations in place to ensure that places like Ancestry.com and 23andme can’t sell that information off, but can you guarantee that’s going to be the case in ten years? Twenty? We’re one wrong government and one strong lobby away from this law being changed.

Finally, the everyday asshole is the final axis. And no. I’m not talking about that guy who dragged you on twitter, although he could theoretically watch if he had the tech. I’m talking about scammers, thieves, doxxers and other malcontents, who could theoretically see your transaction information, as well as all your smart contracts, and act accordingly.

Most scammers have to rely on the law of large numbers to get their cash. They call enough people and soon enough they’ll get someone vulnerable or gullible enough to believe that their grandson was actually a car accident and they absolutely must have 50 bitcoin right now or the doctors won’t be able to operate. (Seriously. This is a scam my own grandmother encountered. She told them promptly to fuck off. Because yeah go Nana!)

Now imagine scammers had access to a series of public blockchains where your financial data is stored, another where your medical data is stored, and a third where your DMV records are kept. This could be possibility in the future.

Suddenly, they’re armed with data and capable of honing their cons, scams and schemes, with a sophisticated array of information. Granted, there’s zero reason to believe that sensitive data like medical records and driving information won’t be behind an enterprise, hybrid or private/permissioned blockchain, but leaks happen, and if we don’t have control over our data, then it’s inevitable it’ll be used against us.

I’ll cap it off there for now. Come back next week and I’ll throw down some points for the other side.

—Joseph Morton