Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insights on policy and regulation.
In the brief window that I considered making this newsletter about crypto king Tom Emmer's bid to be speaker of the House, he pulled out of the race, so we will continue with our regularly scheduled programming.
The chaos in D.C. does illustrate one uncomfortable truth that even the most optimistic corners of Crypto Twitter seem to finally be realizing: Digital asset regulation is nowhere on the legislative agenda. The only shred that remains is KYC and AML, the three-letter acronyms that inspire dread among the privacy hardliners.
Since the collapse of FTX, the need to apply the basic standards of traditional banking to the crypto sector has been the sole pillar of blockchain regulation to gain real bipartisan support. Sens. Elizabeth Warren (D-Mass.) and Roger Marshall (R-Kans.) twice introduced a bill to crack down on money laundering in crypto, a group of senators led by Mitt Romney (R-Utah) and Mark Warner (D-Va.) unveiled a slightly less reviled national security bill called the CANSEE Act, and crypto favorites Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) proposed an amendment to the National Defense Authorization Act aimed at illicit financial transactions.
If the appetite for such legislation wasn't clear enough, over 100 lawmakers just wrote a letter to the Biden administration asking to address what they described as "crypto-financed terrorism" after the attacks in Israel and the Wall Street Journal's coverage of Hamas using crypto to fund its operations. While Crypto Twitter continues to debate whether the WSJ piece was a hit job designed to sink the industry, Congress has made clear that know-your-customer and anti-money-laundering legislation is the only digital asset priority left on the table. (There's even a hearing at the House Financial Services Committee dedicated to the topic this afternoon, if it doesn't get postponed.)
Bitcoin was created on the principles of privacy and erecting a trustless financial system outside of the prying control of governments, so applying the reviled Bank Secrecy Act to blockchain transactions is anathema to many. The issue, of course, is that crypto has moved far away from the early days of Cypherpunk message boards—the most exciting development in recent weeks has been the watch party for a Bitcoin ETF. It's hard to argue that Larry Fink believes in the pirate ethos of decentralization.
I hear over and over again that crypto is trapped in a brewing civil war. Many in the sector, who are not necessarily Satoshi acolytes, realize the Realpolitik need of working with lawmakers to enact some sort of AML/KYC regime. Then there is the DeFi crowd, which tends to take a firm stance on privacy and would rather devote its energy to overturning the Bank Secrecy Act, a serious proposal I have witnessed in person, than accepting the push for illicit finance regulation.
One of these groups is clearly louder and more influential. That reality was reintroduced in Sam Bankman-Fried's trial, when prosecutors brought up private DMs between the former legislative crusader and a crypto reporter, back from the weeks right before FTX's collapse when Bankman-Fried was trapped in a public war of words with the DeFi crowd over his pet bill in the Senate Agriculture Committee. At the time, it seemed like the vocal DeFi opponents would sink its prospects (ironically, his own fraud did the trick.) "They're dumb motherfuckers and about to hand the industry to Gensler on a silver platter," Bankman-Fried wrote.
Nothing has changed over the last year. One source told me that the Signal chat for the Blockchain Association, the crypto industry trade group, has been blowing up with outspoken elements of the DeFi corner making clear they will not cede an inch.
"The DeFi problem, in my mind, is that they want complete privacy at the expense of everything else," my source, who asked to remain anonymous, told me. "If privacy is the main feature of what crypto has to offer, the consumer footprint will be super small and will continue to be viewed suspiciously."
Leo Schwartz
leo.schwartz@fortune.com
@leomschwartz
