SLP239 Jake Chervinsky – Pushing Back on FinCEN non-custodial Bitcoin Regulation

Jake Chervinsky, GC of Compound Finance joins me on the show to talk about Steven Mnuchin’s proposed new regulations for US Bitcoin companies and how to push back:

What the new regulation would do
Terminology ‘unhosted’ and self-hosted
Compliance burden and chilling effect
Can the regulations be pushed back?
Non-US customers of US businesses
FATF and how to push back

Jake’s link:

Twitter: @jchervinsky

Sponsors:

Stephan Livera links:

Podcast Transcript:

Stephan Livera: Jake, it’s been a little while and I’ve been keen to get you on and finally we’re making it happen so welcome to the show!

Jake Chervinsky: Thank you! It’s great to be here!

Stephan Livera: So Jake, before we get started, perhaps you just want to tell us a little bit about yourself and also if you have any lawyer disclosures and things you need to do?

Jake Chervinsky: For sure! My name is Jake Chervinsky, I am General Counsel at Compound Labs, which is an open source development company in the crypto space. I do have one quick disclaimer which you’ve probably heard from lawyers on podcasts before, which is: although I am a lawyer, I am not your lawyer, nor do I represent anyone in the audience, so nothing I say here is legal advice — just my thoughts on the issues we’ll be discussing.

Stephan Livera: Of course. And so the hot topic is some of these new regulations. Can you give us an overview?

Jake Chervinsky: To give you the big picture first, what we’re seeing now is new developments in global anti-money laundering regulation, which is the set of rules that require financial institutions. So for our purposes: Bitcoin exchanges, custodians, and payment processors, to KYC or to collect due diligence information about their customers, like names, addresses, social security numbers, other information — to record that information and then also to report it to the governments, depending on what jurisdiction you’re in. Here in the US, we focus most on the Bank Secrecy Act, which is the federal law that requires a variety of crypto companies including money transmitters to comply with those anti-money laundering obligations. [04:44] What’s happening now — and I think the reason this was the right time for us to get together — is, the financial crimes enforcement network, or FinCEN, which is a bureau of the US Treasury department, has proposed a new rule that would expand the anti-money laundering obligations of those crypto companies beyond where they’ve ever been before. Up until now the majority of the anti-money laundering obligations only applied to transactions of Bitcoin between crypto companies, as in, you’re sending Bitcoin from one exchange to another exchange, or from one exchange to a custodian or some other regulated company. What FinCEN is proposing, essentially, is to expand those record-keeping and reporting obligations to transactions between institutions and wallets. Meaning, the company would have to do some KYC for transactions that a customer like you or me would try to either withdraw Bitcoin from the exchange to our own wallet, or deposit Bitcoin into the exchange from our wallet. So that’s what’s happening here right now in the US!

Stephan Livera [06:03]: So there are a few terms mentioned inside this new proposed regulation. Perhaps you could spell out what they mean? So they say CVC and LTDA. What do those mean?

Jake Chervinsky: Yeah so those are peculiar terms to FinCEN. Basically every government agency comes up with its own acronyms to describe the types of things that we all talk about very differently in the industry. CVC stands for Convertible Virtual Currency. It’s basically just FinCEN’s word for any cryptocurrency or digital asset. Just as an example, the SEC — the Securities and Exchange Commission — uses the term digital asset to describe the same thing. So it’s just a peculiar term for cryptocurrencies or digital assets in general. LTDA is actually a new one that I haven’t seen before until just now! It stands for Legal Tender Digital Asset, which I think we would think of as a CBDC — a Central Bank Digital Currency — meaning, a cryptocurrency that is officially issued by a government, and represents not just a stablecoin that reflects the value of a fiat currency, but actually is recognized as an offical fiat currency.

Stephan Livera [07:26]: Right. While we’re on this whole terminology thing, I think many in the community would perhaps bristle at some of the terminology going around! Obviously we were joking on Twitter about self-hosted or unhosted wallets. Why is there this big difference in the way the terminology is being used? Is this essentially an attempt to reframe the conversation around privacy and sovereignty in our wallets?

Jake Chervinsky [07:54]: Yes I think it is! As I mentioned, the government sort of adopts terms that fit their narrative. I think virtual currency is actually one of them! Something that’s virtual sounds lesser than something that is real. And similarly, the government has adopted the terms hosted wallet and unhosted wallet to describe what we would think of as simply an account at a third-party custodian, or, your own wallet. And I think the reason that they’ve done that in large part is, something that is hosted — a hosted wallet — sort of sounds safe! Right? It’s hosted, there’s someone in charge, it’s all neat and tidy. Whereas something that is unhosted sounds dangerous. There’s no one hosting it, who knows what’s going on, it’s kind of wild and out of control! And I do think that’s the signal that some folks are trying to send by using the terms hosted and unhosted. [08:58] There’s a third term that you mentioned which is self-hosted. I think that one has been a little bit confused among folks on Bitcoin Twitter. Self-hosted is not a term the government has been pushing. It was actually the industry’s response to the term unhosted, in an attempt to say, These wallets are not some scary, wild, uncontrolled, unhosted thing. These wallets belong to real people who are exercising their rights of self-sovereignty in control of their own property, by “hosting” their own wallets for themselves! And I think that wasn’t received totally well because I think you and I would agree, we should really just call these accounts hosted at a third-party, or wallets, because a wallet is the default. But that’s sort of the genesis of that term.

Stephan Livera [09:52]: Well thanks for explaining that. For the listeners, maybe save the firepower against the unhosted wallet term then!

Jake Chervinsky: Yeah I think that’s right! Honestly the truth it, I don’t think it matters what you call them! What matters is the principles underlying this issue and I think we should try not to get too distracted about semantics, and really focus on the issues.

Stephan Livera [10:15]: Of course. So let’s dive a little bit further into exactly what the burden—or reporting obligation, rather — is on some of these Bitcoin exchanges or companies that are regulated. So can you tell us a little bit about the typical reporting obligations and how that would shift under the new proposed regulation?

Jake Chervinsky: Sure. Under current law, regulated institutions have to comply with something called the travel rule, which you probably hear about a lot. And what the travel rule basically says is, when a regulated institution sends Bitcoin or some other digital asset to another regulated exchange, along with the asset must travel information about the parties who are making the transaction. So if an institution is sending Bitcoin to some other institution, they have to include information about the customer who has sent that transaction. The travel rule essentially applies internationally. So it is a US law, but the same travel rule has essentially been implemented in every major jurisdiction with the exception of some places that you think of as offshore banking havens that the westernized world is trying to bring into compliance. But the travel rule has never applied to transactions outside the world of those regulated financial institutions! Anti-money laundering compliance obligations in general do not apply to individuals who are transacting on their own behalf. It only applies when there is a third-party intermediary that’s transferring funds on behalf of customers or on behalf of other people. The proposal that FinCEN has put forward now is similar to what has come to be known as the Swiss rule. This is a sort of different implementation of the travel rule that Switzerland came out with earlier this year, which says that exchanges — or other regulated institutions — also have to collect information about transactions with wallets. Not just transactions with other institutions. The Swiss rule says that in order to process a transaction between institution and wallet, the institution must verify the beneficial owner of the wallet. Meaning, to figure out basically who owns the private key so you can figure out who is the person receiving these funds. And the proposal from FinCEN is very similar. It doesn’t use the word verify, but what it says is: the regulated institution must obtain and retain the name and physical address of the counterparty of a transaction. Meaning, if you’re, let’s just say Kraken for example — you’re a Kraken customer — and you want to withdraw Bitcoin to your own wallet, you would have to provide your name and physical address associated with the public key that you are withdrawing Bitcoin to. And similarly, if you wanted to withdraw Bitcoin from Kraken to someone else’s wallet, you would have to give Kraken the name and physical address of that person even though they are not affiliated in any way with Kraken, or with whatever institution you’re using! [13:54] So it’s an expansion of anti-money laundering obligations in a way that will jeopardize the privacy of more people who are using Bitcoin.

Stephan Livera [14:06]: I’m also curious there because maybe a typical way that Bitcoin companies and exchanges will try to comply there is they will try to say to their customers, Hey! Now, we want to do withdrawals only to you and can you just certify this is only going to you and that you’re not actually directly spending that out to, say, a merchant for example. Is that something we might see?

Jake Chervinsky: It’s certainly possible! The problem with these requirements is it doesn’t make a whole lot of sense to prove who the owner is of a string of letters and numbers. Right? How do you prove the owner of a private key? And so what ends up happening is, these regulated institutions get very confused about how they can comply with these regulations. But they have to comply one way or another or they could be at risk of being penalized for violating the regulation. So one way to mitigate the risk of a violation is for an institution to say, Look, we’re just not gonna allow withdrawals or deposits involving some other third party who isn’t one of our customers, someone we don’t have a business relationship with, someone who hasn’t signed our Terms & Conditions, potentially waiving liability or other rights and litigation, so we’re only going to allow these transactions with our customer. That would obviously be a significant limitation! I think that the biggest fear though, is that these institutions would say, Even for our customers, we fundamentally do not understand how we can verify the owner of a private key, because anyone else in the world could have the same string of letters and numbers and therefore have access to the Bitcoin associated with that private key! So we’re just not gonna allow withdrawals and deposits at all! We’re gonna essentially mandate custody and cut off transactions with people’s wallets. That would be an extreme result, but I do think we need to be at least cautious about the possibility that that’s where this is heading.

Stephan Livera [16:16]: Right so it may be that that’s not where it goes straight away, but it may be that there is a risk there that it would try to push us down this pathway, becoming a walled garden that nobody can leave. And then what would happen to the Bitcoin network at that point? All the Bitcoin that is sort of outside of that walled garden — it would just be a very weird situation! Probably an interesting example you might have seen is in the Netherlands, there was an example of an exchange called Bitonic, and they were asking for basically a wallet screenshot. Now, that doesn’t necessarily verify that this person — well first of all, they could have just shown a screenshot from someone else’s wallet! What’s your take on that aspect? Could that be a way that some Bitcoin businesses try to comply with this rule, even if it’s not technically bulletproof there?

Jake Chervinsky [17:15]: It certainly could be! I think this gets back to theories of regulation. Let’s assume for a second that we think that regulation is appropriate in the first place — which I think maybe you and some of the audience might not agree with! Let’s just accept that premise for a minute! What you want in good regulation is clarity about how the target of the regulation can comply. Generally speaking, businesses are not that afraid of regulation as long as they know how to comply, as long as they’re not worried that something’s gonna go wrong, and they’re gonna get tied up in some lengthy investigation or enforcement action that’s going to result in significant penalties. So you want your regulators to be clear about how companies can comply! I think in this instance, it is very unclear, including in the case of the Netherlands, how a regulated institution can verify the owner of a private key, as you said — a screenshot could be from anywhere! Also, I could sign a message using a private key — that doesn’t mean I’m the only one that has that private key! So I think that there are a lot of open questions about how someone can comply with this rule. The hope is that regulators are providing some clarity to say, Look if you do it this way, if you take a screenshot, we’re not gonna come after you! But again in terms of good regulation, that should be made clear to the public, not just to companies behind closed doors! And we’re not seeing that kind of public process that we would expect in the case of good regulation that works well.

Stephan Livera [18:58]: So what is the impact then in terms of compliance burden and the potential chilling effect here?

Jake Chervinsky: It really depends on how regulators interpret this! If they were to say, in FinCEN’s example specifically, It is enough for the customer who is processing the withdrawal — receiving the deposit — to simply say the name and physical address of the counterparty to the transaction, and no further diligence is required. I suppose the compliance cost is fairly low, but the compliance cost is only one factor to consider. There are others. In terms of a chilling effect I think first of all this is a pretty significant infringement of privacy rights! I think that it’s very different from regulations that have applied in traditional finance — the very specific targeting toward Bitcoin — in the sense that, when you withdraw paper cash from a bank, you do not need to prove anything about where the cash is going when you withdraw it. And similarly if you deposit cash at the bank, you do not need to prove where the cash is coming from. And to have this additional burden on the individual to hand over more information about the people that they’re conducting financial transactions with is a significant infringement of their privacy rights — very different from what we’ve seen before! [20:33] And you can imagine that customers who don’t want to sacrifice their privacy rights would simply leave the jurisdiction! They would start patronizing companies in other jurisdictions! Bitcoin is a global phenomenon, and so I think that there’s a chilling effect in that sense. I also think it may just discourage people from taking custody of their own assets. They may not want to deal with these compliance burdens and they may decide, You know what? I’m just gonna leave these assets in custody because I don’t want to deal with it! And I think all of that is really harmful to Bitcoin! And certainly not worth the alleged benefits that these regulations would provide [to the] government.

Stephan Livera [21:16]: It’s a really interesting point you mentioned there around how customers and go jurisdiction shopping, because I know even in the case of a regulation like FATCA, Foreign Account Tax Compliance Act, and essentially this requires businesses around the world to go be a tattletale back to the US Government if there are any US customers. And so it pushes people in certain ways because now those non-US companies are often just saying, We don’t want you if you’re a US customer! Because we don’t want to deal with that compliance burden! But in a small way like you were saying, maybe US customers will then go and be customers in some other Bitcoin business overseas so that they don’t have to deal with as much of the compliance and that aspect of it!

Jake Chervinsky [22:06]: It’s certainly possible! You make a great point. The more likely outcome is not so much that US citizens start using businesses abroad, but rather that US companies leave, and decide not to serve as US citizens. And as you point out, the US government tends to think that it has unlimited extra territorial jurisdiction, that its laws apply all over the world no matter where you are or who you are. And FATCA is the perfect example of how the US used its — basically the way that its ability to tax companies and to exclude them from the US economy — to force them to comply with US law even though they were outside the US. We see the same thing with someone like BitMEX, where BitMEX was not based in the US, and was at least making some attempt — although debatable how effective it was — to exclude US citizens from its platform, but because there were a couple of US citizens on the platform, the US governments view was, they’re a strict liability for compliance with US law! If you service one US citizen, then you must comply with the full panoply of US laws! And so it is very hard to escape US jurisdiction and I do perceive this as another attempt by US government to reassert its authority globally over the operation of the financial system as a whole. US foreign policy is administered through the country’s control of the financial system, and Bitcoin is essentially an existential threat to that control. Or at least it could be perceived that way — I’m not sure it really is! But I think that’s why we’re seeing this rising concern over a peer-to-peer financial system that does not require the operation of intermediaries that the government can easily regulate.

Stephan Livera [24:14]: From looking through the regulation, the proposed new regulation, I saw some discussion around what’s called a foreign jurisdictions list. And I’m also wondering, what is the potential impact for non-US customers of US Bitcoin businesses?

Jake Chervinsky: Right so this gets straight to the point that we were just discussing, which is: the US government wants to make sure that its rules are followed globally. But there are some jurisdictions where there are some companies that simply refuse to comply! Especially in sanctioned jurisdictions like Iran or North Korea or Venezuela or Myanmar — places like that. And the requirement of the foreign jurisdictions list basically says: We’re also going to extend anti-money laundering compliance obligations for record-keeping and recording. Not just the transactions between institutions and wallets, but also between institutions that are compliant with the Bank Secrecy Act, and institutions in jurisdictions that do not comply with the Bank Secrecy Act. So when an exchange, for example, sends let’s say $15,000 worth of Bitcoin to another regulated exchange that is compliant with the travel rule, the sending exchange does not need to report anything to the government, because the travel rule has been followed. What this new rule would say is: if the institution can’t be sure that the other institution is compliant, then they do need to submit one of those reports to the government. So this is really another way for US government to get more control over institutions in those places that are refusing to play along with the rules that government is setting.

Stephan Livera [26:04]: Stepping back, I guess listeners might be thinking, But hold on, wasn’t there already an obligation for some of this reporting? So an example would be: suspicious matter reporting, or threshold reporting, where if the value goes above a certain amount, these transactions have to get reported to the government agencies like the IRS or to other law enforcement. Does this proposal mean that more data and more information is going to those government agencies, rather than the government agency having to colloquially “get a warrant” or to go through some legal process to ask for that information?

Jake Chervinsky [26:45]: Yeah that’s right. So there’s a difference between an exchange being forced under a subpoena for example, to turn over information to government, versus the exchange having an affirmative obligation to automatically report that information to government. And I think that’s one of the big differences here. Under current law, an exchange certainly already has all of this information about withdrawals to folks’ wallets. But they aren’t automatically turning that information over to the government in the form of a currency transaction report. And in fact, many of the exchanges will even publish information about what kinds of requests they’re getting from government: how many subpoenas they’re getting, how many of them they’re challenging, how many of them they’re actually having to comply with to turn over customer information. This new rule would greatly limit the ability of these exchanges and other companies to protect the privacy of their customers. And that’s a really big concern, not only because in general we should respect consumer privacy and the privacy of people who are transacting in Bitcoin, but also because government just hasn’t shown that they are either using that information effectively — and we could have a really interesting debate about whether the anti-money laundering system we have, which depends on financial surveillance, is even working, if it’s even helping law enforcement to detect and prosecute crime — but also, government hasn’t shown that they are able to safeguard that information. I mean just recently there was a report of a massive hack of the US treasury department specifically, in which an extraordinary amount of sensitive information was lost to hackers. And as we record this we still don’t really have a good sense of what information was compromised and for how long! And I think that the idea that now is a good time to expand the government’s warrant-less mass surveillance and data collection operations in light of everything that’s been going on, is simply wrong!

Stephan Livera [29:04]: It’s a good example recently with the Ledger hack where initially there was a period where I think the number of e-mail addresses and information that got hacked or leaked was much less, and then later it was found out that actually it was much more had leaked. And so now if let’s say in this example where a lot more information must be reported by the Bitcoin regulated company to FinCEN with all the reporting, then there’s gonna be all this data out there of people’s names, potentially their address, and which Bitcoin address they withdrew the Bitcoins to — that’s a lot of potential information that could go to a very dark place if that information were to fall into the wrong hands!

Jake Chervinsky [29:54]: Right! And you know, two things on that: (1) this is really sensitive information! This isn’t — we’re not talking about something unimportant. We’re talking about critical information not just where people live, right? The FinCEN proposal called for collecting the physical addresses of people who are withdrawing Bitcoin to their own wallets. It’s very much like the Ledger hack. If you’re loading up a hardware wallet with a lot of value in Bitcoin, you probably don’t want people to know what your home address is! It’s very sensitive information! (2) What government would say about this concern that these jackpots of sensitive information are being exposed by hackers — what they would say is: that’s a cybersecurity problem. The problem is that companies are not doing a good enough job of protecting customer data. So we need to pass even more regulation, right? The GDPR for example — to require companies to do a better job of maintaining their customers’ privacy. And I think the other side of that policy debate is the one that I would take and probably the one most Bitcoiners would take, which is: this data cannot be protected! There is no perfect cybersecurity system that is going to prevent these jackpots from being compromised! The solution is to simply not create the jackpots in the first place, and given that collecting all this information is yielding very little benefit to government in the first place, maybe we would be better served by simply not collecting it at all!

Stephan Livera [31:36]: Absolutely. We’ve got to think about also the broader context here as some lawyers in this space such as yourself and others have been commenting that this is like a midnight rulemaking. What is that?

Jake Chervinsky: So midnight rulemaking is a term that describes the circumstance where a policy-maker is about to leave office. They’ve maybe a month of time left, and they’re trying to jam through some rule as fast as possible without following the regular order for considering whether the policy that they’re trying to put into place is even good to begin with! Typically this occurs in the US in the transition period between presidencies. So we had a presidential election at the beginning of November. Donald Trump lost the election to Joe Biden. President-elect Biden will take office on January 20th. And at that point the treasury secretary Steve Mnuchin is out of a job. And really, this new regulation is something that Steve Mnuchin uniquely wants to pass! This is really not something that the entire treasury department is behind. It’s really something that secretary Mnuchin believes personally is important. And it’s something he wants to accomplish before he leaves office. So what he’s done basically is to violate the regular order for considering a proposed rule like this. In the United States there’s a federal law called the Administrative Procedures Act, the APA, which sets up the requirements for administrative rule making. And what it says basically is: an agency — before they can put a new rule into place — has to give the public notice of what the proposed rule is, and has to give the public an opportunity to comment on whether the rule is good or not! Whether it could be improved, whether it’s flawed, what the cost-benefit is of the new rule. This is called notice and comment rule making. And for a significant rule — one that’s gonna have a really big impact on industry or in society at large — an agency is supposed to give at least 60 days for the public to give comments. And then usually there’s a long process after that where there’s discussion and the back and forth between the industry and the agency, about whether the rule is good or not! And in this circumstance, because Secretary Mnuchin doesn’t have 60 days — he has only 30 at the time we’re recording this, before he’s out of office—he decided that for this rule there should only be 15 days for the public to comment! And not just 15 days, but 15 days at the end of December leading into early January over Christmas and New Year’s when most people are trying to take a vacation! So the fear is that this is not a genuine process where Secretary Mnuchin is really soliciting input from the public that he will consider before deciding what he wants to do. But rather, that he already knows what he wants to do, and he’s just sort of trying vaguely to go through the steps required to defend the rule from a legal challenge. But really this is a done deal and probably truly at midnight — the day before he is out of office — he’ll decide to make this rule effective!

Stephan Livera [35:18]: And to set the context as well—as I have seen from the discussion — it seems that in other cases, for example in financial services or in the banking industry, there are some cases where the comment period is 6 years! Is that correct?

Jake Chervinsky: Yes that’s right! Sometimes it’s not the actual public comment period where the public can submit formal comments, but where the agency will then — after an initial 60 or 90 or 120-day comment period — will then schedule meetings. They’ll hold round-tables with the industry, they’ll do panels, they’ll talk at conferences, they’ll revise the proposed rule and they’ll republish it and solicit new comments based on the revisions to the rule. And certainly there are circumstances where it does take years to craft good rules. And again, to the extent that we agree that it is appropriate to regulate something like Bitcoin, it is totally fair to believe that for something so novel and unique, something so different from what financial regulators have ever confronted before, there should be a really considered and nuanced, intelligent discussion, not a rush to put any new regulation that has very little benefit for government, at the cost of a huge burden to the industry and to individuals, just because one presidential candidate lost an election and doesn’t have a whole lot of time left for his administration to put in the rules that they’ve already decided are appropriate.

Stephan Livera [38:44]: What can be done now to push back on this in terms of public comments and also from a more formal lobbying approach?

Jake Chervinsky: I’ll give you a few ideas. Some in the short term and some in the longer term. Right now we are confronted with this 30-day sprint where this rule may become effective before January 20th. And as the saying goes, laws are written in ink. They’re very hard to erase! So what we really want to do is stop this rule from becoming effective before January 20th. Once there is new leadership in charge of the treasury department, we strongly believe that we will be able to convince leadership at FinCEN not to make this rule effective. And when I say we what I mean is the group of policy folks in Washington D.C. who work on these issues. So that means CoinCenter, which does phenomenal work, the Blockchain Association which is the group that I do most of my work through, the Chamber of Digital Commerce — all of these policy organizations are working very hard to stop this rule from going into effect. The way that folks can help us achieve that goal is first by submitting public comments. I’ll be sure to provide more information about how to do that over the next couple weeks. We don’t have a whole lot of time, but whatever we can do to convey the message that the process behind this rule and the substance of this rule are both unacceptable, the better chance we have of convincing Secretary Mnuchin that he should not take this last shot at Bitcoin on his way out the door. I also think that in terms of what we can do through the Blockchain Association and otherwise is, we can consider a legal challenge to this rule if it does go into effect. And that is something we are exploring now. We’ve hired one of the best lawyers in the country, Paul Clement, who was the US Solicitor General under President George W. Bush, one of the most respected lawyers in the country, to help evaluate grounds to challenge this rule under the PA. And if it comes to it — I think that is likely what we will do — we will file a lawsuit and we will try to get a judge to stop enforcement of the rule hopefully long enough that we can have a change of administration and then FinCEN will have some cover to walk away from this rule. So that’s all in the short term. I also just want to say, in the long term, I think we need to understand that this is just the beginning! Secretary Mnuchin is particularly hostile to Bitcoin, but that doesn’t mean that once he’s gone, everything is gonna be fantastic and great and wonderful! There are a lot of other policy makers in the US and globally for example within the Financial Action Task Force, the FATF, that believe in regulation like this! So what we really need to do long term is get a lot better at boiling down our arguments of why Bitcoin is so important. Why the benefits of allowing peer-to-peer transactions, of allowing self-sovereignty, why they outweigh the supposed costs to law enforcement. And furthermore why this phenomenon can’t be stopped in the first place! All a country can really do is push this activity into other jurisdictions. They can’t really stop it. So the better we are at making those arguments long term, the better we’re gonna be at defeating this final boss that is trying to over-regulate Bitcoin.

Stephan Livera [42:54]: And is this potentially just a first step towards further regulation and increased surveillance? What kinds of future steps could be taken if this is not pushed back on?

Jake Chervinsky: I think the worst case scenario that I see right now is a bifurcated market very much like you described a little bit ago, where there is one market of clean custodial Bitcoin — Bitcoin that is held by regulated institutions that are not really self-sovereign in any sense, that no person really gets to control on their own, that the government can censor the same way that they censor the traditional financial system — and then a separate market of dirty Bitcoin. That is, Bitcoin that people actually hold themselves and are able to use and send in peer-to-peer transactions and custody themselves. And then no bridge between those two worlds. Every bank and every exchange would be prohibited from allowing deposits or withdrawals to people’s wallets. I think that that is an alarmist view and I don’t want to scare anyone too much, because there are a lot of people that will say that I’m being paranoid and that’s not really where we’re going. But I fear, if you listen closely to policy makers, that what you hear from them is, they’re okay with Bitcoin, as long as it looks likes digital gold in the same way as gold has been centralized in depositories that can be censored. As long as it doesn’t pose a threat to monetary sovereignty, as long as it doesn’t pose any other risks of terrorist financing or money laundering or other illicit activity. And that to me would be the worst case scenario, a total prohibition on transactions with non-custodial wallets. I’m optimistic that we will not get there, I think that we have very strong arguments why that is a categorically worse world, and also why it is not an achievable world. But I do think that’s sort of the final boss that we have to fight here.

Stephan Livera [45:12]: As you mentioned earlier, FATF, Financial Action Task Force, seem to be very much a root cause driver of a lot of this kind of regulation around the world. Could you give us some background on what their influence is on all of this, and perhaps their influence on the domestic regulators around the world such as FinCEN?

Jake Chervinsky: Sure. So the FATF is an international standard setting body comprised of about 40 or so member jurisdictions. So you know the United States and Australia and Germany and all these other countries are members of and send representatives to the FATF. The FATF doesn’t make any law, but what it does do is it makes recommendations for global industry standards. That it then sort of expects all of its members to adopt. And it does reviews on a regular basis of whether its various members have sufficiently complied with those rules. And the only teeth that the FATF has is they maintain a blacklist that basically says, If there’s a jurisdiction that is really out of compliance, then no other jurisdiction should be allowed to transact with that jurisdiction. It’s very much like US sanctions, and there’s a lot of crossover between US sanctions and the FATF blacklist. The interesting thing is, the FATF bounces back and forth between setting its own standards that the member jurisdictions follow, versus following the lead of one or more of the member jurisdictions. Sort of like a pendulum in that sense. So sometimes the US, for example, will decide, Here’s what we think the industry standard should be. And then they get the FATF to adopt whatever that is as its recommendation for the world. And sometimes vice versa, the FATF will actually generate some new recommendation that will bring member jurisdictions into compliance. Right now, what we’re trying to figure out is, is the FATF going to recommend this Swiss rule or something like this new FinCEN proposed rule, that imposes AML obligations on transactions between institutions and wallets, or not! And so far they actually haven’t. So Switzerland and the Netherlands which you mentioned, and the United States, are actually out ahead of what the FATF most recently recommended. So in June of this year the FATF did its 12-month review of its crypto guidance. And what it said basically was, We considered whether any restrictions on peer-to-peer transactions were necessary and thus far we decided there’s insufficient evidence to warrant such new restrictions. But, some of our members expressed concern about this, and we will revisit this as we go forward. So one of the next big turning points that we’re looking to in the coming year is the FATF’s next 12-month review, which should be around June 2021. If they adopt this new Swiss rule or new FinCEN proposal as the global industry standard, then you could imagine seeing what is happened so far in only a couple of jurisdictions very quickly being rolled out to dozens of more jurisdictions and becoming the global standard. So I think we need to work very hard to convince policy makers at the FATF that that is not a good idea! But that’s only something to watch.

Stephan Livera [48:58]: Are there any domestic levers that people around the world can push on with domestic politicians to either push back on this or to change the way FATF is run?

Jake Chervinsky: Yes and no. Yes that there is a lot that people can do on the local level, and it’s always important to point out that politics is local! And ultimately although many of our democratic are not functioning very well these days, our governments are at least supposed to answer to us the people. And to the extent that we can support and elect policy — elected officials specifically — who do not think that these requirements are necessary, and who will push back on them if other members of the government are trying to advance them, the better off we’re gonna be! So here in the US as an example, there are members of Congress who fundamentally oppose this new proposal from FinCEN. In fact, four members of Congress sent a letter to FinCEN led by Warren Davidson, a member of the House of Representatives, advising Secretary Mnuchin that this was a bad idea! And the more of that kind of support we can generate just from a grassroots level by supporting politicians and officials who believe in the principles that we believe in — the principles that support Bitcoin — the more success that we’re going to have. The reason I say also Yes but also No, is because in general the FATF is comprised of representatives who are not elected — they are appointed. And Secretary Mnuchin himself is not elected himself, he was appointed. So no one in the United States cast a single vote for this one individual who has more impact on financial regulatory policy than anybody else. And so it’s very difficult to rein in the expansion of the administrative state. So it’s really hard to get directly to the FATF, but much easier for us to focus on who are we voting for, and what do they believe? And will they make sure that the appointed officials — who are part of the administrative state — will they make sure that those folks are not doing things that compromise our privacy and our self-sovereignty?

Stephan Livera [51:25]: Now, I’m a libertarian and I understand not everybody is a libertarian, and I can certainly appreciate that there may be some more cypher-punk or libertarian minded people who think, Hey, there’s no use trying to even get involved in the political process! Let’s just have technology only and just totally disregard them! And yet there could also be a good counter-argument here that, Well, whatever your view on that is, maybe you are better off trying to push back that regulation to give the self-sovereign and more private Bitcoin more of a runway. What would you say to that kind of idea?

Jake Chervinsky [52:03]: I think that it’s a mistake to view it as an either-or. I think that there’s room for us to do both! Look, I share a lot of the more cypher-punk values and libertarian values that you do — I’m a huge fan of yours! I’m listening with great interest to a lot of your discussion about libertarian ideals and Austrian economics. At the same time, I live in Washington D.C., I’m very active in the policy community here, and I think there’s room for both of us! To do our separate work. I think that you can’t deny that government has influence over the rise of Bitcoin. And basically we can do this the easy way or the hard way. And I think we would all rather do this the easy way than the hard way! I totally appreciate that there is no way that the government could ban Bitcoin. At the same time I would rather not go back to a world where we have to meet up with people in back alleys in order to buy Bitcoin that we can actually custody for ourselves. And that requires us to be engaged in the policy process. It’s not for everyone, and there are some people who just don’t want to get involved in a place like Washington D.C. or any of the other political capitols of the world. That’s fine! That’s sort of how I view my purpose for being here — I will take that hit! And I will do the work of the swamp! Ideally what this leads to is more time for the industry as a whole to professionalize, to mature, to build more products and services that people can use to protect their own sovereignty and to protect their own privacy. So that if someday we do lose this battle from a policy perspective and government just decides, We cannot get our minds around Bitcoin, we’re just not going to allow this to happen — at least we’ve gone as far down the road as we can before we have that adverse result! At the same time I think that there is great opportunity for Bitcoin to rise in a cooperative way, in a symbiotic way, in a way that does not result in infringement of our rights, and I would at least like to hold out hope that we can make that happen!

Stephan Livera [54:30]: What are the key points that Bitcoin proponents should be out here making, and who should they be making them to, such that the risk of overly draconian regulation is minimized? What sort of arguments should we be making?

Jake Chervinsky [54:47]: Yeah. Honestly there’s too many to list or even to keep track of! But I’ll give you at least a couple of ideas and I think we can work on continuing to build this out as time goes on. One is about financial inclusion. I think that that’s an idea that everyone can get behind. That most people in the world as a whole do not have access to reliable financial services. We’re talking about people who live in places where the banks themselves are the criminal enterprise, and there is no way to conduct commerce because there is no way to transact with other people in a safe way at a distance. And I think that Bitcoin is the greatest force for financial inclusion that we can imagine! I think one person to listen to very carefully on that issue for example is Alex Gladstein at the Human Rights Foundation, because he does such a phenomenal job of highlighting cases where people are using Bitcoin not as a speculative investment — which is what I think a lot of policy makers in the developed world think that it is — but truly as a tool for commerce, and a tool to help them live better lives! I also think that there are arguments we can make about the ills of the financial system as it has come up around these very large, very powerful institutions that do not have our best interests at heart. And we’re seeing this now with the rise of major tech companies that have started to dominate the Internet in the same way that the mega-banks have dominated finance. And really, what we don’t want to see is — with all due respect to Facebook — we don’t want to see the Facebooks of the world take over finance the way that they’ve taken over the Internet. And Bitcoin is the response to that! It’s public payments infrastructure, as opposed to a proprietary platform run by a company that is serving its own bottom-line at the expense of its customers instead of on behalf of its customers. Those are just two ideas that I think are particularly persuasive. But I think one of the beautiful things about Bitcoin is there is an argument that will persuade anyone if you could just figure out what principles matter to them and how Bitcoin addresses those principles! Maybe it’s too much of a meme at this point, but Bitcoin fixes this! I know there is always some kind of argument that we can make to persuade folks to get onboard, and I’m confident that the more we focus on sharpening those arguments, the more impactful they will be!

Stephan Livera [57:36]: Of course! And I guess in this instance, although many of us are libertarian as we don’t necessarily want big government, we want small or zero government, but in terms of meeting the other person where they are at — in some cases if you have to make an argument to somebody who is in that sort of position — perhaps an argument might be, Well, if you want your economy to be thriving, you’ve got to care about jobs and businesses! And if you create this regulation and this legislation that is too burdensome, you will create a chilling effect where people may not start businesses or they may be hampered versus international competition in terms of being able to compete! So that perhaps that is an angle, an argument there as well in terms of, There’s going to be an impact on jobs and businesses on your country!

Jake Chervinsky [58:29]: I think it’s a great argument! And right, it might not strike everyone as the best idea — depending on your view of government in the first place — but just as an example, Pierre Rochard put out a really interesting idea recently, which is that the US government should stop selling Bitcoin! It should start building a Bitcoin reserve! And look, that’s a pretty compelling argument! And whether you want the US government to own a lot of Bitcoin or not is sort of besides the point! If you can get government to buy into the asset, then Bitcoin will sort of take care of itself on the other end, right? Bitcoin is in many ways unstoppable! So the more adoption there is, and the more approval there is, I think the more likely it is that we will end up seeing the kind of world that we think Bitcoin will usher in. There are other arguments that we have to think really hard about whether we want to make or not. One of the arguments is, really for the defense community. Which is, Bitcoin is a very effective tool of geopolitical monetary war. If you want to undermine an authoritarian or dictatorial opponent, well sanctions are fine — it’s what we’ve tried to do — but really they’re not fine. I’m just articulating the way you might describe this to a policy maker! Better than using sanctions and cutting a country off from the financial system, is to undermine their own currency, and the more you can promote use of Bitcoin in that society, the less powerful the dictator or authoritarian will be! Now whether we want our governments using Bitcoin as a weapon of geopolitical war we should think very carefully about. But this is just to the point that there is always an argument about how Bitcoin can be used as a tool to accomplish an objective! And I think it behooves us to figure out what those arguments are to promote the likelihood that Bitcoin will rise peacefully, at least to the extent that it can.

Stephan Livera [1:00:44]: Yeah that’s a really good one and it reminds me of how the US government actually funded Tor as a way to essentially have its own operatives be able to operate in places more privately and I think it’s a similar kind of thing where you could see it cutting both ways, but perhaps there’s a net benefit to support it!

Jake Chervinsky: It’s very similar and once we are able to dig a couple levels into the nuance here, what you realize is all technology neutral, all of it can be used for good or ill, and just because a technology is used by some bad actors doesn’t mean that you outlaw it! What it means is you use it for as much good as you can, and you try to limit — perhaps — its use by bad actors to the extent that you can. But this is the story of every technology throughout human history! The first use of an automobile was for a bank robber to get away from the police faster, right? Like this is always what happens! The bad guys use technology first — it doesn’t mean we throw it away! And I do think that if you can get to that level of nuance and admit that, Yes, just like the Internet, Bitcoin is open for use by anyone. But the benefits of Bitcoin, the good that it does for the world, so far outweighs the harms that it may enable by some bad actors — because of that, we should support Bitcoin’s growth and adoption, not try to hinder it!

Stephan Livera [1:02:17]: Right. Maybe then if I were to play-act as a policy maker, they might say, Well fine! You can hold your Bitcoin! But just hold it in this custodial account! And I think in their mind, they don’t see the value so much as perhaps you and I do and the other Bitcoin people do, of a strict supply limit and the ability to use it in a self-sovereign way, and I guess that’s really the argument we have to make!

Jake Chervinsky: Yeah I think that’s absolutely right. And that’s why I give those two examples as maybe the best arguments for Bitcoin as a tool of self-sovereignty, not just as digital gold that you can hold in a depository. That is, the ability to use it in jurisdictions where there is no financial infrastructure that is reliable using intermediaries — and that is the majority of the world! There is no reliable bank in most places where people can just hold it in custody! And the risks that centralizing all of this — not just information but value — in institutions that can be hacked, that cannot safeguard those assets. Think of Mt. Gox as an example! Every couple months we see a big exchange hack! Those are reasons why Bitcoin is much much better as a tool of self-sovereignty, as something people can hold and safeguard on their own and use on their own without relying on intermediaries, than it is as just something you can throw a few dollars in, the same way you might buy the S&P500 Index.

Stephan Livera [1:03:53]: Jake I’m gonna try to get this excerpt out in the next day or two, but in terms of how people can support you or if they can do a comment, have you got any suggestions for them in terms of how they can help?

Jake Chervinsky: Yes! So as of now, so we’re recording at about 6:30PM on Monday, December 21st. The rule actually has not been published yet in the federal register, so the public comment period isn’t open yet. We think that it’ll be published on Wednesday, the 23rd. Once it’s published, I’ll make sure to put out on Twitter some advice about how to write a good public comment, just sort of a how-to of where do you go, how can you write something that’s effective, write simple things like, don’t just curse at the regulators and call them statists! Because that’s probably not gonna help very much! So I would say, follow me on Twitter if you don’t and hopefully we can all work together to share the good arguments that we can advance and we can all get as many public comments submitted as possible before the period closes. And then we’ll see what we can do from there! I am very committed to making the best use of my platform as I can, so I’ll make sure I can share any other ideas about how we can work together to keep Bitcoin as free as possible!

Stephan Livera: Fantastic! Well thank you very much for really shining a light on this issue for us! I think there’s a lot of complicated issues that you’ve really helped untangle for me and for my listeners. So Jake thank you very much for joining me on the show and I hope to chat again soon!

Jake Chervinsky: Thank you so much this was a pleasure! Anytime!

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