Law Decoded: Government sandboxes, test beds and crypto compromises, Oct. 16-23

A line from immortal comic strip Calvin & Hobbes goes “a good compromise leaves everybody mad.” When it comes to laws governing crypto, authorities are usually asking for pretty major compromises because they are, at their very best-intentioned, trying to work things out. While it’s a fast-developing area of law — honestly a treat to cover — that means it’s fast-developing relative to law, not tech.

There is an innate conservatism to anything having to do with how people handle their money. That extends to laws governing how money and investments function. Consequently, everything regulators touch in crypto develops slower than the industry would necessarily like.

It is, however, not an unreasonable instinct that regulators are resolute in setting up controlled ecosystems and sandboxes for all developments before releasing them into the wild. But restricting crypto’s technological capacities requires some compromises. The major news from this week has seen that dynamic play out worldwide, as everything because a test case. 

PayPal’s crypto payments test out New York’s conditional BitLicense and vice versa

After months of rumors, PayPal formally announced that the platform would be onboarding crypto payments.

While Bitcoin’s price leapt at the news, there is a catch. PayPal’s crypto will be locked up on the platform. No tokens in or out, a veritable Alcatraz. PayPal, meanwhile, will be operating on a probationary basis.

PayPal’s crypto platform received the tentative green light from New York’s Department of Financial Services, arguably the most important sub-national financial regulator in the world and the issuer of the famed BitLicense. But in this case that license is conditional. Just as PayPal is testing out crypto in an extremely limited capacity, the DFS is testing out its new format for testing out firms looking to obtain that coveted license.

A fascinating byproduct of this new system is that it pairs firms looking to get into crypto in New York with existing BitLicensees — in PayPal’s case, Paxos. That sets up a dynamic by which established crypto firms will play mentor to companies that may, like PayPal, be far bigger in every other part of their business. Which is cool for the industry, and sets up any existing BitLicensee in a highly advantageous position as more mainstream firms go the way of PayPal.

Bahamas Sand Dollar goes live

In what has turned into a global race for a central bank digital currency (CBDC), the Bahamas seems to have won. The island nation’s “Sand Dollar” went live nationwide earlier this week.

Pilot programs involving functional Sand Dollar wallets have been going on for months. But as with much involving the Bahamas’ system, the central bank’s announcement was quite opaque, consisting of just a two-sentence Facebook post. Interesting is the seeming restriction to national usage. The country’s limited financial reporting standards have made it a popular venue for shell companies and offshoring money. The limited scope is possibly an attempt not to contribute further to this reputation.

The announcement came at a time when government officials in the U.S. and Russia made statements denying the need to be first to release a CBDC. And, indeed, with all due fear of being a condescending American, responsibility for the Bahamian dollar is not the same as responsibility for the U.S. dollar. However, given its outsized role in international financing, the Bahamas faces many of the same concerns of larger economies working out their own CBDCs. Central bankers for such economies will certainly be monitoring the Sand Dollar closely.

Mixers beware

U.S. anti-money laundering watchdog FinCEN fined Larry Dean Harmon $60 million for operating mixing services Helix and Coin Ninja.

This is the first time FinCEN has taken action against a mixer or tumbler, services that combine and disperse cryptocurrencies through extensive nexuses of wallets in order to enhance privacy by obscuring their transaction history. As you can imagine, this is often because the coins have been involved in illegal activity.

While FinCEN has long maintained that crypto businesses need to keep the same sort of client records as banks, actually targeting a mixing operator ups the ante considerably. There’s really no conceivable way for the business model of mixers to incorporate the kinds of AML information that FinCEN requires. Even if you don’t assume that the coins involved have been caught up in some business that falls somewhere on the spectrum from shady to horrifying, a mixer’s function is to strip coins of any features that can be tied to their owner.

To be fair, Harmon is a remarkably easy target. A resident of Ohio, he’s been facing criminal charges for his mixers since February. FinCEN consequently had access to reservoirs of information on Harmon’s mixers that the Justice Department’s investigation had already dug up. Not to mention that FinCEN obviously knew where to find him.

Despite the convenience of the action, it’s obviously jarring news, especially for anyone running a crypto service that enhances privacy, but more generally for anyone who thinks that maybe not every transaction should be packed with personal information.

Further reads

The Electronic Frontier Foundation applauds Coinbase’s new reporting on its interactions with government and its compliance initiatives.

Attorneys for Vinson & Elkins run down the DOJ’s framework for crypto enforcement released earlier this month.

On her podcast Unchained, Laura Shin digs into the DOJ’s methods of tracking down crypto criminals.

Government is frustrating because when it is working right nobody gets exactly what they want. Balancing priorities, managing risk, enhancing compliance — writing about the law entails wading through swamps of such noxious jargon in search of some grove of what people are actually saying. Which is typically compromise.