Psudo-anonymity, Bitcoin, and regulation

What's a cryptocurrency anyway?

Cryptocurrency is a categorical term referencing online currency that utilized blockchain technology. In short, a blockchain is a type of database which is distributed and stored across the internet, such that anyone with an internet connection can both see and submit changes to the database. However, this does not mean that the changes are automatically accepted by the blockchain when they are submitted. Instead the chain "verifies" the change, utilizing algebraic cryptography. Once a change has been verified, it is encrypted and amended to the end of the chain. 

But how are changes or transactions actually verified? This is where the first major split in how cryptocurrency works occurs. Private blockchains rely on a trusted corporation, not necessarily a business but rather a group of individuals, to be the arbitrators of transactions. Public blockchains instead rely one of two systems, proof of work, and proof of stake. Bitcoin operates under proof of work, every time a transaction is submitted work must be done to verify the transaction in the form of a cryptographic question. The first wallet that solves the question is rewarded with some amount of tokens, and the transaction is verified. Proof of work is incredibly harmful to the environment, as the system is designed to waste electricity and degrade components to ensure that the cryptography is secure. Proof of stake seeks to answer this concern by instead asking inverters in the coin to deposit their coins into a shared pool in exchange for a chance to earn tokens as a reward. The more coins and the longer they are stored in the shared pool yield greater chances at being chosen to validate a transaction and receive tokens.

Now that our transaction is verified, the wallet addresses of the sender and recipient added to the end of the ledger of transactions, and crypto-graphically secured using the public key so that it can never be altered. This is what gives crypto its transparency, each transaction can be seen by anyone at any time. You don't need to hold any coins to see these transactions either, as long as you are familiar with the code (or utilizing a tool that someone else made) you can see them for yourself. However, only the wallet addresses are visible, meaning that if someone does not have their name attached to the wallet address the trail ends there, giving us anonymity.

Why regulate crypto?

 So now that we know how crypto works, why does it matter if it is decentralized or pseudo-anonymous? In short, the nature of crypto makes its economic landscape rife with crime and scams. These are not limited to bad actors either, major exchanges and "legitimate" investors have been charged with fraud, from exchanges misleading customers, to money laundering busts, if there is one thing crypto has show itself to be useful for its the facilitation of financial crime. The anonymity of crypto means that once the money is gone, it is almost impossible to track down, often sent from wallet to wallet until the degrees of separation between the victim and the perpetrators are insurmountable. Due to the fact that all transactions are final, once you get your mark you don't need to worry about a card charge-back, that money is staying in your wallet until you decide to do something with it. Phishing is also incredibly common with crypto, if you get access to a simple phrase of 13 randomly generated words you can access someones wallet and do what you wish with their currency. When purchasing something online with crypto, you are at the mercy of the vendor when it comes to refunds or warranties. If you send them money and do not receive the services promised there is nothing that the government or your bank can do for you. 

Crypto is also often the currency of choice for hackers and other dark web actors. A transaction through a bank is harder to get access to, after all those are often not public, however, every bank account is under someones name, and even through the use of pseudonyms it is very difficult to fully cover your tracks and ensure that any online transactions do not come back to you. With crypto, your wallet is not attached to your real life person in any way, meaning that when the F.B.I. comes knocking all they have is a user 's wallet number, and unless they somehow access your wallet the user's personal computer and verify that the number they have and the one stored on your computer match, there is effectively no way to trace the user of the wallet.

However, there is a way to link a user to a wallet, and most U.S. exchanges require you to link your real name and social security number to your wallet in order to comply with U.S. regulatory policy. This means that anyone attempting to use crypto as a legitimate investment or currency in the U.S., or with businesses who operate in the US, your purchase history is almost entirely transparent. Anyone could see any transactions I make using my wallet, and because the exchanges have to remain transparent about who they do business with, my name is also linked to this wallet.

How can you regulate crypto?

The fact that all of these checks occur online and are done using public computers, the blockchain is considered decentralized, meaning that no individual could make a change unless they purchased over half the coins. This fact also makes regulation of who can send and receive bitcoin almost impossible, you cannot block a transaction, and you cannot reverse a transaction. However, at the end of the day a bitcoin is only a piece of code that says you owe one bitcoin. To utilize it in the real world you either need to find a vendor that accepts bitcoin, or it needs to be exchanged for fiat (state backed) currency, both of which can be regulated. 

Due to the fact that it is impossible to stop a bitcoin from being sent, the bulk of the regulation efforts coming out of the United States lie with intermediaries. By punishing real corporations and exchanges that are known to associate with and facilitate criminals the number of avenues to offload ill-gotten crypto into fiat shrink, and it offloads the responsibility of verification to the exchanges. This strategy has proven to be more effective than trying to regulate the crypto itself, as exchanges can only stay in business as long as they continue to de-anonymize their users enough to verify that their crypto was acquired through legitimate means. 

This means that those who use crypto for illicit purposes, whether that be scams, drug trafficking, or money laundering have a hard time finding anyone willing to turn their currency into any form of fiat, and in turn increase the costs of doing business. Keeping up with the rapidly growing list of wallets connected with illiterate activities, and the list of exchanges found to be associated with them has been difficult, but effective in stemming the the number of fiscal crimes facilitated by crypto.

 But what do I think?

Most of this post has been spent on explaining the specifics of crypto and its regulation. I think the current strategy of letting exchanges regulate themselves under threat of being cut off has been effective, not only has the cumulative revenue from scams been reduced dramatically, but the number of deposits made have similarly dropped. 

On individual privacy, crypto almost seems to be the worst of both worlds. Users who have nothing to hide have the least privacy, while those who seek to act maliciously are able to easily conceal their identity and dealings. While the lack of privacy for those who are following the law could in part be attributed to the regulatory efforts of the U.S. government, many exchanges who do no business in the United States also require you to submit personal information to use them. The fact of the matter is that most finical institutions want to know who they are doing business with, and so the privacy aspect of crypto is moot for most users. 

While I certainly could set up a private wallet, somehow obtain crypto without the use of my credit card (which, of course, has my name on it), and then find an online storefront that will accept the crypto without a name, and get the good delivered to me without using my address. After all this, I still need to trust that this store will not simply take my money and run, because if they do there is nothing I can do about it. For the average user this process is so cumbersome (I have to make another account for each step, remember my wallet, double and triple check that the address I've typed in is the correct one, offer blood sacrifice, wait for the full moon, find 3 gold coins, etc.) and the number of things I could actually buy without giving any personal information are so small that realistically there's no way to use bitcoin in your day to day life while remaining truly anonymous. 

If I use my credit card to buy crypto, it is no longer anonymous. If I have something sent to my house it is no longer anonymous. Even digital goods will not remain anonymous if they are sent to my personal email, as whoever I buy from still knows that the wallet address 1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa belongs to Jake Larsen because Jake's email address received the game key that the address paid for.

Unless of course, I scammed 1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa and had them pay for my new game.

 

References used

 

Wolff, Josephine. “The Competing Priorities Facing U.S. Crypto Regulations .” Brookings, Brookings, 13 Jan. 2023, https://www.brookings.edu/techstream/the-competing-priorities-facing-u-s-crypto-regulations-bitcoin-ethereum/.

“What Is Blockchain?” McKinsey & Company, 5 Dec. 2022, https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-blockchain.

Major, Jordan. “Cryptocurrency Scam Revenue Falls 65% in a Year, New Data Shows.” Finbold, 16 Aug. 2022, https://finbold.com/cryptocurrency-scam-revenue-falls-65-in-a-year-new-data-shows/.