Just before Christmas, in yet another snub to the FinTech industry, the Trump administration proposed a last minute rule that shows a preference for maintaining the status quo rather than fostering innovation and competition in financial markets.

Their latest move is even more bizarre than the previous one, and that really says something.

In late October, the administration proposed a rule to lower the reporting thresholds for cross-border payments (remittances) from $3,000 to $250. As detailed here, this rule will impose higher costs on business owners and people electronically transferring relatively small payments, with little expected benefit for law enforcement.

Worse, the administration gave no advanced notice and allowed only a 30-day comment period on the rule. That is half the normal time, a problem that Treasury magnified by timing the proposal to overlap with the period when affected firms had to renew their state licenses. The entire process was very strange for an administration that celebrates its deregulatory successes.

The Treasury Department’s latest rule proposal is even more baffling.

They released the proposal days before Christmas and allowed for only a 15-day comment period. Treasury justifies this short comment period because of “significant national security imperatives,” and because the Financial Crimes Enforcement Network (FinCEN) “has engaged with the cryptocurrency industry on multiple occasions.”

Both of these statements are borderline ridiculous.

With few exceptions, FinCEN’s engagement with financial technology companies has amounted to paying lip service to their concerns and then moving ahead with their agenda as planned. More directly, the fact that this new rule will expand anti-money laundering (AML) regulations under the Bank Secrecy Act (BSA) in a way that further disadvantages FinTech firms cannot possibly justify giving even less time than normal to assess the rule and provide comments. (Treasury ultimately extended the comment period after public pressure that included a letter from Senator-elect Cynthia Lummis (R-WY).)

Perhaps the biggest whopper, though, is that the rule addresses some kind of national security emergency, requiring FinCEN to implement the rule quickly.

Treasury’s national security excuse even conflicts with the Financial Action Task Force’s 2020 assessment of international AML rules. In their report, the task force (the inter-governmental body that sets international AML standards) acknowledges that cryptocurrency could increase money laundering/terror financing risk only if there is mass adoption of “a virtual asset that enables anonymous peer-to-peer transactions.”

These technologies hold a great deal of potential to provide economic benefits, but they are nowhere close to mass adoption. There is no emergency. A relatively small number of people use cryptocurrencies, and they all have to convert the crypto to a national currency at some point. In industry terms, they eventually have to use off-ramps, heavily regulated financial companies that are subject to the BSA/AML regime.

This fact exposes a potentially larger problem with the rule, one that suggests that there will soon no longer be any semblance of a private financial transaction. According to Treasury, “this proposed rule would require banks and MSBs to keep records of a customer’s CVC or LTDA transactions and counterparties, including verifying the identity of their customers, if a counterparty uses an unhosted or otherwise covered wallet and the transaction is greater than $3,000.”

Avoiding all the technical terms, this statement means that the new rule will require financial companies to keep records of people who transact with their customers (their counterparties) using their own private digital wallets. [The term unhosted (vs. hosted) originated with FinCEN and simply refers to a wallet that someone has downloaded on their own, outside of the service provided by an exchange, a bank, an MSB, or some other regulated entity.]  

There is no comparable regulation for people who use cash, and rightfully so. It is unreasonable to expect banks, for example, to keep records concerning their customers’ cash transactions outside of their banking relationship. This new rule is the digital cash equivalent of such a requirement.

It is also problematic on a theoretical level. What, exactly, is the end goal? Do regulators need a map of every single transaction that every single person conducts?

Ironically, the digital technology that regulators seem bent on stifling actually provides more of a roadmap to find criminal transactions than does good old-fashioned cash. And illegal cash transactions, of course, were the focus of the BSA in the first place.

Regulators are simply engaged in a whack-a-mole game, and there is no end in sight. Rather than divert more resources to catching criminals, regulators are forcing financial firms and their customers to pay (directly and indirectly) for a massive records-keeping scheme. The BSA/AML regime forces firms to keep track of millions of reports and bits of information that cannot possibly identify people guilty of crimes.

The regulatory regime has become an end to itself, and officials have steadfastly refused to produce a realistic cost-benefit assessment. Hence the latest round of whack-a-mole.

As blockchain technology continues to evolve—and it will—the stakes of this game will only get higher because of the technology itself. The underlying technology, blockchains, is bigger than just cryptocurrency, and it all but ensures nobody will ever win the whack-a-mole game. 

Decentralized blockchains have the potential to change the underlying structure of the internet. Ultimately, there could be no distinction between basic communication via the internet and financial settlement via the internet. Will the regulators then insist on mapping and monitoring every single email for every single person on the planet? That level of surveillance is incompatible with a free society.

Much like the rest of financial regulation, the BSA/AML regime is decades behind current technology and badly misdirected. It is doing little to focus directly on criminals while actively slowing the proliferation of technology (along with the benefits it can provide).

Even people from inside the bureaucracy are slowly waking up to this reality, though most of those folks rarely say much in public. One exception is Jai Ramaswamy, the Obama-era chief of the Department of Justice’s Asset Forfeiture and Money Laundering division. In November, Ramaswamy penned an article at Coin Center titled How I Learned to Stop Worrying and Love Unhosted Wallets. He notes:

Critically, these are primarily technological advances that give rise to financial innovations, and thus policymakers seeking to prohibit or restrict their development and use would be wise to heed King Canute’s warning about the futility of stopping the ocean’s tides from rising. A sober review of the technology explains why such efforts are bound to fail and will only serve to undermine rather than enhance efforts to detect and disrupt illicit financial activity.

It is not yet clear how the incoming Biden administration will view Treasury’s latest rule. Let us hope they will at least listen to Ramaswamy on this issue.