WASHINGTON — The federal government has been turning the screws against some of the most radical ways that companies are looking to disrupt the traditional financial system, widening the chasm between mainstream finance and decentralized disruptors.
One of Treasury's most recent enforcement actions — the sanctioning of DeFi protocol Tornado Cash — could have long-running consequences for how banks and their decentralized financial competitors interact.
When the Treasury sanctioned Tornado Cash, it set off a
As Treasury increasingly looks to wrangle with the sprawling and evolving DeFi space, it's creating a more bifurcated system between decentralized finance and the more traditional financial sector. While there's always been a gap between the kind of "clean" money that banks deal in and money that moves in less-regulated corners of the economy, Treasury's renewed focus on DeFi makes it clear that the federal government is
"Traditional banks, like the big banks and even those that are mid-sized and smaller, all have significant AML requirements that can be quite onerous, while DeFi is set up to be much less onerous, much less centralized and more democratized. It's just a different system than traditional banks," said Chris Campbell, chief policy strategist at Kroll and former assistant secretary of the Treasury for financial institutions. "And it's becoming more difficult to merge those two worlds."
When money moves through a "mixer" like Tornado Cash, it anonymizes the source of the funds, said Anderson Mccutcheon, chief executive officer of crypto firm Chains.com and longtime industry advocate of creating regulated cryptocurrency-related products. Treasury's Department's Office of Foreign Assets Control accused Tornado Cash of laundering billions of dollars in cryptocurrency, including $455 million allegedly stolen by North Korean hackers.
Banks and other traditional financial companies have tough oversight from U.S. regulators, especially when it comes to anti-money laundering, that means they can't store, borrow, trade or lend this money. Because of this regulation, they're essentially cut out of the market share that DeFi companies are taking, creating a competitive threat to the traditional financial sector.
Effectively, if the current trend continues, the government's crackdown will create a two-tiered track of "whitelisted" and "blacklisted" cash, weaving a complicated set of benefits and downsides for established players in the traditional financial sector, he said.
"That essentially renders the money unusable in the traditional financial system," Mccutcheon said. "So we're very likely to end up with cryptocurrencies that can be put in an exchange, like your top regulated exchanges, and possibly converted into fiat currency and placed in a bank. And we may end up with billions of dollars that can only move within that unregulated decentralized ecosystem. There is no way of converting those funds into legit ones."
This is a double-edged sword for banks. On one hand, billions of dollars locked out of the traditional financial system is lost potential profit. On the other, banks have been trying to convince their regulators that they're a
"In the end, it could significantly benefit the banks," said Campbell. "Right now it's very risky for them, but I do think as things evolve they're going to become much more involved as more consumers move toward DeFi, maybe banks are best positioned, in regulators eyes, to meet that demand."
The initial issue, however, is still whether the federal government and Treasury is overreaching when it comes to Tornado Cash.
Treasury, "has a long, commendable history of utilizing financial sanctions to enhance the national security of the United States," Rep. Tom Emmer, R-Minn., wrote in an open letter to Treasury Secretary Janet Yellen. "Nonetheless, the sanctioning of neutral, open-source, decentralized technology presents a series of new questions, which impact not only our national security, but the right to privacy of every American citizen."
Aside from complaints made by Emmer, along with the complaints of other DeFi advocates and companies, the argument in favor of DeFi has had trouble picking up steam.
"How much of that is more of a political statement than a real economic one, or a serious threat to our financial system?" said Paul Clark, a partner in the Washington office of the law firm Seward & Kissel and a lecturer at Berkeley Law.
Most observers in the financial policy space, in fact, see the increased scrutiny on Tornado Cash and DeFi as par for the course.
"I've seen absolutely no evidence at all of any anti-technology or any anti-blockchain technology effort with the Biden administration," Clark said. "What I see is regulators doing what they're supposed to do, which is saying we see strong evidence of bad actors using this particular type of crypto transaction."
