American blockchain and crypto innovators are fighting to keep their businesses in the United States. All too often they wonder what new, sweeping federal regulation will be the final straw that forces them to move their businesses overseas to places like Europe or Singapore, where blockchain innovation is embraced through streamlined regulation. It begs the question: What is Congress’s role in making the U.S. more hospitable to blockchain and crypto entrepreneurs?
For American blockchain pioneers, new regulations from the Financial Action Task Force (FATF), an international standards-setting body, might be that final straw. In March, the FATF released proposed guidance, which, if codified in the U.S., would include a broad swathe of noncustodial blockchain entities into the money transmission framework. Many entities in the blockchain space that don’t facilitate financial transactions, but instead simply develop blockchain or crypto technology, would have to obtain a money transmission license in each state where they have customers in order to operate domestically… meaning all 53 states and territories that require a money transmission license.
Unfortunately, the Treasury Department, which leads the U.S. delegation to the FATF, contributed to this proposed guidance. This leaves the blockchain industry wondering if FinCEN, a subsidiary of Treasury, will start to crackdown on noncustodial entities, despite its current and pragmatic approach of excluding noncustodial entities from the money transmission system.
The FATF’s proposed guidance is designed to target decentralized finance (DeFi), which is peer-to-peer transacting on a blockchain without a third-party intermediary like a bank. This sector of blockchain transactions significantly expands financial inclusion by providing consumers the opportunity to borrow, lend and transact with each other directly, in real-time, at very little cost. DeFi occurs entirely on a blockchain, so these transactions and agreements are transparent and verifiable, requiring no trust — just smart contracts. When there is no third-party like a bank facilitating a transaction, however, who is transmitting the money? This question propelled the FATF to cast a wide net around the blockchain developers and service providers that build the DeFi infrastructure. From the FATF’s perspective, if there’s no third-party intermediary, then the technology developers should be responsible for maintaining solvency.
Transactions occurring on a blockchain, however, occur in real-time, which means — with respect to DeFi — there is no need for solvency because the funds go directly from person “A” to person “C,” so to speak. There is no person “B” serving as a middleman, and consumer funds are never in limbo. DeFi is just one facet of blockchain-facilitated financial services. Aside from DeFi, there certainly are entities like centralized crypto exchanges and hosted wallet providers that custody consumer funds — and these custodial entities, rightfully, must obtain money transmission licenses. Separately and distinct, however, many of these technology developers (notably DeFi infrastructure developers) only build the blockchain technology. They don’t hold consumer funds or facilitate transactions — they are noncustodial entities.
The FATF proposed rule would require noncustodial tech developers to navigate the complex and expensive money transmission licensing regime: A regime so burdensome that these innovators and developers would be left with no choice but to innovate and develop outside of the United States.
The FATF is expected to reconvene this week to consider the public comments on its proposed guidance, elevating the question of what Congress’s role should be in blockchain policy. While my suggested remedy to this proposed guidance is the Blockchain Regulatory Certainty Act, legislation to exempt a noncustodial entity from needing to register as a money…