DeFi vs. the regulators, by the numbers

From: POLITICO's Digital Future Daily - Thursday Feb 23,2023 09:19 pm
Presented by TikTok: How the next wave of technology is upending the global economy and its power structures
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By Ben Schreckinger

Presented by TikTok

With help from Derek Robertson

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One question raised by the ongoing crypto crackdown is just how much power U.S. regulators can exert over public blockchain networks.

The answer depends in part on how they go about exerting it. They’ve got a few options open to them, but each presents its own dilemmas.

One way they could play it would be to take a laissez-faire approach and attract as much crypto activity to the U.S. as possible. Once a large part of the industry and the infrastructure of blockchain networks is entrenched in the U.S., they could slowly impose more rules and hope that the rules effectively govern activity on the blockchains, even if much of those networks exist outside the U.S.

One problem with the slow-going approach is that, in the meantime, you’ve got a financial Wild West in your backyard, and no one playing sheriff.

So, another approach would be to bring the hammer down. That lets regulators do their job — to regulate — and proactively assert their own interpretation of the rules.

The problem with this is that blockchain networks are by their nature hard to rein in: They’re global, were originally built in order to stymie outside regulation and are still evolving rapidly.

It’s relatively easy for network participants to find work-arounds, and those work-arounds might be at odds with the long-term goals of regulators.

Of course, a global, coordinated response might be more effective, but it’s unclear whether that’s achievable.

In the absence of that, it’s worth pondering a couple recent metrics that illustrate the challenges U.S. authorities face in cracking down on blockchain networks.

2 billion 

That’s roughly how much the supply of the stablecoin Tether has increased in the last 10 days, according to data from CoinMarketCap.

Last Monday, stablecoin issuer Paxos stopped minting new units of BUSD, its Binance-branded stablecoin after being ordered to do so by the New York Department of Financial Services. The company also received a notice from the Securities and Exchange Commission that the agency is considering taking action against the company under the theory that the token is an unregistered security.

The news sent stablecoin users flocking to Tether, extending its dominance of the global stablecoin market.

Paxos is New York-headquartered and touts its compliance-forward, “regulatory-first approach” to crypto as perhaps its chief selling point, though the authorities evidently were not sold.

Tether’s owner, iFinex, is based in Hong Kong.

Last summer, when the Treasury Department issued sanctions on the anonymization tool Tornado Cash, Tether pushed back, indicating it would not go as far as its U.S. counterparts in cooperating with the measure.

In crypto, where defying governments was the original point, the fact that Tether is less amenable to the rule of U.S. regulators is part of its appeal to many users.

By the same token (pun intended), it’s not so popular with U.S. regulators, who fined its owner $41 million in 2021 to settle charges it misled investors about its asset-backing.

So, the Tether boom looks like an unintended consequence of the domestic stablecoin crackdown, even if it was arguably quite foreseeable.

As one advisor to a U.S. stablecoin issuer put it to me, “I guess the easiest way to explain it is: duh.”

45 percent

As of noon today, that’s the portion of new Ethereum transaction blocks added in the last 24 hours that are compliant with Treasury sanctions, according to data from Labrys, an Australian blockchain developer that opposes the compliance practice. That represents a steep drop-off over the course of the winter.

Things were moving the other way last fall.

In October, we took note of the first time that the majority of new blocks added to the Ethereum chain were coming from block-building services that comply with Treasury Department sanctions by excluding banned addresses.

Crossing that 50 percent threshold represented a notable — though largely symbolic — victory for U.S. regulators seeking to impose their rules on unruly blockchain networks.

But it also sparked a concerted backlash. Activists — still rattled by the summer sanctioning of Tornado Cash — called for network participants to shift to non-compliant, off-shore block-building services.

Flashbots, a popular block-building service that complies with Treasury sanctions, announced it would release an open-source version of its software that others could use to build non-compliant blocks.

While the percentage of compliant blocks reached as high as 79 percent in November, compliance has trended downwards over the course of the past month.

In a Telegram exchange with DFD, One of the activists, Berlin-based DeFi developer Martin Köppelmann, attributed much of the decline to the creation of new block-building services that ignore Treasury’s blacklist. In other words, the effort to insulate the network from regulators bore fruit.

Coincidentally or not, the percentage of new compliant blocks began slipping below 50 percent last Monday, around the same time Tether was experiencing its dramatic spike in usage, according to the Labrys data.

Spooking stablecoin users to suddenly flock to an off-shore provider is one thing.

More concerning for U.S. regulators may be the capacity of the second-largest crypto network to adjust its structure to evade their reach.

 

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so your constituents developed generative ai

And heeeeeeere coooooome the white papers… on exactly how government should deal with the rise of generative AI.

In a new one from the Mercatus Center – a libertarian think tank – author Matthew Mittelsteadt explains the technology to lawmakers by way of arguing that it will be key to making 21st century policy.

“Even if lawmakers were to grasp basic notions of AI engineering and acquire a sense of the depth and breadth of AI’s effect, it is an open question whether they would be able to translate that knowledge into a consensus for AI governance,” Mittelsteadt writes. He then enumerates an “incomplete and ever evolving list” of policy questions AI raises, including the government’s role in chip and algorithm development, attracting talented immigrants to foster the tech and how to deal with “externalities” like energy use and workforce disruption.

“The fundamental challenge for policymakers will be recognizing this diversity and understanding that not all AI goals will coexist peacefully, nor will they necessarily match the goals of policymakers,” Mittelsteadt concludes. Good luck! — Derek Robertson

 

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somebody's watching me (sort of)

It turns out VR technology is really, really good at tracking and identifying people.

That’s the takeaway from a new pre-print written by a group of (mostly) UC Berkeley researchers that demonstrated, in their words, how “After training a classification model on 5 minutes of data per person, a user can be uniquely identified amongst the entire pool of 50,000+ with 94.33% accuracy from 100 seconds of motion, and with 73.20% accuracy from just 10 seconds of motion.”

The risk posed to privacy and data rights in the metaverse is well-established, but these findings stand out. Louis Rosenberg, an advisor to the research team and one of the pre-print’s listed authors, wrote for VentureBeat that “What makes the results so surprising is how little data is actually needed to uniquely identify a user in the metaverse, potentially eliminating any chance of true anonymity in virtual worlds.”

I emailed Rosenberg to see if he had any further recommendations or insights for regulators and policymakers worried about the technology, and in the course of noting how the study should be “a wakeup call” for them, he noted the role AI had to play in it as well: “Powerful AI methods were used to process the massive datasets of human motions and enable identification at high accuracy,” Rosenberg wrote. “This is part of a larger trend in which AI technologies are quickly changing our expectations about what is possible and what is not.” — Derek Robertson

 

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tweet of the day

👀 @TimSweeneyEpic (CEO of @EpicGames) is no longer following @RobIox_US

the future in 5 links

Stay in touch with the whole team: Ben Schreckinger (bschreckinger@politico.com); Derek Robertson (drobertson@politico.com); Mohar Chatterjee (mchatterjee@politico.com); Steve Heuser (sheuser@politico.com); and Benton Ives (bives@politico.com). Follow us @DigitalFuture on Twitter.

Ben Schreckinger covers tech, finance and politics for POLITICO; he is an investor in cryptocurrency.

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