A Response to Martin Wolf

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USD rules the black market. Cryptocurrencies aren’t anonymous. And why anonymity actually matters.

“Danger Falling Rocks” from Pixabay

Esteemed economic commentator, Martin Wolf, recently published an opinion piece titled, “The Libertarian Fantasies of Cryptocurrencies,” in which he correctly argued in favor of a more cohesive regulatory regime aimed at the budding cryptocurrency market.

Concerns around energy waste, scams, and tax evasion are justified and require a legitimate debate — but 3 assertions in Wolf’s piece softened the punch it ought to have had.

First, the US Dollar, and cash in particular, remain the currency of choice for illegal activities globally.

Second, most cryptocurrencies are not anonymous — they are actually entirely public.

Third, it is actually this lack of anonymity inherent to public blockchain networks that should be feared most.

Let’s break this down really quickly.

Tax Evasion and Criminal Activity

This is a favorite talking point for economists, but all available data suggests that after Bitcoin’s launch in 2008, the broader cryptocurrency market cap had grown to around $121 billion at the end of 2016 (per CoinMarketCap). Tax evasion and counterfeit goods cost the US government more than $1 trillion per year during that timeframe. To argue cryptocurrencies are the vessel of choice for black markets is to disregard all respectable data available to economists today.

Cryptocurrencies Aren’t Anonymous

Wolf fell in to an all-too-familiar trap with his claim that cryptocurrencies are anonymous — they are pseudonymous. All addresses on the Bitcoin and Ethereum blockchains are publicly auditable using block explorers (sites that allow you to pull up all information on any account address or transaction ID). The most common way to purchase cryptocurrency is through an exchange — but most large exchanges require some level of account verification to withdraw funds from the exchange. This means your account is never really anonymous.

Now, let’s say you meet someone in person, pay them cash, and then have them send the tokens to your new anonymous address. The reality is, you will need to cash out some day. The infrastructure for spending cryptocurrencies in daily life hasn’t evolved to the point where you can simply pay using your tokens. The moment you try to cash out your funds, your anonymity is lost. Your bank account becomes identified with your Bitcoin or Ethereum account address, and the government can pull this information from most exchanges to trace your transaction history back through the public ledger (remember, that’s all the blockchain is!).

Cash is Anonymous — What Happens When It’s Gone?

The internet rose to mainstream use in the late 1990s — meaning until that point in time, cash was king. The idea that you should be able to trace every individual person’s transaction history back several years is quite new. Despite the privacy everyone has sacrificed, tax evasion remains a major problem — as noted above.

So consider this: currently, your credit card purchases are all being tracked. All of your information is being sold to data centers around the globe without your explicit knowledge — giving corporations the ability to predict what you might buy next, or when you might need your next loan, and to be the first ones there offering it to you. Some call this convenience, others call this an invasion of privacy.

Let’s take it a step further though and consider the real implications of a cashless society dominated by banks and corporations. Should the bank know every time you get $50 cash from a friend for groceries because the heating bill was too high this month?

In a cashless society, this transaction is recorded on a ledger that banks and corporations will be judging you by. Should that $50 transaction impact my credit score? In a cashless society, it will.

Consider another situation. There are three bakeries in my area but only one is allergen-free. In a cashless society, these specialty bakeries would be able to just pay a data center for accounts that are likely to be gluten-free and nut-free — then automatically up-charge those accounts anytime they come in.

In other words, a cashless society means an absolute loss of privacy and an increased threat of discrimination against minority groups.

Extend this to cryptocurrencies — now everyone can view your transaction history on the public ledger. Imagine the level of discrimination this could lead to if Bitcoin and Ethereum fail to implement comprehensive privacy mechanisms.

There are several projects with privacy solutions, like Monero’s ring signatures, Zcash’s zero-knowledge proofs, and, to a lesser extent, shuffling on Ignis. On the public ledger, these approaches provide excellent solutions to privacy concerns. In particular, Monero and Zcash make all account balances anonymous, yet each user is provided with their own unique secret passphrase for decrypting all previous transactions — meaning if the government were to audit you and demand access to your history, the only reason you would not be able to do so would be if you had actually lost access to your funds.

One could argue we should just give these privacy tools to banks, but then how can we trust them not to build backdoors in to steal our precious data? The answer is a public network with open source code — and that is what cryptocurrencies provide. So long as even a handful of people believe in the potential of these networks, they will remain operational because they are decentralized. Public blockchain nodes are running all around the world and can’t simply be shut down. This means that in essence, the real winners of the ongoing cryptocurrency tech race could be the operators of a new type of public infrastructure.

Final Thoughts

Blaming new technology for old problems isn’t constructive. With technology advancing so rapidly, the window is fast closing for governments to get involved in these discussions.

While clear regulations are necessary, the ability to enforce these regulations in such a high-tech environment hinges on the ability of governments to be proactive right now in contributing to constructive dialogues on public blockchain networks. Important work on standardization is being done by places like ISO and the ITU, but far more is needed. Let’s not stoke fears only to miss out on the broader opportunity at hand.

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