The National Security Approach to Blockchain In Congress This Fall
National security risks and regulatory challenges posed by the burgeoning crypto industry have come under increasing scrutiny in recent times. Global authorities, including those in the U.S., are seeking strategic methods to reign in the unregulated aspects of the crypto market, while also leveraging the potential of blockchain technology.
Cryptocurrency executives frequently voice concerns about the ambiguous regulatory landscape surrounding their industry. They cite a need for a more structured approach to regulating the trillion-dollar asset class, which harbors enormous potential for its role in the global economy. However, consensus on what such an approach should entail remains elusive.
In Congress this fall, the U.S. is expected to take a more active role in developing a national security approach to blockchain technology and cryptocurrency markets. Many lawmakers have proposed a variety of regulations to govern the industry, including anti-money laundering measures, consumer protection rules, and taxation protocols. These include the Warren-Lummis NDAA amendment and the bipartisan CANSEE Act. Additionally, Congress will explore the potential for using blockchain technology to enhance security and efficiency in government operations.
As part of this effort, representatives from both sides of the aisle are expected to discuss ways to foster innovation while still protecting against cyber threats and other risks associated with digital assets. Ultimately, Congress will seek to strike a balance between providing clarity and guidance for the industry while respecting individual privacy rights and allowing entrepreneurs room to innovate.
The Foundation for Defense of Democracies (FDD), a think tank known for its stringent stance on Iran, has put forward proposals intended to prevent "regulation by enforcement" from becoming the standard in managing crypto's national security risks. The organization recognizes the risk of crypto-enabled money laundering as a significant national security threat. It aims to align the industry with the extensive compliance regime that applies to traditional financial firms, with additional measures to address the unique technical characteristics of digital assets.
The FDD has developed a new framework to stimulate policymakers to fill the gaps and eliminate ambiguities in crypto rules that could impact national security. This framework addresses areas such as privacy-focused coins like Monero and anonymizing currency mixers like Tornado Cash. The goal is not merely to regulate but to proactively create rules tailored to the unique nature of digital assets. However, this framework may not resonate with all stakeholders in the crypto industry. As FDD senior advisor Rich Goldberg suggests, "The industry may oppose some of these steps because they're costly. Or because they're antithetical to their business models."
National security concerns associated with cryptocurrency have escalated in recent years. U.S. adversaries, such as Iran and North Korea, have exploited the pseudonymity and decentralization of blockchain networks to evade sanctions and launder illicit funds. In response to these challenges, the FDD framework aims to build on a plan for countering illicit crypto-finance released by the Treasury Department. The purpose is to enable the Treasury Department to avoid replicating the ad hoc approach taken by the SEC in its enforcement of consumer protection rules.
The past year has witnessed a firestorm over crypto regulation. The Treasury Department's sanctions against Tornado Cash, a decentralized protocol for anonymizing crypto transactions, stirred concerns about overreach. The unprecedented nature of sanctions against a software tool, rather than an entity or individuals, raised fears about the potential implications for all types of users who had nothing to do with money laundering.
The FDD report argues that the U.S. needs to exert pressure on other governments to enforce financial surveillance rules for crypto firms. The think tank calls for an investment in on-chain analysis capabilities by government agencies. It also suggests Congress should consider requiring crypto firms to incorporate such methods into their compliance systems.
Given the rapidly evolving nature of the crypto industry, it's challenging to predict the exact contours of future regulation. However, the FDD's approach suggests an emphasis on proactive rulemaking, with enforcement measures reserved for necessary situations. The Defense Advanced Research Projects Agency (DARPA), renowned for developing the earliest internet technology, is conducting a comprehensive review of cryptocurrencies. The agency has engaged crypto intelligence firm Inca Digital to lead this year-long project.
The aim is to develop tools that provide a granular view of the inner workings of crypto markets to assist authorities in countering illicit uses of digital assets. DARPA's initiative reflects the increasing efforts of federal agencies to thwart rogue regimes, terrorists, and other criminal actors from exploiting crypto for illicit activities. The goal is to map out the cryptocurrency universe in great detail for insights into traditional financial markets, where comprehensive information is more challenging to gather.
Government agencies worldwide have grappled with the policing of cryptocurrency. The industry's lack of regulatory safeguards has allowed it to evolve into a shadow financial system that sophisticated criminals have found ample opportunities to exploit. Inca Digital's work for DARPA aims to help the government understand how money flows in and out of blockchain systems. It also seeks to distinguish genuine crypto trading from bot-driven activity and uncover crypto-based scams.
The future of blockchain technology in national security looks promising yet complex. As blockchain technologies evolve and more use cases emerge, the demand for financial privacy on the blockchain continues to grow. The upcoming conflict between on-chain privacy and financial surveillance won't be easy to resolve. As the blockchain becomes more widely used, people are demanding a greater degree of privacy for their transactions.
