Today's article originates with a comment left by Swca.ch who made the observation that although Blockchain technology prohibits the government from taking funds directly from your cryptocurrency wallet, improved analytic software now gives governments the ability to track wallets and limit blockchain access. Although the government can’t strictly take money from a crypto wallet, advanced blockchain analysis software will someday (if not already) allow them to match public keys to real-world identities and levy real-world penalties to enforce compliance much the same way they do with traditional financial assets - thus weakening one of the main arguments for crypto. In today's article, I'd like to discuss the most important cryptocurrency fork that will ever happen, its impact on the crypto market, and why I believe such a fork is likely.
The Disappearing Privacy of Cryptos
There are many advantages that cryptocurrencies have over traditional fiat currencies, but one commonly cited advantage is that they protect individuals, especially in developing countries, from having funds seized by corrupt governments. When cryptocurrencies were first created over a decade ago, their “pseudonymous” and quasi-private nature provided enough security that most casual users didn't need to be concerned with prying eyes viewing their transaction history. As cryptocurrencies have developed, so has the software used to track them.
There are currently several companies that offer advanced blockchain analytics that allows governments to match wallet addresses to real-world identities and see all transactions that come in and out of a wallet. This creates a situation in which although the government couldn’t strictly take money out of your cryptocurrency wallet, they could still be able to see what amount of crypto you had in your wallet, what income you had made, and what gains and losses you have made through trading.
As Swca.ch correctly pointed out, a government doesn't have to physically seize your cryptocurrency to negate the benefits of crypto as a way of preserving and protecting your wealth against a corrupt government. If a corrupt government can link a real-world identity with a cryptocurrency wallet, then it doesn’t matter that they can’t physically move the crypto with the citizen’s private key. Such a government could coerce the individual into compliance by levying fees or fines or jailing the person. Although cryptocurrency is currently viewed as a way of protecting individuals from having wealth compensated by corrupt governments, this perceived advantage is quickly evaporating every day as new tracking technologies developed.
"What's in a name?"
While it is true that cryptocurrencies will always have some unique benefits due to their inherent nature, I predict that as the government's ability to track cryptocurrencies increases, the government will naturally want to monitor, regulate, and tax them the same as traditional financial assets. Failing to do this would leave a huge source of tax revenue untapped, which I don't see any government willingly passing up. This will negate not only many of the security benefits of cryptos, but also the speed at which cryptocurrencies can innovate. Let's assume for a moment that at some point the government can develop analytic software advanced enough to identify and track every cryptocurrency transaction the same as they're able to do with traditional financial instruments. If this was indeed the case, why would the government have any incentive to give a tax break, discount, or special treatment to a financial asset simply because it is a cryptocurrency? The simple fact of the matter is it would not.
This presents an interesting scenario in which things that are “cryptocurrencies” in name cease to hold the properties that drew many of us to crypto. For example, self-custody of crypto in your wallet is no better than holding stocks in a bank if the government can block your IP from accessing the internet or freeze your funds on the blockchain in much the same way as USDC can be frozen. If you can't access your funds, the issue of "self-custody" becomes irrelevant.
What good is being able to develop cutting edge DeFi protocols if crypto is held to the same standard as traditional banks and lending practices? True, the government may not be able to shut down the protocol itself, but if we ever progressed to the point where it was possible to identify and prosecute the developers and users of banned DeFi products and services, then the fact that the protocol itself can’t be shutdown becomes moot. What good is it that cryptos resist inflation if the government can impose a special crypto-tax on your wallet to offset your “increasing” wealth as they devalue the national fiat?
The Greatest Fork
As they are currently implemented, I believe that the days of quasi-private pseudonymous cryptocurrencies are limited. The technology is rapidly advancing to the point where cryptocurrencies will offer no more privacy and face the same regulation as traditional financial assets. As the technology to track cryptocurrencies improves, pseudonymous cryptocurrencies will face one of two choices. The first option is that they comply with the regulations, taxes, and reporting requirements. Under this option, there will be little incentive to use cryptocurrencies since they will be more or less treated the same as traditional financial assets. On the other hand, crypto projects that attempt to seek out higher profits or provide a more advanced service than was allowed by the regulations would be quickly exposed and face possible prosecution.
Although many cryptocurrencies will be content to comply with government regulations and deliver a mediocre return, I predict that as the government regulation becomes more and more burdensome, some cryptocurrency projects will adopt fully private, anonymous coins as a way to continue to innovate and deliver profits unencumbered by oppressive regulation. This would be even more apparent in corrupt countries where the government inflates the money supply and people use crypto as a way to preserve wealth. Under those circumstances, someone who had bought crypto to protect their purchasing power would view the taxation/confiscation of their crypto not just as a "just and fair" tax needed for the operation of society, but rather as a direct threat to their continued ability to provide for their basic needs.
I want to be clear that this is not a value judgment and not an endorsement of illegal activity in any way, but we have to understand that the desire to preserve and grow one's wealth is a very powerful motivating factor. Especially in countries where governments are viewed as tyrannical and illegitimate, it's not a far stretch to imagine that people would want to use fully anonymous and private cryptocurrencies as a way of protecting their wealth and safeguarding their future.
Discussion
Up to this point with our semi-private cryptocurrencies, we have lived in somewhat of a grey area in which cryptocurrencies are supposed to be reported and taxed and regulated but where governments don't have a full set of tools to enforce the regulations. Especially in the last few years and moving forward, this is changing very rapidly. I believe the greatest and most important cryptocurrency fork will be the split between pseudonymous cryptocurrencies that become mainstream, regulated, tracked, taxed financial instruments, and the minority of cryptos that elect to pursue full anonymity, protect wealth and innovate regardless of regulation.
Although privacy is still a feature of many cryptos, the degree of privacy is rapidly decreasing with new advancements in blockchain analysis. As originally implemented, Bitcoin did give a certain amount of privacy that fiat did not, and although full privacy was not a design goal of Bitcoin, the “pseudo-private” nature of the Bitcoin (and the majority of subsequent coins) has allowed crypto to amble along in an indecisive state where it is neither fully traceable and compliant with government regulation but where it is also not completely private and independent of regulation. The advances in tracking technology will force coins to make a decision; will crypto be fully private and independent of governments, or will it simply be absorbed by traditional finance and subject to the same rules and regulations?
Summary
As technology progresses to the point where “pseudonymous” cryptos become fully traceable, crypto will reach a decision point. At this Greatest Fork, some coins that opt for full transparency and traceability will embrace regulation and try for the long-awaited “mass adoption.” Other coins will laugh at the coins that join the very financial world that they were designed to replace and will opt for full privacy and continue to develop and be used by those who want to "opt-out” of the existing financial order.
This article should in no way be construed as support for any form of underhanded activity and is rather published as a speculative prediction rather than a form of endorsement.
Thanks for reading!
References
https://cryptonews.com/news/this-new-stablecoin-has-a-backdoor-for-freezing-funds-too-2908.htm
https://read.cash/@The.Part.Time.Economist/trump-biden-and-crypto-in-2020-6791472b
Image Credits
https://unsplash.com/photos/ELXrto6Uqas
https://unsplash.com/photos/Q1p7bh3SHj8
https://unsplash.com/photos/u0vgcIOQG08
