From Open to Closed
How Blockchain Could Exacerbate Censorship in Finance
Pongo Points:
• In general, public blockchain protocols don't censor individual addresses, but the products and services that enable individuals to participate and interact with the protocols may not be. It's like having a car with no fuel: Sure, you have an asset, but you're not going anywhere without gas.
• A core ethos advertised by the crypto community is that public blockchains are immutable, open-source, and censorship resistant technologies. While true in theory, what might that mean for companies that must abide by jurisdictional regulations? Or to people who can't spend "tainted" funds that were sent to them from a sanctioned party?
• Another argument that many in the crypto space make is that the internet developed in an open and permissionless way, so crypto should be afforded the same openness. Strictly speaking that's correct, but 99.9% of the internet that is used by the vast majority of individuals is, in fact, highly regulated.
Freedom to Discriminate
One might wonder if a public and censorship resistant blockchain might be a viable path to a more equitable future, especially after reading news articles like Citigroup being fined for discriminating against Armenian Americans when they applied for credit cards. After all, public blockchains are immutable code that can’t be tampered with, so discriminatory abuses could be avoided - right?
Yes and no. Public blockchain protocols themselves can’t discriminate because they’re computer programs. But if one digs deeper and understands what’s public and what’s private in the crypto ecosystem, then things become more complicated. Realistically, anyone could interact with the Bitcoin or Ethereum blockchains without fear of having their accounts1 censored, because they are fairly decentralized public networks at this point. Practically, many could be censored because they use products developed by private companies that are bound by the law.
It’s the same thought as anyone being able to connect to the internet but getting banned by Facebook for breaking their terms and conditions. Sure, you can still use the internet, but a large portion of what many would deem a “usable” portion of the internet has been cut off. Same thing goes for Google, Amazon, Netflix, and pretty much any other internet-based company that must adhere to the regulations of the jurisdictions in which they operate.
The Citigroup fine was due to employees rejecting any credit card application that appeared to come from an Armenian sounding name, due to Armenian-American fraud rings fleeing the country without paying off credit card debt. Blockchains wouldn’t necessarily fix this problem, and might even exacerbate these kinds of problems. Blockchain companies have become comfortable with the idea of blacklisting accounts, which might lead to a worse fate than having your credit card application unfairly rejected…
A Tale of Two Blockchains
Is a dollar worth anything if you can’t spend it anywhere? On a public blockchain, no entity can prevent you from interacting with the network. However, the majority of services that you might use on a blockchain can block you from accessing their products. It’s called “blacklisting” an account, which, as the name implies, means that a particular account can no longer access certain protocols. Technically, any smart contract or crypto service can blacklist any account for any reason.
This leads to crypto’s “uncensored paradox”: If you own a Bitcoin, but you can’t spend it or use it anywhere, does it have any value? Suppose you’re a politician that has raised a bunch of Bitcoin for your campaign, but your account was blacklisted from every exchange on the planet because they don’t like your politics. How would you “cash out” your donations in order to fund your campaign? Even if vendors would accept Bitcoin as payment, what if their accounts are blacklisted by association and they can’t cash out to pay their employees?
It’s a tremendous technological feat that blockchains have grown so large as to become decentralized and fairly tamper-proof, but they do not exist in an vacuum. Nobody can prevent anybody else from acquiring and sending Bitcoin, but they can stop them from using that Bitcoin. What happens with those “dirty” Bitcoin that can never be used, simply because they touched an “untouchable” account? (I’m ignoring the use of mixing services, since those are potentially traceable and blacklist-able too.)
Essentially, “dirty” Bitcoin are forced to circulate amongst themselves in a smaller economy. Just as most vendors won’t accept a physical dollar note that has clearly been marked by a dye pack, the same might be true for crypto - except that crypto cannot be totally “washed” unless done by some sanctioned authority. What would a “crypto cleaning” service or authority even look like?
Open Internet, Closed Companies
Many crypto proponents point to the open and decentralized growth of the internet, and suggest that the digital asset space should be allowed to flourish in the same way. Unfortunately, that’s a half-baked argument since the vast majority of the internet that 99.9% of the world uses on a regular basis is heavily regulated and controlled. Yes, there is the untamed “dark web” where there are “shadowy hackers selling credit card information” from shows like Mr. Robot, but it’s miniscule.
The internet is generally categorized into three major sections: The surface web, the deep web, and the dark web. The surface web is any webpage that’s readily available and searchable by the general public - think Amazon and Wikipedia. The deep web is information that isn’t searchable, but still accessible by some - think your email account and online banking records (this is the largest amount of data by far). The dark web is the smallest component making up less than 0.01% of the internet.
When crypto advocates point to the formation of the internet, many view that argument as pushing for crypto to grow like the dark web. (After all, Bitcoin has roots in the dark web.) Obviously, this is rejected by policymakers and regulators since a global financial system cannot function like the Wild West. Others in the crypto space promote reasonable regulation through the development industry-specific rules and agencies, which is a far more sensible path.
Ultimately, blockchains will likely exist in a space between those two regulatory areas, just as the internet exists between the “approved” surface/deep web and the largely unrestrained dark web. The vast majority of services built on top of blockchains will be regulated and controlled for the benefit of the public, but there will always be the blacklisted services and accounts lurking. It’s up to the lawmakers to build fair and clear rules for digital assets, but the crypto industry must also build something that’s value-add - not just technology that enables illicit activity.
I use the term “account” for the sake of simplicity and clarity, but the correct term is blockchain “address.”