The Honorable Elizabeth Warren
United States Senate
309 Hart Senate Office Building
Washington, DC 20510
December 22nd, 2022
Dear Senator Warren:
Senate Bill “Digital Asset Anti-Money Laundering Act of 2022” (DAAML) promulgates the regulation of various agents in the digital asset ecosystem toward the goal of preventing the use of distributed ledger (“blockchain”) technologies in money laundering, financing terrorism, and illegal drug trafficking [1]. Former CIA Director Michael Morell described blockchain analysis as a “highly effective crime fighting and intelligence gathering tool” and the Bitcoin ledger as an “underutilized forensic tool” (page 3, Morell et al) [2]. The report cited a currently serving official at the CFTC (Commodity Futures Trading Commission) who stated that it “is easier for law enforcement to trace illicit activity using Bitcoin than it is to trace cross-border illegal activity using traditional banking transactions, and far easier than cash transactions” (page 5, Morell et al) [2].
Bitcoin is an example of a distributed ledger technology that was designed and is primarily used for transferring value. However, numerous other distributed ledgers, most notably, the Ethereum blockchain, have their origins in decentralized computing. My analysis of the Ethereum blockchain demonstrated that 49.9% of all transactions entail transfer of funds*. The Ethereum blockchain, like many other distributed ledgers, is used for manifold purposes beyond simply transferring value, including voting, decentralized autonomous organization, litigation, intellectual property attribution, and proof of data authenticity, to name a few applications [3, 4, 5, 6].
Distributed ledger jargon suffers from misnomers that can easily confuse non-technical audiences who approach the subject from a financial perspective while ignoring blockchain’s numerous non-financial applications. For example, Ethereum applications have historically been referred to as “smart contracts”, although they generally have nothing to do with contracts in a legal sense. A “smart contract” is a misnomer for a software program that is stored and executed on a distributed computer known as “Ethereum”. Another example of jargon that is often misinterpreted by non-technical audiences is the term “transaction”.
Most non-technical readers interpret the word “transaction” in a financial sense, similar to a credit card transaction or a commercial interaction in which money is exchanged for a good or service. However, a “transaction” in the context of distributed ledger technology should be interpreted in the broader and more accurate technical sense of a state change. For instance, deleting a record, uploading a cryptographic hash, saving a string such as “Hello, World!”, or updating a database record on the Ethereum blockchain all constitute “transactions”. That is, a “transaction” results in a state change on the Ethereum computer and may or may not entail transfer of value from a sender to a recipient.
Section 3 of DAAML (“Digital Asset Rulemakings”) states: “The Financial Crimes Enforcement Network shall promulgate a rule classifying custodial and unhosted wallet providers, cryptocurrency miners, validators, or other nodes who may act to validate or secure third-party transactions, independent network participants, including MEV searchers, and other validators with control over network protocols as money service businesses.” Preventing money laundering and countering terrorism are obviously worthy goals. However, the measures proposed toward these noble goals are, in my view, misguided.
In proof-of-stake (PoS) blockchain networks such as Ethereum, validators are agents that run peer-to-peer software and use their own “staked” funds to cryptographically validate transactions. To rephrase this generally, validators run peer-to-peer client software that maintains the integrity of the network and keeps it online. Analogously, proof-of-work (PoW) blockchain networks such as Bitcoin (and previously, Ethereum, before a network upgrade that occurred on 15 September 2022 that changed Ethereum from a PoW to a PoS system) rely on miners to incorporate transactions into a distributed ledger.
Legislation that fails to distinguish between financial and non-financial uses of blockchain networks threatens not only the entire blockchain industry but also the very technologies that were developed to promote transparent, democratic, and censorship-resistant computing. Anyone with a modern computer and an internet connection can download an entire distributed ledger, interrogate and interact with the ledger using open-source client software. These agents can fall under the definition of “independent network participant” and “validator”. Classifying these entities as “money service businesses”, along with the regulatory and reporting burden this entails, is unreasonably onerous, in my opinion.
Beyond the stated goals of preventing the financing of terrorism, money laundering, and illicit drug trafficking, legislation that regulates the digital asset ecosystem should also protect consumers from abuse by financial institutions. FTX is neither the first nor the last financial institution, crypto-based or otherwise, to collapse, and these corporate failures should highlight a key value proposition of digital assets: the fact that they can be managed by individuals without having to place trust in third-parties that may or may not deserve their customers’ trust. The classification system put forth in DAAML would largely target innocent individuals while failing to focus regulation where it ought to be focused: on corporations that lost or otherwise gambled away funds of customers who relied on these companies to safeguard their digital assets.
Classifying miners, validators, and independent network participants as “money service businesses” would be analogous to classifying individuals who run file-sharing clients (for example, BitTorrent) as a cloud hosting service. Clearly, a college student running a peer-to-peer node from their dorm is incomparable to Google Cloud or Amazon Web Services. DAAML would severely discourage and unreasonably burden anyone wishing to run free, open-source software with a multitude of non-financial uses, whether or not these parties are involved in verifying transactions that entail transfer of value. DAAML fails to recognize the fact that most transactions on the Ethereum blockchain involve no transfer of value whatsoever. The bill lacks an accurate appreciation of the term “transaction” in a technical sense as it it used in blockchain discourse and is biased by interpretation of the word in a classical financial sense.
Every single transaction in the Ethereum blockchain can be scrutinized with a few lines of code. The tools I used to conduct my analyses are based on open-source utilities such as the Go-Ethereum client and the Python Web3 library [7, 8]. Rich and detailed information about the Ethereum blockchain can be obtained by anyone without the need for proprietary APIs. I encourage lawmakers to conduct their own analyses of blockchain ledgers so that emerging legislation can more effectively protect consumers and counter the financing of terrorism, illegal drug trafficking, and money laundering – without destroying the democratic, decentralized foundations of these technologies.
In particular, I urge you to develop a more nuanced definition of “money service business” that does not target the miners, validators, and independent network participants which serve as the foundation of blockchain networks and keepers of its decentralized integrity. I hope that the arguments made above demonstrate that doing so would be a fallacy.
Thank you for your consideration.
Respectfully yours,
Omar Metwally, M.D.
* My initial analysis of all transactions from the past 10 days yielded a figure of 43%, and this is the number I cited in my original letter to Senator Warren. In a follow-up study, I analyzed all transactions from every 100th block on the Ethereum blockchain beginning with block 16237072 and ending with block 1388368 and calculated that 49.9% of Ethereum transactions entailed value transfer. The ratio of value-containing transactions varies widely from block to block. Access to greater computing resources would enable a more detailed study, and I invite anyone interested in this research question to conduct their own analysis.
References
1. “Digital Asset Anti-Money Laundering Act of 2022”. https://www.warren.senate.gov/imo/media/doc/DAAML%20Act%20of%202022.pdf. Accessed 21 December 2022.
2. “An Analysis of Bitcoin’s Use in Illicit Finance” by Michael Morell, Josh Kirshner and Thomas Schoenberger. 6 April 2021. https://cryptoforinnovation.org/resources/Analysis_of_Bitcoin_in_Illicit_Finance.pdf. Accessed 21 December 2022.
3. “What in the Ethereum application ecosystem excites me” by Vitalik Buterin. 5 December 2022. https://vitalik.ca/general/2022/12/05/excited.html. Accessed 21 December 2022.
4. “How cryptography and peer-to-peer networks contribute value to society” by Omar Metwally. 13 March 2022. https://omarmetwally.blog/2022/03/13/how-cryptography-and-peer-to-peer-networks-contribute-value-to-society/. Accessed 21 December 2022.
5. “Great Explorers” by Omar Metwally. 16 September 2022. https://omarmetwally.blog/2018/09/16/great-explorers/. Accessed 21 December 2022.
6. Maestro Ethereum application by Akram Alsamarae and Omar Metwally. National Science Foundation Grant 1937914. https://maestro.analog.earth
Minimally invasive software 