The United States Financial Crimes Enforcement Network, or FinCEN, recently proposed a series of new regulations applying to financial institutions dealing with digital currencies, such as Bitcoin (BTC). To summarize the proposed regulations, exchanges would essentially be required to file a report with FinCEN when a customer makes a purchase in excess of $10,000, and gather Know Your Customer information any time a transaction of $3,000 or greater is conducted using a non-custodial wallet.
This means that if a customer buys $3,000 worth of Bitcoin and withdraws it to a wallet they control, they would have to not only prove ownership of that wallet but also provide their name and physical address, along with additional identifying information.
Personally, my life stands to change very little. I’ve been living entirely off of cryptocurrency since 2015, unbanked since 2016, and have never used a centralized exchange, receiving all of my coins as compensation for goods and services. But as few live as I do, we will likely see a significant impact on how most cryptocurrency users conduct their business. I would hazard a guess that most users have interacted with a centralized platform requiring KYC.
For the rest of cryptocurrency users, the newly proposed regulations would put a significant friction point on deposits and withdrawals. At present, a user signs up to an exchange, submits KYC documents for approval, and can buy and withdraw Bitcoin to a wallet they control, including a hardware wallet for cold storage. When wishing to realize gains, they can then move the funds back onto the exchange and sell for spending money in the bank.
In the future, however, they may be required to prove ownership of the wallet to which they withdraw, including providing their physical address, and similarly, prove the origin of the funds when moving back on to an exchange. This may lead many users, including the privacy- and autonomy-conscious (of which there are many in the Bitcoin world), to seek other, less intrusive ways of using their digital funds. Making payments directly for the goods and services they desire, rather than first selling for fiat currency, avoids the headache of passing through the regulation-induced friction point every time.
The “centralized exchange closed-loop” experience Bitcoiners will wake up from
There’s a reason why relatively few people have engaged in regular transactions and purchases with Bitcoin — they haven’t needed to. The average user signs up for an exchange account, buys crypto, and may sell to realize some gains. Some of the more hardcore users may even buy a hardware wallet and transfer funds to it from an exchange, which could be an infrequent transaction of significant amounts with no real requirement for speed or particularly low fees. The basic process of buying for investment purposes, and occasionally selling to realize gains or to spend, is relatively smooth with centralized exchanges, which is why so few have ventured far out of this closed loop so far.
Many Bitcoiners have opted to stay inside this closed loop for exactly the same reason they may soon seek to exit it — avoiding friction. Sure, many will simply deal with the extra regulatory steps, but many more, particularly thought leaders and longtime community staples, will choose to stay closer to the cypherpunk ethos.
Bitcoin’s adoption ecosystem will get the push it needs
Bitcoin was born and bred for decentralized digital payments. At some point, this use case took a backseat to a digital store-of-value, and the tools necessary for it to reclaim this purpose haven’t adequately developed yet — foremost among these, of course, is scaling.
Bitcoin chose to pursue off-chain scaling solutions (Lightning Network) and on-chain transaction optimizations (SegWit). Both of these have seen lackluster development over the past several years, with SegWit transactions making up less than half of daily transactions over three years, and Lightning Network growth similarly stagnating, with very few exchanges or other major ecosystem players having integrated it at this point. As noted above, this hasn’t been that much of an issue with the current state of things.
However, when the average user gets direct exposure to the Bitcoin network as it functions today, they’re in for a rude awakening that will either prompt them to disengage entirely or will place pressure on wallets and service providers to prioritize SegWit and Lightning. In a free market, which the cryptoverse largely is, consumer demand drives innovation to meet its needs. If enough Bitcoiners start demanding that Bitcoin work seamlessly for small and efficient transactions (beyond simply posting about it on Twitter), the market will seriously push for the ecosystem to develop to meet its needs.
Hungry competitors line up to take over the digital cash role
Of course, Bitcoin is far from alone in the competition for cryptocurrency for direct purchases. Since its transition to a more digital gold-focused role starting in 2016 or 2017, quite a few hungry competitors have emerged. In the forefront of people’s minds are, naturally, the main Bitcoin forks, Bitcoin Cash (BCH) and Bitcoin SV (BSV). Both have pursued an on-chain scaling approach and have the capacity to field a large number of transactions cheaply, but neither has achieved a compelling enough differentiator yet to fully take over Bitcoin’s share of the payments market.
Bitcoin Cash has the clear advantage in terms of integrations into valuable services such as Purse.io but lost significant momentum due to repeated forks, each one taking with it a portion of the community and mindshare. Bitcoin SV has quite a few innovations going for it, including social media platforms and rudimentary human-readable username systems. But with a market ranking firmly outside of the top 10 and with far fewer major integrations than Bitcoin Cash, there’s certainly an uphill battle ahead. Additionally, the mark of Craig Wright has soured the project in the eyes of much of the greater cryptoverse, making partnerships and publicity difficult.
Litecoin (LTC) presents an interesting case as the longest-running payments-focused Bitcoin alternative, but so far, it has not yet managed to come into its own. From 2014 to 2017, its transaction volume trended downward, only to rebound significantly as Bitcoin’s scaling issues began to arise. Since then, it has served as a testnet for Bitcoin of sorts, as well as an off-chain scaling solution. Litecoin’s own scaling path seems to be uncertain, as its own Lightning Network implementation found even less success than Bitcoin’s, while its current 4x on-chain capacity compared to Bitcoin still leaves plenty of growing room. Will Litecoin remain as a substitute until Bitcoin or another project evolves to fully take the payments lead, or will this be the opportunity it needs to take over the digital cash role? Either way, its fate seems to be inexorably tied with that of Bitcoin.
The dark horse in this division may very well be Dash, whose name is literally an abbreviation of “digital cash” and has competed for this use case longer than any other alternative except Litecoin. And despite steady growth in transaction numbers, regardless of a bull or bear market, it has largely gotten lost in an increasingly crowded field of payments coins, some with crypto celebrity backers, especially after the realignment from a privacy focus to an everyday payments focus.
Unlike its competitors, however, Dash has spent years working on quite a few real improvements to the payments experience, including instant transaction settlement and anti-51% attack protection, making a Dash transaction arguably more secure in seconds than what its competitors could achieve in minutes or even hours — an experience that’s particularly useful for in-person retail payments. This, combined with the recent release onto testnet of the long-awaited “Evolution” upgrade, which not only provides human-readable usernames and contact lists but also fully-decentralized digital identities, could make 2021 an interesting year for the crypto payments space. It remains to be seen whether the combination of instant payments with protocol-level ease of use will be enough to catch the attention of an industry with a notoriously short attention span.
The new U.S. regulations regarding non-custodial wallets may push more cryptocurrency users to skip the exchanges altogether and use their coins to directly buy and sell goods and services. Will this be enough to push Bitcoin to reclaim its peer-to-peer digital cash purpose by finally getting scaling solutions, such as the Lightning Network, developed enough so that they’re easily usable by the average person? Or will one of its children choose this time to shine, taking over the payments space while Bitcoin holds down the investment use case?
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.