Privacy Concerns are Not an Existential Threat to Bitcoin

By John Banks

On Nov. 24 we asked, “When will Bitcoin have a meaningful correction?”

The very next day, a concerning piece of news triggered a correction-worthy sell-off into the Thanksgiving holiday (crypto markets never close).

But the Bitcoin correction then self-corrected, almost wholly reversing over the weekend that followed.

At the worst point of the correction — or perhaps call it a crypto flash-crash — Bitcoin in U.S. dollar terms (BTC/USD) was down close to 16% from its pre-Thanksgiving high.

But as of this writing on Monday, Nov. 30, BTC/USD has blasted its way to new all-time highs above $20,000.  

So, a meaningful correction? Hmm. An extremely quick one if so. Blink and you missed it.

As a point of note, Bitcoin is up more than 160% year-to-date and up close to five-fold from the March meltdown lows. It is also up more than 40% for the month of November alone. 

With upside performance like that, you are going to see some volatile downswings on occasion. They come with the territory.

Part of what happens is that, when a bull-market trend gets heavily extended, buyers will step back if they sense a flurry of sell orders hitting the market.

This can create a kind of air pocket where the price drops suddenly. The market may then find support where buy orders below the market are clustered.

If demand is still strong, volatile corrections tend to resolve quickly once buyers determine the selling pressure has eased. Their mood of patience can then flip back to urgency as the price starts to rise again. 

The drop also occurred mainly over the Thanksgiving holiday, which makes perfect sense. Though Bitcoin is a 24-hour market, there will be reduced trading volume, and thinner markets, when North American trading desks are closed.

Bitcoin had run so far, so fast, it would not have been surprising to see a correction with no news at all.

But there was in fact news this time, and it had the crypto community worried.

Brian Armstrong is the CEO of Coinbase, the most valuable North American crypto exchange (and a likely candidate to go public in the next six months). On Nov. 25, Armstrong Tweeted the following: 

Last week we heard rumors that the U.S. Treasury and Secretary Mnuchin were planning to rush out some new regulation regarding self-hosted crypto wallets before the end of his term. I’m concerned that this would have unintended side effects, and wanted to share those concerns…

You can read the Armstrong Tweet thread in its entirety here.

The gist is that the U.S. Treasury might try to force “Know Your Customer” (KYC) type identity disclosure rules on the users of individual crypto wallets. In the United States, KYC rules are largely in place for crypto exchanges, but not for self-hosted wallets or the user who holds their own keys.

Armstrong is right that forced disclosure rules for self-hosted crypto wallets would have a negative impact on the crypto space. They would create headaches for many crypto assets, and would act like a bottleneck for rapid crypto adoption. 

But some members of the crypto community feared that a regulatory violation of wallet privacy would pose an “existential threat” to Bitcoin, and that is not at all true. We can break this out into parts:

  • The U.S. government will not be able to regulate self-hosted wallets easily. If they try, they will receive significant political pushback and could lose in court.
  • While forced identity disclosure of self-hosted wallets would be problematic in many ways, it would not threaten Bitcoin — though it could well threaten other crypto assets.
  • Bitcoin’s dominant use case is not privacy-based. While privacy is a helpful feature, Bitcoin could fulfill its mission and mandate even with no regulatory privacy at all.

To the first point, it is easy to forget that property rights are alive and well in the halls of the U.S. Congress. There are plenty of legislators who see the defense of property rights as an important aspect of government, and who will require extraordinary proof before signing off on privacy violations.

This does not mean self-hosted wallets will automatically be protected from privacy intrusions or forced identity disclosures. But it does mean that the U.S. government would have to go through a process of explaining itself before pushing intrusive rules through the system, in a manner consistent with other property and privacy norms.

For example, does the government have a right to know how many rare baseball cards you own or how many collectible cars? Can the government place onerous disclosure requirements on any type of asset, for any reason, in the vague name of financial transparency? Not necessarily — and not without a court fight that private-property advocates could win.

With that said, even if the U.S. Treasury pushes through identity disclosure rules for self-hosted wallets, this would not threaten Bitcoin in terms of its core use case. To understand why this is true, consider that the largest potential buyers of Bitcoin have no use for anonymity in the first place.

To the extent that Bitcoin becomes a store of value for corporations, pension funds, family offices, investors, and even central banks, anonymity does not make a difference at all.

Entities with the capacity to purchase Bitcoin in large amounts typically already have to disclose what they own, if not to the public then on some type of regulatory form, which means the whole self-hosted wallet question is moot.

This is true even for wealthy individual investors, who have a hundred different ways to shield their identity or create a veil of anonymity while still obeying legal disclosure rules. Think of the real estate property which is owned by an LLC, which is in turn owned by another LLC, which is managed by an offshore trust.

The bottom line is that there are so many ways to maintain the privacy veil, while still jumping through requisite legal hoops, that the buyers of Bitcoin with the capacity to hold large amounts will not be deterred. They were used to the legal disclosure cat-and-mouse game anyway. 

To be clear, it would not be a good thing if the U.S. government pushes through identity disclosure rules that impact self-hosted wallets. It would be a setback for the crypto asset space, and for private-property rights in general. And certain growing areas of the crypto industry, like the “Defi” decentralized finance movement, would likely be hurt.

But Bitcoin itself would be fine, because Bitcoin is not about privacy. It is about serving as a global consensus store of value, which gives the holder of Bitcoin the ability to opt out of a fiat-based system.

Think of Bitcoin as a sort of opt-out mechanism for monetary and fiscal policy.

If you don’t like how the U.S. government is handling its currency and debt mix — and you don’t like how Europe, Japan, or China are handling theirs, either — you can buy Bitcoin as a store of value instead.

Or, to put it another way, think of Bitcoin as a way to vote against central-bank management and to vote in favor of a global consensus algorithm instead.

If hundreds of millions of people and business entities, all around the world, mutually agree to store their savings in a digital asset of fixed quantity, with ease of access through an intermediary payments layer, then all who participate in that consensus can move a portion of their savings out of the fiat realm. That is the big idea here, and privacy has nothing to do with it. We are not belittling the value of privacy, or claiming that privacy as a feature has no importance. Instead we are pointing out that privacy is not a central feature of Bitcoin’s enduring appeal. The store-of-value dimension is.

Note, too, that the ability to invest in publicly traded company shares is highly useful, and valuable, even though no self-hosted wallet is available for, say, owning a stake in Google, Apple, or Netflix.

One could say that KYC rules are in place for all forms of corporate-share ownership, to the extent one can only own shares through a brokerage (which presumably keeps KYC data on file).

Is this ideal? Perhaps not. Is it an impediment to doing business? Not really, because the mountains of capital invested in publicly traded shares do not turn on a libertarian notion of privacy in the first place.

We do readily admit that the hidden goings-on of regulators have made us wary of large sections of the crypto space. More than two years ago, for example, we laid out our view to TradeSmith Decoder readers that so-called “privacy coins” — crypto assets specifically built to evade regulatory authority — were bugs looking for a windshield.

But again, that is not what Bitcoin is or does. Bitcoin is a non-replicable global consensus store of value network — a kind of “digital gold” with a higher level of user functionality than gold itself.

This is why, with each passing week, if not each passing day, you hear more and more bullish drum beats in the news, like this story from Nov. 28: The Guggenheim Funds Trust, which has $233 billion in assets under management, recently filed an amendment with the U.S. Securities and Exchange Commission (SEC) to invest up to 10% of the net asset value of its roughly $5 billion Macro Opportunities Fund in the Grayscale Bitcoin Trust (GBTC). Translation: Another half a billion that could be flowing into Bitcoin. This kind of thing is becoming old hat,  you see, because the biggest, smartest, most financially savvy institutional players in the world have done their due diligence on Bitcoin — and they get it.