Regulation could reshape crypto exchanges within two years

The co-founder of the crypto investment firm BlockTower Capital has predicted big changes to the way exchanges work are imminent—suggesting that most trading platforms will only allow withdrawals to whitelisted addresses within the next couple of years.

In a Twitter thread, Ari Paul said he believes a separate ecosystem for “clean” coins will soon emerge where digital assets can be traced to a regulated institution. This could pave the way for a murky underworld where laundering ill-gotten crypto becomes big business.

Paul argued that some of the world’s biggest crypto exchanges are already clamoring to catch up with tougher financial regulations that are designed to prevent the likes of Bitcoin from being used to fund drug trafficking and terrorist activity. The big question now, he said, is when governing bodies will begin flexing their muscles and move to enforcement.

He explained that this enforcement may be exceedingly light touch, as seen with initial coin offerings as they peaked in 2017 and 2018. This could end up meaning that plenty of people can easily launder cryptocurrencies in bulk—moving them from centralized to decentralized exchanges (and vice versa) with little scrutiny.

“Or maybe enforcement will be strict… I don’t know,” the CIO wrote on Aug. 26.

“I don’t have a great idea of how this plays out beyond the obvious,” he added. “I think you will get a real ecosystem of whitelisted coins as well as a robust gray market with small conduits between them.”

All of this means that there will be a concerted push to get “dirty” coins into circulation on exchanges so they can be withdrawn to whitelisted addresses.

He stressed that none of this is guaranteed—but said his predictions are based on “legitimate fear” given what regulator guidance currently states.

Crypto Twitter speaks

Paul’s vision of what the future will look like was met with an array of interesting responses. One of those came from Justin Newton, the founder of the digital identity company Netki. He wrote: “If this happens, we have failed as an ecosystem.”

The BlockTower Capital executive replied to Newton by saying that cryptocurrencies have always been antithetical to government control—and the existence of a gray market could be chalked up to a win.

Alex Gladstein, chief strategy officer for the Human Rights Foundation, believes the future may not be as clear cut as regulators hope. He wrote: “Within a year or two, it will be very hard to reliably tell the difference between a normal Bitcoin transaction and one that could be something much more complicated. Withdraw coins from ‘whitelist’ exchange, move once. Tx looks healthy. But is it? Won’t be able to know.”

The founder of Chain Haven, Christopher Chase, said Paul’s prediction risks completely fracturing the crypto industry: “This is very negative IMO.”

Paul replied to Chase by saying that, although it is negative, it’s also a symptom of success. “Regulators only care about crypto as it grows,” he wrote. “Regulators had barely heard of DeFi before this year.”

Everything may not be lost

Not everyone agrees with Ari Paul’s prognosis, and one of them is Coin Center’s director of research Peter Van Valkenburgh, who said that these dire predictions are unlikely to bear fruit in the near future.

This is because of the so-called “travel rule,” which has been introduced by the Financial Action Task Force (FATF.) Introduced in June 2019, the travel rule requires exchanges, digital wallet providers and some banks to store and share data belonging to the customers making a transaction.

According to Van Valkenburg, the travel rule only applies when a transaction is taking place between two exchanges. It isn’t relevant for self-hosted wallets. To give a clearer example, he wrote:

“Think of a traditional bank. Banks let people perform transactions between themselves and customers at other banks, and they let people withdraw cash that the customer keeps on her person (and can easily then use to pay others directly) (a self hosted wallet).”

Paul replied by saying that physical cash’s continued existence is not guaranteed—with many countries actively considering an outright ban because of how it enables consumers to evade Anti-Money Laundering and Know Your Customer measures entirely.

Those concerns were behind the FATF’s recent call for a clampdown on “so-called stablecoins” in July.

Ultimately, the interesting debate shows that digital assets still have a long way to go before regulatory clarity is achieved—and, if and when that happens, things might get messy.