DeFi's Big Use Case: D(on't)KYC
When I got my start in trading in the 1990s, if I had asked a colleague about "KYC" they would likely have assumed I misspoke and was proposing we get fried chicken for lunch.
Because KFC was a thing and KYC was not.
Hard as it may be to believe in this age of all-powerful compliance departments, my clearing bank never asked who my trades were for. There was no account opening process. No documents needed faxing and no personal information needed collecting.
My clearing bank would only ask where they should be sending the stock or money.
I could buy and sell for whomever I wanted.
I was reminded of those carefree days by this Twitter post, which corroborates my personal experience that compliance departments have not always been the world's financial gatekeepers.
Which raises an obvious question: Should they be?
The Twitter poster thinks they should not, arguing that overbearing KYC rules are "sacrificing jobs, innovation and opportunities by chasing an extremely ineffective and indirect compliance regime."
I think I agree: Turning the financial system into an arm of law enforcement always seemed like a questionable idea.
And things seemed to work just fine in the pre-KYC 1990s.
But I'm a sucker for contrarian takes, so there's a high probability I'm agreeing just because I can't help myself.
Fortunately, that take is seconded by a much less impressionable thinker: Tyler Cohen agrees, too.
Cohen contends that AML/KYC laws are "hugely expensive and largely ineffective at their stated purpose."
Those laws cost about $300 billion a year to implement, he notes, and recover perhaps $3 billion a year in illicit funds ("a tiny, tiny fraction of the amount of illicit revenues").
Cohen cites a study from the law professor Ronald Pol that declares AML laws to be "the world's least effective policy experiment":
"Anti-money laundering policy intervention has less than 0.1 percent impact on criminal finances, compliance costs exceed recovered criminal funds more than a hundred times over, and banks, taxpayers and ordinary citizens are penalized more than criminal enterprises."
Yikes.
Worse still, AML/KYC laws may even increase crime: Requiring banks and companies to collect so much of their customers' personal information creates a honeypot of data that can't help but attract criminal hackers.
And, worst of all, these laws are "injurious to innovation," according to Cohen.
The purpose of finance is to connect buyers with sellers and savers with investors: Adding friction to that process makes finance less effective, and less-effective finance means slower growth, less innovation, and fewer jobs.
It's hard to quantify that: I can't say for sure that KYC-less finance was more effective in the 1990s.
But it was definitely more fun.
Back to the future?
In the conclusion of his study, Ronald Pol encourages policy makers to rethink and redesign AML laws.
Cohen thinks they should be scrapped.
Neither outcome seems likely to me: The US government only seems to get more enthusiastic about turning finance into an arm of law enforcement, and few people outside of crypto seem to mind.
But it may be that the more restrictive centralized finance becomes, the more evident the merits of decentralized finance will be.
That would be a welcome development. DeFi is in need of new use cases and perhaps this is one: A financial system where you don't know your customer — call it DKYC.
If you think DKYC is a contrarian bridge too far, I hear you: The cost of compliance has to be weighed against a counterfactual of all the crimes that didn't occur because bad actors were denied access to the financial system.
And in DeFi, we have the factual costs of things like rogue states accelerating their missile programs with looted crypto.
I don't know how to measure those costs against the impossible-to-quantify benefits of a frictionless financial system.
Anecdotally, it seems like DeFi has so far attracted quite a few of the bad actors who have been denied access to TradFi — and it's maybe not generated enough tangible innovation to offset that.
So, should we be seeking a common-sense middle ground?
If so, DeFi could be the answer there, too: Vitalik has noted that, with zero-knowledge-proof technology, DeFi should soon offer "lots of new opportunities to satisfy [regulatory] policy goals and preserve privacy at the same time."
That doesn't sound quite as fun as a return to the anything-goes 1990s.
But it might be a big improvement on the state of finance in the 2020s.
No comments:
Post a Comment