Crypto debates on Infrastructure Bill matter beyond the US – and matter to DeFi

US lawmakers received more than 35,000 calls over the past few days (CNBC) over a single word in the Infrastructure Bill: broker.

The debate matters beyond the US: it shows the level of confusion created when we copy-paste familiar concepts from traditional finance to the context of crypto-assets and blockchain, which many lawmakers are still unfamiliar with.

We know what ‘broker’ means for traditional activities, but who is a broker in the world of blockchain and crypto-assets? And, even more challenging, are there any brokers in Decentralized Finance (DeFi)?

The ‘broker’ negotiations were really about DeFi, argued Wharton’s Kevin Werbach. He tweeted that ‘the debate over the infrastructure bill is not about regulating proof of work vs. proof of stake. Nor is it about banning crypto As I said earlier in the week, it’s about DeFi.’

A proposed amendment attempted to exclude much of DeFi from the Bill’s scope, and therefore from the Bill’s tax reporting obligations. The amendment’s proposers wanted to exclude from the definition of ‘broker’ anyone:

‘developing digital assets or their corresponding protocols for use by other persons, provided that such other persons are not customers of the person developing such assets or protocols.’

This language did not make the cut on the Senate floor, but crypto advocates are now turning their attention to the House of Representatives, where the Bill will be debated next if the document in its entirety is passed by the Senate today.

Crypto advocates came out in large numbers to have the initial language on ‘broker’ changed. This was the first coordinated crypto lobbying effort of this scale in the US. Although the effort ultimately did not produce the language sought by the crypto advocates, it certainly achieved a lot. Out of the 2,700 pages of text, the small crypto provision in the Bill continued to make headlines over the past days. Even the Treasury and White House got involved on the crypto-amendments tabled.

Lawmakers unaware of the distinction between proof-of-work and proof-of-stake (or the existence of so many other consensus mechanisms), probably have a better clue by now. Chances are higher they now know more about what validators do and why it is a bad idea to make stakers, software developers or miners subject to tax reporting requirements for transactions taking place on-chain.

Let’s have a look at the initial language (which ultimately passed) and the proposed amendments (all rejected by the Senate).

The initial definition of broker, subject to tax reporting requirements, was ultimately retained:

‘any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person’.

This broad definition could subject validators, miners, stakers and others to obligations to collect information on the crypto-transfers they somehow ‘effectuate’ through their ‘services’ and report that information to the US tax authority.

Anyone who is slightly familiar with public blockchains, mining in PoW and staking in PoS, or DeFi, knows that it is nearly impossible to collect that information for a number of persons involved that could technically fall under this definition of broker. Requiring a miner on the Bitcoin blockchain to report on transfers in crypto-assets taking place on-chain is like asking your internet provider to report on your online banking transfers. A miner safeguards the blockchain infrastructure but has no business in vetting the content of your transfer. Likewise, in DeFi, decentralized pools as they exist right now do not ‘see’ your crypto transfers. Developers of non-custodial wallets would have no clue about the crypto-transfers you make from your self-hosted wallet.

The question is whether lawmakers accept that. Or whether they will impose reporting obligations regardless of the current capability of miners, validators, developers, etc. to collect the tax info. If US law would require that, the fear is many developers, miners, validators, etc. would simply leave the US and move to more crypto-friendly jurisdictions. We’ve seen the mass migration of crypto miners out of China after a crackdown there, with some miners moving to US states such as Texas instead.

To avoid this scenario, three senators proposed an amendment to narrow the definition of broker. The Wyden-Lummis-Toomey amendment proposed to exclude from the ‘broker’ definition anyone:

  • (A) validating distributed ledger transactions,
  • (B) selling hardware or software for which the sole function is to permit a person to control private keys which are used for accessing digital assets on a distributed ledger, or
  • (C) developing digital assets or their corresponding protocols for use by other persons, provided that such other persons are not customers of the person developing such assets or protocols.

Sen. Portman, who had been involved in drafting the initial language, tweeted: ‘I agree with Senators Wyden, Toomey, Lummis that we can do more to clarify the intent of the cryptocurrency provision & the Senate should vote on their amendment.’

Sigh of relief for crypto advocates, but the relief did not last long. Shortly after, Sen. Portman, together with other senators, proposed a competing amendment. The Portman-Warner-Sinema amendment wanted to exclude from the definition of ‘broker’ anyone:

  • (A) validating distributed ledger transactions through proof of work (mining), or
  • (B) selling hardware or software the sole function of which is to permit persons to control a private key (used for accessing digital assets on a distributed ledger).

That meant the DeFi exclusion in the Wyden-Lummis-Toomey language (point C above) was deleted. Moreover, the validator exclusion in (A) was limited to proof-of-work blockchains, disregarding blockchains using other consensus mechanisms such as proof-of-stake. As a result, miners on the Bitcoin and Ethereum blockchain would have been excluded from the Bill’s tax reporting obligations, but validators on proof-of-stake blockchains (which are less energy intensive) would not. Developers and others could still be considered ‘brokers’ under this definition, and would therefore be subject to its tax reporting duties.

Meanwhile, the Treasury was pushing for the Warner-Portman-Sinema amendment, the Washington Post[1] reported. The White House also voiced support for the Warner-Portman-Sinema version.[2]

A little later, the Warner-Portman amendment was itself amended, as the realization must have kicked in that the limitation to PoW did not make much sense. PoS was added to the proposed exclusion:

  • (A) validating distributed ledger transactions through proof of work (mining), or proof of stake (staking), without providing other functions or services, or
  • (B) selling hardware or software the sole function of which is to permit persons to control a private key (used for accessing digital assets on a distributed ledger).

Then the amendment was reportedly amended again, to cover all validators (regardless of the consensus mechanism, whether PoW, PoS or something else):

  • (A) validating distributed ledger transactions through proof of work (mining), or proof of stake (staking), without providing other functions or services, or
  • (B) selling hardware or software the sole function of which is to permit persons to control a private key (used for accessing digital assets on a distributed ledger).

Someone must have explained that there are many different consensus mechanisms, not just the PoW that made headlines for its energy footprint, or PoS.

Neither one of the two amendments prevailed over the weekend, when the original language was sent to the Senate floor for a vote.

The only hope for crypto advocates was to have Unanimous Consent (UC) among senators to change the original language, before the Bill would go off to the House of Representatives (assuming the Bill in its entirety passes in the Senate today).

Sunday night’s negotiations did not force a breakthrough. On Monday, however, crypto advocates saw a glimmer of hope.

The drafters of the competing amendments came to a compromise. Senators Toomey (R-Pa.), Lummis (R-Wyo.), Portman (R-Ohio) and Sinema (D-Ariz.) (and, according to some sources, also Sen. Warren) agreed on new language, which Treasury head Janet Yellen supported (CNBC).

It narrowed the definition of broker. Instead of covering anyone who, for consideration is ‘responsible for regularly providing any service effectuating’ crypto-transfers on behalf of someone else, the definition was limited to:

‘any person who (for consideration) regularly effectuates transfers of digital assets on behalf of another person.’

The new bipartisan amendment would also have kept the exemptions for validators and wallet developers, excluding from ‘broker’ anyone:

  • (A) validating distributed ledger transactions without providing other functions or services,
  • (B) selling hardware or software for which the sole function is to permit persons to control private keys which are used for accessing digital assets on a distributed ledger).

To pass, the new language needed the unanimous support of all senators. One senator (Sen. Shelby, R-Al) objected, which meant the last-minute efforts to amend the provision were in vain and the original language was retained. If passed, the Infrastructure Bill will impose tax reporting requirements on

‘any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person’.

No (explicit) exemptions for miners, validators, developers, and so on. If the Infrastructure Bill passes, in its entirety, in the Senate today, it will go to the House, where negotiations will continue in the Fall.

Rep. Tom Emmer already sent around a letter to all House Representatives imploring them to exclude non-custodial blockchain technology providers from the tax reporting requirements. These persons ‘do not broker transactions and have no way to comply with such requirements’, he argued, and the current language will ‘further regulate innovation out of the United States’.

What can explain the reticence to alter the broker definition?

One explanation is a lack of familiarity with blockchain and crypto-assets by many lawmakers. It is a fast-moving industry and even those working in it full-time sometimes struggle to keep up. While it may seem obvious that there are different consensus mechanisms beyond PoW to the insiders, and that non-custodial wallet providers or validators cannot be expected to collect information on the content of transactions, this isn’t necessarily clear to the uninitiated.

Moreover, the frequent headlines about Bitcoin’s energy consumption or reports about the reliance on crypto in ransomware all contributed to a sense of hostility from many lawmakers towards the crypto industry.

Another explanation has been offered: the Infrastructure Bill needs to be financed in one way or another and the crypto provision was inserted to help plug the funding gap. The crypto obligation is expected to raise US$28 billion in the next ten years, based on the original language (although it’s not clear how this estimate was calculated – calculations of this type are not normally shared with the public). If that original language is amended, the $28bn estimate may need to be revised downwards. That opens the door to renewed attacks on the financial impact of the Bill in its entirety – something that its proposers probably want to avoid desperately.

The crypto provision is only one part of the 2,700 page Bill. Discussions on the ‘broker’ concept and its impact on the crypto industry cannot be detached from discussions on the Bill in its entirety.

Why does this discussion in the US Senate matter to anyone outside of the US?

It matters because it shows the difficulty of relying on traditional financial concepts to deal with digital assets in general, and DeFi in particular. We know what we mean by ‘broker’ in the traditional financial context, but who is a broker in DeFi? What’s the nature of the beast of a miner, developer of open source software or a decentralised exchange? And even if these persons are sufficiently different from traditional brokers, will lawmakers be willing to let them off the hook for reporting and tax requirements?

Government budgets are under pressure and the hostility towards the crypto community is high among a sizeable number of lawmakers and regulators. Part of that hostility is attributable to a lack of familiarity and concerns over money laundering and environmental impact blown out of proportion in some news reporting. However, simply ‘educating’ public officials about blockchain and crypto may not be sufficient to alter the mood.

The bigger question is whether governments are willing to accept decentralized financial services that are not as easy to tax, monitor and subject to disclosure requirements as their centralized counterparts. If governments are not willing to accept that new world, no amount of explaining the blockchain basics may change that.

[1]  https://www.washingtonpost.com/politics/2021/08/06/crypto-bitcoin-infrastructure-senate/

[2] CNBC: https://www.cnbc.com/2021/08/06/white-house-backs-senators-pushing-for-stricter-crypto-reporting-rules.html

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