The Most Important Debate in Crypto

Dear Bankless Nation,

Bankless hosted a livestream debate between FTX founder Sam Bankman-Fried (SBF) and ShapeShift founder Erik Voorhees this past Friday.

If you’ve not seen it yet, you’re missing out! 👈📺

The debate saw a fiery clash between two crypto giants on perhaps the most important topic hanging over the heads of everyone in crypto: How should crypto be regulated?

Both SBF and Erik fundamentally agree on what decentralized finance should be.

The whole point of DeFi is a financial system where anyone regardless of their social status can permissionlessly access and store their wealth. Towards that end, the protocol layer must be kept free from regulatory hawks.

That means no asking for permission to deploy smart contracts.

Alexey Pertsev, the Tornado Cash developer who still sits in Dutch jail, should be freed immediately.

That means blockchain validators should be free to perform consensus on Layer-1. Individuals and crypto companies working at the validator level as block builders, proposers and running relayers should be left free.

Everything at the protocol layer must be permissionless.

Both are also in agreement that centralized exchanges and intermediaries should be subject to regulation.

Knowledge-based tests (do this quiz on blockchains 101 before you buy), rather than wealth-based requirements (only those with a net worth of $1M+ can buy ETH), is one harmless way by which centralized intermediaries could be regulated.

But that’s where the agreements end.

SBF believes the industry should comply with OFAC sanction lists.

To do so, crypto companies and projects should proactively maintain “blocklists” of wallet addresses committing illicit activity, and ensure these wallets do not interact with their platforms.

Because OFAC sanctions have traditionally targeted groups i.e., North Koreans, Iranians etc, rather than individuals, this imposes negative externalities on too many innocents.

As Erik points out eloquently in his blog (and in the debate):

But the OFAC list includes entire countries. It includes the entire nation of Iran, with 83 million people. It is illegal for any American to do business with any Iranian.  You know those insanely brave Iranian women standing up against oppression in Iran right now? Those women espousing the greatest American virtue of individual liberty and doing so while literally facing torture and death?  If you’re an American, it is illegal for you to interact economically with those women, because of OFAC. This is not just absurd from an enforcement perspective, but is plainly unethical.

SBF is also willing to accept regulatory licensing of DeFi’s frontend:

… the following activities would potentially require some license/registration/etc. 1) An American hosting a website on e.g. AWS that actively provides a front-end that encourages and facilitates US retail users to trade on decentralized protocols. 2) Actively marketing DeFi products to US retail investors

What might that look like in practice?

DeFi protocols would need to apply for a crypto license with a “Department of Crypto Consumer Protection”.

This license would be presumably granted contingent on a laundry list of requirements like “maintain a U.S. domicile for your headquarters” or “maintain a capital reserve ratio of minimally 20%” and “no wallet addresses linked to crime should be interacting with your platform”.

Violate any of these, and your license is revoked.

Want to fork Compound?

The code is all there on Github, but first fill up this 30 page application form to be submitted to the Department of Crypto Consumer Protection.

That would be an absolute disaster. All DAOs would be hamstrung, pending the acceptance of the license. Needless to say, DeFi as it exists today would look completely different.

It would mirror TradFi in creating a world of finance between the privileged haves and unprivileged have-nots.

To be clear, this would still allow some form of DeFi innovation.

Developers can still deploy all kinds of exciting dapps on public blockchains. But by virtue of a licensing regime, many retail users (particularly the poor or the sanctioned) would be blocked from accessing them.

Why would SBF advocate such a rule then?

Is it not an egregious violation of DeFi’s most fundamental principles?

A Tale of Two Futures

And finally we arrive at the key contention of the debate.

SBF sees this as an acceptable compromise with regulators if the protocol layer is kept free to innovate, while Erik believes that to be too big of a political compromise.

Note that this isn’t a debate about what DeFi would ideally look like.

It’s a debate over “What’s the best deal we can strike with regulators without crippling Web3?”

What would regulators accept? What is the range of acceptable opinion on crypto regulation? Where does the crypto Overton window sit in Washington?

The internet is roundly considering Erik to have “won” the debate. But winning a debate where most of the spectators are already DeFi-converts isn't quite the same as winning over regulators and a world of crypto-skeptics who vastly outnumber us and who quite frankly, are hostile to crypto and are OK with having it banned.

SBF’s regulatory proposal, as absurd as it may be to DeFi-natives, may very well be the best deal the industry will get if the other options on the policymaking table was to regulate builders at the protocol layer, or even ban them.

The problem is that it’s extremely difficult to tell what the “best deal” is as an outsider.

That depends on the kinds of beliefs American policymakers hold in their head about crypto. It depends on the motivations of dozens of concentrated lobby groups in Washington who hold the power to influence the shape and form of public policy, and who have a stake in how the crypto industry affects their bottomline.

So unless you’re a policy wonk in the beltway who understands the existing state of political sentiment, how you think governments should regulate crypto amounts to a philosophical exercise at best.

And to be sure, that philosophical exercise is not without value.

That academic exercise determines the width of the Overton window. It prescribes the “goalposts” by which we evaluate regulations.

But that is not the point of the debate – both Erik and SBF are already in agreement about the goalposts.

Policymaking is the art of compromise, not about what is best or bad.

And before buying into the characterization of SBF as a crypto-villain, we should at least understand his arguments from this point of view.

You may agree that Erik is right in that regulation of DeFi frontends would cripple the Web3 experiment beyond a point of no return, but you can also believe SBF’s regulatory proposal is the best shot we have at Web3.

The two are not mutually exclusive.