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“Privacy comes at a cost.”

— Justice John Roberts

The cost/benefit analysis of privacy: E2EE vs stablecoins

This weekend’s arrest of Telegram founder Pavel Durov has made me wonder something. 

If Durov can be arrested because Telegram has failed to sufficiently cooperate with law enforcement, why is it legal for Signal, WhatsApp and iMessage to be designed so that it’s impossible for them to cooperate with law enforcement?

Unlike its biggest competitors, Telegram does not default to end-to-end encrypted messaging (E2EE) — you have to opt-in, which hardly anyone does — so it has access to a mountain of messages that law enforcement occasionally asks to look at.

Because they default to E2EE, WhatsApp and others don’t have access to their users' messages, so law enforcement doesn’t bother asking to see them. 

End-to-end encryption provides full privacy for users of messaging apps and full immunity for the companies that offer them.

In one sense then, Pavel Durov has been arrested because his messaging app offers less privacy than its competitors.

But if law enforcement wants to see our messages, as they clearly do, why is E2EE allowed by governments at all? 

In the US, you might think it’s because of a principled stand on freedom of speech — but, as discussed yesterday, the US’ commitment to the First Amendment is half-hearted at best. 

In Europe, you might think legislators just haven’t gotten around to banning it yet — but the EU has been threatening to ban E2EE for years and nothing has come of it (so far — it’s still trying). 

The longer lawmakers wait, the harder it might get, because encryption is useful and increasingly popular.

Encrypted data reduces the risk that your data will be leaked in a hack; a growing minority of even law-abiding people don’t want tech companies seeing their data; and stories are abound of journalists, activists and dissidents using encrypted apps to communicate safely.

In short, E2EE remains legal in most places because it's useful enough, popular enough and ubiquitous enough to give lawmakers pause before accommodating law enforcement requests to ban it.

There are lessons in this beyond messaging. To remain legal, stablecoins may need to become at least as useful and popular as encryption.

Digital cash

Much as WhatsApp is unaware of what its users are messaging each other, stablecoin issuers are unaware of who most of their users even are.

Only the identity of the large accounts that create and redeem stablecoins are known to the issuers — most of the people using them in payments and DeFi remain anonymous.

This gives stablecoins the same privacy as physical cash, which, to pro-privacy types like myself, is one of their most redeeming features.

To many others, however, it’s an unredeemable flaw. 

In a recent blog post, JP Koning makes the case for why stablecoins, like bank deposits, should be KYC’d.

Among other fair points, Koning invokes the principle of “technological neutrality,” which asserts financial products should be regulated according to their function, not their underlying technology: “Same function, same regulations.”

Stablecoins have the same function as bank deposits, so by Koning’s logic, they should be subject to the same KYC regulations — which is to say, issuers should know the identity of every holder of their stablecoin in the same way that banks know the identity of every holder of their bank deposits. 

To do so, stablecoin issuers would have to replace their current practice of blacklisting addresses suspected of holding illicit funds with a practice of whitelisting (ie, pre-approving) addresses before they are able to hold any funds.

This would most likely make stablecoins (and much of DeFi) unusable.

If you think stablecoins and the decentralized financial system that depend on them are useless, that would be no great loss.

But if (like me) you think stablecoins expand financial inclusion, modernize payments and enable new financial primitives, you might think those benefits will outweigh the cost of the financial privacy they provide.   

You might also think that financial privacy is not a cost, but a benefit to the world.

Lots of people do.

The most recent policy platform of the Republican Party, for example, includes the statement that “every American has the right to…transact free from Government Surveillance and Control.”

If so, stablecoins do us a service by extending cash-like privacy to bank-like savings accounts.

I don’t know if that will be enough of a benefit to keep governments from imposing bank-like KYC requirements on stablecoins, as Switzerland recently did.

Stablecoins are estimated to have 27.5 million monthly active users vs nearly three billion for just WhatsApp.

Big Tech has successfully preserved its users’ messaging privacy by arguing that the societal benefits of end-to-end encryption outweigh the costs identified by law enforcement.

Will stablecoins be able to do the same for their users’ financial privacy?

It may be a race to get similarly popular before governments decide they’re not popular enough.

— Byron Gilliam

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