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Crypto will be held to a higher standard

If a burglar uses a ladder to climb in the second floor window of your home, you could try suing whoever made the ladder for enabling the crime, or suing Home Depot for selling the ladder to the burglar, but I don’t think you’ll have much luck.

The ladder-maker’s lawyers would likely mount an “abnormal use” defense: Ladders are intended for cleaning windows, not breaking into them.

(They’d argue the same if the burglar sued for damages after falling off a defective ladder during the attempted break-in — defective or not, that’s not its intended use!)

Home Depot’s lawyers would likely make a “foreseeability” argument: There was no way for the store’s salesperson to know they were selling a ladder to someone intending to use it for a home invitation instead of a home renovation.

And both defense teams might argue that ladders pass the “risk-utility test”: Ladders are useful to society — and there’s no way to design them so that they can be used to clean windows but not be used to break into them.

I’m not a lawyer (although I sometimes play one in this newsletter), but I have enough faith in the US legal system for these common-sense arguments to prevail in court.

It’s not a given, though.

The closest real-life precedent I could find is Sony Corp. of America v. Universal City Studios, Inc. (aka, the "Betamax case") from 1976, in which Universal sued Sony for copyright infringement because people were using their new Betamaxes to record movies and television shows (which you weren’t supposed to do at the time).

A district court initially ruled in favor of the defendant (Sony), but was subsequently overruled by the Ninth Circuit Court, which held Sony liable for copyright infringement — but Sony appealed to the Supreme Court and won a reversal in a 5-4 decision.

Home recording devices were found to have enough non-infringing use cases that their manufacturers should not be held liable for any copyright infringements they may have enabled.

But the flip-flopping rulings and slim majority at the Supreme Court show that it’s hardly an open-and-shut case — so much so that testimony from the beloved Mr. Rogers in support of Sony may have been the difference-maker. 

The implications for manufacturers generally are therefore limited, but there’s one undeniable takeaway: If you need to convince five old people that your new fangled-technology has legitimate use cases, it helps to have Mr. Rogers vouch for you.

Now let’s do crypto mixers.

Don’t expect reasonable

Seemingly without exception, people in crypto find it exasperating that the developers of Tornado Cash could be found liable for money laundering.

It’s understandable why: If Sony can’t be held liable for what people do with their Betamaxes, how can crypto developers be held liable for what people do with the code they write?

Ladder manufacturers aren’t liable for break-ins, automakers aren’t liable for reckless driving, Microsoft isn’t liable for, well, anything…even gun makers can’t be held liable for the bad, but very predictable things some people do with guns.

Unfortunately, I don’t think ladders, cars, Windows or guns are the applicable comp here.

Instead, I think it’s financial products. 

Blockchains are effectively financial systems and cryptocurrency is effectively, well, currency — so it seems commonsensical that they would be treated as such by US courts.

If so, I’d expect them to receive far more scrutiny than makers of non-financial products and services.

As best I can tell, there’s no one legal principle or case law precedent to support that expectation — there’s just a mountain of historical evidence that 1) financial products will always be more heavily regulated than non-financial products and 2) offering financial services entails more legal liability than offering non-financial services.

For example: When I worked at banks and brokers, I was constantly taking tests to demonstrate my understanding of the legal and illegal uses of financial products (most of which I had nothing to do with) — but no construction worker is ever tested on how to legally use a ladder.

(I still take about 30 tests a year to keep my various FINRA licenses active, just in case this newsletter lark doesn’t last forever.)

It’s even worse for my former employers.

US financial firms have as many as 15 federal agencies scrutinizing them — three of which are replicated 52 times at the state level. 

I don’t know how many agencies regulate the market for ladders, but I’m sure it’s less than 60. 

Is there any reason to think crypto finance will be exempt from the above spider web of financial regulators?

Don’t get me wrong, I think crypto should be exempt — there are no laws in the books that give any of these regulators jurisdiction over the peer-to-peer transactions that happen in decentralized finance.

I’m just skeptical that the industry’s very reasonable explanations will win them that exemption.

If, for example, we apply the logic from my ladder analogy to crypto mixers, I think we get a very different result. 

Abnormal use? Mixers are explicitly designed to obscure the origins of money (which will sound indistinguishable from money laundering to the average judge and jury).

Foreseeability? No one could argue with a straight face that Tornado Cash being used for money laundering was unforeseeable. 

The risk-utility test? Good luck convincing a jury of 12 normal people that crypto’s current utility significantly outweighs the risk of laundering money for North Korea.

And if that’s not enough of a mountain to climb, Tornado Cash, unlike Sony, won’t have Mr. Rogers vouching for them.

None of this is legal advice, of course.

But I suspect that Mr. Rogers’ warning will apply here: Explanations, no matter how reasonable, won’t always help.

So here’s some life advice for crypto people from an ex-finance person: Expect to be held to a higher standard.

— Byron Gilliam

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