Blockdaemon Blog

Navigating the World of Blockchain Compliance

Daemon News
Oct 4, 2021
By:
Shannan
Stewart
&

Blockchain regulation is inevitable. As the market leader in blockchain infrastructure, this is important to us. We are taking it seriously.Currently, the infrastructure we manage is unregulated. This can be seen as blockchain’s base-layer and is comprised of decentralized, open-source technology. The nodes we host and the validators we run are the building blocks for many companies.

Want to hear more about how Blockdaemon can help you with your Blockchain journey? Contact us today to chat more about our blockchain solutions, or read on to get a closer look at what’s new.

Today, Blockdaemon is a non-custodial entity and doesn't hold or control customers’ assets.

Blockdaemon is purely a base-layer provider, and this positions us well in today’s regulatory landscape.

The Regulatory Landscape is Slowly Changing.

The United States recently passed the bi-partisan Infrastructure Bill. This signals the start of the shift.

Regulation will have a meaningful impact on our nascent industry.  We are already preparing for what we anticipate regulators are going to be asking for and expecting from our industry.We anticipate a major component of Anti-Money Laundering/Counter-Terrorism Financing (AML/CFT) within blockchain will be to monitor the node activity, particularly as it relates to proof-of-stake. This activity occurs on top of the base-layer technology that we cater to, rather than the technology itself.

Technology is the code we run.

With this in mind, we can better anticipate the shifting sands of the future regulatory environment.

The Role of Compliance

Regulations are in place to eliminate illicit activity in an economy.

Additionally, guidance and regulations aim to cut waste, fraud, abuse and maintain financial and economic stability. The benefits are apparent with financial services of AML/CFT compliance programs and risk-based procedures such as Know-Your-Customer (KYC) and Know-Your-Customer's-Customer (KYCC). KYC standards are designed to identify and verify customers’ information such as  who and where they are, their source of funds, and the nature of their activities. If you've ever opened a bank account at a regulated financial institution, then you've been through KYC as a condition of opening the account or accepting your funds.

Gathering and analyzing this information helps identify risk and inform rogue elements.  Today, the lines between fiat and cryptocurrencies are blurred. More and more large financial institutions are looking at cryptocurrency and the supporting blockchain technology with an eye towards how they can utilize these innovations to support their customers.Financial inclusion is growing.

We expect cryptocurrency regulation to become just as rigorous in the new financial systems as it is with legacy financial institutions. Banks have to know who is depositing or allocating money the same way blockchain operators are expected to follow similar requirements for digital assets. As a leader in the industry, we are embracing an opportunity to  be ready for that possibility.

At Blockdaemon, Compliance is Critical

Of course, we will abide by regulatory frameworks where required. Our job as an industry leader, however, is to set the bar higher than the rules that are in place currently.

By reaching high, we front-run any potential changes. We set standards according to our own benchmarks. Our caliber of investors expect nothing less.

Proof-of-Stake Regulation

We anticipate that proof-of-stake services will be a focus for regulators in the near future.Recently, proof-of-stake has become extremely popular. The blockchains powered by this technology are valued in the hundreds of billions. The dawn of Ethereum 2.0 will further accelerate this popularity. Ethereum 2.0 will introduce millions of crypto users to proof-of-stake for the very first time. It will be the largest DeFi mass-adoption event ever. Blockdaemon will be at the forefront of this seismic event, as we operate over 10,000 Ethereum 2.0 validators.

Proof-of-stake will garner more regulatory attention because it is public and reward generating. Rather than passively sitting on crypto assets, by “staking” or “delegating”  coins/tokens, delegators and the node operators actively generate a return. Customers can delegate to Blockdaemon validators to generate rewards in the blockchain’s native token, and we generate rewards for operating a high-performing node on the network.

For some networks, the percentage of rewards you receive is directly proportional to the volume of tokens delegated to the validator node, Stake Proportional, and for others it is the volume of validators (or nodes known as Validator Proportional).

Proof-of-Stake Rewards Occupy a Gray Area

Staking rewards sit in a regulatory gray area. Unlike a bond dividend, staked tokens must be actively received and to reiterate, the delegator maintains full control of their staked/delegated asset - the node operator does not, at any point, control the asset.Staking tokens is a right to perform duties on-chain. These duties can be carried out by the holders themselves, or delegated to be carried out on someone's behalf.

Either way, it does not sit comfortably under the rules of any current asset class.  

Proof-of-Stake Is Unregulated… For Now

There are no defined regulations around proof-of-stake services. There is no mandate, for example, to know who someone is when they delegate to a public validator and receive rewards from their staked assets. This could raise alarm bells with authorities.  

Furthermore, not every blockchain operates the same - the naming conventions alone are many times different (staking, baking, delegating, validating, voting, escrow, etc.)  Certain chains, such as Cardano, issue rewards automatically at a protocol level. Other chains, such as Tezos, rely on the validator to distribute tokens as rewards. All of these factors must be considered by regulators when it comes to shaping policy.

As it reaches wider adoption, we expect proof-of-stake will attract more of a spotlight. Questions will be raised around how to classify this new asset class and the responsibilities that are born with it.

Blockdaemon’s proactive approach

We’re extremely proactive in our approach to AML/CFT compliance. We’re actively building a toolbox for the activity that takes place on top of our ‘base layer’. This is a three-pronged risk-based approach:  

1. Data & Analytics

We’re implementing tools for KYC screening and  monitoring on-chain node activity. It is imperative that we have these in place to monitor the funds which flow in and out of our validator nodes. By looking at on-chain data, we can identify potentially suspect behaviour. An example could involve screening a wallet address for prior suspicious activity before allowing delegation to our validator nodes.  

Monitoring for behaviors like delegating a undelegating in quick succession could indicate risk which could be an indication of attempted money laundering or some type of illicit activity.

This kind of behaviour is contrary to the purpose of proof-of-stake -  being a part of the network and community and aiding in the network or blockchain’s stability. There will be a growing demand for additional screening and monitoring for cryptocurrencies/blockchains... We are already utilizing various systems and tools for KYC screening including wallet addresses from public delegators.

2. Team Building

We’re rapidly expanding our in-house compliance team made up of industry experts. They are best placed to navigate all aspects of compliance. This lets us better understand and prepare for the current and future landscape.

3. Educating & Communicating

We are committed to helping policy-makers understand the industry. As part of this, we’ve recently joined the Blockchain Association among other non-profit organizations providing us with the most up-to-date information from a steadily changing regulatory environment and a direct line to policy makers.

Together with our fellows in the industry, we will educate, innovate, and communicate. Ultimately, this will improve the dialogue between regulators and the blockchain space.

Wrap-up

The crypto market is a trillion-dollar industry. It is natural that any industry of this size will face regulation. Much of this regulation today falls under the existing legal system. Initial Coin Offerings (ICOs) are a clear example.We have seen many ICO projects classified as unregistered Securities by the SEC in the wake of the 2017 ICO boom.

This scrutiny stemmed from the large influx of capital which flowed into the ICO space. Often, this capital came from retail investors. The legal frameworks surrounding Securities were created almost one hundred years ago. However, they are just as relevant today as they were long before the dawn of the crypto community. Now, we stand at the precipice of a new wave of regulation. The unregulated base layers may not remain unregulated for long. However, with our proactive approach, we are well poised.

Through our technology and participation, we will continue to deliver a fully compliant, exceptional blockchain infrastructure service.

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