CAI0039

Written evidence submitted by Argent Labs Ltd

Argent is a leading self-custody wallet built by Argent Labs Ltd. We are a company incorporated in England with a team distributed worldwide, but with a particular concentration in the UK.  We have over 500,000 downloads of our mobile and browser extension wallets. Started in 2018, we have raised over $50m from Europe and Silicon Valley’s leading investors.  At Argent we are passionate believers in the potential of web3 and are grateful for the opportunity to make this submission and assist in the formulation of policy for the industry.

When considering web3 regulation it’s important to reflect the differences that exist between its centralised (CeFi) and decentralised (DeFi) components.  The key characteristics of CeFi are that it is: (i) permissioned: access is exclusive; (ii) centralised: decision making is concentrated; and (iii) custodial: digital assets are controlled by a third party.

This is in stark contrast to DeFi, which is: (i) permissionless: open to all; (ii) decentralised: decision making is distributed; and (iii) non-custodial: users control their digital assets. 

The fact that CeFi and DeFi are diametrically opposed in these fundamental characteristics means that they will often require different regulatory approaches. A framework that assumes intermediaries will continue to play the role of establishing trust between parties in a transaction (i.e. CeFi) is unlikely to map across well to an ecosystem that establishes trust via blockchain protocols without intermediaries (i.e. DeFi). 

Opportunities of DeFi

If regulation is not crafted in a way that reflects these core features of DeFi there is a real danger that users will lose access to the transformational opportunities that it provides over and above CeFi. In particular:

(i) more efficient markets: DeFi protocols can deliver lower transaction costs (intermediary fees are removed) and faster settlement speeds. Scaling solutions (like StarkNet from StarkWare and zySync from Matter Labs) will improve this current performance by orders of magnitude;

(ii) more accessible and inclusive markets: anybody can access DeFi at any time - users are not confined to opening hours of traditional intermediaries. The absence of gatekeepers means that users are not exposed to unlawful or discriminatory treatment (e.g. from a traditional broker) and there is the potential for dramatic improvements in social inclusion;

(iii) deeper transparency: DeFi protocol activity is publicly available on-chain, providing a new level of visibility to consumers over fees and mechanics in financial markets. New tools are being developed to make this information more digestible by non-technical users;

(iv) greater user control over funds: self-custody through wallet software (such as Argent) allows individuals to maintain complete control over their digital assets which facilitates easier switching, provides better security and increases flexibility;

(v) wider interoperability: digital assets can be transferred between protocols more easily, giving consumers greater financial freedom. This leads to highly competitive markets and a better offering to consumers; and

(vi) accelerated innovation: by leveraging open source software in DeFi, new primitives are possible which can be deployed like “money lego” and combined in innovative ways to create new products and services. This is an evolution of the open banking principle that was so instrumental in driving the FinTech revolution in the UK over the last several years. 

Regulatory approach

By treating DeFi like CeFi or traditional finance (TradFi), we will not have a regime that is clear and fit for purpose. This will stifle the bottom-up innovation that is emerging from DeFi and which will transform finance in the same way the internet transformed access to information. Without careful stewardship of DeFi regulation we may miss the generational opportunity for consumers, businesses and the general public to benefit from the next phase of financial services innovation, and for this to be built in the UK. The concentration of world leading finance, academia and law make the UK a natural place for the global DeFi hub to be established, which would bring with it all the associated employment, tax and R&D benefits.

To navigate this successfully, we will need to adopt a novel approach to regulation that allows public interest objectives to be met whilst preserving the fundamental principles of DeFi. One such principle is self-custody of assets, which is facilitated by “unhosted wallets”, software that enables users to conveniently engage with DeFi by providing an accessible user interface and abstracting away technical complexity (“DeFi Wallets”).   Argent is a type of DeFi Wallet called a “smart contract wallet”, which means that the rules for how the DeFi Wallet completes transactions can be programmed. This allows for greater flexibility, utility and security for the user. For example, the wallet can be recovered through a social mechanism, it can be locked, and additional fraud prevention measures can also be incorporated, giving greater protection to the user and reducing financial crime within the industry.

Illicit finance

The main concern raised in connection with DeFi Wallets is that they may present an increased risk of illicit finance as they can be operated on a pseudo anonymous basis i.e. without the wallet provider verifying the real world identity of the user. This claim was rejected by HM Treasury in their consultation response to the implementation of the FATF “Travel Rule”, and we agree with their view that there is no evidence that DeFi Wallets enhance the financial crime risk. 

Much of the commentary on web3 privacy is based on a misunderstanding of the underlying technology which, for all intents and purposes, is 100% public. This default mode - where activity in relation to almost every cryptocurrency and digital asset is: (i) visible to everybody; (ii) cannot be changed; and (iii) is easily searchable - does not make it well suited to illicit finance. So a DeFi Wallet, although it is not directly linked to a real world verified identity by the wallet provider, is still revealing all the digital asset interactions and allows those to be traced throughout the ecosystem - which is a level of transparency that does not exist for cash transactions in the TradFi system.

Individual privacy

Maintaining individual financial privacy is vital if this technology is to continue developing - very few individuals or businesses would choose to have their entire financial history publicly accessible when tied to their real world identity.  One way of balancing the two considerations of privacy and crime prevention in the context of DeFi Wallets is to focus on the places where conversion between fiat and crypto currencies / digital assets takes place i.e. payment on/off-ramps. At Argent, KYC is carried out during the fiat on-ramp process by our third party payment services providers and without the need for us to handle any fiat or cryptoassets, or access personal information. From a consumer protection perspective, if all jurisdictions also required these checks to be completed by the on/off ramp payment services providers, then there would be no scope for regulatory arbitrage and the potential for anonymous illicit transactions would be greatly reduced without undermining personal privacy.  To require KYC to also be carried out by the DeFi Wallet would be the equivalent of requiring that the identity of the parties in all cash transactions be established - regardless of the sum involved - significantly expanding surveillance of the general public. The impact of any malicious or inadvertent data breach would also be exponentially larger as the loss of individual privacy would not be confined to that particular data set. The ability to connect a single transaction to all the other past, present and future transactions across the DeFi ecosystem would mean that the data subject's entire financial life would have effectively been disclosed. By adding more places where user personal information is collected we would be increasing this risk.

We don’t think that holding cryptoasset transactions on DeFi Wallets to a higher standard than currently imposed is justified - especially since, in contrast to cash, these transactions remain on a public, immutable and searchable record.  DeFi Wallets are increasing becoming the mechanism through which consumers undertake a variety of other web3 activities (e.g. interacting with decentalised autonomous organisations - DAOs) which don’t give rise to elevated risks of money laundering or terrorist financing. We believe that continuing to place the KYC function on the fiat payment services providers and not extending it to DeFi Wallets strikes the right balance between individual privacy rights and illicit finance.

It may also be possible to solve this equation through the use of “zero knowledge proofs”, which use cryptography to prove facts about information without the need for that information to be revealed. Applied to KYC, a zero knowledge proof allows identity to be verified without the need for personal information to be shared. This area is currently undergoing a period of rapid development and Argent is hopeful that its application will provide entirely new solutions to these privacy challenges. Such technology is also supportive of financial inclusion as it removes the ability to discriminate against a user based solely on their identity as opposed to their objective suitability (e.g. for loan finance).

Developer liability

DeFi is made possible by virtue of smart contracts, software programmes that run on blockchains and which allow this new financial system to operate without intermediaries by executing specific actions when certain conditions are met. One important question for the industry is the liability of the programmers of these smart contracts. The High Court, in the case of Tulip Trading vs Van der Laan and Ors, recently found that cryptoasset software developers do not owe a duty of care towards downstream users of those cryptoassets. This decision is subject to appeal, but it is our view that the decision of the High Court on this principle is correct. Extending liability to open source developers would have an enormously chilling effect on this community, which is an essential driving force for rapid innovation in the space. Many critical parts of the web 1.0, web 2.0 and web3 technology stack would not exist had individuals faced personal liability for contributing to a community and/or public good project in this way.  If the UK is to fulfil its stated objective of being the global hub for crypto investment, it should maintain the freedom for open source software developers to write and publish code.

The path ahead

As DeFi grows the benefit delivered to users - particularly in currently under-served communities - will accelerate. This will improve accessibility, transparency, costs, speed and choice in financial services to UK (and global) consumers. In this new paradigm, not all routes to achieving joint policy objectives need to be regulatory. In many cases, technological solutions will be more appropriate. In addition to deploying zero knowledge proofs as described above, blockchain analysis software is a very effective way of combating money laundering and terrorist financing.

It is also clear that much more needs to be done to educate the general public about the opportunities of web3 generally and DeFi in particular. Many people in minority or low socio-economic groups have historically had difficulty in accessing financial services under the legacy system. DeFi addresses this by removing the traditional barriers to entry and offering a route that doesn’t judge participants based on (potentially) discriminatory criteria.

Historically, many retail users have engaged with cryptoassets for mainly speculative purposes. However, as adoption increases, the focus of activity will move away from this type of use and onto more value-additive and less volatile activity such as the procurement of loan finance for a new business or raising and managing funds for a public good project through a DAO.

From a jobs perspective, the web3 industry is at the leading edge of the new world of work. An ecosystem in which people self-organise around shared passions and are remunerated in a more transparent and meritocratic way. The speed with which openings are being created in this space is extraordinary, and accessing them will be second nature to the web3 native generations.  Although the direct benefit of these new ways of working will mostly be enjoyed by new entrants into the market, we all benefit from giving people more ways of being productive members of society. 

We view this inquiry as the beginning of a continuing dialogue on web3 and DeFi policy. New frameworks will be required to fit a decentralised financial system that operates without gatekeepers. Building this will require much cooperation and coordination of stakeholders across the ecosystem - both within and outside of DeFi.  It’s vital that we get this right as decentralisation is the foundation upon which everything within web3 is built - and this movement offers a rare opportunity to fix systemic problems caused by legacy infrastructure.

We look forward to engaging more deeply on these issues going forward.

Argent Labs Ltd

September 2022