A Civil War is brewing in crypto

Quietly in the background, a steady divide has been forming in crypto. You wouldn't know it from a distance — especially if you're mostly watching from afar, or just the type that just points and laughs at the ups and downs of prices.

But for those in the space, it's been a striking turn of events to watch even the most celebrated wunderkinds get dragged by a faction that is increasingly growing louder and louder. The industry is nearing a push comes to shove moment.

I had written about the beginnings of it all a few weeks ago — the writing on the wall coming when the U.S. Treasury added the notorious crypto mixer to its sanctioned entities list. In effect, the U.S. government made it illegal for any American to interact with the crypto mixer that had allegedly been used to "launder more than $7 billion," according to the Treasury's announcement.

It was a big move, but some people shrugged it off. "Oh, well. Tornado Cash was never going to last. Of course the government was never going to let an anonymous cash mixer on the internet continue to exist," was mostly the sentiment from the moderate camp. But for crypto purists, an egregious overstep had been committed. This wasn't just a small regulatory reach — it was the shot heard round the world!

That's because to one camp, (the moderates) crypto was always just digital money. Thus, it's not unreasonable to say that trading digital money should probably follow the same rules and restrictions as trading money. But to the other camp (the purists) crypto is not just digital money — it's an entirely different system with its own rules. The most important one is that it's permisionless — meaning that no one authority can say whether you can or cannot interact with that system. That is the back story.

Things boiled over the past two weeks, when the wider crypto world reacted to a circulated draft of potential legislation that could seek to reign in other aspects of decentralized finance (DeFi) or online applications that let users borrow, swap, or lend crypto without centralized intermediaries.

Crypto billionaire and CEO of the centralized exchange FTX Sam Bankman-Fried then posted his initial thoughts on what proper regulation of DeFi might look like. Turns out, a lot of people weren't happy with his take. Perhaps a tinge of it stemmed from the fact that DeFi inherently seems at odds with the idea of a centralized exchange like the one that has catapulted Bankman-Fried to the status of one of the richest young people on Earth. But even more anger stemmed from his stance that protocols should respect the "allowlists" or sanctions lists set out by regulators.

That quickly triggered a bunch of claims that SBF "was selling out crypto" or even claims that Bankman-Fried was somehow the "devil," according to one crypto YouTuber who calls himself "BitBoy." (BitBoy, I should note, also infamously accepted sponsorship money from Celsius, the centralized crypto exchange that has now filed for bankruptcy and ensnared billions of dollars of user funds. So, he's not exactly the compass anyone uses in crypto.)

Bankman-Fried, though, had to deal with the broader backlash from crypto purists.

This weekend, Bankman-Fried went on a podcast to debate his position on moderate acceptance of regulations with Erik Vorhees, an early Bitcoin advocate and noted libertarian thinker. Representing the positions of the purists, Vorhees eloquently stated why resisting allowlists or any government overreach matters so much to the movement.

SBF (bottom left) and Erik Vorhees (top right) appear on the Bankless Podcast to discuss crypto regulations.

"The entire purpose of this financial foundation is that all of humanity can use an open, immutable financial layer. We are separating money from politics, we are separating money from the state. And in the same way that the church was separated from the state and everyone now hails that as one of the greatest things that humanity ever did, it comes to us to do the same thing for money."

Caught somewhat defending more of a realist's perspective, Bankman-Fried delivered a position that could be summed up as "bend, don't break with regulators."

"I think in general, showing respect, even if you disagree, has a lot of merit,” SBF said during the debate, pointing out sanctions lists and anti-terrorism stances by regulators tend to be pretty strongly held positions. You can watch the entirety of the two-hour debate between the two crypto thought leaders here. It was a fascinating back and forth on the nitty-gritty and gnarly questions that now face regulators and the industry as a whole around trying to figure out what becomes on and off limits.

"Being willing to entertain compromise and being really open about acknowledging the benefits of other people's positions over the last year has led us to a world where, as of today, things are mostly the same in terms of what is actually doable in crypto and where a large swath of D.C. is much more open to moving in a positive, rather than a negative, direction on the regulatory front," SBF said.

I should note that Bankman-Fried is an investor in one of my projects, and I should note he's also a major Biden donor. He certainly is connected in D.C. — perhaps more so than anyone else in crypto as far as a positive light or sway is concerned. Perhaps that's why Vorhees was so adamant about trying to get his points through to him. Either way, the purists are not about to bend the knee on points that suddenly make crypto just an extension of the old financial system.

It will be interesting to see if regulators succeed in cutting crypto off at the knees before the loudness of crypto purists take over the movement. It's unclear who will win in that scenario, and would likely be a lose-lose for everyone. If it's any indication, clearly momentum seems to be with the purists in crypto. A poll of those who listened to the debate showed about 90% of people sided with Vorhees. Of course, it's likely none of them are politicians or regulators.