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Deep Dive: The European Union’s Cryptocurrency Kill Switch and Why it Matters

Key Highlights

  • The European Union has updated the Data Act with refined rules regarding crypto, including the requirement for smart contract creators to add a “kill switch” as an added security measure.
  • The “kill switch” requirement has become divisive, with some crypto projects opposing the act for encroaching on a core crypto tenet, decentralization.
  • The urgency for blockchain regulation has increased due to the multitude of crypto-related crashes and their subsequent reverberations across borders, leading governments to set clear boundaries in the crypto industry.

Governments and regulators around the world have promised to make 2023 a definitive year for implementing meaningful crypto legislation. The European Union (EU) is kicking off the trend with an updated “Data Act” that includes refined rules regarding crypto, namely, smart contracts.

In crypto, you can describe smart contracts as automatic scripts that initiate the terms of a contract through the blockchain. Ultimately, it executes actions once the criteria of the contract have been met. Smart contracts have been one of the major breathtaking technologies in crypto that have given the ability to permit trusted transactions and agreements between anonymous sources to occur without involving a centralized third party, and are kept accountable by being irreversible, unalterable, and visible on the blockchain at any time.

Smart contracts also allow for seamless, automated, and secure transactions to occur outside of a centralized system. They also ensure that third parties cannot tamper with agreements and allow entities to conduct complicated transactions efficiently and accurately.

What Are Kill Switches and What Does This Data Act Entail?

The EU recently approved Data Act, and one of the requirements is that companies that have been and are building smart contracts, now need to include what is called a “kill switch” as an added security measure. The kill switch is like a command or button that enables the creators of smart contracts to shut down the smart contract in the case of emergencies such as a glitch in the code that makes the contract vulnerable or an all-out cyberattack.

While this move by the EU does have clear consumer advantages in creating emergency measures that protect user data, crypto funds, or whatever else is stored in a smart contract, however, the decision has become divisive as some crypto projects oppose the act for encroaching on a core crypto tenet, the foundation that blockchain, the technology that birthed cryptocurrencies, is built on, decentralization.

The Kill Switch Debate

Kill switches inherently give one person or group of people the power to interfere with the functioning of the blockchain, which goes against the premise of immutability that blockchain offers. When much of the appeal and development of blockchain and crypto comes from its decentralized nature, putting the power to kill a smart contract in the hands of one individual or group worries many projects and developers.

This new mandate also sparks confusion due to its lack of clarity as to what the “kill switch” clause entails. Does it allow a “pause” button that can restart the contract at any point, or is a “destroy” button that completely ends its operation required? Furthermore, many experts view the regulation as redundant and a “one-size-fits-all” solution that ignores the nuances of blockchain operations and the fact that most reputable crypto projects already implement a kill switch feature on their own accord.

Expert Opinion

Luke Lombe, Core Builder at Spool DAO, explained, “The DeFi ecosystem is sounding the alarm bells over the EU’s recent ‘kill switch’ mandate for good reason, it raises concerns about the immutability of smart contracts and the potential risks it may pose to the safety and security of the industry.”

In the event of a hack, administrators need to act swiftly to ensure consumer data, and in some cases, ensure valuable crypto isn’t stolen. A kill switch enables them to do so. It’s also important to keep in mind many smart contracts already use kill switches for this reason, whether they are mandated to do so or not.

But Lombe also worries that the mandate undermines the security of smart contracts, and making the inclusion mandatory could backfire. He explained, “Requiring human intervention as a mandatory practice creates a potential backdoor into smart contracts. Understanding that this mandate can have unintended consequences with far-reaching and potentially detrimental implications. In theory, the ‘kill switch,’ which allows for the termination of a smart contract may be abused for malicious purposes, such as market manipulation or unfairly gaining advantages.

“Simply, the potential harm to consumers and the potential threat to the integrity of DeFi cannot be overlooked. A situation like this also might suggest a limited understanding of blockchain technology and its benefits among the regulatory bodies responsible for the mandate. Our recommendation is to increase collaboration between regulators and industry professionals to enhance comprehension of the potential repercussions associated with such measures before they’re implemented.”

This mandate is likely the first of many regulations set to roll out this year, as many governments and legislators turn their attention to stabilizing the industry.

Why Does Blockchain Regulation Have a New Sense of Urgency?

Simply put, the multitude of crypto-related crashes and their subsequent reverberations across borders are likely the main impetus for increasing regulations. Governments are looking to set clear boundaries in the crypto industry while it’s still relatively nascent and not as widespread as it could be later.

Many crypto and blockchain-based projects are still bruised from the industry-wide downturns and crashes of the past year and are using this time to rebuild and recalibrate the industry, with mainstream adoption being the primary objective. Trying to rein in a budding industry with such wide-reaching possibilities is harder to do when it’s booming, and establishing clear rules now could help foster more sustainable growth.

Although the undoing of FTX and Sam Bankman-Fried are the most notable, many blockchain projects suffered at the hands of irresponsible development and unclear regulations to protect users. Creating clear and understandable guidelines with firm repercussions for misdeeds is intended to make the industry less volatile and more viable.

However, there is still an important question to ask; does good intent always translate into fair regulation? Some projects are skeptical that vague legislation could end up causing more harm to the industry in the long term.

Chao Cheng-Shoreland, Co-Founder and CEO at ShelterZoom, stated, “Smart contracts create the basis for maximized efficiency, self-governance, and anti-fraud. Under EU laws, personally identifiable information is already fortified from being visible on public blockchains. While the EU’s Data Act surely aims to ensure the security of smart contracts and digital assets, introducing a mandated ‘kill switch’ for smart contracts could undermine and reverse the trust and governance that smart contracts provide as we enter the Web3 era. This could potentially undo the positive intentions behind the Data Act.”

There are still many details the regulation will have to flesh out, and it could be used as a springboard for more comprehensive security protocols and resource provisions. Likewise, projects worried about handing over the keys to their smart contracts to one person should look for ways to ensure ways for multiple parties to agree on when to utilize it. But in the meantime, blockchain projects based in the EU will have to adhere to these rules to continue operating until more substantial regulations see the light of day.

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