How my views on financial privacy have evolved over a decade

I began exploring the topic of financial privacy and payment anonymity in the early days of this blog. Over the past decade, my views have shifted significantly—here's how and why.

Rereading my earliest mentions of financial privacy, they now seem a bit... idealistic? extreme? For instance, in my 2014 post entitled Fedcoin, a central-bank issued digital currency, I suggested that the product should be 100% anonymous, like coins and banknotes.

Criminals would undoubtedly exploit unlimited anonymous digital currency, as I acknowledged in a 2018 article entitled Anonymous digital cash. But I figured that the bad guys would find their own ways to transact anyways, say through their own mafia-created payments system, so central banks may as well go forward with anonymous digital currency, the benefits to civil society of unlimited e-cash ultimately outweighing the cost.

I wouldn't support these same ideas today, or would at least modify them, as I'll show further down.

But idealistic and extreme aren't quite the right words. I think that I was right, at least when looking at things from a certain vantage point, but it was still early in my blogging career and I hadn't yet explored other vantage points

To be clear, financial privacy, or the ability to make transactions anonymously or near-anonymously, isn't just something that criminals require. It's crucial for regular folks, too, and in my earlier blog posts I spent a lot of time detailing why this is so. After a cashier dropped my card behind the counter (and potentially skimmed it?), I wrote that cash provides buyers with a "shield from everyone else involved in a transaction" in my 2016 post In praise of anonymous money. And I still agree with that, and to this day always pay with cash when the store I'm at feels a bit sketchy. I worry that this shield will disappear as cash usage continues to decline.

Civil society's need for private transactions isn't just a weird fringe view. In a 2018 entitled Money is privacy, I described the work being done on privacy and payments by Federal Reserve researchers Charles Kahn, James McAndrews, and William Roberds. Licit transactions can unintentionally evolve into a long-term relationship, they write, including clawbacks, extraterritorial rulings, and new forms of product liability. To boot, personal information linked to digital transactions can be stolen in data breaches.
 
According to the three Fed researchers, the ability to transact anonymously converts a potentially thorny transaction into a one-and-done relationship. Licit payments that might have otherwise been deemed too dangerous can proceed, the extra trade making the world better off. (See also my 2020 article Central banks are privacy providers of last resort.)

As for crypto, I've described blockchains as dystopian hellscapes or panopticons, because every single transaction is mapped out for all to see. That makes blockchains just awful places to carry out conventional business. Firms require a degree of secrecy in order to hide their corporate strategies and tactics from competitors—but the medium doesn't permit secrets. Blockchains need more privacy. (See my 2022 post DeFi needs more secrecy, but not too much secrecy, and the right sort of secrecy). 

So what changed?

Starting in 2018, I focused more on studying fraud, including ransomware, tax evasion, and gift card schemes. I found gift card fraud particularly intriguing: semi-anonymous payment systems linked to Google Play and Apple iTunes have enabled an entire industry of scammers, including IRS and tech support fraudsters, to launder stolen funds. Network operators like Google and Apple, as well as major retailers such as Target and Walmart, quietly profit from all of this fraud. (See Gift Cards: When Good Products Do Bad Things [2021] and In-game virtual items as a form of criminal money [2019].)

Which led me to my next big truth: if privacy is crucial, so is the necessity of criminalizing money laundering.

Money launderers are the financial intermediaries who, knowing full well that a customer's funds are dirty, conduct transactions with them anyways, in a way designed to disguise its source.

The willful laundering of a criminal's money is an extension of the original crime, making a launderer just as morally and ethically culpable as the criminal they are helping. By facilitating the final release of illicit funds, the money launderer enables the crime to fulfill its purpose, completing the damage caused by the initial offense—be it theft, extortion, or human smuggling. This is why the launderer's actions deserve to be criminalized. (See A short and lukewarm defence of anti-money laundering standards from 2021).

The crime of money laundering bears a striking resemblance to the centuries-old crime of fencing—the art of accepting and redistributing stolen property. (See my 2024 post "I didn't launder the cash, your honor. The robot did") In earlier times, thieves were responsible for reselling their stolen goods themselves. However, by the 17th century, this task was often outsourced to specialized intermediaries, or 'fences.' At first, there was no legal term for this crime, but in 1692, England formally criminalized fencing, and deservedly so.

Thinking more about the crime of money laundering led me to become more critical of stablecoins, for instance. From 2014-2018 my articles on stablecoins were mostly neutral or positive, but now my posts focus on the fact that stablecoin issuers, by turning a blind eye to those using their platform, have allowed themselves to become launderers for all types of criminals. (Among others, see my 2019 post From unknown wallet to unknown wallet and my 2023 post Why do sanctioned entities use Tether?)

At this point, you may be able to see my conundrum.    

If, like fencing, money laundering should be criminalized (and indeed it is illegal in most parts of the world), that collides with my prior belief in the importance of financial privacy. After all, the only way for a banker, money transfer agent, or stablecoin issuer to be safe from a money laundering charge is to show that they did a good faith job collecting enough personal information to ensure that they weren't dealing with criminals. And giving up personal information is necessarily privacy-reducing.

One way to resolve my conundrum would have been to pick a side and advocate for it, but I think both sides are important, so I've generally tried to find a compromise. Most of my writing on the topic over the last five or six years has been trying to wrestle with where to draw the line between financial privacy and the crime of money laundering. 

My compromise position has generally advocated a privacy safe harbour for small day-to-day transactions. But anything above a certain monetary ceiling needs to be identified in order to avoid a money laundering charge.

Here are some examples of my often clumsy attempts to balance the two ideals:

• The purchasing power of the $100 note has been eaten away by inflation. Let's improve basic payments anonymity by re-introducing $500 notes, but burden those notes with a tax in order to make up for the benefits accruing to criminals. See my posts A tax, not a ban, on high denomination banknotes and Pricing the anonymity of banknotes from 2018, and Supernotes from 2019.
• If we’re going to issue a central bank digital currency, it shouldn’t be fully anonymous or fully surveilled. Instead, it should provide a limited, rationed degree of anonymity. See The dematerialization of cash (2017) and Anonymity vouchers (2019).
• Below a certain monetary threshold, cash transaction reports (CTRs) and suspicious activity. reports (SARs) needn't be filed, which means small transactions enjoy a degree of privacy. However, these thresholds are not adjusted for inflation. To preserve the small privacy safe harbour, those thresholds should rise over time in-step with the general price level. New financial products should enjoy the same shield. (See my 2020 article Why Aren’t Anti-Money-Laundering Regulations Adjusted for Inflation? and my 2023 posts In praise of anti-money laundering thresholds and Even crypto mixing deserves a threshold).
• While the crypto privacy bot Tornado Cash makes blockchain transactions private, it is also a money laundering machine, a point I made multiple times beginning in 2021 with Tornado Cash and money laundering. The proper way to build a privacy bot is to take a balanced approach that begins with screening out bad actors, and only then provides privacy, thus ensuring that the tool isn't used for laundering money. (I explore this balanced approach in my 2022 post Crypto’s privacy/commingling dilemma , my 2024 post "I didn't launder the cash, your honor. The robot did" and my 2023 article Thoughts on Privacy Pools and the law.)
  

Balancing the two ideals rather than taking an either/or approach has led me to adopt a more comparative approach to thinking about financial privacy. I've begun to analyze cross-country differences in the intensity of financial surveillance as conducted by national financial intelligence units. Canada, for instance, has chosen a balancing point that is far more in favor of financial privacy (and accordingly more accepting of money laundering) than the U.S. has, as illustrated in my 2024 post Your finances are being snooped on. Here's how.

So that's where I've landed after ten years of writing about privacy. Hard-core privacy advocates and civil libertarians would probably describe me as a sell-out or a wishy-washy centrist because I'm willing to compromise on financial privacy. Fair enough. But I do wonder how many privacy advocates would go so far as to call for an all-out decriminalization of money laundering. Doing so would maximize privacy, but surely no privacy advocate thinks that bankers who clean money for the mob should by allowed to walk free. We are probably closer than they think.

I look forward to seeing how my opinions evolve over the next ten years, as I'm sure they will. Thoughts or comments?

Pricing the anonymity of banknotes

Banknotes are useful. Not only do they provide their owner with a standard set of payments services, they also offer financial anonymity. This post introduces the idea of trying to price the anonymity component. 

To help think about why we might want to price anonymous banknote usage, I’m going to make an analogy. Imagine Walmart sells special suits that allow people to become invisible. While most Walmart customers always pay for the goods they find in the aisles, a few try these invisible suits on, grab a bunch of stuff, and sneak out without paying. The product is weaponized and turned against its provider.

This same sort of weaponization characterizes the modern provision of banknotes. The government, like Walmart, provides citizens with a privacy-enhancing product: cash. Because its coins and banknotes don’t leave a paper trail, they act as a financial cloak. In the same way that an invisible suit can be used to evade Walmart’s checkout counter, a government-issued banknote can be turned against its provider by allowing users to avoid paying for the government services they have consumed. 

Walmart may wish to do something about the weaponization of invisible suits, especially if the costs imposed by abusers of suits begin to exceed the amount of income the company gets from buyers of invisible suits. One option Walmart has is to stop selling the product. No one would fault them for putting an end to an unprofitable business line. Invisible-suit aficionados could just shop elsewhere. 

But what if Walmart is society’s only provider of invisibility? This complicates things. While a few bad apples regularly abuse Walmart’s invisible suits by using them to steal, many others use the suits in legitimate ways. So while a decision to stop selling invisible suits might improve Walmart’s finances, it might also make society worse off. 

This same tension crops up in the debate over the future of cash. A ban on cash would help reduce tax evasion and improve government finances. But since banknotes are the only anonymous financial product, and no other entity is permitted to provide banknotes, a ban would put an immediate end to financial privacy. Because privacy is something that regular folks value for licit reasons, their welfare would be reduced.

Say Walmart does the noble thing. It continues to stock invisible suits to meet the public’s demand for privacy. But the company still has costs it must meet, including wages, inventories, and rent, and with a steady loss of payments facilitated by the weaponization of invisible suits, that hurdle becomes much harder to clear. To plug deficits, Walmart may have to ask all its rule-abiding customers to pay a little bit more for their purchases by raising all of prices by a little bit. 

But an across-the-board price increase hardly seems fair. Those abiding by Walmart’s rules are being asked to make up for a shortfall that is entirely the fault of suit-stealing rule breakers. Honest shoppers who don’t generally like to use invisible suits will be particularly furious — and who can blame them? They are being asked to pay more for the goods they hold dear in order to support the use of a single product they never cared for much anyway. 

This same lack of fairness plagues modern tax systems. The government needs to fund (via taxes) the services it provides, but the presence of cash is weaponized against the system by tax cheats. The funding gap that emerges must be made up for by all of the remaining citizens — the non-cheaters. So taxes, or the price of government services, will be higher in the presence of cash than in a world without cash. Non-cheaters, particularly those who don’t use cash, will feel betrayed because they must pay higher taxes to support the ongoing provision of a product they don’t necessarily value. 

Walmart may have a better option. Instead of increasing the price of all goods to make up for the behavior of a few invisible-suit users, it can just raise the price of suits high enough to make up for the shortfall. So customers who like invisibility end up bearing the costs imposed by thieves who weaponize suits. This targeted approach seems like a fairer path for Walmart to take. It releases a large chunk of its customer base from the obligation of offsetting the invisibility-induced shortfall while still giving those who value the privacy provided by invisible suits the option of buying them.

If setting a higher price for invisibility is the best option for Walmart, what about modern banknote-providing governments? In the same way that Walmart increases the price of invisible suits to offset the shortfall created by those who weaponize them, a government can introduce a levy on cash users. Rather than placing this levy on all banknote denominations, it might target high-denomination banknotes instead. The idea is that bulky $1s and €5s may be less useful in large-scale tax evasion than $100s and €200s. 

By setting a levy or negative interest rate of 5 to 10 percent per year on high-denomination notes (there are various ways to do this), the government would be able to earn a large-enough stream of revenue to help offset the shortfall created by cash-using tax evaders. The effect would be a lower tax bill for all non-cheaters, both for those who generally do not use cash and those who use only small-denomination notes ($1 and €5s). In effect, the anonymity provided by $100s and €200s would now be directly paid for by the users of those $100s and €200s. Unlike an all-out ban on banknotes, financial anonymity would still be provided. 

I think it makes sense for the Walmart in our thought experiment to give anonymity pricing a shot. Maybe governments should entertain the idea, too.

[This post was originally published at the Sound Money Project. I've modified it slightly for clarity.]

Setelinleikkaus: When Finns snipped their cash in half to curb inflation

On the last day of 1945, with World War II finally behind it, Finland's government announced a new and very strange policy.

All Finns were required to take out a pair of scissors and snip their banknotes in half. This was known in Finland as setelinleikkaus, or banknote cutting. Anyone who owned any of the three largest denomination Finnish banknotes — the 5000 markka note, the 1000, or the 500 — was required to perform this operation immediately. The left side of the note could still be used to buy things, but at only half its value. So if a Finn had a 1000 markka note in their wallet, henceforth he or she could now only buy 500 markka worth of items at stores. As for the right side, it could no longer be spent and effectively became a bond (more on this later).

Source: Hallitus kansan kukkarolla, by Antti Heinonen

Setelinleikkaus was Finland's particular response to the post-War European problem of "monetary overhang," described in a 1990 paper by economists Rudi Dornbusch and Holger Wolf. After many years of war production, price controls, and rationing, European citizens had built-up a substantial chest of forced savings, or involuntary postponed consumption, as Dornbusch & Wolf refer to it. With WWII now over, Europeans would soon want to begin living as they had before, spending the balances they had accumulated on goods and services. Alas, with most factories having been configured to military purposes or having been bombed into dust, there wasn't nearly enough consumption items to make everyone happy.

It was plain to governments all across Europe what this sudden making-up of postponed consumption in a war-focused economy would lead to: a big one time jump in prices.

This may sound familiar to the modern day reader, since we just went through our own wartime economy of sorts: the 2020-21 battle against COVID and subsequent return to a peacetime economy. The supply chain problem caused by the COVID shutdowns combined with the big jump in spending as lockdowns expired, spurred on by a big overhang of unspent COVID support cheques, led to the steepest inflation in decades. 

According to Dornbusch and Wolf, European authorities fretted that the post-WWII jump in prices could very well spiral into something worse: all-out hyperinflation, as had happened after the first World War. Currencies were no longer linked to gold, after all, having lost that tether when the war started, or earlier, in response to the Great Depression. 

To prevent what they saw as imminent hyperinflation, almost all European countries began to enact monetary reforms. Finland's own unique reform — obliging their citizens to cut their stash of banknotes in two — would reduce the economy's stock of banknotes to just "lefts," thereby halving spending power and muting the wave of post-wartime spending. After February 16, 1946 the halves would be demonetized, but until then the Finns could continue to make purchases with them or bring them to the nearest bank to be converted into a new edition of the currency.

As for the right halves, they were to be transformed into a long-term investment. Finns were obligated to bring each right half in to be registered, upon which it would be converted into a Finnish government bond that paid 2% interest per year, to be repaid four years later, in 1949. It was illegal to try and spend right halves or transfer their ownership to anyone else (although it's not apparent how this was enforced).

In theory, turning right halves into bonds would shift a large part of the Finnish public's post-war consumption intentions forward to 1949, when the bonds could finally be cashed. By then, the economy would have fully transitioned back to a civilian one and would be capable of accepting everyone's desired consumption spending without hyperinflation occurring.

To our modern sensibilities, this is a wildly invasive policy. Had setelinleikkaus been proposed in 2022-23 as a way to dampen the inflationary effects of the reopening of COVID-wracked economies, and we all had to cut our dollar bills or yen or euros in half, there probably would have been a revolt.

With the benefit of hindsight, we know that setelinleikkaus didn't work very well. Finland continued to suffer from high inflation in the years after the war, much more so than most European countries did.

Why the failure? As Finish economist Matti Viren has pointed out, the reform only affected banknotes, not bank deposits. This stock of notes only comprised 8% of the total Finnish money supply, (Finns being  uncommonly comfortable with banks) so a major chunk of the monetary overhang was left in place.

Another glitch appears to have been the public's anticipation of setelinleikkaus. According to
former central banker Antti Heinonen, who wrote an entire book on the subject, banks began to advertise their services as a way to avoid the dangers of the upcoming monetary reform (see images below). So Finns deposited their cash prior to the final date, the monetary overhang to some degree evading the blockade.

Finnish bank advertisements warning of the upcoming note cutting
Left: "Bank accounts are fully secured in the banknote exchange."
Right: "Depositors are protected."
Source: Hallitus kansan kukkarolla, by Antti Heinonen (Translations via Google Translate)

If the Finnish experiment was a dud, other European responses to the post WWII overhang — either  redenominations, temporarily blocking of funds, or all-out write offs of bank accounts — were more successful. Germany's monetary reform of 1948, which introduced the Deutschmark and was later dubbed the "German economic miracle", is the one that captures the most attention, but here I want to focus on a lesser known reform.

Belgium's Operation Gutt, named after Belgium's Minister of Finance, Camille Gutt, was the earliest and perhaps the most dramatic of the post-war monetary operations. Taking place over four days in October 1944, Belgium contracted its entire money supply, both banknotes and deposits, from 165 billion to 57.5 billion francs. That's a two-thirds decline! You can see it illustrated in the chart below, along with the monetary reform enacted by the Dutch the following year, inspired by the Belgians.

A chart showing the incredible contraction of Belgium's money supply in 1944
Source: Federal Reserve Bulletin, October 1946 (red arrow is my emphasis)

It's not just the size of Operation Gutt that is striking to the modern eye. It's also the oddity of the tool being used. Today, we control inflation with changes in interest rates, not changes in the quantity of money. To soften the effect of the global COVID monetary overhang, for instance, central banks in the U.S., Canada, and Europe began to raise rates in 2022 from around 0% to 4-5% in 2024. 

By making it more lucrative for everyone to save and less attractive to borrow, central bankers were trying to reduce our propensity to spend our COVID support payments, and with less spending, prices wouldn't get pushed up as fast. This reliance on interest rates as our main tool of monetary policy is a relatively new phenomenon. In times past, central banks tended to lean heavily on changes in the supply of money, which may explain why in 1945, their main response — in Europe at least —  was to obliterate the public's money balances rather than to jack up interest rates to 25% or 50%.   

It's worth exploring in some more detail how Operation Gutt was designed. On October 9, 1944, Belgian bank depositors had 90% of the money held in their accounts frozen, leaving just 10% in spendable form.

As for holders of banknotes, there was no Finnish-style cutting. Rather, Belgians had four days, beginning October 9, to bring all their banknotes to the nearest bank, only the first 2,000 francs qualifying for conversion to newly printed versions. All notes above that ceiling got blocked in a separate account (along with excess deposits), some of which would be released slowly over the next few years—while the rest would remain frozen forever, subject to whether the owner was deemed to have been a collaborator who got rich during the occupation. (Finland's setelinleikkaus also had this same "cleansing" motivation.)

In 1944, a line forms at the National Bank of Belgium to exchange notes.
Source: National Bank of Belgium on Flickr

In this sense, the post-WWII European monetary reforms were not only designed to reduce inflation, but also had a moral basis. Think of them as progenitors to India's 2016 demonetization, which was designed to catch so-called "black money," although it failed to do so.

Did Operation Gutt work? Incredibly, the decimation of two-thirds of the money supply in just a few days did not cause an immediate fall in Belgian prices. According to Belgian economic historians Monique Verbreyt and Herman Van der Wee, the Belgian retail price index stood at 260 the month of the reform, but had risen to 387 by September 1945. So it would seem that the whole operation failed. This surely draws into question the quantity theory of money, one of the basic tenets of monetary economics. A decline in the money supply, all things staying the same, is supposed to cause a fall in prices. Here is a glaring case in which it didn't.

However, the National Bank of Belgium (NBB), the country's central bank, strikes a more constructive tone. In a recent retrospective on Operation Gutt, the NBB describes the reform as a gamble that paid off over time, eventually inspiring the "Belgian Economic Miracle", a period of low inflation and fast growth lasting from 1946-1949. By contrast, France did not embark on its own monetary reforms, the NBB takes pains to point out, and it thereby "paid the consequences of post-World War II inflation well into the 1960s." Belgium's inflation rate was also much lower than Finland's in the four or five years after the war. 

Which gets us back to Finland. Unlike the Belgian central bank, Finland's central bank — Suomen Pankki — notably avoids almost all mention of its post-war reform on its website. According to Matti Viren, setelinleikkaus led to "distrust towards the authorities and economic policy for decades," so there may be some sheepish reticence on the part of the central bank to draw attention to it.

But setelinleikkaus and Operation Gutt aren't just archaic monetary policy dead-ends. One day I suspect they'll be back. Not just as a special tool for responding to emergencies, but as a day-to-day policy wrench, albeit in a new and refined form. 

Cash, which is awkward to immobilize for policy reasons, will be gone in a decade or two, leaving the public entirely dependent on bank deposits and fintech balances which, thanks to digitization and automation, can be easily controlled by the authorities. To rein in a jump in inflation, central bankers will require commercial banks and companies like PayPal to impose temporary quantitative freezing on their clients'  accounts, but unlike Finland's 1945 blockade, the authorities will be able to rapidly and precisely define the criteria, say by allowing for spending on necessities — food, electricity, and gas— while embargoing purchases of luxury cars and real estate.

The future version of setelinleikkaus won't be clumsy, it'll be a precise and surgical inflation-fighting tool, albeit a controversial one.

Memecoins are the point

Cypherpunks wanted to change the world. We ended up with memecoins.

Our story begins with some very smart and idealistic developers, known as cypherpunks, creating a new technology know as a blockchain. Blockchains are databases, but decentralized. Advertised as being "censorship-proof," they reduce the possibility of users being subjugated to third-party interference.

Cypherpunks have always wanted their tamper-proof databases to flourish, go mainstream, and improve regular people's lives. A video from 2015 pans out from an interconnected power plant, grocery store, hospital and airplane before loftily declaring that Ethereum, one of today's largest blockchains, will be "the secure backbone for everything from e-commerce to the internet of things."

Some of you may remember another famous video from the mid-2010s, in which a young Vitalik Buterin, co-creator of Ethereum, challenged viewers: "What will you build on top of Ethereum?"

The world has responded. Forget interconnected power plants and grocery stores. The most popular thing being built on top of blockchains are memecoins. 

A memecoin is a pure gamble. These valueless tokens, typically created anonymously, usually have a mascot, or meme, loosely associated with them, some well-known examples being dogecoin, pepe, HarryPotterObamaSonic10Inu, gigachad and dogwifhat. A memecoin provides no dividends and leads to no productive activity. Its price depends entirely on subsequent players emerging to repurchase it at a higher price. The result is a hyper-volatile pyramid betting game.

via Twitter

Memecoins don't quite jive with the cypherpunk dream of creating a fairer system, one in which everything, including all of high-finance—and by that I mean banking, payments, insurance, and investments—has migrated over to blockchain nirvana. A memecoin is the epitome of low-finance. It belongs in the same gutter as some of the grimiest members of the financial world: lotteries, slots, chain letters, raffles, HYIPs, and other zero-sum games.

Cypherpunks and their fellow travelers are offended by memecoins. They want their blockchains to be used for more noble reasons:

• it’s sucking the energy out of crypto [link]
• it is a complete bastardisation. a total mockery, a clown show [link]
  
• things have hit an all-new bottom with 2024: racist, sexist, and other shitheaded memecoins which are merely a vehicle to transfer wealth from the many to the most obnoxious people on the planet [link]
  
• besides undermining the long-term vision of crypto that has kept so many of us in the space, memecoins aren't very technically interesting [link]

Buterin, too, gripes that "even the non-racist memecoins often seem to just go up and down in price and contribute nothing of value in their wake." Trying to find a silver-lining, he implores memecoin makers to donate a portion of their supply to charity, sort of like how raffles are used to fund good works. 

Cypherpunk's frustration with memecoins understandable. But I don't think the cypherpunks should be complaining. Guys, what exactly did you think your zero-rules financial substrates were going to be used for?! Memecoins are the point.

Memecoins as the fundamental unit of blockchains

People have a natural predilection to gamble, but gambling has a bad wrap and so many gambling games have been declared illegal. Memecoins are a great example of this, their presence being prohibited on society's official financial venues including its stock exchanges and commodity markets, as well as its casinos and online betting sites.

Up in Canada, which has historically been a haven for scummy finance, the closest you can get to floating a memecoin is by taking the junior gold route. Start by incorporating a gold exploration company, buy the rights to some worthless property in an isolated region of northern Canada, list the company on a junior stock exchange, promote your sham as the next big gold mine, and sell out to the latecomers. You're basically created a memecoin; a token based on nothing. 

But this is an arduous way to run a memecoin. You still need to disguise yourself as a regular firm, publish audited financial statements, and hire a board of directors, plus you'll have to provide your real name, which means potential lawsuits or criminal charges. A pure memecoin, say like dogwifhat, which isn't burdened by any of these costly real-world obligations, would never get permission to be listed, even on Canada's shadiest junior stock exchange.

Enter blockchains, which are inherently anarchic. Blockchains allow folks to deploy illegal and unregulated betting games without the authorities being able to step in and say: "Hey, you can't do that." With mainstream exchanges and casinos being closed off to them, it's no wonder that memecoins have come to dominate the new medium.

If your blockchain doesn't experience a constant stream of memecoin issuance, it's effectively dead. Hordes of crazy gamblers buying and the selling meaningless, non-productive coins is a sign of a flourishing and fertile censorship-resistant financial medium. Sleezy promoters competing to draw attention to their favorite memecoin on social media isn't "sucking the energy" out of crypto; it's the whole point of crypto.

Source: Twitter

As for the cypherpunk idealists complaining about memecoins, they need to accept the fact that blockchains will probably never become the "backbone of everything." Instead, blockchains will continue to serve as a major hub for grimy low-finance; stuff like memecoins and ponzis that can't make the jump to official venues. Many of these low-finance services will be illegal or shady or distasteful, because those are precisely the things that need protection from third-party interference. (And to be fair, certain banned low-finance services can be quite useful.) If you're going to hock censorship-resistance to the world, don't grumble about who shows up at the table.

Memecoins have sometimes been described as a potential gateway drug or Trojan horse for broader adoption of blockchains. "Once they try dogwifhat, they won't be able to resist my quadratic voting project." But that's just wishful thinking. Serious and "respectable" high-finance services, say like insurance and banking—the stuff we all need for day-to-day life—are by necessity legal and thus welcome on mainstream habitats, and so these services and their users need never gravitate to the same rule-free substratum that memecoins have.

What will you build on top of blockchains? Memecoins. Memecoins are the fundamental financial unit of crypto.

---

P.S. I must be running out of material because I wrote an early version of this post back in 2018 for Breakermag

The magnificent Swiss 10-centime coin

The Swiss 10-centime coin has a lot to teach us about monetary economics.

On its face, the Swiss 10-centime (rappen in German) looks like a pretty unremarkable coin. It's the second-lowest value Swiss coin, the Swiss version of America's lowly nickel, the sort of coin that many people might prefer to throw in a jar and forget about. But I recently learnt via @alea on Twitter that the 10-centime has the distinction of being the oldest original coin in circulation, its size, design and composition remaining unchanged since 1879.

Below are the 1879 and 2023 versions. They're exactly the same.

It's the stability of the coin's composition in particular that strikes me. Since its debut almost 150 years ago, the 10-centime has contained three grams of cupronickel—75% copper and 25% nickel. The only exception was from 1932 to 1939, when it was made of pure nickel. 

The U.S. five-cent coin, or the "nickel," has also had a remarkably long period of stability. Debuting in 1866 as a five gram cupronickel coin comprised of 75% copper and 25% nickel, the nickel has maintained the same metal content throughout its entire existence (except for the wartime five-cent coin), although unlike the 10-centime it has undergone a few decorative changes.

What makes the enduring stability of the Swiss 10-centime and the American nickel so unique is that it runs contra to the dominant coinage timeline, which typically involves a series of changes to a coin's metallic content over time. The main reason that coin compositions have been prone to change is that the global economy has generally been characterized by inflation, or a rising price level. With coins, this has had the unfortunate effect of steadily pushing the market value of their metal content higher, to the point that it eventually exceeds the coin's face value.

When this happens Gresham's law takes hold. It becomes profitable for speculators to melt the coin down in order to sell it as raw metal, the coin disappearing from circulation. Gresham's law, you may recall, is the dictum that when the official value of a monetary instrument is set too low, then it will be hoarded or exported, the "good" money being driven out leaving only what remains – the "bad" money – to circulate in its place. As a result, coin shortages occur and it becomes harder for the consumers and retailers to conduct basic commerce. 

In the early 1960s, for instance, a big rise in the price of silver led to hoarding of U.S. dimes and quarters, which at the time were 90% silver and 10% copper.

Source: New York Times (1964)

To prevent coins from being tossed into the melting pot and causing shortages, governments have typically reminted them out of cheaper material once their metal value approaches their face value. That's indeed what the U.S. monetary authorities did in 1965 with the Coinage Act, when they decided to henceforth mint new dimes and quarters out of cupronickel rather than silver.

Another reason for the regular alterations in coin metal content is to protect the mint's profits, which typically flow through to the government. Buying raw metal is one of a mint's largest costs, so when metal price rise, mint officials search around for cheaper types of metal. Either that or they reduce the size of the coin itself.

After commodity prices boomed in the 1970s, the 10-centime coin's smaller cousin, the Swiss 5-centime – produced from two grams of cupronickel since 1879 – was replaced by an aluminum-bronze version made of 92% copper, 6% aluminum, and 2% nickel. Nickel is a relatively pricey metal, so subbing it out with cheaper materials not only prevented the 5-centime coin from ever reaching its melting point, but also protected the Swissmint's profits.

Canada's 5-cent coin has gone through even more compositional changes than Switzerland's 5-centime. Beginning life in 1858 as a sterling silver coin, the five cent coin was diluted to 80% silver in 1919, got converted to pure nickel in 1922, then cupronickel in 1982, and finally became 94.5% steel in 1999—steel being by far the cheapest of these materials.

Monetary headroom

The 10-centime coin has avoided these transformations. You can see why in the chart below, which illustrates the market value of the nickel and copper making up the 10-centime going back to its original minting in 1879.

When it was created in 1879, the 10-centime had just 1.2 centimes worth of cupronickel in it. That effectively gave the coin a massive amount of metallic "headroom," or space between its metal content and its face value—8.8 centime's worth.

Zoom forward 150 years or so to 2024 and the market value of this three grams of cupronickel has more than doubled from 1.2 centimes to 2.8 centimes. That's a big jump, but still far below – 7.2 centime's worth – the coin's ten-centime face value. Given that plenty of headroom remains, Gresham's law won't be kicking in any time soon. I'd hazard that the cupronickel 10-centime has a few more decades of life, unless the Swiss give up on using cash before then and simply cancel their coinage altogether.

The 10-centime's fat amount of historic headroom isn't the only factor driving its endurance. Another factor has been the relative strength of the franc, Switzerland's monetary unit, composed of 100 centimes. To illustrate this, let's take a look at its competitor, the American five-cent piece.

Not worth a nickel

Below, I've charted out the market value of the five-cent coin's cupronickel content going back to its introduction in 1866.

Back in 1879, when the Swiss 10-centime was introduced, the U.S. nickel had just 0.4¢ worth of copper and nickel in it, giving it a massive 4.6¢ worth of monetary headroom. But over the decades that headroom has been entirely eaten up by inflation. In 2006 the nickel's metallic content exploded above its face value for the first time, and again in 2011. Since 2020 this state of affairs seems to have become permanent, with the value of the metal currently clocking in at 5.5 cents, around fourteen-times higher than 1879.

The high price of the nickel's metal content has been eating into the U.S. Mint's profits. The chart below shows the amount of seigniorage, or profit, that each coin provides to the mint. Seigniorage is the difference between the face value and cost of producing coinage.

Source: US Mint 2023 annual report

As you can see, in 2023 the U.S. Mint lost an incredible $93 million producing nickels! It hasn't made a profit on the five-cent coin in almost twenty years. That the nickel's metal mix hasn't been updated despite almost two decades of consecutive losses indicates bureaucratic failure. Something at the U.S. Mint is broken.

At the same time, we are seeing signs of the nickel falling prey to Gresham's law as hoarders remove them from circulation. A few years ago, investment manager Kyle Bass, who made his fame shorting various mortgage-related instruments during the 2008 credit crisis, bought 20 million nickels in anticipation of eventually melting them down and selling them for more than their face value. In a conversation with me on Twitter, Bass confirms he still keeps the nickels at a storage facility.

I do other business with the storage facility. My agreement is in basis points of value (less than 25bps) and not sq ft.

— 🇺🇸 Kyle Bass 🇹🇼 (@Jkylebass) February 27, 2024

No doubt other speculators have adopted the same strategy. As metal prices inevitably continue to rise, expect serous shortages of nickels going forward, unless the U.S. Mint finally decides to do something about the problem.

Let's bring the 10-centime back into the conversation. By all rights, the 10-centime should have had a much shorter life than the U.S. nickel. In 1879, the nickel was the more valuable of the two coins by a long shot. At the time, the going exchange rate was one U.S. cent to five Swiss centimes, which means a nickel was worth around 25-centimes. Given that it was worth so much more, the nickel had a much wider region of monetary headroom, and so it seemed destined to enjoy a much longer period of time before its metal value caught up to it and Gresham's law kicked in.

But not so. The less valuable centime has proven more enduring.

As I hinted earlier, the reason for this is the Swiss franc's extraordinary strength over the last century. Below I've plotted out the long-term franc-to-dollar exchange rate.

In 1880, one dollar was worth 5.18 francs. Today, a dollar is worth less than a franc. Put differently, the purchasing power of the Swiss franc and its centime subdivisions has improved by a factor of five relative to the dollar's purchasing power. And so the value of the cupronickel embedded in the 10-centime coin hasn't inflated nearly as fast as the value of cupronickel in the U.S. 5-cent piece. That's why Kyle Bass isn't hoarding lowly 10-centime coins.

The U.S. Mint is belatedly scrambling to make changes to the metal content of the nickel. In its 2022 report to Congress, it asked legislators for the authority to mint an updated five-cent coin made of 80% copper and 20% nickel, the idea being to reduce costs by using more of the red metal, which is the cheaper of the two. Either that or use an alloy known as C99750T-M, which is composed of 51% copper, 14% nickel, the remaining being cheaper-cost metals zinc (33%) and manganese (2%).

In the end, the nickel and 10-centime tell two very different stories. One, a coin that’s run out of headroom, becoming a financial liability for a mint that seems mired in bureaucratic inefficiency. The other, a relic of stability, quietly enduring in a world of change.

A glass half-full take on Caucasus sanctions evasion

Ed Conway of Sky News recently published a very good investigation on sanctions evasion being carried out through the Caucasus. He visits the Lars border crossing between Georgia and Russia to document how smugglers are openly moving British and German luxury cars into Russia, in contravention of sanctions on Russian luxury car imports.

In a subsequent interview, Conway describes this as the the "most depressing" bit of journalism he has ever worked on. He agrees with his host that the west's sanctions are "performative," in that they are simply there to make Western voters feel good, but in reality achieve very little. He concludes: "The toughest sanctions regime in history, is anything but..."

For anyone who supports Ukraine's cause, this is all difficult to watch. However, I think that Conway has arrived at a glass half-empty interpretation of the details of his own reporting. What follows is my glass-half-full take on Conway's visit to the Caucasus. What I'm hoping to convey – using the details from his video – is that we (i.e. the West) are doing ok. Yep, we could be doing better (and hopefully will), but let's take heart at what we've achieved to date.

Conway tracks two new Range Rovers being smuggled from Tbilisi, Georgia's capital, northwards to the Lars border crossing with Russia. Prior to Conway making contact with them, the Range Rovers have already been on a circuitous trek. Manufactured in Solihull, UK in 2024, we learn that the vehicles were originally shipped by Jaguar Land Rover to a dealer in a country that does not share a border with Russia, so not Georgia, but perhaps Turkey or the Emirates. Thus the first leg of their journey would have involved a long trip in a container ship or RORO cargo ship from England to Dubai or Istanbul.

In the second leg, the smugglers who acquired the car in Turkey or UAE paid for it to be shipped to Georgia, either by boat or overland.

In the third leg, which is the only leg that Conway observes, two single trucks can be seen transporting each Range Rover through Georgia to the Lars border crossing along a skinny winding road. The Range Rovers are deposited in a parking lot next to a "forlorn" cafe on the Georgia side of the border (the parking lot appears to have no security), and after a few days a new driver is paid to take the car to the Russia side and leave it there. 

The parking lot where sanctioned luxury cars are stored at the Georgia-Russia border

Now the fourth leg begins. Another driver is contracted to bring the vehicle to its final destination in Russia. This last leg is no small trip, with the biggest Russian markets, Moscow and Saint Petersburg, at a distance of 1,800 km and 2,500 km respectively from the border.  

These successive legs add up to an arduous trip. The shipping bill is likely quite large. To boot, along each leg of this journey additional paper work must be completed, insurance purchased, border officials bribed, storage fees paid, transit license plates acquired, and taxes levied. It is Western sanctions that have imposed this haphazard shipping burden and jungle of administration on Russia's trade in Range Rovers.

But compared to what? Understanding the burden we've imposed on Russia requires that we compare the current state of affairs to the one that was taken away; namely, the highly-developed patterns of trade that existed before sanctions were deployed in 2022. As economists like to say, it's the opportunity cost, or the value of the next-best alternative, that represents the true burden of the sanctions on Russia.

What Russia has lost is the full expertise and capital of Western logistics being brought to bear on the problem of bringing Range Rovers as cheaply and rapidly as possible from Jaguar Land Rover manufacturing plants to Russian buyers. This involved Range Rovers being loaded en masse into highly-efficient RORO cargo ships in the UK and sent – not along a circuitous route passing through the Suez Canal or around the Cape of Good Hope – but by the shortest passage possible, the Baltic Sea.

In the pre-sanctions era, vehicles destined for Russian buyers were unloaded at the Port of Saint Petersburg, Russia's second-largest city, or next door at the massive Port of Ust-Luga. So the goods passed through customs just once, rather than multiple times. These two Baltic ports are purpose-built for handling large amounts of vehicles as efficiently as possible. From there the Range Rovers were transferred to their final Russian destination – not piece-meal, as appears to be the case with the Lars crossing – but in batches via dedicated rail infrastructure and multi-level car haulers. 

Illicit Range Rovers being transported one-by-one via flat bed truck to the Georgia-Russia border

Thanks to sanctions, Russia's first-choice trade route – optimized over many years of trial and error – no longer exists. It's been replaced by an improvised Rube Goldberg trade route involving two much longer sea journeys followed by a crappy single-lane road wending its way through the mountains of Georgia to a border crossing that was never designed to handle large volumes of trade. Once across the border, the contraband cars must be on-shipped using rail or road infrastructure that pales in comparison to the significant economies of scale that characterize the Saint Petersburg/Moscow hub. This is plainly an awful fix.

There's another new cost that needs to be factored in, too: the risk of being caught. Given that it is likely that the dealer in the Emirates or Turkey is part of the sanctions evasion conspiracy, they run the risk of having their dealership status being revoked should Jaguar Land Rover catch them. The dealer will therefore only sell to Russians or other Russian-linked third-parties if the price offered is a high one, enough to compensate them for the risk of losing their franchise.

This extra risk premium, combined with all the additional transportation and intermediation costs listed above, gets embedded into the final all-in price that folks in Moscow will have to pay for a new Range Rover. How high is this price? Certainly much higher than before sanctions were applied. Stephanie Baker, author of Punishing Putin, found in her reporting that western cars in Moscow showrooms were being sold for twice as much as in the U.S. The Times describes luxury Bentleys selling in Moscow for about £400,000 plus £50,000 in VAT—the same model costs just £250,000 in the UK.

Think of this extra price wedge as a sanctions tax on rich Russian car buyers. So yes, cars are squeaking through the West's sanctions blockade, as Conway's reporting reveals, but let's not forget that this comes at a big cost.

A 2,000 km drive from Tbilisi to Moscow

The sanctions tax includes another component. A car is not just a one-time purchase. It represents a commitment to make long chain of repairs and tune-ups over its lifetime. Since the new Range Rovers in Conway's video are illicit, they won't qualify for any dealership support. The warranty is probably void, too. Telematic upgrades provided by Jaguar Land Rover servers in the UK have likely been turned off. Furthermore, since Jaguar Land Rover no longer sends parts to the Russian market, all replacement parts will have to be smuggled over the border, the cost of ongoing car servicing ballooning.

So in the end, voters in the West can take at least some pride from what western sanctions have achieved. By sanctioning luxury cars, we've forced Russian elites to divert more of their finite wealth to paying for circuitous, awkward, and risky pathways into Russia. This means these elites have less left over for other things.

Now, that doesn't mean western voters can relax, and Conway's reporting is good fodder for galvanizing voters to ask their representatives for further action. While sanctions have made the pathway for Range Rovers and other goods into Russia a long and winding one, we need to keep making it even longer and more awkward.

For instance, Conway's video teaches us that there is just one way road connecting Russia to Georgia. What a fantastic chokepoint for western sanctions to target! By working more closely with Georgian authorities, the U.S. and its allies may be able to induce them to add a number of frictions to the Lars border crossing, thus forcing car smugglers to divert contraband vehicles to even more roundabout trade routes, the end result being Russian elites paying an ever higher price.

How should money laundering laws apply to DeFi?

Everyone agrees that money laundering laws apply to DeFi. The question is: how to apply them?

DeFi, or decentralized finance, is an emerging segment of the broader financial industry that delivers traditional financial services, say like trading or lending, using a novel type of database—blockchains.

These blockchains allow people to create financial robots, or bots, that the public can engage with in order to get financial services. And not just any sort of bot. These are autonomous, unstoppable, non-upgradeable financial bots. They operate independently of humans; once its creator sets it free, the bot never needs the intervention of its creator—or anyone else—ever again. The bot is unstoppable; once its code is live, it can't be erased, upgraded, or altered. The bot is incapable of deviating from its original code; it is forever locked in place.

(Most financial services provided on blockchains don't quite meet the strict standard described above. These "fake" DeFi bots are upgradeable and are driven by a human operator or team behind the scenes. The application of money laundering laws to fake DeFi bots is straight-forward. What I'm addressing in this post is the true DeFi bots, the ones that are autonomous, unstoppable, and non-upgradeable.)

Historically we haven't received our financial services from autonomous, unstoppable non-upgradeable agents. We've always gotten them from brick and mortar institutions like banks and brokerages. These institutions are run by human executives and employees who rely on a fairly malleable set of machine aids, like websites and Excel spreadsheets and SQL databases.

The application of money laundering law to banks and other financial institutions is well understood. If a bank consciously allows dirty money onto its platform, we punish the bank and the folks who run it. This follows from 18 U.S. Code § 1956, which says that anyone who knowingly conducts a transaction involving dirty money, and does so in a way to conceal its origin or disguise its control, can be punished with up to twenty years in jail for money laundering.

Here's the question: when financial services are provided through the mediation of autonomous, unstoppable, non-upgradeable bots, and not human-operated banks and brokerages, who does society punish when dirty funds are processed? What DeFi party is liable under 18 U.S. Code § 1956?

The bot itself is nonpunishable. It simply keeps on ticking. It's not a human and can't learn from punishment. So that's a dead-end.

There is no human operator or governor to punish (at least, not in the case of pure DeFi bots). The bot is 100% autonomous, operating without the aid of a human behind the scenes.

What about the creator? I've argued in a previous post on a particular DeFi bot, Tornado Cash, that it makes a lot of sense to hold the creators of unstoppable non-upgradeable financial bots accountable for money laundering, even if those creators are no longer involved with the bot in any way. To protect themselves from being charged with money laundering, creators will choose at the very outset to equip their financial bots with a means for screening out dirty funds, thus complying with the law. I'll let you read that post yourself.

There's another option. In a recent exchange with a member of congress, a DeFi lobbyist suggests that the users of unstoppable non-upgradeable financial bots—not the creators—be held liable for their own bad conduct. Here's the clip:

How should money laundering laws apply to DeFi? If users—not developers—are liable, as the clip suggests, that renders DeFi radioactive, since any user that commingles their licit funds in a tool along with criminal funds is now a potential money launderer. https://t.co/rbhtrQyi9h

— John Paul Koning (@jp_koning) September 11, 2024

This is an interesting solution. Let's work out how money laundering law spreads into DeFi if a user-pays-the-price strategy is adopted.

Say that criminals regularly place dirty funds with a certain DeFi bot, perhaps a decentralized exchange (like Uniswap), in order to clean them, and this is a widely-known fact. Next, let's look at what happens when a user with licit crypto submits their funds to the same bot. By consciously allowing their clean funds to be commingled with dirty funds and swapped for them, these licit users have themselves become bad actors. After all, helping criminally-derived funds make a getaway is a crime: we call it money laundering.

Under this user-pays-the-price scenario, DeFi becomes radioactive. Anyone interacting with an unstoppable, non-upgradeable financial bot is playing with fire, since a potential money laundering charge is just around the corner.

In an effort to reduce the odds that they face a money laundering charge, users may try to shop around for bots that have been coded with filters for screening out bad actors. Creators may try to compete with each other to attract users by providing genuinely compliant bots.

The upshot is that whether society decides to makes creators of financial bots liable for money laundering, or users liable, the end result may very well be the same. Bots will be built with anti-crime devices, thus falling in line with society's money laundering laws. That's a good result.

However, for pragmatic reasons my preference is to hold creators liable rather than users. My mental model of a prototypical retail user of financial services is a frazzled individual who doesn't have the bandwidth or knowledge to grasp exactly what they are doing with their money, because their time is divided between their family, jobs, education, church, hobbies, and other important things. What an awful burden to put on these people: "Oh, by the way, be careful where you get your financial services online, because you might be caught laundering money for the mob." Indeed, one of the advantages of dealing with a traditional bank is that a licit user needn't worry about this hazard.

Creators, on the other hand, are far fewer in number than users, are likely to be financially savvy, and probably have far more time to devote to the intricacies of financial law. And so the creator class will be better able to bear the burden of being targeted with the burden of a potential money laundering charge, and instigating the necessary compliance.

So if we had to choose who to be liable for the bad conduct flowing through unstoppable non-upgradeable financial bots, I say target creators, if possible, and not users. We all agree that money laundering laws apply to DeFi—the end goal being bots that exclude criminals—but placing the liability on users is an an inefficient and unfair way of extracting compliance.

Stablecoins – a digital version of Swiss bearer savings books

Before anti-money laundering laws arrived in Switzerland, anyone could walk into a Swiss bank and open an account without showing any ID. The bank would then issue you something called a bearer savings book, otherwise known as inhabersparheften or livrets d'épargne au porteur. Ownership of the savings book was considered by the bank to be proof of ownership of the underlying funds in the account. The person who opened the account could keep the book or, if they wanted to, pass it on to someone else without notifying the bank, at which point this second person was now entitled to the underlying funds, who could pass the book on to a third person, etc.

In essence, Swiss banks were issuing their very own version of cash.

As time passed and society's awareness of money laundering grew, usage of Swiss bearer savings books accounts was circumscribed by law. In 1977, banks were required for the first time to identify the initial customer to open the account. Also, anyone who wanted to withdraw over CHF 25,000 had to be identified by the bank. But the savings books still enjoyed a significant degree of anonymity. After account opening and prior to withdrawal, books could continue to circulate without identity checks.

In 2003, the issuance of new bearer savings books was prohibited by the Swiss government. Banks were now required to cancel existing savings books when they were presented to a bank's physical desk. Existing bearer savings books could continue to circulate anonymously from hand to hand, like cash, but thanks to steady cancellations they represented just 0.002% of the total assets held in Swiss bank accounts by 2019.

And so ended the Swiss bearer savings book. In the meantime, however, a similar financial instrument has arrived: the stablecoin.

To get some stablecoins, you need to deposit funds with the issuer, which will identify you upon deposit, but after that the stablecoins are free to circulate in the wild without any sort of checks. You can send them to a friend, and she can send them to a relative overseas, and that relative can transfer them to a drug dealer, and none of these subsequent owners need to show their IDs to the issuer. Stablecoin issuers, much like Swiss banks that once issued bearer savings books, often have no idea who they are dealing with.

So if Swiss bearer savings books have long been prohibited, why are stablecoins allowed to proliferate?

This is exactly the point made last month by FINMA, Switzerland's financial regulator, when it indicated that it will no longer tolerate the anonymous transfer of stablecoins. New guidance states that the identity of anyone holding a stablecoin must be "adequately verified by the issuing institution." So not only yourself, but your friend, her relative, and the drug dealer in the above transaction chain will be required to provide their ID.

To justify its new policy, FINMA appeals to the idea of technological neutrality. My take on technological neutrality is that just because a financial product—in this case a payments product—appears on a novel medium, or substrate (i.e. a blockchain) doesn't mean it is exempt from the same rules that already apply to equivalent products like bank savings books, which are issued on older substrates. Same function, same regulations.

Up till now, stablecoin issuers like Tether have tried to dodge these identification requirements with the legal fiction that only primary holders of stablecoins (i.e. those who originally deposited funds to get stablecoins) are their customers, and so it is only to this batch of holders that they have a due diligence obligation. Secondary, tertiary, and subsequent holders are not "customers", and so the issuers say they don't need to identify them.

But FINMA isn't buying this argument, and rightly so. All holders, not just primary ones, have a "permanent business relationship" with the issuer, says FINMA, and so everyone must be identified. You can certainly understand why FINMA wants to get ahead of this problem. If regular Swiss banks all see that stablecoins are enjoying special treatment, then they'll all join in on the party by switching over to the new substrate.

FINMA's guidance may not seem like a big deal. There are only two Swiss franc stablecoins to which it applies, and they are both tiny. Bitcoin Suisse's XCHF has under 1 million CHF in circulation, and Centi's CCHF doesn't appear to have much more. (Facebook may have run into an earlier informal version of this rule when FINMA assessed initial versions of its Libra stablecoin.)

But as a respected part of the global regulatory fabric, FINMA could very well be copied by other regulators. More importantly, FINMA is a member of the  Financial Action Task Force, or FATF, an umbrella organization representing the anti-money laundering authorities of 38 major nations. FATF promotes global anti-money laundering standards by blacklisting countries that fail to adopt them. If FINMA's policy on stablecoins is indicative of an emerging FATF approach to stablecoins, then expect it to spread.

The shocking thing to me is that it has taken this long for a major global regulator to issue a concrete ruling on the issue of stablecoin anonymity. It's about time. Standard anti-money laundering practice requires financial institutions to verify who is using their platform. Stablecoin issuers shouldn't get a free ride.

China is slowly joining the economic war against Russia

I recently shared a chart on Twitter showing Chinese exports of ball bearings to Russia. Here it is:

Having accelerated after Putin's invasion of Ukraine to a run-rate of around US$5-7 million per month in 2023, Chinese ball bearing exports to Russia have been ratcheted down to the $2-3 million level in 2024, about where they stood prior to the invasion.

What's going on here? As Russia's closest ally, shouldn't China be sending Putin all the ball bearings he  wants? Russian tanks are being destroyed every day and ball bearings are a crucial component for building replacements.

Before answering this question, we need a bit of background.

We can think of the economic response to Russia's illegal invasion of Ukraine as progressing in two stages. The first stage of the economic war involved a coalition of liberal democracies (U.S., the EU, Canada, Japan, Switzerland, South Korea, Norway, the UK, and more) reducing their own economic linkages to Russia. Europe drastically scaled down its imports of Russian natural gas. Imports of Russian crude oil into Japan and Germany were slashed to bare bone levels. Western corporations like Coke and John Deere decamped. And the U.S. made an effort to cut down on exports of military goods and so-called dual-use items, which have both commercial and military applications. Ball bearings fall into this category, since they are useful not only for civilian vehicles but also artillery and tanks.

The second stage of the economic war has only recently ramped up, and involves the coalition exerting its influence on non-coalition countries like Turkey, United Arab Emirates, China and India in order to get them to cut down on their economic linkages with Russia.

A key component of this next stage are the U.S. secondary sanctions that were introduced in December 2023 by the U.S. Treasury's Office of Foreign Assets Control ("OFAC"). I've written about them here, here and here. 

In short, if OFAC catches a foreign bank in Shanghai, Delhi, or Dubai facilitating transactions involving Russia's military-industrial complex, including dual-use goods, then that bank risks being cut off from the U.S. banking system. Because the U.S. banking system is so vital, foreign banks prefer to cease all offending Russian trade. This effectively stops Turkish or Chinese ball bearing manufacturers (as well as any other businesses that deals in dual-use goods) from dealing with Russian buyers, since these manufacturers are reliant on their local banks for cross-border payments.

Along with OFAC's introduction of secondary sanctions, there has also been a big step-up in U.S. export controls, which are overseen by a different agency, the U.S. Department of Commerce's Bureau of Industry and Security ("BIS"). The BIS maintains a list of U.S.-produced dual-use items. American and foreign entities are required to get a license from the BIS before exporting, reexporting, or importing certain items on its list.

In March 2024, the BIS broadened the criteria that triggers a licensing requirement. The criteria now includes any involvement of entities listed under fourteen different OFAC sanctions programs, the majority of which are linked to Russia and Ukraine. So for example, if a Hong Kong-based wholesaler intends to re-export a BIS-listed item to a country like Armenia, or transfer that item within Hong Kong, and they fail to realize that the recipient is an actor on one of OFAC's Russia-related sanctions list, then that Hong Kong wholesaler has now violated U.S. export controls. To prevent violations, intermediaries like our Hong Kong wholesale must sharpen their screening requirements.

These new rules, which have been described as a BIS "force multiplier" of OFAC's sanctions program, are intended to assert influence over a broad cross-section of dealers that specialize in indirectly re-exporting goods to Russia. These indirect routes often proceed through a labyrinth of pit-stops in jurisdictions like UAE, Hong Kong, and Kyrgyzstan.

Back to ball bearings. How is the second stage of the economic war progressing? The chart at the top of the page suggests the new measures may be working. Recall too that in February I wrote a post tracking what seemed to be some initial anecdotal indications of success. In the rest of this article I want to use another four or five months of data to provide a more complete picture of how China's interactions with Russia have being affected.

China is crucial to Russia because it has a become a key source of goods destined for the battlefield. According to a report from the KSE Institute, some 44% all Russian parts destined for the Ukraine battlefield were linked to producers in coalition nations, primarily the U.S. These include parts that have been branded by American stalwarts like Intel and Analog Devices. Mainland Chinese producers accounted for 47% of battlefield goods (see chart below). However, progressing further down the value chain to country of dispatch, around 56% of all battlefield parts—including the U.S.-produced ones—get to Russia by way of China, and another 22% via Hong Kong, a special administrative region of China. Together, almost 80% of Russia's battlefield parts are dispatched from these two Chinese sources.

Source: KSE Institute

In other words, not only is China producing its own battlefield goods destined for Russia, but it is also responsible for the final re-routing to Russia of most U.S. produced battlefield goods, at least in the period starting in January 2023 and ending that October.

The items that make up the battlefield goods cited by the KSE Institute are derived from the coalition's Common High Priority List, which includes 50 dual-use items that Russia seeks to procure for its weapons programs, one of which is ball bearings. For the rest of this article I will focus my analysis on the four most important goods on the Common High Priority list: Tier 1 items. Tier 1 items consist of microelectronic circuits (processors, memories, amplifiers, and other circuits) that the BIS says play a "critical role" in the production of advanced Russian precision-guided weapons systems. Russia lacks the ability to produce these items and is reliant on a limited number of global manufacturers, according to the BIS, which only amplifies their importance to Russia.

The chart below shows Chinese exports of Tier 1 items to Russia as reported by China's customs authority. Prior to Russia's invasion of Ukraine, these exports typically came in at around $5 million per month. Post-invasion, they rose to a range of $10 million to $34 million per month, suggesting significant military diversion. 

With the arrival of secondary sanctions in December, monthly Tier 1 exports have fallen below the pre-invasion watermark of $5 million.

The above customs data does not include Hong Kong, which along with mainland China has become a major Chinese source of Tier 1 exports to Russia. To provide a more complete picture, the chart below adds Hong Kong customs data to the mainland customs data. Running between $25-$60 million during most of the war, Tier 1 exports to Russia from the Chinese mainland and Hong Kong have collapsed to sub-$15 million levels this summer, lower than at any point in 2021.

That's quite a big plunge, and certainly suggests that the coalition measures are working with respect to China. Skeptical readers may suggest that China has stopped exporting Tier 1 items directly to Russia only to re-route them via third party nations. According to this theory, the $40-$50 million decline in monthly Chinese exports is being made up by a $40-50 million rise in Chinese exports to, say, Kazakhstan, which eventually make their way to Russia.

Below, I've plotted all Tier 1 exports from the Chinese mainland and Hong Kong to a group of Russian neighbours that includes Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, and Uzbekistan.

China's Tier 1 exports to Russia's neighbours rose after the invasion, suggesting significant diversion of exports to Russia, and in March 2024 hit $7 million, their second-highest level over the entire 2021-2024 period. However, over the last three months Tier 1 exports to Russia's neighbours have plunged below even pre-invasion levels.

So no, the theory that third-parties have replaced direct China-Russia trade is not borne out in  the data.

In sum, a variety of U.S. economic tools including secondary sanctions, bolstered export controls, and other types of moral suasion seem to be prying China out of the arms of Russia and into the coalition's effort to economically strangle the Russian war machine.

But there's more to be done. China's exports of high priority goods like circuits and ball bearings have fallen in 2024, but they haven't yet hit zero. That will require more pressure on the Chinese government as well as enforcement against Chinese and Hong Kong companies that violate sanctions and/or exchange controls, as well as against intermediaries in third-party nations like Kazakhstan. To further tighten the screws, the coalition will need to constantly broaden the range of economic activity between China and Russia that it deems off-limits. For now, the coalition says that it is perfectly fine for Chinese companies to export cars and vacuum cleaners to Russia, but there may be a time at which that permissiveness will have to change.

In fact, one of the coalition's biggest escalations in the sanctions war occurred in June, with the U.S. secondary sanctions program being extended to include Russian banks. (I wrote about this here.) In effect, Russian financial institutions are now off-limits for Chinese banks (and banks elsewhere, too), unless these Chinese banks want to lose their access to the U.S. banking system. This blacklisting of Russian banks will make it very difficult for Chinese exporters to continue doing business with their now-unbanked Russian counterparts, further eating into the trade relationship between the two nations.

The trade data in the above charts does not yet include the effects of the extension of sanctions to Russia's banks, but I suspect the effects will be significant.

Welcome to the economic war against Russia, China. We hope you continue to do your part.