Tuesday, February 11, 2020

Cutting Martin Sellner off from the payments system

I few weeks back I learned who Martin Sellner is. If you haven't heard of him, Sellner is a prominent Austrian populizer of remigration, the idea that non-whites living in Western nations should be sent back to where they come from.

In a recent tweet from his wife, Brittany Sellner, we find out that Sellner has been kicked off of by a long list of banks and payments platforms.

The companies that are accused of removing Sellner include German bitcoin exchange Bitpanda, a number of European banks, and payments processors PayPal and Stripe.

Should we support efforts to stop prominent remigrationists from making payments? It's a tricky question, one I've touched on before. What should be the ground rules for removing individuals with views like Sellner's from payments platforms? 

A bit of background first. Sellner isn't your typical advocate for the forced repatriation of ethnic minorities. He doesn't walk around with a shaved head or a swastika tattoos. He's personable, clean cut, well-dressed, social media savvy, and suave.

Sellner and his fellow Identitarians, the group to which he belongs, distance themselves from predecessor groups who have espoused versions of remigration, say like the neo-Nazis. Identitarians do not advocate racial superiority, hate, or violence. "We respect other cultures, we don't hate different cultures, we just want to preserve our own culture," says Sellner in this video.

To help spread ideas like remigration, Sellner has pulled off a number of stunts. These include crashing a theatrical piece in which all the actors were refugees and hiring a boat to sail the Mediterranean and harass NGOs that are helping boat people.

Although Sellner says that he respects other cultures and doesn't advocate hate, this doesn't square with the fact that any remigration would be an incredibly violent event. "I don't hate you. I respect your culture. I just want to kick you out of the country." What an incongruent set of beliefs!

How might remigration play out? Let's imagine how it would work in my home town of Montreal. (Yep, Quebec has its own Identitarian branch). Many Montrealers are members of a visible minority, including those of Middle Eastern, North African, West African, Latin American, and Asian descent. Laws would have to be struck down so that these people's citizenship could be revoked. Even the most despicable Canadians haven't been treated this way (think Luka Magnotta or Paul Bernardo).

Next, these new non-citizens would be rounded up and interned. Then they'd be sent down to the Old Port and shipped out by ocean freighter. Those who didn't leave peacefully would be hunted down, maybe shot. Any whites who helped them would become criminals. Whole neighbourhoods would be denuded of their population. Businesses across Montreal would suddenly cease to exist. Mixed-race families would be torn apart. It would be awful. 

Remigration is a violent idea. But at the same time, removing someone like Martin Sellner from the payments system is no small matter. Like garbage disposal service, or running water, or electricity, the ability to make payments is a necessity. If folks like Martin Sellner can't pay, they can't live.

The water utility generally won't sever the neighbourhood asshole's connection just because he's being unpleasant. Likewise, as long as Sellner isn't doing anything explicitly illegal, should he not be able to get access to basic payments services? If access to electricity, water, and garbage disposal services are all apolitical, maybe the same should apply to payments.


I'd suggest the following way to referee this conflict.

We can think of the payment system as being comprised of backbones and onramps. A backbone is a shared piece of financial infrastructure across which a nation's payments/payments information flows. Any given country will have just a handful of payments backbones. Each one of them processes a huge amount of economic value.

For instance, one of the key American payments backbones is Fedwire, a large-value payments system operated by the Federal Reserve. In Europe the equivalent is Target2. In Canada it is LVTS. You probably haven't heard of these utilities. But they are vital to every one of us. Every time we want to make a payment, we are (ultimately) using one of these giant but unknown pieces of financial infrastructure. The utility bill you paid from your bank account last week? It was settled on Fedwire (or Target2 or LVTS).

Banks act as onramps to these backbones. Your account at the State Bank of Toledo, for instance, is your means for accessing Fedwire. Vancouver City Savings Credit Union is your gateway to Canada's LVTS.

Whereas the list of payments backbones is short, the list of onramps is long. There are 4,700 banks in the U.S. Which means there are 4,700 access points. In Europe, there are 1,056 financial institutions that directly participate in Target2. Canada has fewer banks, around 90.

Banks aren't the only type of onramp. Non-bank financial institutions and fintech firms provide indirect access to Fedwire and Target2. PayPal, for instance, is a popular way to make payments, but it doesn't actually hold customer deposits or have access to Fedwire. Rather, all customer funds are custodied at JP Morgan, PayPal's banker. So PayPal account owners get access to Fedwire via JP Morgan.

I'd argue that backbones like Fedwire and Target2 should not be allowed to block Martin Sellner. So if an onramp sends Sellner's utility bill payments or his donations to be processed by a backbone, that backbone shouldn't censor those transactions.

Onramps, however, should be able to choose if they want to serve Martin Sellner or not.

Onramps like banks will often specialize in building up expertise in serving a certain set of customers (i.e. some banks may cater to business customers rather than individuals). Or they may have designed their brands to attract a wide range of customers and employees. Connecting Martin Sellner may not be consistent with an onramp's expertise. Sellner is a risky client, after all, one who has received payments from terrorists. A bank that lacks the ability to closely monitor his transactions should be free to ask him to leave.

Sellner may also threaten the onramp's brand. By connecting Sellner, the onramp could be damaging  its relationship to the rest of its customers, or put the onramp's commitment to its employees, many of whom may be visible minorities, at risk. Onramps should be free to protect their brands from being associated with remigrationists.

As I said, onramps are plentiful. While it might be a nuissance to be cut off by one of them, Martin Sellner will always be able to find an alternative payments provider. If not, he and others like him might consider starting their own onramp, say an Identitarian bank or First Amendment Payment Processing.

The same logic doesn't apply to backbones. Because backbones are often set up as government-enforced monopolies, anyone who has been denied access will have no other option for making payments.

Backbones aren't solely creatures of government monopoly. Strong market forces push everyone to use the existing shared payments infrastructure. The privately-owned Visa and MasterCard networks, for instance, are incredibly useful because everyone is already connected to them. A new competing card backbone can only become useful by attracting a large base of card users, but it can't attract this user base if it isn't already useful. This chicken & egg problem is incredibly difficult to solve. And so we tend to congregate around a few central payments hubs.

I think it would be dangerous to start regulating access to payments backbones such as Visa or Fedwire on the basis of moral fitness. The core service that a payment backbone provides—universal financial connectivity—is as important as water or electricity. Excluding someone from any of these systems could potentially kill them. We may not like Sellner's ideas, but don't forget that he's a human.

Once we start trying to rid ourselves of the world's Martin Sellners, we risk politicizing the entire backbone layer of the payments system. Other people who aren't so threatening could end up getting exiled simply simply because they are unpopular or different.

I'm far less worried about exclusion at the onramp level of the payments system. Even if PayPal or Bank Austria won't connect Martin Sellner, another onramp will. This doesn't mean that prominent remigrationists get off scot-free. They will end up atoning for the violence of their ideas by having to endure a constant stream of of inconvenient and embarrassing disconnections and reconnections.


Which gets us back to the original tweet. The list of institutions that have disconnected Sellner is comprised solely of onramps. Not a single backbone (Target2, Visa, MasterCard, SWIFT) has removed him. I'd say that these results abide by the rough set of rules set out in this post: onramps, not backbones. So far, the cutting off of Martin Sellner has been a fair one.

And while being cutoff by PayPal, Stripe, and a few banks has no doubt been a pain for Sellner, there are still several onramps that continue to serve him. On his website, Sellner accepts donations to the following IBAN account number HU85117753795858688200000000. A quick search shows that this account is held at Hungary-based OTP Bank.

Donors can also pay him via SubscribeStar, a subscription-based crowdfunding platform. (Presumably he added SubscribeStar after being cutoff by Patreon, the more mainstream alternative.)

Sellner also accepts cryptocurrency donations using a Coinbase Commerce button:

Screenshot of Sellner's website from February 10, 2020

Coinbase is one of the worlds largest cryptocurrency exchanges. The Coinbase tool that Sellner is using on his site provides a relatively painless way for merchants to receive cryptocurrency payments. Using Internet Archive's Wayback Machine, I see that while Sellner has been accepting cryptocurrency for some time now, but he only recently upgraded his cryptocurrency payments option to Coinbase Commerce.

Coinbase describes itself as an "open financial system for the world". Perhaps serving Martin Sellner is not inconsistent with this philosophy. "Coinbase provides payments services to everyone, remigrationists or not." On the other hand, Coinbase's mission statement also includes the goal of "bringing about more economic freedom... and equality of opportunity in the world." Remigration is certainly not about economic freedom or equality. It is about destroying it.

A quick glance through Coinbase Commerce's terms of service specifies that an account cannot be used in ways that are
"threatening, intimidating, harassing, hateful, racially, or ethnically offensive, or instigate or encourage conduct that would be illegal, or otherwise inappropriate, including promoting violent crimes."
Sellner himself may be as gentle as a dove, but the idea his is promoting—remigration—isn't. One wonders why Coinbase has agreed to do business with him.

Monday, January 27, 2020

What happens when a 96 bitcoin ransom payment ends up on Bitfinex?

"Hello, to get your data back you have to pay for the decryption tool, the price is $1,200,000... You have to make the payment in Bitcoins."

This is a snippet from a recent court case concerning ransomware that just crossed my desk. Companies that fall victim to ransom attacks fear the publicity it might attract, so the details of these attacks are usually swept under the table. But in this case, the ransom payer—a British insurer that traced the bitcoins to Bitfinex, a major bitcoin exchange—has appealed to the UK High Court for an injunction, thus providing us with a vivid peak into the inner workings of an actual attack.

Ransomware is a big issue these days. A hacker maliciously installs software on a victim's computers, encrypts various files, and then asks for a bitcoin ransom to fix the problem.

It's the bitcoin leg of this transaction that has made these attacks economical. Prior to bitcoin, running an illicit business based on ransom payments was fraught. Bank accounts leave a paper trail. Cash, though anonymous, can't be transferred remotely. And gift cards are limited to small amounts. With bitcoin, hackers finally gained access to a form of electronic cash that allowed them to not only make remote ransom demands, but large ones too.

A steady parade of ransomware has since emerged. While early types of ransomware like WannaCry, CryptoLocker, and Locky targeted personal computers for small amounts of money, the most recent strains—Maze, Sodinokobi, Nemty, and others—attack governments and enterprises for million dollar amounts. The Nunavut government, a territory in Northern Canada, was a recent victim:

One thing I've never really understood is why ransomware can be so widespread given that all bitcoin transactions are written to the public blockchain. I mean, can't a bitcoin ransom payment be easily tracked to its final destination, say a bitcoin exchange, and frozen?

The court case in question, AA v Persons Unknown & Others, Re Bitcoin, provides some insights into just that. Although the judge heard the case back on December 13, 2019, the text of the injunction was only released a few days ago.

It makes for entertaining reading. Here's a short timeline:
  • In Autumn 2019, a Canadian company was hacked. The hacker installed BitPaymer, a strain of ransomware, which encrypted the company's files
  • The hacker demanded $1.2 million in bitcoins
  • Luckily, the Canadian company had cyber crime attack insurance with a British insurer
  • The British insurance company hired an "Incident Response Company" to pay the ransom
  • The response company negotiated for a reduction in ransom to $905,000
  • The bitcoins were acquired and sent to the hacker on October 10, 2019. According to the injunction, the purchase of the 109.25 coins was conducted by "an agent of the Insurer, who was referred to as JJ."
  • Having receive the ransom, the hacker provided the fix. The files were successfully decrypted
  • The insurance company wanted its money back, so in December it hired a blockchain analytics company, Chainalysis, to trace the ransom payment
  • Chainalysis tracked 96 of bitcoins to an address linked to Bitfinex, a major bitcoin exchange
  • The insurer then went to British High Court to force Bitfinex to reveal the identity of "PERSONS UNKNOWN WHO OWN/CONTROL SPECIFIED BITCOIN" and to freeze the 96 bitcoins.

So were the 96 bitcoins returned to the insurer?

For now, we don't know the final outcome. The document only brings us up to December 13, 2019, when the judge gave Bitfinex till December 19 to provide the names of “persons unknown”, the owner of the 96 bitcoins. To prevent "persons unknown" from getting wind of the proceedings and fleeing with their coins, the hearing was held in private and the text of the case suppressed. The document having been made public, we can assume that some sort of resolution was arrived at.

It's interesting to speculate what this resolution might have been. Bitcoin is still a relatively new, and thus largely undefined, phenomenon. As bitcoin cases slowly trickle into the court system, the decisions made by judges will be important in determining the eventual legal status of cryptocurrencies.

It could be that "persons unknown" is the same individual who perpetrated the initial ransom attack, and they just haven't yet sold the 96 bitcoins yet. In which case the conclusion is simple: the guilty party will be prosecuted and Bitfinex will return the bitcoins.

But it is more interesting (and more likely) that "persons unknown" is a third-party (say an over-the-counter broker) who bought the bitcoins from the hacker, and deposited them at Bitfinex, and hasn't sold them yet.

This third-party could be entirely innocent about the origin of the coins. They might try to say to the judge: "hey—we didn't know the 96 bitcoins we bought were linked to ransom payments. We shouldn't have to give them back."

But that's not how property law works. Even if you accidentally come into possession of stolen property—and surely ransomed bitcoins qualify as stolen—then a judge can still force you to give them back to the rightful owner. This would be bad news for the innocent broker. Being obliged to cough up 96 bitcoins could easily bankrupt it.

"Persons unknown" might respond to the injunction by pleading that the 96 bitcoins are a form of money, like banknotes, and so they needn't be returned. Banknotes, coins, and other highly-liquid paper instruments have a very special legal status. If you unknowingly accept some banknotes from someone who just obtained them illegally (say via ransom or theft), the law can't compel you to give those banknotes back to the original victim. Money, as the great British jurist Lord Mansfield once declared, isn't like regular property: it "can not be recovered after it has passed into currency."

This special legal status (which I’ve written about before) was granted to banknotes centuries ago in order to ensure that these early forms of money remained highly liquid. If every merchant had to verify that the notes they were about to receive weren't stolen, the wheels of trade would have ground to a halt. Whether a modern judge would be willing to extend this sanctuary to cryptocurrency, and thus allow “persons unknown” to keep the 96 coins, remains to be seen. But I’m skeptical.

Another possibility is that the person (or company) that innocently accepted the 96 ransomed bitcoins and deposited them on Bitfinex has already sold them. If so, which party does the British insurance company have to pursue? Some entity (or group of entities) must now be in possession of the 96 bitcoins, right? Can’t the insurer just go after the next person down the chain?

I don't know the specifics about how an exchange like Bitfinex hold bitcoins for clients, but it may be very difficult to pinpoint who actually has title to those specific 96 bitcoins. When bitcoins are deposited at an exchange, they are sent to the exchange's hot wallet along with all other incoming bitcoin deposits. So the ransomed bitcoins would have been commingled with a bunch of clean bitcoins.

When the person who originally deposited the 96 bitcoins on Bitfinex put in an order to sell on the exchange's order book, the unsuspecting buyers (all of them Bitfinex customers) would now have a claim on various bitcoins held in Bitfinex's hot wallet. Are the bitcoins on which they have a claim necessarily the ransomed ones, and thus subject to the injunction? Or do the buyers just have a general claim on any random bitcoin held on their behalf by Bitfinex? If so, would that mean that Bitfinex itself is on the hook for paying the insurer 96 bitcoins?

Anyways, you can see how this all gets complicated very fast. A lot is riding on how thoroughly the history of unspent bitcoin outputs can be traced.

Given bitcoin traceability and the ease of getting an injunction, one can imagine that it might make sense for insurers, bitcoin exchanges, and over-the-counter traders to build some sort of private "ransom registry". The moment that an insurer pays a ransom to a hacker, that insurer simultaneously announces the offending address to the registry. A verified OTC trading desk can now protect itself from potential bankruptcy by always checking the registry to make sure that any bitcoins offered to it are "good" bitcoins. Exchanges too would likewise cross-check incoming bitcoin deposits against the registry.

This would be good news for potential ransom victims. With the exits for ransom payments being choked off, these sorts of exploits would become less feasible. Extortionists may simply stop trying to run their schemes.

You could also imagine hackers coming up with strategies for dissuading victims from posting transactions to the ransom registry. "If you announce the ransom payment to the registry, we'll leak your files to the public," or something along those lines.

Or maybe extortionists will simply start to use bitcoin mixers more. Mixers are services that allow people to commingle their bitcoins in order to preserve anonymity. Astonishingly, most ransom payments don't currently go through mixing services. According to Chainalysis, the company that was hired by the British insurer, around half of the addresses to which ransom is paid redirect the bitcoins to an exchange.

But even if hackers did use mixers, bitcoin exchanges may be reticent to accept incoming deposits. Binance, for instance, recently refused to make a payout to Wasabi, a wallet that automatically mixes bitcoins. Should exchanges like Bitfinex all refuse to accept bitcoins that have been mixed, that chokes off the ability to extort people using bitcoin as ransom.

For now, we don't know how the defendant’s responded to the injunction. But in any case, it makes for interesting speculation.

Sunday, January 26, 2020

Monetary policy is not a tightrope

[This is a guest post by Mike Sproul. Mike has posted a few times before to the Moneyess blog.]

Here is a summary of the Federal Reserve’s Principles for the Conduct of Monetary Policy, which aims at “walking the tightrope” between inflation and unemployment:
…the central bank should provide monetary policy stimulus when economic activity is below the level associated with full resource utilization and inflation is below its stated goal. Conversely, the central bank should implement restrictive monetary policy when the economy is overheated and inflation is above its stated goal.
In contrast, here is the real bills doctrine:
Money should be issued in exchange for short-term real bills of adequate value.
The real bills doctrine was developed by practicing bankers over centuries of experience, and was written into the Fed’s original charter. The real bills doctrine survived for centuries because banks that obeyed it survived. They tended to stay solvent, and they provided an elastic currency that grew and shrank with the needs of business. At the same time, the real bills doctrine helped banks to avoid inflation, recession, liquidity crises, and bank panics.

In this essay, I hope to make the point that as long as the Fed obeys the real bills doctrine, it cannot go wrong in issuing as much money as the public will absorb. In other words, monetary policy is not like walking a normal tightrope. It is perfectly safe to lean in the direction of “too much money”, but dangerous and pointless to lean in the direction of “too little money”.

A few points to notice:

1. As long as new money is issued in exchange for adequate backing, the Fed’s assets will move in step with its issue of money, and there will be no inflation. This explains (among other things) why the Fed was able to issue enormous amounts of money after 2008, without causing inflation.

2. If unemployment is a threat, then the Fed should not hesitate to issue new money (adequately backed). Unemployment is often caused by a tight money condition and accompanying liquidity crises. Issuing new money in this situation will relieve the liquidity crisis, thus reducing unemployment. Meanwhile, adequate backing assures that the new money will not cause inflation.

3. If inflation is a threat, then a restrictive monetary policy will only succeed in creating a tight money condition, without addressing the real problem, which is too little backing per unit of money. The right solution to inflation would be to correct whatever problem is causing the Fed’s assets to fall relative to its issue of money, and then, so long as backing is adequate, issue as much money as the public will receive. The only drawback is that the public might be faced with unwanted cash piling up in vaults and mattresses, but the storage cost of too much cash would be insignificant in comparison to the recessionary effects of too little cash. Besides, unwanted cash can only pile up so much before it simply refluxes to its issuer.

The recessionary effects of tight money, as well as the stimulative effects of issuing new money, have been noted by nearly all observers of monetary history.
The remedy was forthcoming in a scheme prepared at a meeting which had been held a week earlier (April, 1793) at Pitt’s private house. It provided for the creation of additional liquid assets in the shape of Exchequer bills, to be lent to temporarily embarrassed firms. By this means the channels of trade were successfully thawed, and, as it proved, without loss to the Treasury. Clearly, therefore, the panic was due to a temporary need for greater liquidity, which the Bank could not this time meet by contracting advances to the government, since these were needed to prosecute the war. (Ashton and Sayers, p. 10, 1953).
The real bills view is that the Fed should not only provide liquidity in times of crisis, but should provide abundant liquidity at all times, in order to assure that crises never get started in the first place. So the real bills doctrine tells us not to worry that the Fed’s balance sheet has been exploding over the last few months. An exploding balance sheet may be exactly what the economy needs. But the “tightrope” mindset makes the Fed wary of issuing too much money, for fear of causing inflation. This fear is unjustified. On real-bills principles, the Fed need only take the simple precaution of only issuing cash in exchange for assets of adequate value, and inflation will cease to be a threat. We have nothing to fear from too much money, and everything to fear from too little. Rather than unwinding the Fed’s balance sheet, the Fed should unwind its “tightrope” approach to monetary policy.

Wednesday, January 15, 2020

Flooding or marijuana? Two theories for falling cash demand

When Canada legalized marijuana in October 2018, the amount of banknotes in circulation took a sudden plunge.

In a 2019 paper available here, economists Charles Goodhart & Jonathan Ashworth theorized that because the marijuana trade has always been conducted using anonymity-providing cash, legalization meant that Canadians could now buy pot with debit and credit cards. Thus the big drop in cash held that October.

Here is one of the charts that the pair used:

Source: Goodhart & Ashworth

Goodhart & Ashworth went on to suggest that October's $1.5 billion decline in cash outstanding (1.4% of all banknotes!) provided early evidence that Canadian Prime Minister Trudeau’s 2015 promise to keep "profits out of the hands of criminals" had been successful.

Hold on! said Bank of Canada researchers Engert, Fung, Molnar, & Nicholls. In a paper published at the end of 2019, Engert et al confirmed that there had been a huge decline in notes outstanding in October 2018. (In fact, it was the biggest October decline since the Bank of Canada, our central bank, was founded in 1935.)

But unlike Goodhard & Ashworth, who could only rely on public national data on banknote usage, Engert et al had access to non-public information. The Bank of Canada economists disclosed that when huge amounts of rain inundated the city of Toronto in August 2018, two of Canada's big banks lost access to their regional note distribution centres.

Regional distribution centres are where banks bring excess banknotes collected from their customers. The centres are equipped with machines for sorting notes for quality. Good notes can be recycled back into the economy. Bad ones get sent back to the Bank of Canada. Distribution centres are also used to receive new notes from the Bank of Canada to stock bank ATMs. 

Perhaps the two banks couldn't get physical access to their Toronto centres because the vault doors were blocked by water? Were the sorting machines damaged? Maybe the notes were water-logged and had to go through the Bank of Canada's lengthy mutilated banknote redemption process? 

Whatever the case, the banks could no longer bring excess notes to their Toronto distribution centre for sorting and eventual return to the Bank of Canada, or to recycle back into the economy. Furthermore, to keep their customers happy with fresh bills, the two banks had to get extra "contingency" banknotes from the Bank of Canada. This clogging up of the system translated into far more banknotes in existence than normal. When the two banks finally "regained access" to their "quarantined" notes in October, they sent the entire surplus back to the Bank of Canada.

Using data from the Bank of Canada's proprietary Bank Note Distribution System (BNDS), which breaks down the banknote statistics for each of the Bank of Canada's 10 regional distribution points across the country, Engert et al produce the following chart for the Toronto area.

Source: Engert et al

August 2018 had a big jump in "net withdrawals" (presumably as the two banks asked the Bank of Canada for contingency banknotes and hoarded customers' unwanted and unsorted notes) followed by the huge compensating decline in October as they returned their excess note supplies.

Since Toronto is Canada's biggest city by a long shot, it biased the national statistics observed by Goodhart & Ashworth. By contrast, proprietary BNDS data shows that Montreal, Vancouver, Calgary, and other distribution points (which did not have flooding) did not show any decline in cash circulation during the October legalization of marijuana. But Montrealers smoke plenty of pot. If Goodhart & Ashworth's theory is right, we would have expected to see a big drop in Montreal regional net withdrawals of cash too.

It's not that Goodhart & Ashworth's theory about a general linkage between marijuana and cash usage is wrong. It's probably true that legalization of marijuana could get reflected in national banknote stocks.

But in Canada's case, the rollout of legalization hasn't gone smoothly. According to a recent Statscan report, only 28% of cannabis users reported obtaining all of the cannabis they consumed from a legal source. Much of this is due to the fact that prices are much higher at official stores Crowd-sourced data from Statscan shows that whereas it costs $10.23 per gram in a store, illegal pot goes for just $5.59.

Be careful of patterns in the data. They're not always what they seem.

Sunday, January 5, 2020

Cryptocurrency in a land of strict gambling laws

Kim Jin-Woo, K-pop star jailed for online gambling [source]

I recently read that South Korea will not be taxing capital gains on cryptocurrencies next year. Young Koreans who became paper multi-millionaires when XRP or some other cryptocurrency skyrocketed from 0.1 cents to 25 cents have reason to celebrate. They can sell without having to give up a single won of their winnings to the Korean tax authority.

Letting off the crypto-rich may sound like a bad tax policy. In this post I'll make the argument for why it isn't. Cryptocurrency gains enjoyed by a retail clientele probably shouldn't be taxed (nor should a big loss on their cryptocurrency holdings allow them to reduce their taxable income.)

Few nations have taken to cryptocurrency with as much gusto as South Korea. In a study from earlier this year, Larry Cermak found that on a per capita basis, South Koreans generate more visits to cryptocurrency exchanges than any other nation except for Singapore.

Why do South Koreans like crypto so much?

Korea's gambling industry may give us some insights. While gambling has been slowly liberalized in many parts of the world, South Korea's gambling rules are positively draconian.

To begin with, casino gambling is illegal in Korea. Not only that, but under the Habitual Overseas Gambler law Korean citizens are prohibited from gambling in other countries too. Earlier this year K-pop star Seungri was accused of gambling in Vegas while Shoo, another star, was convicted for visiting Macau's casinos.

Oddly, there are 23 casinos in Korea. The catch? Only foreigners can visit them. Just one of these casinos is open to South Koreans, the Kwangon Land Casino. But it is located in a coal mining area far from any big city. Given huge demand and restricted supply, gamblers who visit Kwangon must "reserve seats for blackjack and baccarat and, while waiting, wade into thick crowds to place a bet on other players’ hands."

Some Koreans try to evade harsh gambling rules by frequenting foreign gambling websites. But this requires a degree of tech savvy. Foreign currency must be snuck onto an online wallet like Skrill, and a VPN will probably be necessary since foreign casino sites are often blocked by the Korean government, redirecting to to warning.or.kr.

This roundabout route to betting isn't without danger. K-pop star Jung Jin Woo was recently imprisoned for online gambling (see image at top).


Enter cryptocurrencies, a new type of gambling technology. People who buy cryptocurrencies such as bitcoin, litecoin, and XRP are making a bet on what they think a subsequent round of players will pay for the tokens, the second round's expectation in turn a function of what they believe the third wave of players will pay. If they get this guessing game right, the earliest players win at the expense of the late ones.

The prices generated by these 24/7 mind-games are incredibly volatile. But that's part of the excitement. Bet correctly and one's entire financial life can be upgraded. With so few opportunities for wagering, no wonder that Koreans have flocked to these new financial games.

If cryptocurrencies are just another form of gambling, why hasn't the Korean government blocked them? I can think of two reasons. First, since cryptocurrencies are decentralized bearer instruments, it is difficult to screen them out. Sure, centralized exchanges can be shut down. But the stuff will squeak through informally anyways. Secondly, cryptocurrencies have been mis-marketed as a monetary technology rather than a gambling technology. The term cryptocurrency, for instance, misappropriates the word currency while bitcoin co-opts coin. Tricked into thinking that these new tokens are a form of money or currency, the Korean government has allowed them to slip through its gambling dragnet.

[Yes, there are a few niche cases in which cryptocurrency does serve as a genuine monetary technology. For instance, Matt Ahlborg has a great article chronicling how Nigerian remitters are using a combination of gift cards (iTunes, Steam, Best Buy, etc) and bitcoin to evade Nigeria's capital controls. But the majority of cryptocurrency activity is still generated by gamblers in rich developed nation, the few developing nation monetary use-cases piggy-backing on top.]

Which finally gets me back to the topic of taxing cryptocurrency winnings. In most nations, gambling winnings are not subject to capital gains taxes. (Nor can losses be used to reduce taxes). If you win $10,000 in roulette up here in Canada, you don't have to worry about the tax harvesters at Revenue Canada taking any of it. Lose $10,000, however, and the opposite applies. You can't deduct that $10,000 loss from your taxable income. The US is an exception. It is one of few nations to tax gambling gains.

There are decent reasons for eschewing a tax on gambling winning (and its converse, a tax rebate on gambling losses). Tim Worstall had a good post about this a few years back. "The point about betting of all types," says Worstall, "is that the winning of some people are, and must be, entirely offset by the losses of others." Gambling, in other words, is a zero-sum game. So if a government taxes winning roulette players and offers a tax rebate to losing roulette players, the two flows cancel each other out. On net, no taxes on roulette will be collected.

That seems like a pretty dumb tax. It has all the administrative hassles of a regular tax without generating any of the tax income.

Cryptocurrencies, like other gambles, don't generate any real wealth. Everything that a winning cryptocurrency player earns is necessarily paid by an eventual loser. Since winnings are equivalent to losses over the life-time of a cryptocurrency game, any tax income that a government collects on crypto winnings will eventually be offset by the rebate that it disburses on crypto losses. Like the roulette tax of the previous paragraph, there doesn't seem much point in bothering.

(There are some complications here. All cryptocurrencies are international gambling games--they are played across many national borders. Citizens of certain nations may have gotten into the game earlier than others. Assuming that the average Korean punter bought into bitcoin and XRP later than Americans and Europeans, a Korean capital gains tax may actually generate large losses to the Korean government. This is because the Korean government will end up paying out far more in tax rebates to losers than the taxes it collects from winners.)

By comparison, the tax situation with stocks is entirely different. A tax on stock market capital gains  and associated tax deductability of capital losses don't precisely offset each other. This is because companies like Microsoft or Exxon are not zero-sum games. The underlying businesses generate consistent income that accrues to investors. And so the revenues that the government enjoys from taxing winning stock owners far exceeds the government's payouts to losing stock owners.

So in sum, there are good reasons not to implement a gains/losses tax on betting games like roulette, poker, or cryptocurrency. Interestingly, a decision to avoid taxing cryptocurrency gains may actually help promote their usage as monetary instruments. Calculating how much tax one owes after each purchase made with cryptocurrency is a pain. Remove that headache and people may be more willing to spend them.

Thursday, December 26, 2019

The Watergate banknotes

Cash isn't quite anonymous, it's anonymous-ish.

To illustrate this, a few years ago I wrote about the 1932 Lindbergh kidnapping case. The ransom was paid in gold certificates, not Federal Reserve notes. By coincidence, the U.S. went off the gold standard the next year, and all gold certificates were called in. So when the kidnapper spent some of his gold certificates in 1934 to buy gas, his purchase was odd enough to out him to the authorities.

I recently stumbled on a more recent example of cash de-anonymization. Most people know the gist of the Watergate scandal, but to recap five burglars were caught breaking into Democratic headquarters at the Watergate building on June 17, 1972.

Who were they and what were they doing there? At first, no one had a clue. But the police did find around $3,600 in cash on them, much of it in sequentially-numbered $100 banknotes. See the serial numbers below:

Testimony of Paul Leeper, May 1973, Hearings Before the United States Congress, House Committee on the Judiciary [source]

A series of sequential banknotes meant that the cash had come fresh from the U.S. Bureau of Engraving and Printing, the agency that produces banknotes on behalf of the Federal Reserve. The new notes would have been sent to a bank which in turn distributed the notes in their original sequential order to customers.

The serial numbers of the Watergate notes also gave a geographical sense of where they had been issued. There are 12 regional Federal Reserve Banks. Notes beginning with F are issued into circulation by the Federal Reserve Bank of Atlanta, those beginning with C by the Federal Reserve Bank of Philadelphia.

Two days after the break-in, FBI agents contacted these two district banks for more information. It turns out, Federal Reserve Banks do keep track of banknote serial numbers. The Philadelphia Fed informed agents that the notes in question had been shipped to a private bank, the Girard Bank & Trust in Philadelphia, while the Atlanta Fed had shipped theirs to the Republic National Bank in Miami. 

Unfortunately, the two commercial banks did not record the serial numbers of the bills that they had distributed to the public. However, one of the burglars--Bernard Barker--happened to have an account at the Republic National Bank in Miami. (The trail to the Girard Bank & Trust turned cold).

Scanning through Barker's bank information, investigators discovered that several months before five large deposits had been made into his account. This included four checks totaling $80,000 drawn on a Mexico City bank and one for $25,000 from a Miami bank. These funds were eventually traced back to the the Committee to Re-Elect the President, an organization created to help raise funds for Nixon's upcoming election campaign.

And there was a smoking gun. A money trail from the pockets of the Watergate burglars to the President's administration. The burglars, it was further discovered, had been hired by Committee to Re-Elect the President to wire-tap Democrat party phones and photograph documents. So the President was spying on his political enemies.


There is an interesting sidebar to this story. Two days after the break-in, Senator William Proxmire, chairman of the Financial Affairs Subcommittee, contacted the Fed for information about the banknotes. In a book published in 2008, economist Robert D. Auerbach accused Arthur Burns, Nixon's appointee to lead the Fed, of refusing to cooperate with Proxmire's requests. Presumably Burns wanted to protect his boss.

In his book, Auerbach cited the following internal document, a timeline of the Federal Reserve Board's actions after the Watergate break-in. It is available in the Arthur Burns papers in the Gerald R. Ford Presidential Library:

Congressman Ron Paul aired Auerbach's allegations in front of Congress in 2010. An investigation was soon initiated by the Office of the Inspector General, an independent body that conducts oversight and audits of the Federal Reserve. In 2012, the OIG exonerated Arthur Burns and the Fed. The report noted that Burns was complying with FBI requests to avoid sharing the information lest this interfere with the investigation.


So banknote users are never entirely anonymous--the serial numbers can be used to unveil who they are. In Watergate's case it was a fairly blunt tool. The notes could only be traced to the burglar's Miami bank, not to his account.  But if tellers at the Republic National Bank had been dutifully recording the serial numbers of notes they gave to their customers, the tool would have been much more accurate, pinpointing Barker as the direct source of the Watergate banknotes.

No bank teller want to tediously record numbers by hand. But in today's world, it is technically possibly for ATMs to record banknotes using built-in serial number readers. Is this actually happening? I am pretty sure that serial numbers are not being collected by North American banks. People would be furious about potential invasions of privacy.

But not so in China. Since 2013, Chinese ATMs and tellers are required by law to record the serial numbers of all banknotes. (I am not sure if the same law applies to Hong Kong):

I snipped the above screenshot from a marketing brochure from Glory Ltd, a Japanese company that specializes in cash handling technology. Chinese laws surrounding banknote serial number collection have ostensibly been put into place to prevent counterfeit yuan from entering into circulation. But one could imagine this technology being used by the authorities to track licit money flows.

Say that a Chinese human rights activist deposits ten ¥100 banknotes into their bank account. The police might be curious about who is financing this activist. In theory, they could ask the People's Bank of China, the nation's central bank, to search the various serial number databases for the name of the owner of the bank account from which the ten ¥100 notes originally came. In this way an anonymous cash donation could be de-anonymized.

Chinese citizens who use cash in potentially risky transactions have probably already devised a solution. They can evade serial number sniffing by going through an extra step of "mixing" their cash prior to spending it. This might involve breaking up the notes in a few shops prior to passing them on to the intended recipient. Of course, this trick will only work as long as retailers are not required to install their own note-reading hardware.

I often write about the contradictions of anonymous payments. It would have been great to catch Nixon's thugs with technology that completely de-anonymizes banknote movements. But it is abhorrent to know that human rights activists might be prosecuted using this same technology. Striking a balance is difficult.

Thursday, December 19, 2019

Buying coffee with Tesla shares

It's fascinating to see how brokerages these days are offering no-commission trades, fractional share ownership, and debit card-linked accounts. With this combination of features, maybe we're getting closer to the day when we can buy a $2.50 coffee with 0.007 Tesla shares.

Right now, a debit card purchase can only proceed if there are uninvested cash balances in the linked-to account. But what if the securities held in your brokerage account could also be debit-cardized?

Imagine going to Tim Hortons, ordering a double double, and paying with your RobinHood MasterCard debit card. Behind the scenes RobinHood, an online brokerage, checks your account. All you own is a few shares of Tesla. RobinHood won't actually transfer the shares to Tim Hortons. Instead, it quickly sells a small fraction of these—0.007 shares—for $2.50 cash.

Since RobinHood doesn't charge commissions, selling the shares costs you nothing. MasterCard signs off on the transaction and presto, you've got your coffee. You own 0.007 fewer Tesla shares while Tim Horton's will soon get $2.50 in cash from RobinHood.

Stock markets aren't open on the weekend. So what happens if you want to buy groceries on Sunday? Maybe you've got 2.1 shares of Tesla in your RobinHood account. They were worth around $825 at Friday close. Something catastrophic could occur over the what remains of Sunday, but RobinHood is pretty sure that come Monday morning, those shares probably won't be worth less than $500. And so it will allow you up to $500 in weekend debit card payments. When the market opens on Monday it sells whatever Tesla shares are necessary to settle up your grocery purchase.      

If the option of paying with volatile assets like Tesla were to be widely adopted, you'd expect traditional banks to get into the game. Right now banks offer deposits denominated in fiat units like dollars or yen or pounds. But there's no reason they couldn't provide Tesla-denominated checking deposits. The fact that banks don't do this is a good tip-off that there isn't a very big demand to make transactions using volatile instruments.

Why do people prefer to pay for things using stable instruments rather than volatile ones like Tesla shares? My guess is that it has something to do with FOMO.

Given a choice between paying with their regular bank debit card or a RobinHood card, most people will choose their regular card. Spending away Tesla shares could mean that they miss out on a potentially big jump in price. But spending away fiat-denominated deposits doesn't produce any negative emotions, since deposits can always be replaced at the exact same price come next week's paycheck.

(As I suggested last year, this is a weird example of Gresham's law, where lottery-type instruments like Tesla don't get recruited as money because the market puts less value on them than a hopeful individual does.)

If no one wants to use Tesla shares to buy coffee, they might prefer to set up their RobinHood debit card to sell lower-risk securities. For example, a RobinHood customer could have their card draw down on a bond ETF like the iShares Short Treasury Bond ETF (SHV), which primarily invests in US Treasury bills.

Since SHV's price hardly fluctuates, anyone who uses SHV units to buy coffee needn't fear missing out on a big payday.

At the same time, they'd earn far more than they would on checking account. SHV currently pays around 1.68%, which after a 0.15% management fee comes out to around 1.53%. That's about the rate you could get on a high-interest saving account, which aren't usually designed for everyday spending.

Will this sort of debit-cardization of stocks & ETFs ever happen? I don't know. There could be regulations that prevent the practice, or maybe some sort of hidden cost that makes it too expensive. On the other hand, cryptocurrencies and gold have already been debit-cardized, the gold and bitcoins being sold the moment that a card purchase is initiated. I don't see why it wouldn't be technically possible to do the same with other exchange-traded liquid assets like stocks.

Crypto-linked cards haven't been very successful, probably due to the FOMO problem I mentioned earlier. (Last year, Coinbase shut down its Shift crypto card). Tesla shares would probably suffer from the same. But a low-risk ETF held in a Robinhood account wouldn't be quite so hobbled. 

Thursday, December 12, 2019

Bitcoin and sanctions

I recently watched a video with Alex Gladstein on the importance of financial privacy. In general I agree. We should be working on expanding the scope for transacting privately, although I am conscious of the tradeoffs. Anonymity helps good people evade bad rules, but we need to be wary of how it abets bad people evading good rules. (See for instance my recent post on the good & bad of using prepaid debit cards to donate anonymously).

In the above list, Gladstein intimates that bitcoin has a positive role to play in evading U.S. sanctions. I have two quick points to make.

I mean, there are U.S. sanctions that I agree with and those that I don't agree with, and I'm sure the same goes for Gladstein. I hope that the sanctions that I agree with are in fact the morally justified ones, and the ones I don't agree with are the immoral ones. By my reckon sanctions on the apartheid regime in South Africa were justified, and same with the ones on North Korea and Zimbabwe government officials. Those on Cuba and the recent ones on Iran are not.

One (admittedly-blunt) sorting mechanism for determining the morality of U.S. sanctions is how much international consensus there is on levying them. If plenty of nation's support sanctioning a regime then the odds that the target is a genuinely bad actor are higher than if just the U.S. thinks so.

Trump's recent round of Iran sanctions has almost no international buy-in. America's European allies are furious that the U.S. left the Iran nuclear deal, a carefully negotiated agreement to control Iran's access to nuclear technology. The Chinese and Russian are upset too. On the other hand, Obama's earlier round of Iran sanctions had broad support. Even Russia and China were on board.

So if consensus is a reasonable hurdle for judging sanctions, then Trump's Iran sanction don't pass muster, but Obama's passed the smell test.

All of which is to say that if bitcoin is indeed an effective tool for evading the current round of Iranian sanctions, then it had a negative role to play as spoiler to the previous round of "good" sanctions. Bitcoin might have delayed (or prevented) the 2015 Iran nuclear deal that did eventually emerge. Which would have been unfortunate.

If we do care about the morality of sanctions, bitcoin doesn't really solve anything. We need to get the sanctions correct at the outset. Don't like Trump's Iran sanctions? Try to convince your neighbours about it. Tell your American friends. Go to a protest. Dial up your government representative. Yep, it's an incredibly blunt tool. But it's the best we got.

The second point I want to make concerns how useful bitcoin actually is as a sanctions buster. In his presentation Gladstein mentions Ziya Sadr, an Iranian who can't use Visa or PayPal but can use bitcoin.

Sure, Bitcoin may give some tech-savvy Iranian freelancers a means to connect to external buyers. But it hasn't helped where it really counts. It hasn't allowed Asian refiners to keep buying Iranian oil or European manufacturers to keep their factories running. Pretty much every foreign company has stopped dealing with Iran. As a result, the nation's oil exports have cratered and its economy has gone into a tailspin. This has had a tremendously negative effect on regular Iranians.

Let's not just single out bitcoin for being ineffectual. The euro, the world's second largest currency, has also been a useless sanctions buster.

Last month I wrote a post about why U.S. sanctions are so effective. Let me give a brief recap. A foreign company--say a European refiner--currently has to choose between continuing to buy crude oil from Iran or no longer accessing U.S. markets. This means not only being shut off from U.S. energy exports, but also doing without U.S refining technology, expertise, and financial access. Any refining executive who ignores the sanctions could be blacklisted from entering the U.S. for travel, or sending their kids to U.S. schools, or getting U.S. medical care.

Source: BBC

And so given an explicit choice between the US and Iran, most companies have chosen the US, since it has much more to offer. In our globally interconnected world, the population of willing-to-be-sanctioned companies is pretty much non-existent.

Having some sort of alternative money like euros or bitcoin doesn't provide much of a work-around.

Say that our European refiner decides to do a bit of business with Iran under the table in euros (or bitcoin) rather than dollars. All sorts of people will touch this transaction, not just the payment side but also the movement of crude. A banker, a bitcoin exchange, or a freighter captain could rat the refiner out to the US Justice department. And so the refiner would be fined or even worse blacklisted, which would means losing all access to US resources. The risk is simply too high.

In sum, the case for bitcoin as a sanctions buster is not clear-cut. Genuine evil leaders probably should be sanctioned, the less ways to short-circuit the blockade the better. And given the way that U.S. sanctions are structured, bitcoin may not provide much help anyways.

Saturday, December 7, 2019

A way to make anonymous online donations

Paying for things online usually means giving up plenty of privacy. But this needn't always be the case. Last night I donated to a local charity via their website and didn't have to give up any of my personal information.

The trick for achieving a degree of online payments anonymity? Not bitcoin, Zcash, or Monero. I used a product created by old fashioned bankers: a non-reloadable prepaid debit card. (I wrote about these cards here and here).

Had I used a credit card or PayPal, all sorts of parties would have gotten access to my personal information including the site owner, the payments processor, my bank, the site owner's bank, the credit card networks, my partner, and many more. To get a good feel for how many different parties touch an online payment, check out this graphic by Rebecka Ricks, which shows how PayPal shares your information.

I bought my prepaid card--a Vanilla card--with $25 cash at a pharmacy. For it to be usable online I had to register it at Vanilla's website. That meant inputting my postal code. But that's all the information that Vanilla asks for. In my case I used my actual postal code, but I doubt that the system would have protested if a privacy-conscious user were to submit the wrong one.*

So at this point I've got a fully-loaded online-enabled card that has not been directly fed any information about my identity. (Note that this is how the process work in Canada. It may be different in the U.S. and elsewhere).

Next step, choose a charity. At the charity's website I entered my Vanilla debit card number, the CVV, and $10 as my amount to donate. The site also asked me to enter the name on the card. Because a prepaid card only says "For You" on it and not your name, just enter that or John Doe. Voila. Payment made:

Why on earth would anyone want to make an anonymous online donation? For my part, I was simply experimenting with my prepaid card. But I can think of several licit reasons for why people might want to donate anonymously with prepaid debit cards:
  1. Many people share bank accounts. They might not want their partner to know that they are donating to a cause that their partner might not support.
  2. A donor may not want the donee to know their identity lest the donee use it in a way that hurts the donor. For instance, if in public life I am a well-known conservative Evangelical, but I donate to a cause (say abortion education) that I privately support, I might prefer avoiding any chance that the donee leak my information in an attempt to 'out' me.
  3. I like the charity, but don't trust it or its chosen payment processors to protect my information from hackers.
  4. I don't want the charity to have my information so it can't inundate me with spam.
If non-reloadable prepaid cards can meet people's legitimate privacy needs, there is also a nefarious side to them. Anonymity allows people to evade rules about donations. For instance in Canada, there is a certain type of donation that is highly regulated: political donations. Below I've listed a few keys regulations:
  • No cash donations above $20
  • No anonymous donations above $20
  • The identities of contributors that have given $200 or more must be reported to Elections Canada, which will publish them
  • No single individual can contribute more than $1600 in a year.
Canadians have good reasons for supporting these limits. We don't want wealthy people to have an outsized influence on politicians. And we want donations to be transparent so we can see how politicians might be influenced by certain donors.

I can imagine plenty of scenarios in which motivated donors may want to break these rules. Say that a set of business owners in the restaurant industry stand to profit if the Liberal candidate wins because she supports removing regulations that increase restaurant operating costs.

After legally donating $1600 to the Liberals, some less savoury restaurant owners might want to illegally funnel more funds into party coffers. Cheques, credit cards, and other banking routes would be too risky. They establish a clear connection between the owner's identity and the donated funds.

A motivated restaurant owner can instead use $10,000 in cash to buy prepaid debit cards. They then go to the Liberal's website and donate $199.99 fifty times (for a total of $9999.50) using bogus names like John Doe, Jane Doe, etc. Since each transaction is under $200, they won't trigger the rule that requires such donations be reported to Elections Canada. And the Liberal Party probably doesn't have the capacity to cross-check each of the fifty payees to verify that they are associated with real identities.

This rinse-and-repeat strategy highlights one of the ambiguities of prepaid regulations. To reduce the potential for fraud and money laundering, regulators in Canada and the U.S. disallow non-reloadable prepaid cards with a face-value in excess of $500 (I believe that's the number). But since these cards are relatively anonymous, there's nothing preventing a would-be fraudster from using multiple cards to get around the cap.**

In any case, I'm not saying that this sort of donation fraud is occurring. But it's plausible. There's a reason that gift card and prepaid card fraud is rampant in North America. The relative anonymity that cards offer makes them a tempting tool for criminals.

As always, there is a yin/yang nature to anonymous payments. Anonymity is great when it protects well-meaning people from harm, but not so great when it protects bad people from good rules. Striking a balance is tricky.

* To access Vanilla's website, I had to disable my tracking blocker. Which means that the website probably has all sorts of processes going on in the background while a Vanilla user enters their postal code. These processes could link the user to their identity by cross-referencing the data gleaned by Vanilla's trackers against other data that has been collected elsewhere. This is probably an issue for these who want all-out privacy, and steps would have to be taken to mitigate information leakage. As they say, there is probably no such thing as pure anonymity, only degrees of anonymity. But for anyone who simply wants to enable a prepaid card in order to prevent their partner or the donee from seeing their transactions, then it's probably not a big deal.

**The way to nip donation fraud in the bud would be to require payment processors to avoid processing any prepaid debit card payment for political parties, or to limit cards to some inconvenient amount like $5 so that a rinse-and-repeat strategy is too costly to perform. It is possible that this tactic has already been adopted by payment processors.