Canadian guilt, Russian oil

We Canadians are overwhelmingly pro-Ukraine and anti-Putin, so when the CBC published an expose last week about "banned Russian oil" sneaking into Canada, it was read in despair by most of us. What an awful failure of Canadian sanctions policy. 

As with a lot of sanctions media coverage, I saw things a bit differently: "Not bad. We're doing our part!" That's because if you add some more context to the CBC article, the data that it presents can be read as good news.

The article takes issue with 2.5 million barrels of refined oil products made from Russian-produced crude that have been indirectly imported into Canada since the start of Putin's invasion of Ukraine in 2022. Given that around 1,000 days have passed since the invasion, that works out to roughly 2,500 barrels per day of Russian-linked refined oil products arriving on Canadian shores. (Analyzing oil flows on a per-day basis is industry standard and also makes it easier for our brains.)

In the grand scheme of things, 2,500 barrels per day is a drop in the bucket. Canada consumes around 1.6 million barrels of refined oil products per day, according to CAPP, which includes stuff like gasoline, diesel, and jet fuel. So just 0.1% of our consumption is Russia-tainted. Even so, every barrel matters, and we should strive to avoid any contribution to Putin's war chest.

But there's more context. 2,500 barrels per day of Russian refined oil products is far less than what we imported prior to the war. According to the Canada Energy Regulator (CER), between 2017 and 2022 Canada was regularly importing around 10,000 barrels per day of refined petroleum products directly from Russia (see chart below). After banning imports of Russian crude and refined oil products, Canada's direct imports fell to zero in 2023. Into this void, indirect imports of 2,500 barrels per day of Russian-linked refined products, the flows that the CBC spotlights, have emerged.

A 75% decline from 10,000 barrels per day to 2,500 barrels per day is not too shabby.

Canada's direct imports of Russian refined petroleum products, which hit zero in 2023. Source: CER

2,500 barrels is still not zero. But we can also take comfort from the fact that those barrels are not as profitable for Russia as they used to be. In the pre-war era, Canada was importing refined petroleum products directly from Russia, but in the post-war era we are importing Russian oil indirectly via a third-party, India. More specifically,  oil in its raw form -- crude oil -- is being shipped all the way from Russia to India by tanker, where it is upgraded by Indian refineries, and only then is it onshipped to Canada.

This new workflow is a big downgrade for Russia. Before it can be used, crude oil has to be converted into pricier consumable types of fuel like gasoline for cars and jet fuel for planes. Upgrading crude oil creates extra profits for whoever does it. Russia's refineries used to capture the entire upgrading margin. They refined the raw oil after it was pulled out of the ground and then regularly sent 10,000 barrels per day of the final product to Canada. But now India is capturing those extra profits on the 2,500 barrels per day that are sent to Canada.

So not only has the quantity of Russian-linked refined products imported by Canada shrunk by 75% since the war began, but thanks to the interposition of Indian refiners at the expense of Russian ones, the quality of Russia's revenue stream has been downgraded: pound-for-pound, Russia's indirect exports to Canada are a far less lucrative for Putin than they were back in 2021, because his refining margin has disappeared.

Compounding Russia's woes is the much more circuitous route that its oil must now take. Prior to 2022, Russian refined oil exports were loaded onto boats in Russian ports like Saint Petersburg and shipped via the Baltic Sea to Canada, around 4,000 nautical miles away. That's a 15-day voyage according to Sea-Distances.

These days, that 15-day voyage has tripled, even quadrupled. First, Russian crude oil must travel from the Baltic to India, a 7,500 nautical mile journey that can take 30 days. That's if it goes through the Suez canal. Passing around the southern tip of Africa amounts to a 12,000 mile trip taking up to 50 days. Once refined in India, the product must travel another 8,000 miles from India to eastern Canada. 

What an incredible amount of travel to get a barrel of Russian refined oil to Canadian markets! A good way to visualize these new transportation frictions is provided by the Kyiv School of Economics, which charts the volume of Russian oil being transported by oil tankers over time. Thanks to the forced rerouting of crude to less efficient routes as countries like Germany and Canada close their borders to Putin, Russia's oil on water is 163% higher than the pre-invasion average.

Record volumes of Russian oil on water is not a good thing for Putin. It mean higher transportation costs. Source: KSE

The extra transportation and insurance costs that "oil on water" entails inevitably eat into the final price that Russia can negotiate with buyers like India for its barrels of crude. For these long distances to be financially worthwhile for Indian businesses, they will only buy Russian crude at a discount to the going world price. According to the Dallas Fed, the Russia discount regularly clocks in at around $20 below the market price. This constitutes a big step down for Russia -- prior to the war it was receiving the full world price.

The upshot is that Canadian imports of Russian oil are down, and even though some Russian refined petroleum products are indirectly making their way to Canada, this is only after we've extracted our pound of flesh from Putin by forcing him to give up his refining margin and by obliging him to accept a crude oil price discount on account of distance traveled. So let's take some pride from that.

Does that mean we shouldn't do anything about our indirect imports of Russian oil product?

I want to clarify that Canada isn't importing "banned" products or breaking Russian sanctions. For better or for worse, the coalition's sanction on Russian crude oil have been designed to allow crude to continue to flow around the world, the intent being to avoid a big spike in oil prices while still hurting Russia. The 2,500 barrels of indirectly-refined refined oil we get each day are fair game.   

But that doesn't mean Canadians should do nothing. The CBC article is a good effort to name-and-shame certain Canadian importers that are accepting Russian-linked crude from third-parties, including Everwind Fuel's Point Tupper oil storage facility in Nova Scotia. C'mon, Everwind. Why not choose better trading partners, ones who aren't acting as go-betweens for Putin?

However, the best step we can do to counter Russia is to focus on producing more renewables, crude oil, and other commodities, as well as to find reliable ways to get these resources to market. 

Unlike Europe and the U.S., which have plenty of economic and financial heft, Canada doesn't have any sizable economic chokepoints that we can lever to hurt Russia. We could cut down on the 2,500 barrels per day of Russian-linked oil imports, but as laudable as that might be it doesn't constitute a genuine chokepoint. Canada's edge is that our economy is remarkably similar to Russia. Both of us extract a bunch of resources. The more we compete with Putin in resource extraction, the more we reduce the prices he relies on, thus impairing his ability to fund his invasion of Ukraine.

Here’s why we tolerate fake check scams

Source: Better Business Bureau

The daily news is filled with personal stories about bad experiences with banks. Here’s a recent example. In November 2024, a charity inadvertently accepted a fake check from a would-be donor. The charity's bank allowed the charity to deposit the check, crediting it with the funds. A few days later the bank discovered the fake, but only after the charity had transferred some of the "donated" funds back to the donor, a scammer. The bank then raided the charity’s bank account for the full amount, leaving the charity out of pocket.

Readers will find this story disturbing. Banks are supposed to protect scammed customers, not kick them while they are down, especially charities. Many of us will wonder if the payments system needs to be fixed. 

But payments systems are complex organisms that have evolved over many centuries. When viewed from afar, what appears to be a glitch is often actually an element of a balanced whole. Solving the problem of fake check scams would upset this balance, introducing new complications further down the payments process.

Let’s look a bit more closely at the scam.   

The anatomy of a fake donation scam

Approached by a stranger who wanted to donate money, Motorcycle Missions – a Texas-based charity that helps helps veterans and first responders with post-traumatic stress disorder – was sent a $95,000 paper check in the mail. Motorcycle Missions proceeded to deposit the check at its bank, Chase, which immediately credited the charity for the full amount. A few days later, the stranger asked for some of the money back. His assistant had made a mistake, the stranger claimed, and the check was supposed to be for just $50,000. So Motorcycle Missions helpfully wired $45,000 to the stranger's account.

But it was a scam. The check, donation, and donor were all fake. Unfortunately, the $45,000 that flowed out of Motorcycle Missions's account and into the account of the scammer was very real. Chase promptly seized $95,000 from the charity’s account as compensation for the amount of money that it had created upon accepting the fake check. Because it had paid out $45,000 to the scammer, the charity was left $45,000 out of pocket.

Unjust? It seems so. Charity gets tricked by scammers only to have his fat cat banker, the one who processed the check, refuse to help him. Unfortunately, scams like this are all too common.

Exploiting the check timing gap

In addition to exploiting the constant need of charities for funding, fake donation scammers exploit a weakness in the check payments system. Specifically, they target the timing gap between a bank’s initial crediting of funds to a depositor’s account and the point at which a check’s authenticity is finally verified.

When someone accidentally brings a scammer's fake check to the bank, banks will do their best to catch it. But some fakes sneak through. This is where the timing gap opens up. 

The amount indicated on the face of the fake check is credited to the depositor’s bank account. The customer can then spend it (or be duped into paying off their scammer). But behind the scenes the actual processing and settlement of the fake check grinds on. A few days or even weeks later the check’s true nature is eventually discovered. But, by then, the sneaky scammer has already received their electronic payment.

So why don’t we just fix things by removing the timing gap?

The tradeoff between speed and security

The payment system is a combination of tradeoffs and sacrifices. We can remove the check timing gap, but this means introducing other weak spots into the checking system.

For instance, we could easily put a quick end to all fake donation scams by stipulating that banks only credit funds to depositors’ accounts after the paper check has been irrevocably confirmed to be legitimate. In that case, if Motorcycle Missions were to accidentally deposit a fake check, it needn’t worry. The check will eventually be caught and the charity won’t be hit with a $45,000 charge. Knowing that the system has a perfect defence, scammers would stop check scamming.

But there are consequences to fixing the timing gap. All of us check-users would now be required to wait days, even weeks in some cases, before we can spend our money.  

Speed is an important feature of any payments system. Because Motorcycle Missions was probably a longtime and trusted customer, Chase allowed the charity to use the amount printed on the face of the check immediately, even though the check hadn’t definitively settled. In bank-speak, banks will lend or grant provisional credit to their check-cashing customers. 

This service is important to us. We may have bills due two days from now. We can’t wait weeks for our checks to be 100% settled.

In fact, check speed is considered so important that according to U.S. law, specifically Regulation CC, all checks deposited must be made available for withdrawal by the business day after the day of deposit. Since the only way for banks to meet these standards is to grant provisional credit, the timing gap is legally baked into the system. 

And into this gap scammers stream. We accept these chinks in the check system because we want the overall process to move more quickly.

Who bears the costs of speedy checks?

If society has decided to tolerate the fake check problem in order to get more speed out of the check system, someone has to bear the extra credit risk of these fakes. Which unfortunate party is held responsible?

Commercial law places this risk squarely in the lap of bank customers. (See also). When a bank puts money in a customer’s account upon deposit of a check, it is lending to them. As with any loan, the lender can collect should the borrower default (say, because the check was fake). 

That’s exactly what happened with Motorcycle Missions. It was granted $95,000 in provisional credit after depositing a fake check, only for the loan to be called when the fake was discovered.

We might not think this is fair. Surely banks are better at evaluating whether a check is fake or not than customers. So why not shift the burden of absorbing the cost of fake checks onto banks and away from the public? 

We could certainly design a payments system along these principles. Now when Motorcycle Missions deposits a fake $95,000 check, and its bank credits it the amount, Chase must absorb the $45,000 expense when the fake is discovered.

In this system, not only would banks make check payments go fast by offering provisional credit. They would also take on all of the risk of fake checks. What a win for bank customers! We’d get maximum speed and complete safety. 

But it’s not that easy. 

To absorb the costs of extra credit risk, banks like Chase would probably increase monthly checking account fees. Rather than passing on the costs of fake checks exclusively to the scammed customers, as in the current system, every customer would bear part of the burden in the form of higher fees. 

This spreading-out of costs is a win for vulnerable customers who, given the precariousness of their business or personal lives, are more likely to fall for fake check scams and be hurt by associated penalties. But the rest of the bank’s customers may not be as thrilled, preferring charges fall on those who make mistakes. 

In sum, what happened to Motorcycle Missions is unfortunate. But solving the problem of fake checks isn’t as easy as one might think. Changes to a tightly-wound system like the check system involve tradeoffs. You don’t get something for nothing.

P.S.: Please consider donating to Motorcycle Missions here.

[A version of this article was originally published at the AIER's Sound Money Project.]

Stablecoins are non-fungible, bank deposits are fungible

On Twitter/X, I recently suggested that the network effects of the stablecoin market are massive. Tether, which has four times more wallets than all other stablecoins, is locked-in as the stablecoin lingua franca, just like English has been locked-in as the global language of business. 

In case you've missed the trend, stablecoins are fiat money (primarily U.S. dollars) that are issued on a new type of database called a blockchain. The total value of stablecoins in circulation has grown from $0 to over $200 billion in a decade, with Tether dominating at $138 billion.

When I said at the outset that the stablecoin market is governed by network effects, what I meant is that a positive feedback loop exists whereby the value that a network (i.e. languages or stablecoins) provides to users increases as more users join the network. Once a given stablecoin has entered into this virtuous loop, other issuers cannot join in, and will have troubles competing. It's a winner take all market that Tether and its stablecoin USDt (and perhaps smaller competitor USDC, issued by Circle) have already won.

Larry White, a monetary economist who I've mentioned a few times on my blog, asked me why I think network effects are present in the stablecoin market. We don’t see network effects with other U.S. dollar payment media like checkable deposits, Larry points out (and I agree), so it's not clear why we should see this with stablecoins.

Here's my logic.

Stablecoins aren't fungible, bank deposits are

The key is that while U.S. dollar stablecoins—Tether's USDt, Circle's USDC, PayPal USD, etc—are pegged to the dollar, and thus seem to be alike, they are not actually completely alike. That is, they are not fungible with each other. 

Fungibility is one of my favorite words, and I write about it quite often on this blog. It means that members of a population are interchangeable, or perfectly replaceable with each other. All grams of pure raw gold are interchangeable. Not all grams of pizza are alike—pizza is non-fungible.

U.S. dollar bank deposits (say Well Fargo dollars and Chase dollars) are fungible with each other. Rather than being independent, they are fused together as homogeneous and singular U.S. dollars. A Chase dollar is just as good as a Wells Fargo dollar for the purposes of making payments.

That's not the case with stablecoins, which are like pizza. Or better yet, in the same way that Chinese yuan and UAE dirham are pegged to the dollar but remain independent currencies, each U.S. dollar stablecoin is pegged to the dollar but functions as its own distinct non-fungible currency. For the purposes of making payments, one stablecoin is not as good as another one, just like how dirham balances aren't perfect replacements for yuan.

The reason behind this difference is that U.S. banks cooperate with each other by accepting competitor's money at par on behalf of their customers. For instance, I can take a Wells Fargo check to my Chase branch and Chase will accept it 1:1 even though it represents a competing bank's dollar. Or I can send an ACH payment directly from Wells Fargo to Chase, and Chase will accept that Wells Fargo dollar at par and convert it into a Chase dollar for me. 

The effect of this reciprocal acceptance is that all U.S. banking dollars are tightly knit together, or interchangeable. A fungible standard has been created.

I can't perform these same actions with stablecoins. I can't send 100 USDC to Tether to be converted into 100 USDt, nor send 100 USDt to Circle, which issues USDC, to be converted into 100 USDC. Stablecoins issuers are loners. They've chosen to avoid banding together to weave a unified U.S dollar stablecoin standard.

This lack of standardization explains some weird things in the stablecoin market, like why there are so many markets to trade USDt for USDC (see below). Notice that the clearing price in these stablecoin-to-stablecoin markets is never an even $1, but always some inconvenient price like 0.991 or 1.018.

Some of the multiple markets for trading USDt for USDC, all at varying prices Source: Coingecko

 

There is no equivalent trading market for Chase-to-Wells Fargo balances or TD-to-Bank of America dollars. These banks' dollars are perfectly compatible and don't require such markets.

The advantages of a single dollar standard

Harmonization is useful. Anyone can walk into a McDonald's and purchase a Big Mac for $5.69 with whatever brand of bank dollar they want. Money held at small banks is just as useful as money at massive ones: the Bank of Little Rock may only have five branches, but its dollars are accepted at McDonald's all across the world, on par with those of Chase, America's largest bank.

McDonald doesn't accept stablecoins, but if it did, it would have to offer multiple prices for a Big Mac: i.e. 5.73 USDt and 5.68 USDC. Each stablecoin serving as its own particular unit of account is inconvenient, both for McDonald's and its customers. PayPal USD probably wouldn't even be accepted at McDonald's: it's too small.

The lack of standardized stablecoin market becomes even more awkward in asset markets. If you want to buy $1 million bitcoins on, say, Binance, there's a whole array of different U.S. dollar stablecoin markets available, including bitcoin-to-USDt, bitcoin-to-USDC, and bitcoin-to-FDUSD. (FDUSD refers to First Digital USD, a medium sized stablecoin.)

The table above shows the prices of bitcoin and ether on Binance, the world's largest crypto exchanges. Notice that liquidity in both Binance's bitcoin and ether trading market is compartmentalized into different stablecoins rather than being fused into a single homogeneous US dollar-to-bitcoin market. Source: Coingecko

You can forget about easily buying bitcoins with PayPal USD stablecoins. No crypto exchange offers that trading pair; PayPal USD is too small to be worth the hassle.

This has the effect of fragmenting the liquidity of the stablecoin market into different buckets. Instead of stablecoins-in-general having a certain level of marketability, each individual stablecoin has its own distinct liquidity profile in asset markets.

In contrast, the liquidity that a Wells Fargo dollar, a Bank of Little Rock, or a Chase dollar provides to their owner in the context of asset markets has been unified into a collective whole. If you want to buy shares of Blackrock's iShares Bitcoin ETF, there isn't a separate market for Wells Fargo-to-bitcoin or Chase-to-bitcoin. As for Bank of Little Rock dollars, they are just as fit for bitcoin purchases as its much largest competitors.

A winner-takes-all market

Now we can understand why network effects dominate the stablecoin market.

If you want to start using stablecoins to trade crypto or buy stuff, you will always be arm-twisted by market logic into choosing the largest most liquid stablecoin. And your decision to go with the largest one makes that stablecoin a little more liquid, thus solidifying its pole position.

Selecting a smaller stablecoin like PayPal USD makes little sense. McDonald's will never accept it, and there are many crypto assets that you won't be able to buy with it. Even when certain PayPal USD trading pairs are available, the bid-ask spreads will be wide, imposing much larger costs on you than if you simply went with a larger stablecoin. Thus network effects, working in reverse, repel uptake of PayPal USD.

The unsafe stablecoin is the largest

Tether remains the largest stablecoin, despite being one of the most unsafe stablecoins. (USDC does not get top marks for safety, either.) Network effects explain this.

Stablecoin rating agency Bluechip awards Tether a D rating, noting that it is "less transparent and has inferior reserves... USDT is not a safe stablecoin". Under normal conditions (i.e. those not characterized by network effects) the safest stablecoins would have long-since displaced Tether from its leading spot. But in stablecoin markets, the safest stablecoins—Gemini USD, PayPal USD, and USDP, all rated A or A- by Bluechip—remain insignificant players. The virtuous circle in which Tether is locked dominates all other factors.

These are the best-ranked fiat stablecoins according to Bluechip. But they are also tiny, with market capitalization below $1 billion. There appears to be no point trying to be a safe stablecoin, since the network effects arising from liquidity completely dominate any safety concerns that users might have.

Eyeing Tether's profits, new competitors are entering the stablecoin market. But this is a game they probably shouldn't bother playing. PayPal arrived last year with PayPal USD, but to date it remains mostly irrelevant, despite huge growth in the overall stablecoin market over the same period. Ripple and Revolut are also slated to bring out their own products. They're also destined to mediocrity, because they're too late to make the jump into the virtuous loop that Tether and (to a lesser extent) Circle occupy. 

(There is one caveat. Should one of the two leaders eventually be shutdown for money laundering offenses or sanctions evasion, one of these also-rans could be vaulted into their spot.)

Might the stablecoin sector eventually migrate over to the unified fungible standard that characterizes banking deposits? 

No, that's probably not going to happen. For a fusion to occur, Tether and runner-up Circle, which issues USDC, would have to start accepting their competitors' stablecoins at par. But they won't go down this path, since that would kill off the network effect that gives them their unrivaled dominance over the rest of the pack. No, it's in the interests of the leaders for chaotic non-fungibility to continue. 

Alas, this lack of standardization may limit the stablecoin sector's broader potential to serve as a cohesive global payment alternative to the better-organized banking standard. Sometimes a bit of cooperation trumps competition.

Someone is wrong on the internet about the SWIFT network

There's a chart that has been circulating for a while now on social media that shows payments traffic on SWIFT, a key global financial messaging network. Below is a version from the Economist, but I've seen other versions too.

Source: The Economist

When banks make cross-border payments between each other, say euros to dollars, they need to use a communications network to coordinate the debiting and crediting of accounts, and SWIFT is the dominant network for doing so. Think of it as WhatsApp for banks.

Here's the problem. The main conclusion that pundits are taking away from the chart is the wrong one. Most of them seem to think that the chart illustrates an erosion in the euro's global popularity (i.e. de-euroization) and a simultaneous move towards the dollar for global trade. The Economist, which entitles its chart "Dollarisation," is also guilty.

Today I'm going to show you why that's the wrong conclusion; there is no SWIFT-related de-euroization. The reason for going through this effort isn't just because it's fun to dunk on wrong folks. It can also teach us some interesting things about the massive bits of unsung payments infrastructure that underlie our global economy, including not only SWIFT but also Europe's T2 and the U.S.'s Fedwire, two of the world's busiest financial utilities.

Let's dig in. The problem with trying to analyze charts of SWIFT messages across various currency jurisdictions is the data isn't necessarily comparable. As I said at the outset, commercial banks around the world use SWIFT to coordinate cross-border payments with other banks, and that is what people are hoping to measure with the SWIFT chart at top. But muddying the waters is the fact that in the EU, banks also use SWIFT for domestic payments. Here's how:

The most important bit of payments infrastructure in both the U.S. and EU are their respective central bank's large-value payments (or settlement) systems. When commercial banks make crucial domestic payments with each other, typically on behalf of their customers, these payments are settled in real-time using each commercial banks' respective account at their central bank, in the U.S.'s case the Federal Reserve, and in Europe's case the European Central bank, or ECB. The ECB's mechanism for settling payments is known as T2 (and previous to that, Target2.) The Fed uses Fedwire.

To coordinate this "dance of databases," the central bank and participating commercial banks need to communicate clearly and rapidly with each other, and that's where financial messaging networks come in. Fedwire doesn't use SWIFT for this. It comes fitted-out with its own proprietary messaging network for member banks. But the ECB has chosen a different setup. Up until 2023 the ECB had outsourced all messaging to SWIFT, a bank-owned cooperative based in Belgium.

Now you may be able to see why comparing the amount of euro payments made using SWIFT messages to dollar payments made using SWIFT is an apples to oranges comparison. Both data sets include cross-border payments, but the EU dataset also includes a large amount of domestic payments. The U.S. dataset doesn't.

This means that the variations in the amount of euro payments messages that get captured in the chart at top may not reflect dramatic geopolitical shifts like "de-euroization, but may be linked to more banal things like changes in local EU payments habits. And indeed, I'm going to show why domestic and not international factors explain the 2023 drop in the euro share of SWIFT messages. 

In 2023, the ECB replaced its Target2 settlement system with a new system called T2. Two key upgrades were introduced with T2 that ultimately affected SWIFT message flows. 

The first of the upgrades was a new language for constructing messages, with the ISO 20022 messaging standard replacing the legacy MT messaging format. (I wrote about ISO 20022 in an article entitled The Standard About to Revolutionize Payments.) 

This change in payments lingo has had a big effect on the sum of SWIFT data displayed in the chart at top. Both the ECB and SWIFT provide explanations for this, but here is my shorter summary. Prior to the 2023 changeover, a type of euro payment known as a liquidity transfer was regularly captured in the SWIFT chart. A liquidity transfer occurs when a European commercial bank, which often has several accounts at the ECB, must rebalance between its accounts when one of them is running low. These within-bank liquidity transfer messages aren't terribly interesting and have nothing to do with global payments, but were included in the SWIFT dataset nonetheless up until 2023, thus fudging the results. 

With the arrival of ISO 20022, messages related to euro liquidity transfers are now conveyed using a new type of message. Thus the big decline in the euro's share of SWIFT messages in 2023 — liquidity transfers have effectively dropped out of the chart. This is a good thing, though, since the omission of these relatively unimportant within-bank transfers means we're getting a cleaner and more accurate signal.

The second upgrade introduced in 2023 was the opportunity for European commercial banks to choose among multiple messaging networks for accessing T2. Under T2's predecessor, Target2, banks only had one access choice: the SWIFT network. With T2, European banks can also use SIAnet, owned by the Nexi Group. (I wrote about this upgrade here, in which I described T2's switch from an older Y-copy topology to a network agnostic V-shaped topology.)

In that older post, I suggested that adding additional access points was a healthy step for Europe, since it meant more resilience should one network suffer an outage. And in fact, Europe is already reaping the benefits. When SWIFT failed for several hours on July 18, 2024, the ECB issued the following alert:

"T2 is operating normally. However, due to an ongoing SWIFT issue, some incoming messages do not reach T2 immediately. Similarly, some T2 outgoing messages might not reach the receiver immediately... There is no impact on traffic sent or received via NEXI. Participants may continue sending new instructions and queries to CLM/RTGS/CRDM. Updated information will be provided at the latest by 16:30."

Whereas an outage of SWIFT in 2021 or 2022 would have seriously slowed down Europe's financial activity, the addition of Nexi's SIAnet to the mix in 2023 limited the damage caused by the 2024 SWIFT outage. By contrast, the UK's central bank, the Bank of England, remains entirely reliant on SWIFT for messaging, and so the 2024 outage caused more disruption for Brits than Europeans, according to the Financial Times.

Unfortunately, I can't find any data on how many European banks have actually chosen to shift their T2 messaging needs over to Nexi. But I'd imagine that it isn't negligible, given that Nexi's SIANet is already being used by banks to access other key bits of Europe's payments architecture including STEP2, a pan-European automated clearinghouse. And so some non-negligible portion of the drop in the euro's share of SWIFT messages in the top chart is due to a shift away from SWIFT.

If the SWIFT chart at top doesn't mean what people think it means, what is the euro's status as a global trading currency? A 2024 article from the ECB clears this up. In short, the euro's international role hasn't eroded over the last few years. The de-euroization memes are all wrong.

The irony of all of this is that rather than reflecting a decline in Europe's status, the SWIFT chart illustrates the opposite. A bunch of healthy advances are driving the euro's share of SWIFT payments down, including a more accurate classification of financial messaging data thanks to a better messaging language, combined with a much needed de-SWIFTication of European messaging flows. It's not as juicy as euro critics make it out to be.

After twelve years of writing about bitcoin, here's how my thinking has changed

What follows is an essay on how my thinking on bitcoin has changed since I began to write on the topic starting with my first post in October 2012. Since then I've written 109 posts on the Moneyness Blog that reference bitcoin, along with a few dozen articles at venues like CoinDesk, Breakermag, and elsewhere.

An early bitcoin optimist

I was excited by Bitcoin in the early days of my blog. The idea of a decentralized electronic payment system fascinated me. Here's an excerpt from my second post on the topic, Bitcoin (for monetary economists) - why bitcoin is great and why it's doomed, dated November 2012:

"Bitcoin is a revolutionary record-keeping system. It is incredibly fast, efficient, cheap, and safe. I can send my Bitcoin from Canada to someone in Africa, have the transaction verified and cleared in 10 minutes, and only pay a fee of a few cents. Doing the same through the SWIFT system would take days and require a $35 fee. If I were a banker, I'd be afraid." [link]

I was relatively open to Bitcoin for two reasons. First, I like to think in terms of moneyness, which means that everything is to some degree money-like, and so I welcome strange and alternative monies. "If you think of money as an adjective, then moneyness becomes the lens by which you view the problem. From this perspective, one might say that Bitcoin always was a money," I wrote in my very first post on bitcoin. Second, prior to 2012 I had read a fair amount of free banking literature—the study of private money—so I was already primed to be receptive to a stateless payments system, which is what Bitcoin's founder, Satoshi Nakamoto, originally meant his (or her) creation to be. 

A lot of bitcoin-curious, bitcoin-critics and bitcoin-converts were attracted to the comments section of my blog, and we had some great conversations over the years. My bitcoin posts invariably attracted more traffic than my non-bitcoin ones, all of us scrambling to understand what seemed to be a newly emerging monetary organism.

My early thoughts on the topic were informed by having bought a few bitcoins in 2012 for the sake of experimentation, some of my earlier blog posts describing how I had played around with them. In 2013 I wrote about the first crop of bitcoin-denominated securities market (which I dabbled in)—predecessors to the ICO market of 2017. I also used my bitcoins to buy altcoins, including Litecoin, and in late 2013 wrote about my disastrous experience with Litecoin-denominated stock market speculation. In Long Chains of Monetary Barter I described using bitcoin as an exotic bridging currency for selling XRP, a new cryptocurrency that had just been airdropped into the world. I didn't notice it at the time, but in hindsight most of these were instances of bitcoin facilitating illegal activity, i.e. unregistered securities sales, which was an early use case for bitcoin.

Although Bitcoin excited me, I was also critical from the outset, and in later years my critical side would only grow, earning me a reputation among crypto fans as being a salty no-coiner. In a 2013 blog post I grumbled that playing around with my stash of bitcoins hadn't been "as exciting as I had anticipated." Unlike regular money, there just wasn't much to do with the stuff, my coins sitting there in my wallet "gathering electronic dust."

 "...the best speculative vehicles to hit the market since 1999 Internet stocks."

What my experimentation with bitcoin had taught me was that the main reason to hold "isn't because they make great exchange media—it's because they're the best speculative vehicles to hit the market since 1999 Internet stocks." But that wasn't what I was there for. What had tantalized me was Satoshi's vision of electronic cash, a revolutionary digital payments system. Not boring old speculation.

In addition to my practical complaints about bitcoin, I also had theoretical gripes with it. The "lethal" problem as I saw it back in my second post in 2012 is that "bitcoin has no intrinsic value." Over the next decade this lack of intrinsic value, or fundamental value, would underly most of my criticisms of the orange coin. Back in 2012, though, the main implication of bitcoin's lack of intrinsic value was the ease by which it might fall back to $0. As I put it in a 2013 article:

"Bitcoin is 100% moneyness. Whenever a liquidity crisis hits, the only way for the bitcoin market to accommodate everyone's demand to sell is for the price of bitcoin to hit zero—all out implosion" [link]

But if the price of bitcoin were to fall to zero then it would cease to operate as a monetary system, which would be a huge disappointment to those of us who were fascinated with Satoshi's electronic cash experiment. Adding to the danger was the influx of bitcoin lookalikes, or altcoins, like litecoin, namecoin, and sexcoin. In theory, the prices of bitcoin and its competitors could "quickly collapse in price" as arbitrageurs create new coins ad infinitum, I worried in 2012, eating away at bitcoin's premium. The alternative view, which I explored in a 2013 post entitled Milton Friedman and the mania in copy-paste cryptocoins,  was that "the earliest mover has superior features compared to late moving clones," including name brand and liquidity, and so its dominance was locked-in via network effects. Over time the latter view proved to be the correct one.

The "zero problem"

Despite my worries, I was optimistic about bitcoin, even helpful. One way to stop bitcoin from falling to zero might be a "plunge protection team," I offered in 2013, a group of avid bitcoin collectors that could anchor bitcoin's price and provide a degree of automatic stabilization. In a 2015 post entitled The zero problem, I suggested that bitcoin believers like Marc Andreessen should consider donating $21 million to a bitcoin stabilization fund, thus securing a price floor of $1 in perpetuity. 

No fan of credit cards, in a 2016 post Bitcoin, drowning in a sea of credit card rewards, I suggested that bitcoin activists encourage retailers that accept bitcoin payments to offer price discounts. This carrot would put bitcoin on an even playing field with credit card networks, which use incentives like reward points and cashback to block out competing payment systems.

My growing disillusionment

By 2014 or 2015, I no longer saw much hope for bitcoin as a mainstream payments system or generally-accepted medium-of-exchange. "For any medium of exchange to displace another as a means for buying stuff, users need come out ahead. And this isn't happening with bitcoin," I wrote in a 2015 post entitled Why bitcoin has failed to achieve liftoff as a medium of exchange, pointing to the many costs of making bitcoin payments, including commissions, setup costs, and the inconveniences of volatility.

In another 2015 post I focused specifically on the volatility problem, which stems from bitcoin's lack of intrinsic value. If an item has an unstable price, that militates against it becoming a widely used money. After all, the whole reason that people stockpile buffers of liquid instruments, or money, is that these buffers serve as a form of insurance against uncertainty. If an item's price isn't stable—which bitcoin isn't—it can't perform that role. 

Mind you, I did allow in another 2015 post, The dollarization of bitcoin, that bitcoin might continue as "an arcane niche payments system for a community of like minded consumers and retailers." I even tracked some of these arcane payments use cases, such a 2020 blog post on retailers of salvia divinorium (a legal drug in many U.S. states) falling back on bitcoin for payments after the credit card networks kicked them off, followed by a 2021 post on kratom sellers (a mostly-legal substance) doing the same. But let's face it, a niche payments system just wasn't as impressive as Satoshi's much broader vision of electronic cash that had beguiled me in 2012, when I had warned that "if I was a banker, I'd be afraid." 

The dollarization of bitcoin

By 2015 a lot of my pro-bitcoin blog commenters began to see me as a traitor. But I was just changing my thinking with the arrival of new data.

Searching for Bitcoin-inspired alternatives: Fedcoin and stablecoins

Bitcoin's deficiencies got me thinking very early on about how to create bitcoin-inspired alternatives. By late 2012 I was already thinking about stablecoins:

"What the bitcoin record-keeping mechanism needs is an already-valuable underlying asset to which it can be tethered. Rather than tracking, verifying, and recording the movement of intrinsically worthless 1s and 0s, it will track the movement of something valuable." [link]

Later, in 2013, I speculated about the emergence of "stable-value crypto-currency, not the sort that dangles and has a null value." These alternatives would "copy the best aspects" of bitcoin, like its speed and safety, but would be linked to "some intrinsically valuable item." A few months later I predicted that "Cryptocoin 2.0, or stable-value cryptocoins, is probably not too far away." This would eventually happen, but not for another few years.

My dissatisfaction with bitcoin led me to the idea of decentralized exchanges, or DEXs, in 2013, whereby equity markets would "adopt a bitcoin-style distributed ledger." That same year I imagined central banks adapting "bitcoin technology" to run its wholesale payments system in my post Why the Fed is more likely to adopt bitcoin technology than kill it off. In 2014 I developed this thought into the idea of Fedcoin, an early central bank digital currency, or CBDC, for retail users.

If not money, then what is bitcoin?

By 2017 or so, even the most ardent bitcoin advocates were being forced to acknowledge that Satoshi's electronic cash system was not panning out: the orange coin was nowhere near to becoming a popular medium-of-exchange. This was especially apparent thanks to a growing body of payments surveys (which I began to report on in 2020) showing that bitcoin users almost never used their bitcoins to make payments or transfers, preferring instead to hoard them. So the true believers pivoted and began to describe bitcoin as a store-of-value, or digital gold. It was a new narrative that glossed over Satoshi's dream of electronic cash while trying to salvage some monetary-ish parts of the story.

I thought this whole salvage operation was disingenuous. In 2017 I wrote about my dissatisfaction with the new store-of-value narrative, and followed that up with a criticism of the digital gold concept in Bitcoin Isn’t Digital Gold; It’s Digital Uselesstainium. (The idea that store-of-value is a unique property of money is silly, I wrote in 2020, and we should just chuck the concept altogether.)

But if bitcoin was never going to become a generally-accepted form of money, and it wasn't a store-of-value or digital gold, then what exactly was it? 

I didn't nail this down till a 2018 post entitled A Case for Bitcoin. We all thought at the outset that bitcoin was a monetary thingamajig. But we were wrong. Of the types of assets already in existence, bitcoin was not akin to gold, cash, or bank deposits. Rather, it was most similar to an age-old category of financial games and zero-sum bets that includes poker, lotteries, and roulette. The particular sub-branch of the financial game family that bitcoin belonged to was early-bird games, which contains pyramids, ponzis, and chain letters. Here is a taxonomy:

A taxonomy showing bitcoin as a member of the early-bird game family

Early-bird games like pyramids, ponzis, and chain letters are a type of zero-sum game in which early players win at the expense of latecomers, the bet being sustained over time by a constant stream of new entrants and ending when no additional players join. Pyramids and ponzis are almost always administered by thieves who abscond with the pot. Bitcoin, by contrast, was not a scheme nor a scam. And it was not run by a scammer. It was leaderless and spontaneous, an "honest" early-bird game that hewed to pre-set rules. Here is how I described it in a later post, Bitcoin as a Novel Financial Game:

"Bitcoin introduces some neat features to the financial-game space. Firstly, everyone in the world can play it (i.e., it is censorship-resistant). Secondly, the task of managing the game has been decentralized. Lastly, Bitcoin’s rules are automated by code and fully auditable." [link] 

This ponziness of bitcoin was actually a source of its strength, I suggested in 2023, because "it's tough to shut down a million imaginations." By contrast, if bitcoin had an underlying real anchor, like gold, then that would give authorities a toe hold for decommissioning it.

Bitcoin-as-game gave me more insight into why most bitcoin owners weren't using bitcoin as a medium-of-exchange. Its value as a zero-sum bet was overriding any functionality it had for making payments. In a 2018 post entitled Can Lottery Tickets Become Money?, I worked this out more clearly:

"Like Jane's lottery ticket, a bitcoin owner's bitcoins aren't just bitcoins, they are a dream, a lambo, a ticket out of drudgery. Spending them at a retailer at mere market value would be a waste given their 'destiny' is to hit the moon." [link]

If bitcoins weren't like bank deposits or cash, how should we treat them from a personal finance perspective? Feel free to play bitcoin, I wrote in late 2018, but do so in moderation, just like you would if you went to Vegas. "Remember, it's just a game."

Bitcoin is innocuous, don't ban it

By 2020 or 2021, the commentary surrounding bitcoin seemed to be getting more polarized. As always there was a set of hardcore bitcoin zealots who thought bitcoin's destiny was to change the world, of which I had been a member for a brief time in 2012. But arrayed against them was a new group of strident opponents who though bitcoin was incredibly dangerous and were pushing to ban it.

A vandalized 'Bitcoin accepted' sign in my neighborhood

I was at odds with both sides. Each saw Bitcoin as transformative, one side for the good, the other for the bad. But I conceived of it as an innocuous gambling device, one that only seemed novel because it had been transplanted into a new kind of database technology, blockchains. We shouldn't ban bitcoin for the same reason that we've generally become more comfortable over the decades removing prohibitions on online gambling and sports betting. Better to bring these activities into the open and regulate them than leave them to exist in the shadows.

Thus began a series of relax-don't-ban-bitcoin posts. In 2022, I wrote that central bankers shouldn't be afraid that bitcoin might render them powerless. For the same reason that casinos and lotteries will ever be a credible threat to dollar's issued by the Fed or the Bank of Canada, neither will bitcoin.

Illicit usage of bitcoin was becoming an increasingly controversial subject. Just like casinos are used by money launderers, bitcoin had long become a popular tool for criminals, the most notorious of which were ransomware operators. My view was that we could use existing tools to deal with these bad actors. Instead of banning bitcoin to end the ransomware plague, for instance, I suggested in a 2021 article that we might embargo the payment of ransoms instead, thus choking off fuel to the ransomware fire. Alternatively, I argued in a later post that the U.S. could fight ransomware using an existing tool: Section 311 of the Patriot Act. Which is what eventually happened with Bitzlato and PM2BTC, two Russian exchanges popular with ransomware operators that were put on the Section 311 list.    

Nor should national security experts be afraid of enemy actors using bitcoin to evade sanctions, I wrote in 2019, since existing tools, in particular secondary sanctions, are capable of dealing with the threat. The failure of bitcoin to serve as an effective tool for funding the illegal Ottawa protests, which I documented in a March 2022 article, only underlined its low threat potential:

"Governments, whether they be democracies or dictatorships, are often fearful of crypto's censorship-resistance, leading to calls for bans. The lesson from the Ottawa trucker convoy and Russian ransomware gangs is that as long as the on-ramping and off-ramping process are regulated, these fears are overblown." [link]

Other calls to ban bitcoin were inspired by its voracious energy usage. In a 2021 blog post entitled The overconsumption theory of bitcoin, I attributed bitcoin's terrible energy footprint to market failure: end users of bitcoin don't directly pay for the huge amounts of electricity required to power their bets, so they overuse it. No need to ban bitcoin, though. The way to fix this particular market failure is to introduce a Pigouvian tax on buying and/or holding bitcoins, which I described more clearly in a 2021 blog post entitled A tax on proof of work and a 2022 article called Make bitcoin cheap again for cypherpunks! 

Lastly, whereas bitcoin's harshest critics have been advocating a "let it burn" policy approach to bitcoin and crypto more generally, which involved leaving gateways unregulated and thus toxic, I began to recommend regulating crypto exchanges under the same standards as equities exchanges in a 2021 article entitled Gary Gensler, You Should be Watching How Canada is Regulating Coinbase. Yes, regulation legitimizes a culture of gambling. But even Las Vegas has stringent regulations. A set of basic protections would reduce the odds of the betting public being hurt by fraudulent exchanges. FTX was a good test case. After the exchange collapsed, almost all FTX customers were stuck in limbo for years, but FTX Japan customers walked out unscathed thanks to Japan's regulatory framework, which I wrote about in a 2022 post Six reasons why FTX Japan survived while the rest of FTX burned.  

So when does bitcoin get dangerous?

What I've learnt after many years of writing about bitcoin is that it's a relatively innocuous phenomena, even pedestrian. When it does lead to bad outcomes, I've outlined how those can be handled with our existing tools. But here's what does have me worried. 

If you want to buy some bitcoins, go right ahead. We can even help by regulating the trading venues to make it safe. But don't force others to play.

Whoops, You Just Got Bitcoin’d! by Daniel Krawisz

Alas, that seems to be where we are headed. There is a growing effort to arm-twist the rest of society into joining in by having governments acquire bitcoins, in the U.S.'s case a Strategic Bitcoin Reserve. The U.S. government has never entered the World Series of Poker. Nor has it gone to Vegas to bet billions to tax payer funds on roulette or built a strategic Powerball ticket reserve, but it appears to be genuinely entertaining the idea of rolling the dice on Bitcoin.  

Bitcoin is an incredibly infectious early-bird game, one that after sixteen years continues to find a constant stream of new recruits. How contagious? I originally estimated in a 2022 post, Three potential paths for the price of bitcoin, that adoption wouldn't rise above 10%-15% of the global population, but I may have been underestimating its transmissibility. My worry is that calls for government support will only accelerate as more voters, government officials, and bureaucrats catch the orange coin mind virus and act on it. It begins with a small strategic reserve of a few billion dollars. It ends with the Department of Bitcoin Price Appreciation being allocated 50% of yearly tax revenues to make the number go up, to the detriment of infrastructure like roads, hospitals, and law enforcement. At that point we've entered a dystopia in which society rapidly deteriorates because we've all become obsessed on a bet.

Although I never wanted to ban Bitcoin, I can't help but wonder whether a prohibition wouldn't have been the better policy back in 2013 or 2014 given the new bitcoin-by-force path that advocates are pushing it towards. But it's probably too late for that; the coin is already out of the bag. All I can hope is that my long history of writing on the topic might persuade a few readers that forcing others to play the game you love is not fair game.

It's time to trash the "store of value" function of money

When we first learn about money and banking in high school or university, we are all taught that money has three functions: medium of exchange, unit of account, and store of value. Maybe it’s time for educators to throw out this triumvirate. It’s not very accurate. 

We need a simple and teachable device to take the triumvirate’s place. I propose the money Venn diagram.

Before I explain the money Venn diagram, let’s revisit the textbook triumvirate.

When something is a medium of exchange, what is meant is that it is generally acceptable in trade. You can use it to buy stuff at the grocery store, or purchase stocks on the stock market, or get things online. 

The quality of being a medium of exchange is really more of a gradient than a matter of either/or. Banknotes, for instance, are good at brick and mortar shops, but useless online. Your debit card works great at shops, but forget trying to buy shares with it. But both are sufficiently widely accepted to qualify as a medium of exchange.

Because cryptocurrencies like Bitcoin and Litecoin aren’t widely accepted, they don’t make it across the line to qualify as a medium of exchange. Neither do Walmart or Target gift cards. Cigarettes don’t qualify either, but that wasn’t the case in 1950 when Milton Friedman used them to buy gas:

Milton Friedman describes the time he used cigarettes as money. (I get this from his book "Money Mischief".) pic.twitter.com/1NSjY9vZNX

— John Paul Koning (@jp_koning) November 6, 2020

The unit of account function of money refers to the fact that our economic conversations and calculations are couched in terms of a given monetary unit, whether that be the $, ¥, or £. In Canada and the US, prices are expressed in grocery aisles with dollars, our salaries use dollar units, and our debts are denominated in dollars. We don’t express prices in terms of government bonds, or Microsoft shares, or cigarettes or bitcoins. These things don’t function as a unit of account.

Thirdly, when money acts as a store of value we mean that it preserves value over time and space. Whereas the first two functions are quite useful, the store of value isn’t. Every asset functions as a store of value: houses, diamonds, banknotes, deposits, bitcoins, LSD tabs, lentils, cars, spices. And so it is meaningless to cast store of value as a unique function of money. Monetary economists such as Nick Rowe and George Selgin have proposed, and I concur, that we just chuck store of value from the definition of money.

But we are still left with two useful definitions for money, unit of account and medium of exchange. Which gets us to the money circle.

Note that the two circles in the diagram, medium of exchange and unit of account, don’t perfectly overlap. About 99% of the time the things we use as media of exchange are also the things we use as a unit of account. So the contents of our wallets or our bank accounts, dollar banknotes and dollar deposits are functionally equivalent to the $ units displayed in signs in grocery aisles.

But for the remaining 1% of the time, the unit of account and medium of exchange are separated. The idea of a separation is tough to get one’s head around. Luckily we’ve got a nice example. In Chile the prices of many things, particularly real estate, are expressed in terms of the Unidad de Fomento. But no Unidad de Fomento notes or coins circulate in Chile. It is a purely abstract unit of account.

Apartments for sale in Chile, priced in Unidad de Fomento

If a Chilean wants to buy an apartment that is priced at 840 Unidad de Fomento, she must use a separate medium of exchange, the Chilean peso, to make the payment. The peso is issued by Chile’s central bank, the Banco Central de Chile, in both paper and account form.

How many pesos must she pay? Every day the Banco Central de Chile publishes the exchange rate between the Unidad de Fomento and the peso. Right now one Unidad de Fomento is equal to 28,969 pesos. If an apartment were priced at 840 Unidad de Fomento, a Chilean would have to hand over 24 million Chilean pesos today.

Why has Chile separated its unit of account from its medium of exchange? I have discussed the issue at length. But the short answer is that it was a trick the government used to help cope with high inflation in the 1960s. Chilean inflation has been well under control for decades now. The practice of using the Unidad de Fomento as a unit-of-account has continued nonetheless.

You can see why it’s rare for these two functions to be separated. It’s awkward to do conversions every time one wants to pay for something. For the sake of ease, we tend to evolve towards systems where the medium of exchange and unit of account are united. But these exceptions are still important enough that we need a Venn diagram.

To sum up, money isn’t best thought of as a medium of exchange, unit of account, and store of value. Let’s just think of it as just a medium of exchange and a unit of account. For the most part these circles overlap, and the two functions are united. But this isn’t always the case. 

[My article was originally published at AIER's Sound Money Project in 2020 under the title A Simpler and More Accurate Way to Teach Money to Students]

Tornado Cash un-OFAC'ed

The next chapter in the Tornado Cash saga just dropped. Last week a court ruled last that Tornado Cash, a bot that can be used for obfuscating crypto, is safe from being sanctioned.

I first wrote about Tornado Cash in 2021, before its legal troubles began, warning of the risks ahead. I've been tracking Tornado's legal saga since then. (See here | here | here ). The saga serves as a bellwether for how financial services hosted on blockchains are to be sliced and diced under existing laws, in particular the crucial anti-money laundering statutes and sanctions laws. More generally it foreshadows how autonomous techno-beings, many of which don't yet exist, are to be treated by the law.

In the newest chapter of the saga, a court ruled that America's sanctions authority, the U.S. Treasury's Office of Foreign Assets Control (OFAC), does not have the authority to sanction a certain type of smart contract, or string of autonomous code, that undergirds Tornado Cash: its so-called immutable contracts.

Recall that in August 2022, OFAC sanctioned Tornado Cash, which accepts traceable crypto from users and returns it in untraceable format. Tornado had been used by the sanctioned North Korean hacker group Lazarus to obfuscate its financial tracks. OFAC listed Tornado Cash's website tornado.cash along with 53 Ethereum addresses.

The sanctions were relatively effective. Americans could no longer use the bot without risking fines or imprisonment. Those who had funds deposited in Tornado had to ask OFAC for special permission to withdraw them. In the months after the sanctions were announced, usage of the privacy bot plunged and the amount of crypto deposited fell by over half.
 
After two different sets of plaintiffs challenged OFAC's actions in court, the appeals court in one of the cases returned a verdict last week. An immutable smart contract is "unownable, uncontrollable, and unchangeable—even by its creators," and therefore it doesn't qualify as property. Because OFAC's sanctioning power is limited to that which is property, it follows that OFAC cannot sanction immutable smart contracts.

This not-property ruling only applies to twenty immutable Tornado Cash contracts that were on OFAC's sanctions list. Tornado's mutable contracts, those that can be controlled and changed, remain property—and thus can stay on the list of sanctioned contracts. Unless OFAC wins on appeal, it will presumably have to unsanction those twenty immutable contracts.

Now, it's possible that as long as the remaining sanctioned mutable contracts are crucial to the functioning of the Tornado Cash bot, the revised sanctions blacklist will still have an effect. And if OFAC adds other key mutable Tornado Cash smart contracts to its list (say like the contracts allowing governance, which for some reason were not originally sanctioned), American users will continue to steer clear of Tornado Cash, the bot's anonymizing capacities remaining lower than otherwise, thus diminishing its ability to serve North Korean interests. 

But if not, what can OFAC do? 

Sanction users, not code

I've already done a bit of digging on this question. In response to the sanctions, I wrote an article in late 2022 entitled: How to stop illegal activity on Tornado Cash (without using sanctions) The gist was to explore alternative tools for countering illicit activity on Tornado rather than the blunt tool of sanctioning its actual smart contracts. What I suggested was to apply pressure to the users of the smart contracts. "Rather than punishing code, penalize the people who use the code."

The logic goes like this. Any user who deposits crypto to Tornado Cash, even someone with clean crypto, is providing North Korea with prohibited financial services, the Tornado bot being the means by which the two sides are connecting as counterparties. Whether intentional or not, a user's deposits broaden the anonymity set of Tornado Cash, or its ability to obfuscate larger amounts of illicit funds sourced from sanctioned counterparties like Lazarus.

Think of it as sanctioned North Korean users passing on sanctions taint to all other Tornado Cash users by virtue of everyone interacting via the same bot, Tornado Cash. This taint spreads to those who deposited their crypto (clean or dirty) to Tornado at the same time as Lazarus and/or those who have continued to deposit to it in light of the known fact that the North Korean group regularly deposits stolen funds to the platform.

OFAC issues a public alert stating that any foreigner can and will be sanctioned if their funds interact with North Korean funds on Tornado Cash. In response, some foreign users will risk being designated and continue to engage with Tornado. Many will not. As for U.S. users, OFAC can threaten them with potential civil monetary penalties if they aid North Korea using Tornado as their a tool. A $10,000 fine for interacting with sanctioned North Korean actors via the Tornado Cash bot will probably discourage most usage.

Another core set of Tornado Cash users who OFAC has legal leverage over are the relayers—real life individuals who provide an extra layer of privacy to Tornado Cash users. (I explain here why relayers are necessary for full privacy). OFAC can threaten foreign relayers with sanctions and U.S.-based relayers with civil monetary penalties.

Pressuring these various groups of users won't stop Tornado Cash code from functioning, but it will certainly constrain the activity it facilitates, and thus make it harder for North Korea to anonymize its funds. And it is consistent with the court's not-property ruling because users, not contracts, are being targeted.

I'm not saying that OFAC will follow this playbook, or that it should, but it certainly is an option. There is another route, though, and that is to go to Congress and ask for the ability to put sanctions on immutable entities. 

More broadly, Tornado Cash may just be the first in an emerging population of unownable and uncontrollable techno-beings—bots, machines, drones, androids, AI agents,  automatons, and golems—that operate independently of human control, many of which will end up doing very dangerous things. Society may want the legal ability to protect its members from these immutable contraptions, including by sanctioning them.

For instance, imagine the following scenario...

A Russian AI-guided assassin bot

If a Russian assassin is regularly poisoning people (including U.S. citizens) for criticizing Putin, OFAC can sanction that assassin, thus preventing any American entity from dealing with him and blocking all of his accounts, his car, and his interests in various companies. That might not stop the assassin, but it'll make his job more difficult. In doing so, OFAC is simply fulfilling its mandate to use its sanctioning powers to protect Americans.

Say the assassin creates an artificial intelligence and imbues it with all of his assassin's lore, providing it with an artificial body and then throwing away the keys, rendering the robot immutable. The court's recent not-property ruling suggests that while OFAC can ably defend Americans from the flesh and blood assassin, it cannot protect them from the assassin's immutable killing robot—even though the robot performs the precise same killing function as the living assassin using the exact same techniques.

This is obviously an incongruity, one that seems like it should be fixed. Or is there a specific reason why we should provide legal safe harbor to all unownable and uncontrollable techno-beings? Feel free to explain in the comments.

In any case, OFAC's efforts to apply its national security mandate to Tornado Cash are probably not over. Let's see how it responds. Some sort of resolution is important because we are still in the early stages of being inundated with self-guided autonomous agents.

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?