tag:blogger.com,1999:blog-67045734624033124592024-03-19T08:42:04.902-04:00Moneynesseconomics, monetary economics, central banking, free banking, gold, the history of economic thought, finance, stock markets, economic history, Canadian economics, and the visualization of data.JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.comBlogger640125tag:blogger.com,1999:blog-6704573462403312459.post-55224231820349568162024-03-18T17:09:00.011-04:002024-03-19T08:41:33.192-04:00How PayPal can use stablecoins to avoid AML requirements and make big profits<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXG-rrjK0OM6ROTt-uZ6RWJ3yS5NE6wf9wUJ_UKNEuGjC48_PUCoUYGVaxojt9bpQE94UTdi8Wlm0iDlRar_hhEQps1gOGPUOkpGrUYgy2bpx6x12ORkNSB3Vbxb9CK-2ENp_Ix3gziZ_F5tZTwEBxPQCcAncl8XQVvVHe7C8EmEAbZ_dsw4gkIBDGB_c/s1097/pyusd.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="472" data-original-width="1097" height="276" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXG-rrjK0OM6ROTt-uZ6RWJ3yS5NE6wf9wUJ_UKNEuGjC48_PUCoUYGVaxojt9bpQE94UTdi8Wlm0iDlRar_hhEQps1gOGPUOkpGrUYgy2bpx6x12ORkNSB3Vbxb9CK-2ENp_Ix3gziZ_F5tZTwEBxPQCcAncl8XQVvVHe7C8EmEAbZ_dsw4gkIBDGB_c/w640-h276/pyusd.PNG" width="640" /></a></div><p><br />There's a new financial loophole in town: <i>stablecoins.</i> Stablecoins are dollar, yen, or pound-based payments platforms that are built using crypto database technology. <br /><br />Financial institutions are always looking for loopholes to game the system. Typically this has meant avoiding capital requirements or liquidity ratios in one jurisdiction in favor of a looser standards elsewhere. The new stablecoin loophole allows for a different set of financial standards to be avoided, society's <i>anti-money laundering</i> regulations.<br /><br />I'll explain this new loophole using PayPal as my example. <br /><br />PayPal now offers its customers two sorts of regulated platforms for making U.S. dollar payments. The first type will be familiar to most of us. It is a traditional PayPal account with a U.S. dollar balance, and includes PayPal's flagship platform as well as PayPal-owned platforms Xoom and Venmo. These all have <i>strict </i>anti-money laundering controls.<br /><br />The second type is PayPal's newer stablecoin platform, PayPal USD, which has <i>loose </i>anti-money laundering controls. PayPal USD is built on one of the world's most popular crypto databases, Ethereum. Dollars held on crypto databases are typically known as stablecoins, the most well-known of which are Tether and USDC.<br /><br />What do I mean by fewer anti-money laundering controls?<br /><br />If I want to transfer you $5,000 on PayPal's traditional platform, PayPal will first have to grant both of us permission to do so. It does so by obliging us go through an account-opening process. PayPal will carry out due diligence on both of us by collecting our IDs and verifying them, then running our information against various regulatory blacklists, like sanctions lists. Only after we have passed a gamut of checks will PayPal allow us to use its platform to make our $5,000 transfer.<br /><br />Contrast this to how a payment is made via PayPal's new stablecoin platform. <br /><br />First, we both have to set up an Ethereum wallet. No ID check is required for this. That now allows us to access PayPal's stablecoin platform. Next, I have to fund my wallet with $5,000. I can get these these funds from a third-party who already holds money on PayPal's stablecoin platform, say from a friend, or from someone who buys goods from me, or from a decentralized exchange. Again, no ID is required for this transaction to occur. Once I have the funds, PayPal will process my $5,000 transfer to you.<br /><br />Can you spot the difference? In the transaction made via PayPal's legacy platform, PayPal has diligently got to know everyone involved. In the second transaction, PayPal makes no effort to gather information on us. And lacking our names, physical addresses, email addresses, or phone numbers, it can't do a full cross-check against various regulatory black lists. </p><p></p><p>More concretely, PayPal's legacy platform does its best to stop someone like Vladimir Putin, who is <a href="https://sanctionssearch.ofac.treas.gov/Details.aspx?id=35096">sanctioned</a>, from ever being able to sign up and make payments. But if Putin wanted to use PayPal's new stablecoin platform, PayPal makes almost no effort to stop him from jumping on. <br /><br />One of the biggest expenses of running a legacy financial platform is anti-money laundering compliance. Programmers must be deployed to set up onboarding and screening processes. Compliance officers must be hired. If a transaction is suspicious, that may trigger a halt, and the transaction will have to be painstakingly investigated by one of these officers. The platform is hurt by lost customer goodwill <span><span>–</span></span> no one likes a delay. <br /><br />That's where the stablecoin loophole begins.<br /><br />PayPal can reduce its costs of getting to know its customer by nudging customers off its traditional platform and onto its PayPal USD stablecoin platform. Now it can onboard them without asking for ID. Since it no longer collects personal information about its user base, fewer transactions trigger flags for being suspicious, and only rarely do they register hits on sanctions blacklists. That means fewer halts, delays, and costly investigations. PayPal can now fire a large chunk of its compliance staff. The reduction in costs leads to a big rise in earnings. Its share price goes to the moon.<br /><br />For now, PayPal's stablecoin platform remains quite small. Only $150 million worth of value is held on the platform, as the chart at the top of this post shows. The company's legacy platforms are much larger, with around <a href="https://s201.q4cdn.com/231198771/files/doc_financials/2023/q4/Q4-23-PayPal-Earnings-Release.pdf">$40 billion</a> worth of balances held. Given the compliance cost difference, though, I suspect PayPal would love it if its stablecoin platform were to grow at the expense of its legacy platform. <br /><br />I've used PayPal as my example, but the same calculus works for the financial industry in general. If every single bank in the financial system were to convert over to a stablecoin platform for the delivery of financial services, and no longer use their legacy platforms, the industry's total anti-money laundering compliance costs would plummet.<br /><br />So far I've just explained this all from the perspective of financial institutions, but what about from the viewpoint of the rest of us? Society has set itself the noble goal of preventing bad actors from using the financial system. A large part of this effort is delegated to financial institutions by requiring them to incur the expense of performing due diligence on their platform users. This requires a big outlay of resources. Many of these costs are ultimately passed on to us, the users.<br /><br />If institutions like PayPal switch onto infrastructure that doesn't vet users, then resources are no longer being deployed for the purposes we have intended, and the broader goals we have set out are being subverted. Is that what we want? I'd <a href="https://jpkoning.blogspot.com/2021/06/a-short-and-lukewarm-defence-of-anti.html">suggest</a> not.<br /></p><hr /><br /><span style="font-size: x-small;">Some followup thoughts:</span><p><span style="font-size: x-small;">1. PayPal's stablecoin platform employs fewer anti-money laundering controls than its regular platform. On the other hand, its stablecoin platform has stricter standards in other areas, including the safety of its customer funds. I wrote about this <a href="https://jpkoning.blogspot.com/2023/09/there-are-now-two-types-of-paypal.html">here</a>: "It's the PayPal dollars hosted on crypto databases that are the safer of
the two, if not along every dimension, at least in terms of the degree
to which customers are protected by: 1) the quality of underlying
assets; 2) their seniority (or ranking relative to other creditors); and
3) transparency." </span></p><p><span style="font-size: x-small;">2. The pseudonymity of stablecoins is something I've been writing about for a while. In a 2019 post, I worried that at some point this loophole would lead to "hyper-stablecoinization," a process by which <a href="https://jpkoning.blogspot.com/2019/11/from-unknown-wallet-to-unknown-wallet.html">every bank account</a> gets converted into a stablecoin. I'm surprised that almost five years later, this loophole still hasn't been closed.</span></p><p><span style="font-size: x-small;">3. The typical riposte to this post will be: "But JP, stablecoins are implemented on blockchains, and blockchains are transparent. This prevents bad actors from using them, and so stablecoins should be exempt from standard anti-money laundering rules." I don't buy this. Bad actors <i>are </i>using stablecoin platforms, despite their pseudo-traceability. "Its convenient, it's quick," say<a href="https://jpkoning.blogspot.com/2023/12/why-do-sanctioned-entities-use-tether.html"> a pair of sanctions breakers</a> about payments made via Tether, the largest stablecoin platform. Society has deputized financial institutions to perform the crucial task of vetting all their users. By not doing so, stablecoin platforms are shirkers. Trying to outsource the policing task to the public or to the government by using a semi-transparent database technology doesn't cut it.</span><br /></p><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com2tag:blogger.com,1999:blog-6704573462403312459.post-50966067275502288142024-03-13T21:34:00.007-04:002024-03-17T09:22:25.008-04:00Have the sanctions on Russia failed?<p>I very much enjoy economist <a href="https://twitter.com/robin_j_brooks">Robin Brooks's</a> tweets, especially his charts showing how sanctions imposed on Russia have affected regional trade patterns. While direct trade between Europe and Russia has collapsed thanks to Russia's invasion of Ukraine and subsequent sanctions, the chart below shows a suspicious-looking countervailing boom in European trade with Kyrgyzstan. <br /><br />A big chunk of these European goods are presumably being on-shipped from Kyrgyzstan to Russia.</p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">New all-time highs for Italian (lhs) and Austrian (rhs) exports to Kyrgyzstan in Nov '23. This goes on from every single EU country to every single country in Central Asia and the Caucasus. When you add all that up, the numbers are big. The EU looks the other way for 2 years now. <a href="https://t.co/Na5SrV9bpz">pic.twitter.com/Na5SrV9bpz</a></p>— Robin Brooks (@robin_j_brooks) <a href="https://twitter.com/robin_j_brooks/status/1766834220041638255?ref_src=twsrc%5Etfw">March 10, 2024</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script>Now, you can look at this chart and arrive at two contradictory conclusions. The first is that the EU's sanctions are not working because they are being avoided via third-party nations like Kyrgyzstan. (This is Steve Hanke's <a href="https://twitter.com/steve_hanke/status/1766855748061892677">take on</a> Robin's charts.) Or you can see the charts as evidence that the sanctions are working, for the following reasons.<br /><br />Sure, prohibited goods are filtering through to Russia <span><span>–</span></span> that was always going to be the case. But consider all the extra nuisances and frictions that now exist thanks to sanctions. For instance, instead of JCB tractors being shipped directly from factories in Europe to Russia, they have to be transferred to a third-party country, like Armenia, then perhaps re-routed to yet another country for the sake of obfuscation, say UAE, prior to those tractors finally entering Russia. (One of Robin's charts <a href=" https://twitter.com/robin_j_brooks/status/1766161321194672501">illustrates</a> the rise of the EU-Armenia-UAE-Russia nexus). <br /><br />These new roundabout trade routes introduce all sorts of additional costs including taxes, customs fees, shipping, insurance, and warehousing, not to mention extra palms to grease. There is also the extra risk of getting caught somewhere along this chain. A dealer involved in moving tractors to Russia via a third-party country, for instance, might be blacklisted by JCB (which has <a href="https://www.global.jcb/en/info/20220308.html">voluntarily chosen</a> to exit Russia), losing their dealer status.<br /><br />These combined costs get built into the final sticker price that Russian must pay for contraband American and European imports. Think of this extra wedge as a "sanctions tax." This sanctions tax leaves Russians with less in their pocket. And that means fewer resources for Putin to wage war than if the sanctions had never been levied. <br /><br />So when I see Robin's charts of various transshipment routes, they suggest to me that sanctions are effective courtesy of the <i>sand-in-the-gears</i> effect I just explained.<br /><br />Now, this doesn't mean that I think the coalition's existing sanctions program is sufficient. We are in a sanctions war with Putin, and that necessitates constantly opening up new economic fronts in order to throw Putin off guard and make it harder for him fund his war. The transshipment points illustrated in Robin's charts are a sign to me that existing sanctions are working, but they also seem like a great target for future sanctions. <br /><br />And in fact, the coalition has already taking two steps to pressure transshipment to Russia. <br /><br />The U.S. Treasury recently imposed <i>secondary sanctions</i> on any foreign financial institution that facilitates transactions involving Russia's military/industrial complex. (I wrote about this <a href="http://jpkoning.blogspot.com/2024/02/the-first-round-of-us-secondary.html">here</a>). What this means, for example, is that banks in transshipment points like Kyrgyzstan will have to be more careful when they deal with Russian entities. Any trade involving the military-industrial sector that passes through Kyrgyzstan will likely grind to a halt. Other non-military trade transiting through Kyrgyzstan, say JCB tractors, will probably continue to make it through, but thanks to heightened sanctions risk, banks will pass on this risk to Russians in the form of a higher sanctions tax.<br /><br />The second step is the EU's new and very provocative "no-Russia clause." It requires EU exporters to <a href="https://www.dentons.com/en/insights/articles/2024/march/6/impact-of-the-eus-new-no-re-export-to-russia-clause">contractually prohibit </a>their trading partners from re-exporting certain restricted goods to Russia. If caught, fines must be paid or the contract voided. That adds more sand in the gears.<br /><br />One hopes that the coalition of nations arrayed against Russia continues to increase its pressure on transshipment points. For instance, the EU could widen the range of goods subject to the no-Russia clause, the current list being somewhat limited. For now, though, my guess is that Robin's charts will show that the coalition's sanctions program is doing a better job in 2024 than it did in 2023, with the EU's no-Russia clause and the U.S.'s secondary sanctions being the proximate cause of that improvement.<br /><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com3tag:blogger.com,1999:blog-6704573462403312459.post-83082847686371070452024-03-05T07:47:00.004-05:002024-03-05T08:53:27.073-05:00It's time to get rid of "crypto"<p>Call me a pedant, but I'm not a fan of the word "crypto". It may have been a serviceable category back in 2011 when there was only one type of crypto thingy <span><span>–</span></span> bitcoin. But it's ceased to be a meaningful term and, if anything, it causes a regression in understanding.<br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGOnvodWBGft65-3ZxJ9kdW22OBpmXpoxGIUNTk6a2OomYIy6ugnxWaXtgwQ2NJi5lJck7v0vduLlQWCs8bxLFsQZvQbRWxTotFFfTnUcqFrP-7uXEXf6drEpYFAphFx6tXXR1DmNSmQiEBnnKB0sVTIGJhHdXg3Xm7X2u8XeY6r7ChCLKHWRgYWmphyphenhyphenk/s612/fidelity.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="571" data-original-width="612" height="374" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGOnvodWBGft65-3ZxJ9kdW22OBpmXpoxGIUNTk6a2OomYIy6ugnxWaXtgwQ2NJi5lJck7v0vduLlQWCs8bxLFsQZvQbRWxTotFFfTnUcqFrP-7uXEXf6drEpYFAphFx6tXXR1DmNSmQiEBnnKB0sVTIGJhHdXg3Xm7X2u8XeY6r7ChCLKHWRgYWmphyphenhyphenk/w400-h374/fidelity.PNG" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://www.fidelity.ca/en/investments/solutions-portfolios/all-in-one/">Fidelity</a></span><br /></td></tr></tbody></table><br /><p>Case in point is the above diagram from Fidelity, which <a href="https://www.fidelity.ca/en/investments/solutions-portfolios/all-in-one/">suggests</a>
that clients should conservatively invest 40% of their wealth in
"equity," 59% in "fixed income", and the other 1% in "crypto." <br /><br />These categories are nonsensical because in many cases, crypto
*is* equity. (And in other cases, crypto *is* fixed income.) Fidelity's buckets are not mutually exclusive.<br /><br />For
instance, take MKR tokens, which are inscribed on the Ethereum
blockchain and are a <a href="https://www.coingecko.com/">top-100</a> asset listed on CoinGecko. MKR may sound like it deserves to fall in the crypto bucket, but hold on a sec. As a MKR holder, you enjoy
a right to the earnings of MakerDAO, which is effectively an offshore
bank. You enjoy buybacks, voting control, and a residual claim on assets
after creditors in case of windup or bankruptcy. Guess what, folks.
That's equity! Yep, buying MKR shares is economically equivalent to buying shares in Bank of America. </p><p>Likewise with Dai tokens, the payments instrument <span><span>–</span></span> aka stablecoin <span><span>–</span></span> that MakerDAO issues to customers on the Ethereum blockchain and the <a href="https://www.coingecko.com/">25th largest asset</a> on CoinGecko. Sounds like crypto, no? But along with being pegged to the U.S. dollar, Dai pays interest of 5%. That puts it firmly into the fixed income bucket, very much like an uninsured interest-yielding account at the Bank of America.<br /><br />What exactly is crypto, then? <br /><br />The word "crypto" describes a database technology, not an asset class. Various asset classes <span><span>–</span></span> equity, bonds, options, and savings accounts (or <a href="https://jpkoning.blogspot.com/2023/07/the-strange-new-world-of.html">various combinations</a> of these) <span><span>–</span></span> can be recorded and stored on crypto databases, much like how MKR shares are served up on Ethereum, one of the most popular crypto database. These crypto databases fall in the same bucket as an Azure SQL database or an Oracle databases, both of which record assets but neither of which belongs itself to an asset class.<br /><br />So now you can see why Fidelity counseling its customers to invest 99% in equity + fixed income and 1% in crypto is absurd. It's a category mistake, like if Fidelity advised folks to hold 99% in equity + fixed income and 1% in assets stored on Oracle databases. </p><p>Telling customers to invest 1% of their wealth in generic assets stored in Oracle databases isn't just a category mistake; it's downright reckless. All sorts of wild financial stuff appears on Oracle databases, including sports bets and zero day options. Conservative investors have no business touching these. As for crypto databases, they are particularly notorious for holding financial fluff like ponzis and digital chain letters (i.e. litecoin, dogecoin, floki inu and their various ancestors and cousins); none of which Fidelity should be hocking to serious customers. <br /><br />Crypto doesn't refer to an asset class, it describes the database technology on which assets appear. Better yet, let's just get rid of the word altogether. It's beyond repair. <br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com8tag:blogger.com,1999:blog-6704573462403312459.post-54955779695647460772024-02-29T21:22:00.018-05:002024-03-01T14:51:20.934-05:00Why my favorite coinage is Byzantine coinage<p>What do I like about Byzantine coinage?<br /><br />Most people probably admire the <a href="https://en.wikipedia.org/wiki/Solidus_(coin)">Byzantine solidus</a>, a gold coin that maintained its weight and purity for over 600 years, which is quite remarkable for a coin. The solidus was exported all over the world, including to Europe, which lacked gold coinage at the time, making it the U.S. dollar of its day.<br /><br />That's neat, but it's not the solidus that impresses me. It's Byzantium's small change that I like. <br /></p><p>The availability of small change is vital to day-to-day commercial life. Alas, the minting of low-value coins has often been neglected by the state. Small change isn't sexy. And it has often been unprofitable to produce. But that didn't stop the Byzantines. After a monetary reform carried out by <a href="https://en.wikipedia.org/wiki/Anastasius_I_Dicorus">Emperor Anastatius</a> in 498 AD, Byzantium began to issue a number of well-marked and differently-sized bronze coins of low value. Anastatius, who had been an administrator in the department of finance prior to becoming an Emperor, appears to have had a fine eye for monetary details.<br /><br />Let's start with the follis, worth 40 nummi. (The <i>nummus </i>was the Byzantine unit of account.)<br /><br /></p><div class="separator" style="clear: both; text-align: center;"><iframe allowfullscreen='allowfullscreen' webkitallowfullscreen='webkitallowfullscreen' mozallowfullscreen='mozallowfullscreen' width='380' height='266' src='https://www.blogger.com/video.g?token=AD6v5dyfMtr6xAzGvG4sxG_5_DJoywzhz2ZeEl9mvyxrRtLXe7v9AQy52UohrTUxZBrasP8RC0PuUQtO1TUm2-Vk7Q' class='b-hbp-video b-uploaded' frameborder='0'></iframe></div><br />The follis in <a href="https://conservatoricoins.com/showcase-coin-justinian-plague-follis-constantinople-540-1-ad/">the above video</a> was minted in 540 AD by Justinian I, some forty years after Anastatius's monetary reform. At 23 grams, it contains an almost comically-large amount of material. For comparison's sake, that's the same heft as four modern quarters. Allocating so much base metal to a single coin illustrates the Byzantine's dogged commitment to producing a usable set of low denomination coins for the population.<br /><br />The decision to go with the hulking follis was better than the small change strategy that the English would pursue hundreds of years later. English monarchs either neglected small change altogether, forcing the public to<a href="https://www.cointalk.com/threads/medieval-cut-pennies.266902/"> hack up silver pennies</a> into smaller chunks by hand. Or, if they did produce low value coins, did so in the form of silver <a href="https://en.wikipedia.org/wiki/Halfpenny_(British_pre-decimal_coin)">halfpennies</a> and <a href="https://en.wikipedia.org/wiki/Farthing_(English_coin)">farthings</a>, the smallest English denominations. Which was not a good idea. Silver has a much higher value-to-weight ratio than bronze, so the half-penny and farthing ended up being <a href="https://jpkoning.blogspot.com/2023/06/the-lower-limit-to-silvers-usefulness.html">absurdly tiny</a>, as illustrated in the video below from the <a href="https://twitter.com/SDetectorist/status/1667899080842829824">Suffolk Detectorist</a>. <br /><br /><br /><div class="separator" style="clear: both; text-align: center;"><iframe allowfullscreen='allowfullscreen' webkitallowfullscreen='webkitallowfullscreen' mozallowfullscreen='mozallowfullscreen' width='380' height='266' src='https://www.blogger.com/video.g?token=AD6v5dz9GUootwC52nDTHoCcjT77cFnpFx62LS1sdLd68qz1ZVzOON4q8SWJL_cDanfdzH6LcMtUKURAVty_yYqOzQ' class='b-hbp-video b-uploaded' frameborder='0'></iframe></div><br />"Weighing only three troy grains each, these were 'lost almost as fast as they were coined,'" writes monetary economist George Selgin of the farthing. And because the two coins were so small, almost no information could be conveyed on their face. No, as far as small change goes, the Byzantine's bronze coins were the way to go.<br /><p></p><p>Anastatius had another theoretical option available to him, one which wouldn't have tied up so much raw material. He could have made a <i>token coin</i>. With a token coin (say like James II's tin halfpennies, which came almost a thousand years later, and which I wrote about <a href="https://jpkoning.blogspot.com/2023/06/the-lower-limit-to-silvers-usefulness.html">here</a>), the value of the coin doesn't rely on the metal in it, but on the ability of the issuer to repurchase it at the stipulated weight. By issuing the follis as a token, the Byzantines could have been able to make it smaller, say half the size, yet still rate it at 40 nummi, thus saving large amounts of bronze for alternative uses.<br /><br />But the Byzantines appear to have been committed <i>metallists</i>, abiding by the principle that the value of money comes from the value of the metal in it. And so they bequeathed the world the monster-sized follis.<br /><br />In additions to the follis, Anastatius introduced lower denomination bronze coins, including the half-follis (20 nummi), quarter-follis (10 nummi), and <i>pentanummium </i>(five nummi). They are illustrated below. Later emperors would add a three-quarter follis, or <a href="https://en.numista.com/catalogue/pieces297194.html">30 nummi</a> coin, to the mix. At times, a tiny <a href="https://en.numista.com/catalogue/pieces297663.html">1 nummus</a> coin was issued too.<br /></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEkD9OxytpVvbFGntsF4ZFH1mM5cvROqp-X52EHsHs7RjLmLbu2R2iklA4NsOBP3DJ4LydxBQ1p5Qa0UvUOKcZgcszEuf1u2P-oT4LgE7HsCOg9W50DbcXJ3dtOXjrtSZMsRjT5jxCF7XCsEtjMkAnBkK_KModboL29aItCom1hTX_tikPfJ1c-FAmNCs/s1095/byzantine%20small%20change.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="681" data-original-width="1095" height="398" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEkD9OxytpVvbFGntsF4ZFH1mM5cvROqp-X52EHsHs7RjLmLbu2R2iklA4NsOBP3DJ4LydxBQ1p5Qa0UvUOKcZgcszEuf1u2P-oT4LgE7HsCOg9W50DbcXJ3dtOXjrtSZMsRjT5jxCF7XCsEtjMkAnBkK_KModboL29aItCom1hTX_tikPfJ1c-FAmNCs/w640-h398/byzantine%20small%20change.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Follis (40 nummi), half-follis (20 nummi), quarter-follis (10 nummi), and <i>pentanummium </i>(five nummi). Source: <a href="https://www.cointalk.com/threads/the-coinage-reform-of-anastasius.355188/#post-4129643">Cointalk</a></span><br /></td></tr></tbody></table><br />The decision to produce a full array of base coins illustrates Anastatius's sensibility to the transactional needs of the common person, for whom the gold solidus would have been far too valuable to be relevant to their economic lives, almost like a $1,000 bill. Oddly, Anastatius chose not to mint any silver coins. But as the English farthing example illustrates, silver was too valuable to be useful for the lower end of day-to-day commercial life, better destined to act like a modern $50 bill than a humble $1 or $5 bill.<br /><br />Another neat feature of Byzantine coinage is how Anastatius and his successors used each coin's surface area to convey useful information rather than to aggrandize god & state. The obverse of each coin bore the obligatory image of the Emperor, but the reverse side provides loads of monetary data: the denomination, the date of the Emperor's reign in which the coin was minted, the name of the mint, the number of the workshop of the mint. Compare this to Roman coinage, for instance, which often bore expressive portraits on either side of the coin, but next to no data. <br /><br />If you're interested in getting a longer description of how to read Byzantine coins, check out <a href="http://augustuscoins.com/ed/Byz/legends.html">Augustus Coins</a>. <p></p><p></p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">I'm new to Byzantine coinage, but I'm impressed by how much information they managed to pack into such a small area. Here's a great introduction on how to read Byzantine coins: <a href="https://t.co/46sVeROIKx">https://t.co/46sVeROIKx</a><br /><br />The example below shows how to read a follis issued during Justin II's reign: <a href="https://t.co/OSsH930c2g">pic.twitter.com/OSsH930c2g</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1503362509704777728?ref_src=twsrc%5Etfw">March 14, 2022</a></blockquote><p> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> A particularly unique feature of Anastatius's monetary reform was his decision to inscribe the <i>unit of account </i>directly onto his coins. As you can see, the follis has a big "M" on its reverse side, which is Greek for 40. The half follis has a "K", which means 20, and the quarter follis an "I", which is 10. Finally, the pentanummium displays an "Є", equal to 5. All of these numbers indicate the value of the coin in terms of the Byzantine unit of account, the nummus.<br /><br />Nowadays, we take this format for granted. The coins in your pocket all include the coin's value on their face, just like Anastatius's coins did. But what you need to realize is that the coinage of most civilizations, both before and after the Byzantines, rarely displayed how many pounds or shekels or dinars that coin was worth. Take <a href="https://www.reddit.com/media?url=https%3A%2F%2Fi.redd.it%2F65v7ncx8ijm91.jpg">a look at</a> Rome's Imperial era coinage. There's plenty of religious symbolism to be found on the <a href="https://en.wikipedia.org/wiki/Sestertius">sestertius</a>, <a href="https://en.wikipedia.org/wiki/As_(Roman_coin)">as</a>, and <a href="https://en.wikipedia.org/wiki/Dupondius">dupondius</a>. The monarch's face appears, as do dates and names. But there's not a single digit to indicate how many units of account the coin is worth. The same goes for most medieval European coinage. (A lone exception is <a href="https://twitter.com/jp_koning/status/1564963875992342528">Roman coinage</a> from the Republican period beginning around 211 BC).<br /><br />Anastatius's decision to stamp the denomination directly on the coin represents a big improvement in usability. No need for transactors to seek an external source to determine how many nummi a follis was worth. It was right there for everyone to see.</p><p>Some of you may be wondering: <i>why did so many civilizations avoid numbering their coins?</i> </p><p>Ernst Weber, an economist, has put forward one <a href="https://www.web.uwa.edu.au/__data/assets/pdf_file/0017/402245/09_12_Weber.pdf">possibility</a>. A lack of "value marks" may suggest that coins were intended to circulate at "market determined exchange rates" according to their metal content. Coins might have had varying amounts of metal due to inadequate manufacturing technology, people preferring to weigh them prior to payment so as to assess their market value. In this context of <i>non-fungibility</i>, striking a universal unit of account on each coin would be a nuissance, or at least a waste of time.</p><p>According to Weber's theory, Anastatius may have had so much confidence in the ability of his mints to produce durable and homogeneous bronze coins that he dared to affix the nummi unit-of-account onto them.<br /></p><p></p><p>Another reason for not numbering coins may be that a <i>blank slate</i> gave authorities a degree of flexibility to set monetary policy. If a coin isn't indelibly etched with a value, a monarch can alter a coin's purchasing power, or rating, by mere proclamation. This was known as a <i>crying up</i> or a <i>crying down</i> of a coin's value. For instance, an English king might wake up one day and declare a certain type of already-circulating coin that had been worth £0.10 the day before to be worth £0.09 today, thus decreasing its purchasing power. This sort of abrupt change in value would be awkward to implement if said coin already had £0.10 struck on its face.<br /><br />A ruler might have good monetary policy reasons for wanting this flexibility. But this same malleability could be abused, too, in order to profit some at the expense of others. Anastatius decided to forfeit this flexibility by freezing his coin's value in time. The Byzantine public no longer had to deal with the uncertainty of coins being suddenly revalued.<br /></p><p>Unfortunately, the full array of Byzantium small change introduced by Anastatius would only survive for two or three centuries. As time passed, weights would be reduced and workmanship would become "increasingly slovenly," according to numismatist <a href="https://archive.org/details/grierson-byzantine-coinage">Philip Grierson</a>. The quarter follis and pentanummia would be discontinued by Constantine V (741–775). The half-follis ceased under Leo IV (775–780). <br /><br />As for the follis, it would stick around for a few more centuries, but around 850 AD, Theophilus would drop the emblematic M in favor of the unhelpful inscription "Emperor Theofilos, may you conquer," writes Grierson. Thus ended the great period of Byzantine low-value coinage. But during the brief period of time after Anastatius, Byzantine produced one of the best examples we have of good small change, presaging the coins we carry in our pockets today.</p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com0tag:blogger.com,1999:blog-6704573462403312459.post-45545287206115679012024-02-22T17:59:00.008-05:002024-02-23T14:00:40.359-05:00The first round of U.S. secondary sanctions on Russia is working<p>Turkish banks <a href="https://mailchi.mp/middleeasteye/turkish-banks-restart-payments-to-russian-banks-amid-us-sanctions-exemptions?e=bb2f085444">halted transactions</a> with Russian banks last month and are only slowly reintroducing payments for a narrow range of products that are on a so-called "green list," reports Ragip Soylu. This broad debanking of Russia by Turkey is part of the fallout from President Biden's <a href="https://home.treasury.gov/news/press-releases/jy2011">first round</a> of <i>secondary sanctions</i>, announced on December 22. </p><p>Ukraine/sanctions watchers around the world are breathing a sigh of relief. At last the cavalry has arrived! While the Russian sanctions program has <a href="https://twitter.com/jp_koning/status/1759196676793794796">often been described</a> by the press as the "world's strictest", in actuality it has been (till now) alarmingly light-touched due to its lack of the toughest tool of financial warfare: secondary sanctions.</p><p></p><p><b>Primary sanctions vs secondary sanctions</b><br /><br />Secondary sanctions, especially when applied to foreign banks, are far more damaging than <i>primary sanctions</i>, which to date have been the dominant type of sanction levied against Russia. </p><p>With primary sanctions, it is the "primary" layer <span><span>–</span></span> U.S. citizens and companies <span><span>–</span></span> that are cut off from dealing with the designated Russian target(s). However, primary sanction don't prevent non-U.S. individuals or non-U.S. companies, say a Turkish bank, from filling the void left by departing American counterparts, often acting as a re-router of the very U.S. goods that can no longer be moved directly to Russia by U.S. firms. So rather than reducing the amount of Russian trade, primary sanction often lead to little more than a <i>displacement </i>of trade from one route to another. That's a nuissance for the targeted country, but hardly a game changer.<br /></p><p>Secondary sanctions are an effort to combat this <i>displacement effect</i>. They do so by extending the trade prohibitions placed on the primary layer, U.S. actors, to the second layer, that is, to non-U.S. actors. In the case of Biden's December order, foreign banks can no longer facilitate certain Russian transactions that have already been off bounds to Americans for several years. <br /><br />So far, Biden's secondary sanctions appear to be working. In addition to halting all transactions with Russia for a month, Turkish banks have completely <a href="https://twitter.com/jp_koning/status/1758496679400030255">stopped opening accounts</a> for Russian customers. According to Reuters, Turkish exports to Russia <a href="https://www.reuters.com/markets/turkish-russian-trade-hit-by-fresh-us-sanctions-threat-2024-02-19/">fell 39%</a> year-on-year in January. In China, <a href="https://www.pekingnology.com/p/chinese-banks-scrutinize-trade-payments?utm_medium=android">reports say</a> that banks have "heightened scrutiny" of Russian transactions, in some cases going so far as to <a href="https://kyivindependent.com/leading-chinese-bank-halts-operations-in-russia-belarus/">cut off</a> Russian banks. UAE banks have also <a href="https://www.pravda.com.ua/eng/news/2024/02/19/7442486/">begun to restrict</a> linkages to Russia.</p><p><b>Why comply with the U.S.?</b><br /><br />Why do non-U.S. actors bother complying with U.S. secondary sanctions? After all, if you're a Turkish banker in Istanbul, Biden has no jurisdiction over you. America can't put you in jail, or fine you.</p><p>The way that the U.S. is able to sink a hook into non-U.S. actors is by threatening to take away access to the U.S. economy. Foreign banks, for instance, are told they will be exiled from the all-important U.S. banking system if they don't severe or constrict their Russian relationships. Since access to the Ne York correspondent banking system is so important relative to the small amounts of sanctioned Russian business they must give up, foreign banks are quick to fall into line.<br /><br />Biden's secondary sanctions on foreign banks only apply to a narrow range of transaction types, specifically those that support Russia's<i> military-industrial base</i>. In short, any foreign bank that is found to be conducting transactions involving military goods destined for Russia can be penalized. Those foreign banks that deal in, say, Russian food imports needn't worry.</p><p>In addition to obviously prohibited military items, like missiles and fighter jets, the U.S. Treasury has provided a list of not-so obvious items, such as oscilloscopes and silicons wafers, that it deems fall under the category of military-industrial goods. I've appended this list below. The Treasury suggests that these additional items might be used for, among other things, the production of advanced precision-guided weapons.</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0Z_13vRWEPpFUn9xHwHDIf3-vVQLkc-zGrWhRIoXD7NSCXslHCqeFIDUKKZ5kE4EJS1hBLVKWK8azIucgVADT_cp1r4hZ69hFHA3slhggSLeOHJa-l0fvSo6qkA6mpga0oLgc3Lo5QAlZKMfOPgRa-wsTUCt74IMtj5cX_2uJf8K3qgv3_WXNoo7XR8k/s989/specified%20items.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="989" data-original-width="818" height="640" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0Z_13vRWEPpFUn9xHwHDIf3-vVQLkc-zGrWhRIoXD7NSCXslHCqeFIDUKKZ5kE4EJS1hBLVKWK8azIucgVADT_cp1r4hZ69hFHA3slhggSLeOHJa-l0fvSo6qkA6mpga0oLgc3Lo5QAlZKMfOPgRa-wsTUCt74IMtj5cX_2uJf8K3qgv3_WXNoo7XR8k/w530-h640/specified%20items.png" width="530" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://ofac.treasury.gov/media/932446/download?inline">OFAC</a></span><br /></td></tr></tbody></table><br />That's quite an extensive list.<br /><br />Turkish banks appear to have overcomplied by <a href="https://mailchi.mp/middleeasteye/turkish-banks-restart-payments-to-russian-banks-amid-us-sanctions-exemptions?e=bb2f085444">dropping any transaction</a> that even has a whiff of Russia. This <i>de-risking</i> effect is a common by-product of various banking controls, both sanctions and anti-money laundering, whereby banks cease dealing not only with prohibited customers but certain legitimate customers that are superficially similar to prohibited customers that they are deemed too risky and expensive to touch. <br /><p></p><p>According to reports, Turkish banks have reintroduced transactions for <a href="https://meduza.io/en/feature/2024/02/01/turkish-banks-reportedly-cracking-down-on-russian-accounts-in-response-to-u-s-secondary-sanctions">green-listed products</a> such as agricultural products, which aren't actually targeted by the U.S. secondary sanctions.<br /><br />Turkish financial institutions may be particularly sensitive to U.S. sanctions given the fact that an executive of Halkbank, a Turkish government-owned bank, was <a href="https://www.justice.gov/usao-sdny/pr/turkish-banker-mehmet-hakan-atilla-sentenced-32-months-conspiring-violate-us-sanctions">sentenced to 32-months</a> in U.S. jail in 2018 for helping Iran evade U.S. sanctions and money laundering. One of his evasion routes was the notorious <i>gold-for-gas</i> trade, which I wrote about <a href="https://jpkoning.blogspot.com/2012/12/turkey-iran-and-gold-for-gas.html">here</a>. Halkbank itself was <a href="https://www.justice.gov/usao-sdny/pr/turkish-bank-charged-manhattan-federal-court-its-participation-multibillion-dollar">indicted in 2019</a> for sanctions evasion; the case against it is ongoing. <br /></p><p><b>An unforgiving legal standard </b><br /><br />An important element of any alleged crime is the mental state of the alleged criminal, or their "intent." This gets us to another reason for the rapidity and breadth of the debanking of Russian trade. Biden's secondary sanctions have a novel legal feature. The legal standard on which they rely, <b>strict liability</b>, does not require that the prosecution prove intent.<br /><br />Up till now, U.S. secondary sanctions <a href="https://www.gibsondunn.com/wp-content/uploads/2024/02/2023-year-end-sanctions-and-export-controls-update.pdf">have not</a> deployed this sort of a strict liability standard. To demonstrate that a foreign bank has engaged in evading secondary sanctions on Iran, for instance, U.S. prosecutors have been required to show that the foreign bank did so <i>knowingly</i>. If the banker conducted prohibited Iranian transactions unknowingly (i.e. inadvertently or unintentionally), then they couldn't be found guilty of sanctions evasion.<br /><br />Under the strict liability standard set out in Biden's December 22 order, there is <a href="https://www.gibsondunn.com/wp-content/uploads/2024/02/2023-year-end-sanctions-and-export-controls-update.pdf">no onus</a> on U.S. sanctions authority to show that a foreign bank has knowingly conducted transactions linked to Russia's military-industrial complex. Even an unintentional transaction can be punished. Because this strict liability standard makes it so much more likely that foreign banks run afoul of sanctions and get cut off from the U.S. banking system, bankers are rushing to comply.<br /><br /><b>What's next? </b><br /></p><p>When the U.S government asked domestic entities to stop dealing with Russia a few years ago, many of these transactions were quickly displaced to third-parties like Turkey. By deputizing foreign banks to be equally vigilant, secondary sanctions will likely crimp the original displacement effect, resulting in a big and permanent decline in Russian trade.</p><p>To get an idea for what might happen to Russia's military-industrial goods trade, take a look at how Iran's oil exports were halved after Obama imposed secondary sanctions on Iran in 2012, leapt when they were lifted in 2016, and crumbled again when Trump reimposed them in 2018.</p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg2iKyNIigFXBju191u4xearCwuXGYteOpQPplYXaaEUgP9OVMK_nbIl6UIo6nTNZIjZqFg9s__DXqZYmeNdplBQrdWuVaQLdw6HVla9dCdPfnYdXvlnWEve856o114-I-46h10Vp0V1LiyTVOjXiJ1fYJUGfZdEFyO8-mcCzk4SXIzhI8cp91-ZD5XhoQ/s671/secondarysanctions1.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="458" data-original-width="671" height="437" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg2iKyNIigFXBju191u4xearCwuXGYteOpQPplYXaaEUgP9OVMK_nbIl6UIo6nTNZIjZqFg9s__DXqZYmeNdplBQrdWuVaQLdw6HVla9dCdPfnYdXvlnWEve856o114-I-46h10Vp0V1LiyTVOjXiJ1fYJUGfZdEFyO8-mcCzk4SXIzhI8cp91-ZD5XhoQ/w640-h437/secondarysanctions1.png" width="640" /></a></div><br />The lesson is that secondary sanctions on foreign financial institutions can be very effective.<br /><br />Evasion efforts will begin very quickly. When secondary sanctions were first placed on Iran in 2012, Turkish bank Halkbank introduced a <a href="https://www.justice.gov/opa/press-release/file/1210396/download">forged document scheme</a> in an effort to disguise trade in sanctioned crude oil shipments as legitimate food transactions. The U.S. will have to step up its enforcement efforts to plug these holes. Without proper enforcement, the effect of the secondary sanctions will remain muted. <br /><br />Using the secondary sanctions on Russia's military-industrial complex as a model, there are many more sectors of the Russian economy on which secondary sanctions might be placed. The next round could extend to Russian automobile imports, its central bank, or the diamond industry.<p></p><p><b>Secondary sanctions to strengthen the oil price cap</b> <br /></p><p>Even more useful would be to use secondary sanctions to strengthen the most important piece of financial artillery heretofore deployed against Russia: the <b>$60 oil price cap</b>. </p><p>The price cap endeavors to force Russia to accept a below-market price for the oil that it ships, thus hurting its ability to finance its invasion of Ukraine. The cap is currently underpinned at the primary level by threatening banks, insurers, shippers and other businesses located in the EU, U.S., and other G7 countries ("the Coalition") with penalties if they trade in Russian oil above $60. Because Russia has historically been dependent on Coalition service provides for shipping oil, it has been getting less revenue for its oil then it would otherwise receive. </p><p>However, over time a growing chunk of Russia's oil exports has been diverted away from Coalition service providers to third-parties in jurisdictions like Turkey and UAE that are not subject to the cap. This has allowed Russia to sell at prices in excess of $60 and thus recover much of its forgone revenues. If the cap were to be applied not only at the primary Coalition layer, but also at the secondary layer by requiring foreign financial institutions to join in via the threat of secondary sanctions, then much more Russia oil would brought back under the $60 ceiling, and Russia's ability to finance its war against Ukraine would be significantly crimped.</p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com17tag:blogger.com,1999:blog-6704573462403312459.post-49970090376864758162024-01-31T22:18:00.018-05:002024-02-01T07:09:56.598-05:00What does the recent ruling on the Emergencies Act mean for your banking rights?<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiqHJKpHnd2hoNMaD3-pOKKRcFxf9NuhRX8MVSPCRLjBK9fkoMphhrB_Hpbgk3Pp28b9EUJMoQN_BDKzAyeHVCLi2JWBbfYf65SHflfWuZGpQYdq2Oj3BohNsUQ_-esJntFcAamd7WYlRylXXMl0jVPHOpJmxIdME_jIohWEJNjyHPQ16A7mH17gNEvK_A/s933/eemo.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="580" data-original-width="933" height="398" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiqHJKpHnd2hoNMaD3-pOKKRcFxf9NuhRX8MVSPCRLjBK9fkoMphhrB_Hpbgk3Pp28b9EUJMoQN_BDKzAyeHVCLi2JWBbfYf65SHflfWuZGpQYdq2Oj3BohNsUQ_-esJntFcAamd7WYlRylXXMl0jVPHOpJmxIdME_jIohWEJNjyHPQ16A7mH17gNEvK_A/w640-h398/eemo.PNG" width="640" /></a></div><br /><p></p><p>A Federal judge <a href="https://www.fct-cf.gc.ca/Content/assets/pdf/base/2024.01.23-306-22-T-316-22-T-347-22-T-382-22.pdf">ruled last week</a> that the emergency banking measures taken to end the Ottawa convoy protest in 2022 contravened the protestor's rights. In this post I want to provide my reading of this particular ruling and what is at stake for Canadians and their bank accounts. </p><p>To be clear, Justice Mosley's ruling touched on far more than the banking measures, and extended to the broader legality of the government's invocation of the Emergencies Act on February 14, 2022, subsequently revoked on February 23. However, since this is a blog on money, I'm going to limit my focus to the banking bits of the court ruling.</p><p></p><p>(By the way, I've written about emergency banking measures <a href="https://jpkoning.blogspot.com/2022/02/the-trucker-convoy-and-choking-off.html">a few</a> <a href="https://jpkoning.blogspot.com/2022/02/bitcoin-failed-as-tool-for-funding.html">times</a> <a href="https://jpkoning.blogspot.com/2022/03/stripe-and-ottawa-trucker-convoy.html">before</a>.)<br /><br />To remind you, there were two emergency banking measures enacted in February 2022 that affected regular Canadians. The most well-known measure was the freezing of bank accounts. The RCMP collected the names of protestors, and forwarded these to banks and credit unions, which used this information to locate protestors' accounts and immobilize their funds. In the end, 280 bank accounts were frozen. <br /><br />The second and less well-known banking measure was the requirement that banks share protestors' personal banking information with the RCMP and the Canadian Security Intelligence Service (CSIS), including how much money the protestor had in their account and what sorts of transactions they made.<br /><br />Justice Mosley has ruled that these banking measures <span><span>–</span></span> both the freezing and the sharing <span><span>–</span></span> violated the Canadian Charter of Rights and Freedoms. Specifically, they contravened <a href="https://www.justice.gc.ca/eng/csj-sjc/rfc-dlc/ccrf-ccdl/check/art8.html">Section 8</a> of the Charter, which specifies that everyone has the "right to be secure against unreasonable search or seizure." <br /><br />The best way to think about Section 8 is that all Canadians have privacy rights. These rights cannot be trodden on by the government. The police can't conduct unjustified personal searches of your body or home, say by snooping on your credit card transactions. Nor can they seize your bank statements or your computer in order to gather potentially incriminating information on you.<br /><br />This doesn't mean that a Canadian can never be subject to searches and seizures. Section 8 doesn't apply when the person who is subject to a search or seizure has no privacy rights to be violated. So for example, if I leave my old bank statements in the trash on the curb, it's likely that I've forfeited my privacy rights to them, and the police can seize and search them without violating Section 8 of the Charter.<br /><br />An interesting side point here is that Canadians don't forfeit their privacy rights by giving up their personal information to third-parties, like banks. We have a <i>reasonable expectation of privacy</i> with respect to the information we give to our bank, and thus our bank account information is afforded a degree of protection under Section 8 of the Charter. <br /><br />My American readers may find this latter feature odd, given that U.S. law stipulates the opposite, that Americans have<i> no reasonable expectation of privacy</i> in the information they provide to third parties, including banks, and thus one's personal bank account information isn't extended the U.S. Constitution's search and seizure protections. This is known as the <a href="https://en.wikipedia.org/wiki/Third-party_doctrine">third-party doctrine</a>, and it doesn't extend north of the border.<br /><br />Canadians can also be lawfully subject to searches and seizure by the police if these actions are <i>reasonable</i>, as stipulated in Section 8 of the Charter. There are a number of criteria for establishing reasonableness, including that a search or seizure needs to be authorized by law, say by a judge granting a warrant. In addition, the law authorizing the warrant has to be a good one. (Here is <a href="https://ojen.ca/wp-content/uploads/In-Brief_Section-8-of-the-Charter.pdf">a simple</a> explainer.)<br /><br />Before we dive into why Justice Mosley ruled that the government's bank account freezes and information sharing scheme violated Canadians' rights, we need to understand the government's side of argument. <br /><br />On the eve of invoking the emergency measures, Prime Minister Justin Trudeau <a href=" https://globalnews.ca/news/8621256/freedom-convoy-emergencies-act-trudeau-charter-rights/">promised that</a> the government was "not suspending fundamental rights or overriding the Charter of Rights and Freedoms." He reiterated this a week later after the Emergencies Act had been revoked:<br /></p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">When we invoked the Emergencies Act on Monday of last week, we had three principles in mind: restoring peace and order, making sure the measures were proportionate and compliant with the Charter of Rights and Freedoms, and making sure it was time-limited.</p>— Justin Trudeau (@JustinTrudeau) <a href="https://twitter.com/JustinTrudeau/status/1496643402305314825?ref_src=twsrc%5Etfw">February 24, 2022</a></blockquote> <br />But what about the legal specifics of the banking measures? Were they compliant with the Charter, and how? Government lawyers argued from the outset that the requirement for banks to share personal banking information with the RCMP and CSIS did <i>not </i>violate Section 8 of the Charter. While the sharing order constituted a search under Section 8, it was a reasonable search, they said, and reasonable search is legitimate.<br /><br />As for the freezes, and here things get more complicated, the government maintained that they did not constitute seizures at all, and thus weren't protected under Section 8. The government begins with a literal argument. The funds in the 280 frozen bank accounts were not taken or seized; rather, banks were simply asked to "cease dealing" with some of their customers in such a way that these customers <a href="https://www.justice.gc.ca/eng/trans/bm-mb/other-autre/emergencies2-urgence2/qa-qr.html#q30">never lost ownership</a> of their funds. This was a mere freeze, the government claims, rather than a harsher sort of government "taking" of funds , say like a Mareva injunction, warrant of seizure, or restraint order, all of which are seizures under Section 8 of the Charter.<br /><br />As back up, the government offered a more technical argument. According to Canadian legal precedent, it is only certain types of government searches and seizures that trigger Section 8 protections. These are laid out in a case called <a href="https://scc-csc.lexum.com/scc-csc/scc-csc/en/item/2014/index.do">Laroche v Quebec (Attorney General)</a>. Specifically, only those seizures occurring in the process of an investigation and prosecution of a criminal offence are protected. The government maintains that the freezes it placed in February 2022 were <i>not </i>related to a criminal offence <span><span>–</span></span> they were merely designed to "discourage" participation in the protest <span><span>–</span></span> and so they were not the sorts of seizures protected by the Charter. (The government's full argument that it laid out for Justice Mosley <a href="https://www.dropbox.com/sh/47vqm1nv83i7qbf/AABMgMirnMqJ33QBqBdtfzSYa?dl=0&preview=2.+AGC+Factum+on+Merits+of+Judicial+Review.pdf">here</a>.)<br /><br />The invocation of the Emergencies Act required the independent inquiry be launched, the results of which were released in February 2023. The commissioner of that inquiry, Justice Rouleau, ended up <a href="https://publicorderemergencycommission.ca/files/documents/Final-Report/Vol-1-Report-of-the-Public-Inquiry-into-the-2022-Public-Order-Emergency.pdf">siding with</a> the government's assessment of the legality of the bank account freezes. The freezing of accounts was "not an infringement" of section 8 of the Charter, wrote Rouleau, because they were not a seizure. <br /><br />Here I'm going to briefly inject my own personal thoughts as a citizen blogger. <br /><br />Look, I think it's a good thing that the government has various financial buttons at its disposal that it can press to lock or restrict my funds, like restraint orders. But I also think its a good thing that these buttons are subject to certain controls, one of which is that they must respect my basic rights, even in an emergency situation. I find it somewhat worrying that in this particular case the government seems to be arguing that it has at its disposal a new type of "immobilize funds" button that is completely exempt from charter oversight due to the fact that it, somewhat arbitrarily, escapes definition as a seizure. This seems like a distinction without a difference to me.<br /> <br />Disagreeing with both Justice Rouleau and the government's logic, Justice Mosley in his judicial review ends up siding with the counter-arguments deployed by two civil liberties organizations that opposed the government in the case. (Their respective arguments are laid out <a href="https://theccf.ca/wp-content/uploads/CCF-Factum-ea-challenge.pdf">here</a> and <a href="https://www.dropbox.com/sh/47vqm1nv83i7qbf/AABMgMirnMqJ33QBqBdtfzSYa?dl=0&preview=3.+Reply+Submissions+of+the+CCLA.pdf">here</a>).<br /><br />First, regarding the sharing of information with the RCMP and CSIS, Mosley rules this constituted a search covered by Section 8. Contra the government, these searches were not reasonable, and thus they violated the protestors' Charter rights. <br /><br />While the government had argued that the searches were reasonable due to their limited duration and targeted focus, the judge finds that they lacked an "objective standard." Banks only needed a "reason to believe" that they had the property of a protestor before reporting the information to the RCMP or CSIS, but according to Mosley this criteria was too wide and ad hoc to qualify as reasonable. Would a hunch or a rumour qualify as a "reason to believe"? Perhaps.<br /><br />The searches were also unreasonable, according to Justice Mosley, because they had none of the other well-defined standards for reasonable search, including a lack of prior authorization for each search by a neutral third party like a judge. In February 2022 it was bankers, not judges, that carried out the searches, assembly line-like. <br /><br />As for the freezes, Justice Mosley disagrees with the government's arguments, finding that the freezing of bank accounts did indeed constitute a seizure of the sort protected by Section 8. Adopting the viewpoint of a regular Canadian, he first argues that a "bank account being unavailable to the owner of the said account would be understood by most members of the public to be a 'seizure'."<br /><br />Mosley proposes an alternative opinion that it was the forced disclosure of the financial information by banks to the RCMP and CSIS that constituted a seizure. In this reading, what was being seized was personal payments and ownership data. The protestors had a "strong expectation of privacy" in these financial records, and thus Section 8 is applicable. <br /><br />So to sum up, a Federal court has deemed that the bank accounts freezes placed on protestors in February 2022 were indeed seizures, and not some other strange sort of <i>freeze-not-a-seizure</i>, and therefore they were subject to the Charter. As for the searches, they were unreasonable (as were the seizures). The government will be appealing to the Federal Court of Appeal, so these arguments will be re-litigated. Stay tuned.<br /><br />My take is that Justice Mosley's rulings are reasonable and helpful guidelines for future governments seeking to levy banking measures in subsequent emergencies. The ruling doesn't expressly ban the levying of bank freezes, and that's probably a good thing. Let's not forget that the requirement for banks to cease dealings with protestors, albeit illegal in this particular case as per Justice Mosley, was a fairly effective measure. The threat of having their money immobilized helped get the protestors to leave, right? And not a single person was injured. Think of bank account freezes as the domestic version of foreign sanctions, a way to bloodlessly defuse an emergency situation and avoid sending in the more deadly cavalry. This seems like a good tool, no? <br /><br />The catch, as Mosley suggests, is that the government needs to tighten up the the process of freezing bank accounts come next emergency so that they are constitutional. How tight? One might argue that the standard for freezes shouldn't be as high as a regular restraint order on funds during a non-emergency. On the other hand, freezes shouldn't become some sort of dark tool for circumventing the Charter.<br /><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com2tag:blogger.com,1999:blog-6704573462403312459.post-19966121408160944482024-01-24T16:09:00.009-05:002024-02-25T10:34:44.226-05:00Do bitcoin ETFs conflict with bitcoin's original ethos?<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuiC2BKz7GBtg_b-wY0Fkaa7kFN4qgfnovUEOAKsTM9cgAvjrh-QGRulSDxjihUida43BD1bzOkOFWmO8U21y5t-Pn1NHO26z4PS_iFEvwbj8XJR8t8pW-49Q17r-4vF5T5vBt5Ohuhb6hQ_GjXaBVYAfTni8A6-8yR1Ty3YZrisxspn-G1eXqxRLoadg/s731/blackrock.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="333" data-original-width="731" height="292" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuiC2BKz7GBtg_b-wY0Fkaa7kFN4qgfnovUEOAKsTM9cgAvjrh-QGRulSDxjihUida43BD1bzOkOFWmO8U21y5t-Pn1NHO26z4PS_iFEvwbj8XJR8t8pW-49Q17r-4vF5T5vBt5Ohuhb6hQ_GjXaBVYAfTni8A6-8yR1Ty3YZrisxspn-G1eXqxRLoadg/w640-h292/blackrock.PNG" width="640" /></a></div><br />Some folks are suggesting that a bitcoin ETF is absurd because it doesn't fit with Bitcoin's original ethos. On the contrary, I think it's a nice snug fit.<br /><br />It would be a misunderstanding of bitcoin's history to assume that it was the idealism of <i>cypherpunk</i>-ism that gave birth to the Bitcoin movement. Bitcoin would never have got off the ground without a massive amount of old fashioned greed. In bitcoin-speak, this greed usually goes by the term <i>number-go-up</i>, and it was crucial from the start. The new bitcoin ETFs are certainly not cypherpunk, but they are very much in the founding spirit of number-go-up.<br /><br />One of the main goals of the 1990s cypherpunks, if you recall, was to create <a href="https://jpkoning.blogspot.com/2017/11/the-bootstrapping-of-thorne-magic-money.html">anonymous digital cash</a>. And while bitcoin certainly has some roots in cypherpunk ideals, the ethos of number-go-up clashes with the dream of digital cash: after all, an asset with a volatile price makes for an awful medium of exchange. Before long, number-go-up had drowned out the cypherpunks. <br /><br />I recall walking into Montreal's Bitcoin Embassy in 2014, which was located on the busy intersection of St-Laurent and Prince-Arthur. I had already been researching and writing about bitcoin for a few years, but decided to play it dumb to see how the folks at the Embassy would approach the task of teaching a newbie about bitcoin. Instead of preaching to me about how to make a bitcoin payment from my own self-custody wallet, the ambassador walked me over to a large screen showing bitcoin's price. "Look, it's rising," he said in awe. <br /><br />That, in short, sums up bitcoinism. Like 1980s televangelism with its gold-plated cowboy boots, mansions, private jets, and a dose of God on the side, bitcoin is all about the price chart with a small helping of cypherpunk ideology. <br /><br />Number-go-up has always required getting ever more people into the game. Bitcoin, after all, is itself sterile. Unlike a publicly-traded business, it doesn't generate a stream of improving profits, so the only way for its price to keep rising is to recruit more players, much like a pyramid or <a href="https://jpkoning.blogspot.com/2021/03/from-circle-of-gold-to-meganets-to.html">a chain letter</a>. From the early days, getting access to traditional financial and banking infrastructure has been crucial to making this recruitment process go as smoothly as possible.<br /><br />Docking bitcoin to the existing financial edifice began in 2010 with the first bitcoin exchanges, which hooked into the crucial global bank wire systems like SWIFT, as well as local wire systems like the Federal Reserve's Fedwire system and Europe's SEPA system. These integrations were key to pumping the initial rounds of money into the game, and pushing the number above $1, and then $10, $100, and $1000. <br /><br />Later on, bridges to the Visa/MasterCard debit card and credit card networks brought an even tighter fusion between bitcoin and the regular world, more inflows, and more number-go-up. The addition of bitcoin purchases to mobile payment apps like PayPal and Cash App came after. Viewed in this context, ETFs are nothing new, really; they only represent the next coupling between the two worlds.<p></p><p></p><p>As for regular old finance, it isn't complaining. The task of players like Visa is to generate profits <span><span>–</span></span> they want nothing more than to add new products like bitcoin to the list of products they already connect. The curious result is that no chain-letter style product has <a href="https://jpkoning.blogspot.com/2021/03/from-circle-of-gold-to-meganets-to.html">ever gone as mainstream</a> as bitcoin has.<br /><br />Now that bitcoin ETFs exist, number-go-up demands even more linkages to traditional finance and banking. What's next? One possibility: expect the bitcoin community to lobby for federally-chartered banks to be allowed to offer bitcoin products alongside savings deposits and retirement accounts. Banks offering bitcoin to their retail client base may seem inconsistent with bitcoin's more cypherpunk-y dreams of replacing the banking system, but on the contrary: its hard to imagine a more fantastic recruitment tool for number-go-up.</p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com12tag:blogger.com,1999:blog-6704573462403312459.post-79166833214712963702024-01-08T12:41:00.004-05:002024-02-25T12:32:53.433-05:00It's time to impose Iran-calibre sanctions on Russia<p>Russia is sometimes described as the world's most sanctioned nation. And while <a href="https://www.castellum.ai/russia-sanctions-dashboard">that's true</a>, the long list of sanctions that the G7 coalition has placed on Russia in response to its attack on Ukraine are <i>surprisingly light </i>compared to the fewer but far more-draconian sanctions placed on Iran over the last decade or so.<br /><br />This ordering of sanctions precedence is a mistake. With its all-out invasion of Ukraine, Russia has moved past Iran into top slot at world's most dangerous nation. Vladimir Putin merits a sanctions program that is at least as onerous as Iran, if not more so, yet for some reason he is getting off lightly. It's time to apply Iran-calibre sanctions to Russia.<br /><br /><b>What makes a draconian sanctions program draconian?</b><br /><br />What makes the Iranian sanctions program so draconian is that many of the sanctions are so-called <i>secondary sanctions</i>, a feature that has been mostly absent in the Russian sanctions program. <br /><br />When the U.S. or EU levy <i>primary sanctions</i> on an entity, they are saying that American individuals, banks, and businesses (and European ones, too) can't continue to interact with the designated party. This hurts the target, but it leaves foreign individuals, banks, and businesses with free reign to fill the void left by departing American and European actors, thus undoing part of the damage.<br /><br />Secondary sanctions prevent this vacuum from being occupied. The U.S. government tells individuals or businesses in other nations that they, too, cannot deal with a sanctioned entity, on pain of losing access to U.S. economy. It's either us, or them.<br /><br />When applied to foreign financial institutions (i.e. banks) secondary sanctions are particularly potent. The U.S. tells foreign banks that if they continue to provide banking services to sanctioned Iranians, the banks' access to the all-important U.S. financial system will end. Since the U.S. financial system is so crucial, foreign banks quickly offboard all sanctioned Iranian individuals and businesses. The sanctioned Iranian entity finds that it has now been completely removed them from the global financial system. This <i>financial shunning effect</i> is much more powerful than the effects created by primary sanctions or secondary sanctions on non-banks. <br /><br />Notice that I've limited my commentary on secondary sanctions to the U.S. Since it <a href="https://scholarship.law.umn.edu/cgi/viewcontent.cgi?article=1162&context=mjil">first began to use</a> secondary sanctions in 1996, the U.S. Treasury has become a master of the art, whereas as far as I know they are a tool the EU has <a href="https://www.euractiv.com/section/global-europe/opinion/the-eu-paradox-with-tackling-sanctions-circumvention/">long resisted</a> adopting.<br /><br />The bank-focused secondary sanction placed on Iran over the last decade-and-a-half have been particularly devastating because they target a broad sector of Iranian society, most crucially the Iranian oil sector, the life blood of Iran's economy. Secondary sanctions prevent foreign banks from processing Iranian oil trades on pain of losing access to the U.S., and so most foreign banks have chosen to cease interacting with the Iranian oil companies.<br /><br />The chart below illustrates the effectiveness of this approach. When President Obama placed the first round of bank-focused secondary sanctions on Iran's oil industry in 2012, the nation's oil exports immediately cratered from around 2 million barrels per day to 1 million barrels. When he removed them in 2016, they quickly rose back up. And when Trump reapplied the same secondary sanctions in 2018, they collapsed once again, almost to zero.</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEia0WgjQe5gOeM_az6sEz7s4xAEHQSGtHt9uRoaaQz6zreQ6ZfREUHSc0P5prx-iDmKXbFnWda1abhQYrVG4l9iGrXRAfQSFm2so2ND1HeSTRW51zDfAWO5fPA7Mj4s96Bu-cmcQE7T-NfKzw716KXfvEZC-DeYlCNu490uy6WR89Pa9Kl6O0sD1DmJObU/s671/secondarysanctions1.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="458" data-original-width="671" height="437" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEia0WgjQe5gOeM_az6sEz7s4xAEHQSGtHt9uRoaaQz6zreQ6ZfREUHSc0P5prx-iDmKXbFnWda1abhQYrVG4l9iGrXRAfQSFm2so2ND1HeSTRW51zDfAWO5fPA7Mj4s96Bu-cmcQE7T-NfKzw716KXfvEZC-DeYlCNu490uy6WR89Pa9Kl6O0sD1DmJObU/w640-h437/secondarysanctions1.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: CRS [<a href="https://www.everycrsreport.com/files/20200205_R46213_7bb76e54df206bce64dd8b2f4b4c8543148720df.pdf">pdf</a>]</span><br /></td></tr></tbody></table><p><br />In short, U.S. secondary sanctions imposed huge body blows on the Iranian oil industry. These same forces have not been brought to bear on Russia's oil industry. <br /><br /><b>A dovish Russian sanctions program</b><br /><br />While the Russian sanctions program is often portrayed as being strict, it is far lighter than other sanctions programs, including the one placed on Iran, because it is comprised almost entirely of primary sanctions. (For a good take on this, see Esfandyar Batmanghelidj <a href="https://twitter.com/yarbatman/status/1738276813304914285">here</a>). While <a href="https://www.steptoe.com/en/news-publications/a-detailed-look-at-the-countering-america-s-adversaries-through-sanctions-act.html">a small list</a> of secondary sanctions have been placed on Russia, for the most part they have not been of the banking type.*<br /><br />The second reason why the Russian sanctions program is dovish is that the oil component of the EU and U.S. sanctions campaign has been particularly lenient. Take a look at the above chart of Iran oil exports and you can see very real evidence of damage from sanctions. Scan the chart of Russian oil exports below, however, and it suggests business as usual.<br /></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsJoZ7QcCnSdFLKkmMXZKIljBzOx8Z6gqJXqdWcpcLrRh_myb_ZZTi-332G9CyHzo_eFuYyj99mZOivsVSEwXP9_DRRAQEX6VGQQKhIyqIh1WaT_xwMuo6NBh1nxbtlBxUp_3pQphCK6HDs6XW8JoWbi7i_Q2fKlGuGLWAh2-wcEeTFM9do4Hg4_mdd-Y/s597/secondarysanctions2.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="486" data-original-width="597" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsJoZ7QcCnSdFLKkmMXZKIljBzOx8Z6gqJXqdWcpcLrRh_myb_ZZTi-332G9CyHzo_eFuYyj99mZOivsVSEwXP9_DRRAQEX6VGQQKhIyqIh1WaT_xwMuo6NBh1nxbtlBxUp_3pQphCK6HDs6XW8JoWbi7i_Q2fKlGuGLWAh2-wcEeTFM9do4Hg4_mdd-Y/s16000/secondarysanctions2.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: <a href="https://energyandcleanair.org/wp/wp-content/uploads/2023/12/CREA_One-year-of-sanctions_5.12.2023.pdf">CREA</a><br /></td></tr></tbody></table><br /><p></p><p>Sure, the EU and other coalition partners have cut Russian oil imports to almost nil, and that's great. But overall, this effort hasn't done much harm to Putin, since over time the coalition's respective share of Iranian oil exports has simply been taken up by nations like India and China. Both before and after the 2022 invasion of Ukraine, Russia reliably shipped around 1,000 kt/day of crude oil and crude oil products.<br /><br />Underlying this leniency, G7 businesses are still allowed to engage in the Russian oil trade, as long as this doesn't involve bringing the stuff back to the EU. For instance, foreign buyers of Russian oil (say like Indian refiners) are <a href="https://www.consilium.europa.eu/en/policies/sanctions/restrictive-measures-against-russia-over-ukraine/sanctions-against-russia-explained/">allowed to hire</a> European insurers and shipping companies to import Russian oil. <br /><br />There is a limitation on this. European insurers and shippers can only be used by an Indian refiner, or some other foreign buyer, if the purchase price of Russian oil is set at $60 or below. This is what is known as the G7 <i>oil price cap</i>. <br /><br />Because the insurance and shipping industries of the UK, EU, and U.S. have a large share of the market, Russia has had little choice but to rely on coalition intermediaries for selling at least some of its oil at $60. This has come at a cost to Russia; it must sell at below-market prices. And that certainly makes Russia worse off than a world in which there was no oil price cap. <br /><br />But the very fact that these purchases are occurring at all, compared to a world in which Iran-calibre sanctions would prevent them from ever taking place, illustrates how weak the oil price cap is. </p><p>Russia's oil export income is the life-blood of Putin's war economy. These funds gets funneled directly to the front-line in the form of weapons and supplies. It's time to get serious about Russian sanctions, remove the dovish oil price cap, and apply to Russia the same calibre of secondary sanctions that so effectively crimped Iranian oil exports.<br /><br /><b>We may have to deescalate sanctions on Iran in order to escalate them on Russia</b><br /><br />What has prevented the U.S. and its allies from applying draconian Iran-style sanctions to Russia? One of their main worries is that taking a major oil exporter out of the market will have major macroeconomic impact. </p><p>Russia currently exports around 4 million barrels of crude oil per day, as well as a large amount of refined products such as gasoline. Assuming that half of this were to be removed by secondary sanctions, world oil prices would probably rise. Voters in the EU and US would get angry. Neutral countries dependent on oil imports <span><span>–</span></span> China, India, Brazil <span><span>–</span></span> would push back against the colation, because they'd have to scramble to replace a major supplier. Secondary sanctions aren't just a nuisance for these neutral parties. Due to their extraterritorial nature, secondary sanctions impinge on the sovereignty of neutral nations. This creates hostility, understandably so, the negative blowback eventually flowing back to the U.S.</p><p>So if the EU, U.S. and the rest of the coalition are going to get serious about sanctioning the Russia's oil industry, and thus removing a few million barrels of oil per day from the world market, they may need to counterbalance that in order to soften the blow. One way to do so would be to free up more Iranian oil exports, which means softening the sanctions on Iran. <br /><br />That doesn't mean <i>not </i>applying sanctions to Iran. A version of the $60 price cap on Iranian oil probably makes a lot of sense. However, a fully armed financial battleship <span><span>–</span></span> i.e. bank-focused secondary sanctions directed at a major crude oil exporter's oil industry <span><span>–</span></span> may be something that has to be reserved for one country only: Russia. <br /><br />Now, I could be wrong about the world being unable to bear draconian sanctions on two major oil exporters. Maybe I'm creating a false dichotomy, and in actuality the choice is less stark and the coalition can actually apply draconian oil sanctions on both Iran and Russia. If so, I stand corrected.<br /><br />Either way, Russia's oil industry has skated through the invasion and resulting sanctions remarkably unscathed, as the Iranian counterexample illustrates. It's time to cut off Russia's main source of revenues by putting the same set of secondary sanctions that Iran has faced on Russia's oil patch. </p><p></p><p></p><hr /><br /><span style="font-size: x-small;">* There are a few bank-focused secondary sanctions placed on Russia. Notably, Section 226 of <a href="https://en.wikipedia.org/wiki/Countering_America%27s_Adversaries_Through_Sanctions_Act">CAATSA</a> (2017) requires foreign financial institutions, or FFIs, to avoid certain sanctioned Russians or sectors on pain of losing access to the U.S. banking system. (See <a href="https://www.gibsondunn.com/trump-administration-implements-congressionally-mandated-russia-sanctions-significant-presidential-discretion-remains/">here</a>, for example.) However, the U.S. must not be enforcing Section 226 very tightly because I haven't found a single case of a bank being punished under 226. <br /><br />This December, <a href="https://home.treasury.gov/news/press-releases/jy2011">another round of secondary sanctions</a> was imposed on FFIs. Any foreign bank that facilitates transactions involving Russia’s military-industrial base may be cut off from the U.S. financial system. Additionally, any bank that conducts transactions for specially designated nationals who operate in Russia's technology, defense and related materiel, construction, aerospace or manufacturing sectors may face punishment. Note that both rounds of secondary sanctions leave the Russian oil industry untouched.</span><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com13tag:blogger.com,1999:blog-6704573462403312459.post-11003943650228586122023-12-20T08:51:00.008-05:002023-12-20T09:19:45.333-05:00Are flatcoins a good idea?<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJapS8RVgiL3WweU-3-IlWWAFqeSbxKc3OrXdhHKxijMmF2fF4slsz9m8VGJeVHIrCuS40byLZBJcx4xIbfHwTMifisRak3fd9MHsD3Pch01tkySlxN6cWZ-nvaIb1hnKc8Odks0xwtI44yrltX8VU7pOP3YKXPH98z2rqop0bmJrlwE0L55750KUN3mg/s1195/flatcoins3.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="617" data-original-width="1195" height="330" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJapS8RVgiL3WweU-3-IlWWAFqeSbxKc3OrXdhHKxijMmF2fF4slsz9m8VGJeVHIrCuS40byLZBJcx4xIbfHwTMifisRak3fd9MHsD3Pch01tkySlxN6cWZ-nvaIb1hnKc8Odks0xwtI44yrltX8VU7pOP3YKXPH98z2rqop0bmJrlwE0L55750KUN3mg/w640-h330/flatcoins3.png" width="640" /></a></div><br /><p></p><p>I'll start with the conclusion. I don't think flatcoins are a good idea.<br /><br />The idea for flatcoins has been around for a while, but it got a wider airing when it <a href="https://base.mirror.xyz/lt3JR-mZ51q9eIOtGO36L3ZVzCTXmZVnbIiXz6crqzQ">popped up</a> in a Coinbase marketing piece from earlier this year. Now, arch-crypto hater Nouriel Roubini has undergone a Damascene conversion and <a href="https://www.ft.com/content/7774da77-048d-4e75-8350-4fec136cb18f">is about to introduce</a> a crypto flatcoin, suggesting that these novel instruments are "the way forward." <br /><br />What is a flatcoin? <br /><br />If you own one dollar's worth of stablecoins or one dollar's worth of Wells Fargo deposits, both stay locked at $1 dollar indefinitely. A flatcoin, by contrast, slowly rises in value over time to compensate the holder for inflation. So if you own a single flatcoin worth $1 today, it will be worth $1.0001 tomorrow, and $1.0002 the next day, and so on. Twelve months later its value will have arrived at $1.05. This 5% appreciation protects you from 5% inflation, leaving your purchasing power unchanged.<br /><br />Roubini and Coinbase are marketing flatcoins as a blockchain-specific thing, but there's no reason the concept couldn't by packaged up as a traditional financial product, one without a blockchain. Imagine a Wells Fargo account that holds 100 in Wells <i>flatbalances </i>which rise by 3-4% a year. Or imagine a <i>flatnote</i>, the issuer indexing the purchasing power of its paper banknotes to inflation by promising to buy them back at progressively higher prices.<br /><br />Roubini stakes out a role for flatcoins as a potential "global means of payment." As far as monetary/payments technology goes, I disagree. I think flatcoins are an evolutionary dead-end. <br /><br />One of the key features of money that makes it so popular is that it is directly fused to the dominant commercial language that we all use in our day-to-day economic lives. <br /><br />What do I mean when I say commercial language? We converse and haggle with each other in terms of the dollar, we think and plan in terms of dollars, we dream in dollars, and we remember in dollars. Every facet of our day-to-day commercial lives revolves around this very basic measuring unit. (In Europe, the euro serves as the basis of Europe's commercial language, and in Japan it's the yen.)<br /><br />The dollars that we own in our pockets (and in our bank accounts, as well as the stablecoins in our Metamask wallets) have been conveniently designed to be fully compatible with the dollar measuring unit that we refer to in language. That is, our media of exchange are pegged, or wed, to $1. For instance, if I've got to make a $1500 rent payment next week, I know that the 1500 units sitting in my bank checking account are a precise fit for meeting that obligation. I don't know the same about my other assets, say my S&P 500 ETF, my gold, my government bonds, or my dogecoins. <br /><br />This standardization is a convenient feature. It takes a lot of hassle out of day-to-day commercial life. It means that when we buy things or make plans to buy things, it's not necessary to engage in constant translations between the dollar media in our pocket and the dollars in our speech and thoughts and plans. As Larry White <a href="https://books.google.ca/books?id=DX0VCgAAQBAJ&lpg=PA177&ots=Bkazbr1CeA&dq=%22economizes%20on%20the%20information%20necessary%20for%20the%20buyer's%20and%20the%20seller's%20economic%20calculation.%22&pg=PA177#v=onepage&q=%22economizes%20on%20the%20information%20necessary%20for%20the%20buyer's%20and%20the%20seller's%20economic%20calculation.%22&f=false">once put it</a>, harmonizing the unit we use in our speech with the units we transact with "economizes on the information necessary for the buyer's and the seller's economic calculation."</p><p></p><p>Since everyone tends to converge on these very useful standardized units for making payments (i.e. deposits, stablecoins, and banknotes), the markets for them have become highly developed and liquid. This only makes them more useful for payments, in effect locking in their dominance.<br /><br />A flatcoin, by contrast, has been rendered incompatible with the dollars that we use in our speech. One unit might be worth 1.1145 times the dollars we use in our speech today, and 1.1147 tomorrow, and 1.1205 next month. This erases one of the most user-friendly features of money, its concordance with the commercial vernacular, alienating anyone who might use it for their day-to-day spending. Flatcoins will thus be less liquid than standardized 1:1 dollars, and this lack of liquidity will render them even less useful for making payments.<br /><br />There's the secondary problem with flatcoins that stems from taxes. Since a flatcoin rises in value over time, all purchases made with flatcoins will generate a small taxable capital gain. This introduces an administrative burden which makes it even less likely that people will use flatcoins as an everyday medium of exchange. <br /><br />This incongruity between linguistic dollars and flatcoins doesn't mean that people won't hold them. They might be useful as a type of long-term savings vehicle, much like how one might buy and hold a fixed income ETF. But unlike Nouriel Roubini, I don't think they are "the way forward" when it comes to acting as a medium of exchange. No one is going to be buying a coffee with a flatcoin.</p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com15tag:blogger.com,1999:blog-6704573462403312459.post-90396293270593116352023-12-16T08:51:00.014-05:002023-12-18T10:12:34.002-05:00The long arm of OFAC and its reach into the Ethereum network<p>Coinbase, the U.S.'s largest crypto exchange, is openly processing Ethereum transactions involving Tornado Cash, a piece of blockchain infrastructure <a href="https://home.treasury.gov/news/press-releases/jy0916">that was sanctioned</a> by the U.S. government last year for providing mixing services to North Korea. </p><p>Over the last two weeks Coinbase has validated 686 Tornado-linked transactions, according to <a href="https://tornado.pics/">Tornado Warnings</a>. I've screenshotted the table below:<br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj62U46v5JcyH6yg_lSMy-3CwhvnxjlhyphenhyphenlFvGMUgRfMf75pB31jwH_dNxPoQnQ40GybMGbiwjIBOvjKWknGCgAN1zC4aFg48ELSTRUQWAdPT9k4DCmA4ypLJfkz6aO155fJ42c9Aq2xNbbgpVfghezVs3a8JcZSmrVHoBRsl6v0keCeZ_CoQi5pO5Mixck/s1247/tornadoPics.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="1122" data-original-width="1247" height="576" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj62U46v5JcyH6yg_lSMy-3CwhvnxjlhyphenhyphenlFvGMUgRfMf75pB31jwH_dNxPoQnQ40GybMGbiwjIBOvjKWknGCgAN1zC4aFg48ELSTRUQWAdPT9k4DCmA4ypLJfkz6aO155fJ42c9Aq2xNbbgpVfghezVs3a8JcZSmrVHoBRsl6v0keCeZ_CoQi5pO5Mixck/w640-h576/tornadoPics.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">This table shows how many blocks each validator has proposed that includes a transaction that has interacted (either depositing or withdrawing)
with Tornado Cash contracts in
all denominations, or with TORN tokens. Source: <a href="https://tornado.pics/">Tornado Warnings</a> by <a href="https://twitter.com/nero_eth">Toni Wahrstätter</a></span><br /></td></tr></tbody></table><br />This is awkward for everyone involved.<br /><br />First, it's embarrassing for the agency that administers U.S. sanctions, the U.S. Treasury's <i>Office of Foreign Assets Control</i>, or OFAC. OFAC clearly states that U.S. based persons are not to transact with sanctioned entities unless they have a license. Yet here is America's largest crypto exchange interacting with a sanctioned entity, Tornado Cash, without a license. <br /><br />OFAC can look away and pretend that nothing unusual is happening, which is pretty much what it has done so far. But since these financial interactions are clearly displayed on the blockchain, everyone can see the infraction occurring. Eventually, OFAC will have to confront the problem and make some tough decisions, a few of which may end up damaging companies like Coinbase and the Ethereum network.<br /><br />The whole affair is also awkward for the crypto industry. After a 2022 in which much of the ecosystem went bankrupt or succumbed to fraud, crypto currently finds itself in the damaging crosshairs of the culture war and the pervasive threat of being banned. It is desperate for social license, yet here is crypto's leading company choosing to operate in contravention of one of the key pillars of U.S. national defence. <br /><br />Meanwhile, Coinbase's main U.S. competitor, Kraken, has taken a very different approach to dealing with Tornado Cash. As the table above shows, Kraken has processed <i>zero </i>Tornado Cash transactions over the last two weeks compared to Coinbase's 686. These diverging approaches to handling sanctioned transactions only highlight the awkward nature of crypto's "compliance" with sanctions law. <br /><br />Before I dive deeper, we need to fill in the basics. For folks who are confused about crypto, what follows is a quick explanation why Coinbase is interacting with Tornado Cash, whereas Kraken isn't.<p></p><p><b>What is validation? </b><br /><br />To begin with, Coinbase and Kraken operate in many different businesses. Their most well known business line is to provide a trading venue where people can deposit funds in order to buy and sell crypto tokens.<br /><br />I suspect that both companies are being very careful to ensure that their trading venues avoid any dealings with Tornado Cash. If someone were to try to deposit Tornado-linked funds to Coinbase's exchange, for instance, I'm sure Coinbase would quickly freeze those transactions, which is precisely what OFAC obliges it to do. Crypto trading venues have gotten in trouble before for dealing with sanctioned entities: last year Kraken <a href="https://ofac.treasury.gov/media/929541/download?inline">was fined by OFAC</a> for processing 826 transactions on behalf of Iranian individuals.<br /><br />But the issue here isn't these companies' trading platforms. Coinbase's interactions with Tornado Cash are occurring in an adjacent line of business. Let's take a look at how Coinbase and Kraken's <i>validation services</i> business operate.<br /><br />Say that Sunil lives in India and wants to make a transaction on the Ethereum network, perhaps a deposit of some ether to Tornado Cash. He begins by inputting the instructions into his Metamask wallet. This order gets broadcast to the Ethereum network for validation, along with a small fee, or tip. A <i>validator </i>is responsible for taking big batches of uncompleted transactions, one of which is Sunil's Tornado Cash deposit , and proposing them in the form of "blocks" to the Ethereum network for confirmation. As a reward, the validator collect the tips left by transactors.<br /><br />The biggest validators are the ones that own large amounts of <i>ether</i>, the Ethereum network's native token. Since Kraken and Coinbase have millions of customers who hold ether on their platforms, they have become two of the most important providers of Ethereum validation services. Coinbase accounts for 14% of global validation while Kraken stands at 3%, according to the <a href="https://dune.com/hildobby/eth2-staking">Ethereum Staking dashboard</a>. So even though Sunil is not actually depositing any crypto to Coinbase's trading venue, he may end up interfacing with Coinbase via its block proposal and validation business. <br /><br />Validators can choose what transactions to include in their blocks. This explains the difference between the two exchanges. Whereas Kraken chooses to exclude transactions like Sunil's Tornado Cash deposit, Coinbase includes all transactions linked to Tornado Cash in the blocks that it proposes, in the process earning transaction fees linked to Tornado Cash.</p><p>To sum up, Coinbase operates its trading venue in a way that complies with OFAC regulations, but it doesn't run its validation service in the same manner, whereas Kraken does. Next, we need to fill in another important part of the story. What does OFAC do? <br /></p><p><b>OFAC around and find out</b><br /><br />For folks who don't know how U.S. sanctions work, a big part of OFAC's job is to <a href="https://sanctionssearch.ofac.treas.gov/">blacklist</a> foreign individuals and organizations who are deemed to undermine U.S. national security or foreign policy objectives. These blacklisted entities are known as SDNs, or specially designated nationals. U.S. citizens and companies cannot deal with SDNs without getting a license.<br /><br />OFAC also administers <i>comprehensive sanctions</i>. These prevent U.S. individuals or businesses from interacting with entire nations, like Iran. <br /><br />With each of the individuals or entities that it designates, OFAC discloses an array of useful information including the SDN's name, their aliases, address, nationality, passport, tax ID, place of birth, and/or date of birth. U.S. individuals and firms are supposed to take a <i>risk-based</i> approach to cross-checking this information against each of the counterparties they transact with so as to ensure that they aren't dealing with an SDN. They must also be aware of U.S. comprehensive sanctions so they don't accidentally interact with an entire class of sanctioned individuals, say all Iranians. Failure to comply can result in a monetary penalty or jail time.<br /><br />Whereas Coinbase appears to have chosen to ignore OFAC's requirements when it comes to validation, Kraken hasn't, and has incorporated the SDN list into the internal logic of the validation services that it provides. But Kraken has only done so in a limited way, as I'll show below. <br /><br />Five years ago OFAC began to include an SDN's known cryptocurrency addresses in its array of SDN data. To date, OFAC has published around 600 crypto addresses, including around 150 Ethereum addresses, of which a large chunk are related to Tornado Cash. Kraken is using this list of 150 addresses as the basis for excluding certain transaction from the blocks that it is proposing to the Ethereum network.<br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgI2CdFQjfXqMIlt52BgPKsxrrPrBSD_G7AMivGJC9ugiPizn9UxzBsWAvGtQ2EAIbE30Ov18-KG54JPgzHzSHAv3eurK2APmn56kz9OdaGAJjkyvW71s5bcyalQhyphenhyphenTL6zMvfs89I4bsZgo0qTw9XI_KPfhNjuiH394b_4fFXn074i3xi6pAk1VWvdogyA/s586/ofacchart.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="406" data-original-width="586" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgI2CdFQjfXqMIlt52BgPKsxrrPrBSD_G7AMivGJC9ugiPizn9UxzBsWAvGtQ2EAIbE30Ov18-KG54JPgzHzSHAv3eurK2APmn56kz9OdaGAJjkyvW71s5bcyalQhyphenhyphenTL6zMvfs89I4bsZgo0qTw9XI_KPfhNjuiH394b_4fFXn074i3xi6pAk1VWvdogyA/s16000/ofacchart.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Data source: OFAC and <a href="https://github.com/0xB10C/ofac-sanctioned-digital-currency-addresses">Github</a></span><br /></td></tr></tbody></table><br />Among members of the crypto community, this sort of editing out of OFAC-listed addresses is sometimes described as creating "OFAC-compliant blocks." Hard core crypto ideologues believe that it compromises Ethereum's core values of openness and resistance to censorship.<p></p><p>While Kraken's approach may appear to be the compliant approach to proposing blocks, it's not. It's half-compliance, or compliance theatre. <br /></p><p><b>OFAC-compliant blocks as compliance theatre </b><br /><br />Right now, Kraken's block validation process merely weeds out transactions involving the 150 or so Ethereum wallets that OFAC has explicitly mentioned, which includes Tornado Cash addresses. But many of the SDNs linked to these 150 wallets have probably long since adapted by getting new wallets. Kraken isn't taking any steps to determine what these new wallets are, and is therefore almost certainly processing these SDN's transactions in its blocks. This would put it in violation of OFAC policy.<br /><br />Of the 12,000 or so SDNs on OFAC's SDN list, most are not explicitly linked by OFAC to a specific Ethereum wallet. But that doesn't mean that these entities don't have such wallets. To be compliant, Kraken needs to scan the entire list of 12,000 SDNs and verify that none of them are being included in Kraken blocks. Again, it doesn't appear to be doing that.<br /><br />Complying with OFAC isn't just about crosschecking the SDN list. Remember, OFAC has also levied comprehensive sanctions on nations such as Iran, which prohibit any U.S. entity from dealing with Iranians-in-general. Because Kraken limits its block editing to the 150 or so Ethereum addresses mentioned by OFAC, it is almost certainly letting Iranian transactions into the blocks that it is proposing. Which is ironic, since the very infraction that Kraken was punished for last year was allowing Iranians to use its trading platform. Apparently Kraken has one Iran policy for its trading venue, and another policy for its block proposal service.</p><p>Coinbase's decision to ignore OFAC altogether now makes more sense. Perhaps it's better to not comply at all and thereby retain the ability to claim the non-applicability of sanctions law to validation, than to comply insufficiently but in the process tacitly admit that OFAC has jurisdiction over validation. As part of this strategy, Coinbase may try to fall back on arguments that validation isn't a financial service, but qualifies as the "transmission of informational materials," which <a href="https://ofac.treasury.gov/media/5736/download?inline">is exempt from</a> sanctions law.<br /><br />Having started down the path to compliance, the only way for Kraken's validation business to be even close to fully compliant with sanctions law is to adopt the very same exhaustive process that its own crypto trading venue abides by. That means painstakingly collecting and verifying the IDs of all potential transactors, cross-checking them against OFAC's requirements, and henceforth only proposing blocks that are made up of transactions sourced from its internal list of approved addresses. <br /><br />By adopting this complete approach to verifying transactions, Kraken would now be closer to compliance. As for OFAC, it would be relieved of its awkward situation.</p><p><b>There is no easy policy decision for OFAC </b><br /><br />However, this approach has its drawbacks. A requirement that IDs be verified for the purposes of block inclusion would be expensive for Kraken to implement. I suspect that the company would react by ceasing to offer validation services. Even if Kraken and Coinbase were to roll out an OFAC-compliant know-your-customer (KYC) process for assembling blocks, most Ethereum transactions would probably flow to no-hassle offshore validators, which don't check ID because they are under no obligation to comply with OFAC. <br /><br />So in the end, the very transactions that OFAC wants to discourage would end up happening anyway.<br /><br />Compounding matters, by pushing validation away from U.S. soil, the U.S. national security apparatus would have destroyed a nascent "U.S. Ethereum nexus," one they might have otherwise levered as a tool for projecting U.S. power extraterritorially. If you're curious what this entails, consider how the New York correspondent banking nexus is currently harnessed by the state to exert U.S. policy overseas. A San Francisco-based Ethereum nexus would be the crypto-version of that. But not if it gets chased away.<br /><br />To prevent validation from being performed everywhere but the U.S., the government could twin a requirement that domestic block validators implement KYC with a second requirement that all U.S. individuals and companies submit all Ethereum transactions to sanctions-compliant validators. This would pull U.S. Ethereum transactions back onto U.S. soil and into the laps of Coinbase and Kraken. <br /><br />But this is a complicated chess game to play, and you can see why OFAC has been hesitating. <br /><br />On the other hand, OFAC can't prevaricate forever. Sure, crypto is still small. But OFAC is an agency with a democratic mandate to administer law, and law is clearly being broken. It cannot "not govern." To boot, sanctions are a matter of national security, which adds to the urgency of the issue.<br /><br />One option would be for OFAC to offer an explicit sanctions law exception to U.S. blockchain validators in the form of a special license. But that invokes questions of technological neutrality and equal treatment before the law. Why should Coinbase and Kraken be allowed to maintain financial networks that admit sanctioned actors whereas other network operators, like Visa or American Express, do not enjoy this same exemption?<br /><br />This isn't just about fairness. By providing a blockchain carve-out, OFAC may unintentionally spur the financial industry to switch over to blockchain-based validation, because that has become the least-regulated and therefore cheapest technological solution for deploying various financial services. At that point, OFAC will find itself with far less to govern, because a big chunk of finance now lies in the zone that OFAC has carved-out. <br /><br />I don't envy the mandarins at OFAC. They've got a tough decision to make. In the meantime, Coinbase continues to process Tornado Cash transactions every hour. <br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com3tag:blogger.com,1999:blog-6704573462403312459.post-18603319702042244042023-12-05T12:29:00.010-05:002023-12-05T14:30:53.719-05:00Why do sanctioned entities use Tether?<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEju8F4ZtBj1zbOHhXVhzU6w07XbAAQdF88t_IRkmHkXiKW5EMQpP1AMS5XJN_uvT792aHXCOHsqnFNXO6P4_72MQ-Pt8p0nm1l6Ch-KA9kFXaRHCaGVrktlSryQmZ8IIrgHv9-e4YU8Sw5y-VUVJj3jI3yBCbuVfdUHKrhuX9u0A7VSC5X-8nhsZmmSwhQ/s944/tetherimage.JPG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="232" data-original-width="944" height="158" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEju8F4ZtBj1zbOHhXVhzU6w07XbAAQdF88t_IRkmHkXiKW5EMQpP1AMS5XJN_uvT792aHXCOHsqnFNXO6P4_72MQ-Pt8p0nm1l6Ch-KA9kFXaRHCaGVrktlSryQmZ8IIrgHv9-e4YU8Sw5y-VUVJj3jI3yBCbuVfdUHKrhuX9u0A7VSC5X-8nhsZmmSwhQ/w640-h158/tetherimage.JPG" width="640" /></a></div><br /><p></p><p>Tether, a stablecoin, has been <a href="https://www.wsj.com/world/middle-east/militants-behind-israel-attack-raised-millions-in-crypto-b9134b7a">in the news</a> for offering sanctioned actors such as Hamas a means to participate in the global payments ecosystem.<br /><br />In this post I want to explore in more depth how Tether is being used to dodge sanctions. I'm going to avoid drawing on the Hamas example, which has <a href="https://medium.com/@nic__carter/hamas-crypto-funding-the-wsj-and-the-warren-letter-b89cac007683">been controversial</a>, and will instead dissect the U.S. Department of Justice's <a href="https://www.justice.gov/usao-edny/pr/five-russian-nationals-and-two-oil-traders-charged-global-sanctions-evasion-and-money">recent indictment</a> of group of business people who brokered oil purchases from PDVSA, Venezuela's sanctioned state-owned oil company.<br /><br />Let's get right into things. In this particular case, the buyers <span>–</span> who indirectly represented a sanctioned Russian aluminum company <span>–</span> seem to have used two methods for settling payments with Venezuela: <i>bank wires</i> and <i>cash</i>. (Tether makes an appearance in the second.) <br /><br />Before we get to Tether, we need to understand how the bank wires worked.<br /><br />The Russian buyers operated through a network of shell companies, or fronts, set up in places like Dubai. "Because of [sanctions] we are using 'fronting'" the Russians admit. The Russians' Dubai-based shell companies had accounts at an Egyptian bank with a branch in Dubai. In a lovely line, one of the Russians, Orekhov, describes this bank as the "shittiest bank in the Emirates ... They have no issues, they pay to everything." <br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgH-PdTswMi_26I0Wn2g_bN5cuYtV4E5hjKxQnI4ax5DsdJRh-Bp6u0d3qlILV00uvcSxVunbIugZz1lIsIKJbuRpAFhbNYziDQZScxuTgVi_yRJ_lNJXOoUAeLnXndFG9RGmXaH6rdI8n8S_xm0xLGjedx9vm-REiixjew8dleAOPkl_9Kw75184_Vzlk/s582/shittiest.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="235" data-original-width="582" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgH-PdTswMi_26I0Wn2g_bN5cuYtV4E5hjKxQnI4ax5DsdJRh-Bp6u0d3qlILV00uvcSxVunbIugZz1lIsIKJbuRpAFhbNYziDQZScxuTgVi_yRJ_lNJXOoUAeLnXndFG9RGmXaH6rdI8n8S_xm0xLGjedx9vm-REiixjew8dleAOPkl_9Kw75184_Vzlk/s16000/shittiest.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">...the shittiest bank in the Emirates [<a href="https://www.justice.gov/usao-edny/pr/five-russian-nationals-and-two-oil-traders-charged-global-sanctions-evasion-and-money">link</a>]</span><br /></td></tr></tbody></table><br />The more reputable Dubai banks probably didn't want to risk enabling the potentially sanctioned transactions of a Russian shell company, but here was a bank that had no qualms.<br /><br />The Russian front companies couldn't wire U.S. dollars directly to the PDVSA; it was sanctioned. Instead, the payments were sent via the Egyptian bank to a number of foreign shell companies owned by the PDVSA, located in places like Australia, Hong Kong, and the UK. With the payments sent, the Russian's boats could be loaded with Venezuelan oil. <br /><br />The second payment method was U.S. banknotes. In fact, the PDVSA seemed to have preferred cash. In the excerpt below, the Venezuelan contact, Serrano, says that the Russian middleman, Orekhov, lost out on a previous oil shipment because a competing buyer offered to pay 100% in U.S. banknotes. "The key is cash," says Serrano. Venezuela is mostly dollarized, and with the PDVSA cut off from U.S. banks, you can understand why U.S. paper money would be quite valuable to the PDVSA.<br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzhzzOB-c7EDVWq10qySy6tabLQkEQCABjPwuPQ1dMxiB62uZ2GTs7hXNvxo5yqmAXBtt_FOJyFbaWUR4D50GnuubtqCK-rbrI7q1aNFAzql3_0rVUaQXXVbWTutqJeEES9zRuI5g_RLWItC7rM4sV_0QggbyK7HQCtpe6LdA_t4cs5yIgbTUH5CNUULU/s595/cash%20is%20king.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="402" data-original-width="595" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzhzzOB-c7EDVWq10qySy6tabLQkEQCABjPwuPQ1dMxiB62uZ2GTs7hXNvxo5yqmAXBtt_FOJyFbaWUR4D50GnuubtqCK-rbrI7q1aNFAzql3_0rVUaQXXVbWTutqJeEES9zRuI5g_RLWItC7rM4sV_0QggbyK7HQCtpe6LdA_t4cs5yIgbTUH5CNUULU/s16000/cash%20is%20king.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">"The key is cash" [<a href="https://www.justice.gov/usao-edny/pr/five-russian-nationals-and-two-oil-traders-charged-global-sanctions-evasion-and-money">source</a>]</span><br /></td></tr></tbody></table><br />In response, the Russians suggest two cash-based payments options. In the first, they will send a bank wire to a Panamanian bank, and the Panamanian bank will pay the PDVSA cash in Venezuela. "This is simply a service that they do," says Orekhov. The second option that he suggests is to bring paper money to <i>Evrofinance </i>in Moscow. Evrofinance is a bank that is controlled by the PDVSA and <a href="https://home.treasury.gov/news/press-releases/sm622">has been sanctioned</a> by the U.S.<br /><br />The indictment doesn't detail whether either of these two solutions was chosen, but instead focuses on a third cash-based solution, one that involves using Tether, or USDt, as a switch.<br /><br />The indictment documents this transaction particularly well. It's November 2021 and the Russians' ship is about to berth in Venezuela for loading. The Venezuelan contact, Serrano, notifies the Russian, Orekhov, that he needs to get ready to pay for 500,000 barrels of PDVSA oil. Orekhov responds by sending $17 million worth of USDt to a broker in Venezuela, who converts the USDt to cash. "No worries, no stress," says the Russian to his Venezuelan contact. "USDT works quick like SMS." <br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYfl9V7xQRS4Eg2483f-qM4uMcO4fbNlX__-Ba4fWH5-HKiSnzDdhmt6zIOAyC8DSIMGeZHtbWtMPXjHo-HAgasIslqg59G615BiUNB_d2TaFyzQg7oA7lsiyslfM7mww4GkvvLFnthkf0eTONlyp7GrvA7wM6Yq6oCaGE7KRMchU97byv_7XGuQs0rP0/s529/quick%20like%20SMS.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="216" data-original-width="529" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYfl9V7xQRS4Eg2483f-qM4uMcO4fbNlX__-Ba4fWH5-HKiSnzDdhmt6zIOAyC8DSIMGeZHtbWtMPXjHo-HAgasIslqg59G615BiUNB_d2TaFyzQg7oA7lsiyslfM7mww4GkvvLFnthkf0eTONlyp7GrvA7wM6Yq6oCaGE7KRMchU97byv_7XGuQs0rP0/s16000/quick%20like%20SMS.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">"...quick like SMS" [<a href="https://www.justice.gov/usao-edny/pr/five-russian-nationals-and-two-oil-traders-charged-global-sanctions-evasion-and-money">link</a>]</span><br /></td></tr></tbody></table><br />Once the broker receives the $17 million USDt, the cash is placed in a bank where PDVSA officials can collect it. Now the boat can be loaded.<br /><br />So in this case Tether is being used as third-party rail for buying cash in Venezuela. It is serving as an alternative to a set of bank wires made through shell companies, a notably speedier one. "It's quicker than telegraphic transfer," says Orekhov. "That why everyone does it now. It's convenient, it's quick." <br /><br />Going the Tether route also has the benefit of <a href="https://jpkoning.blogspot.com/2019/11/from-unknown-wallet-to-unknown-wallet.html">not requiring</a> a single know-your-customer (KYC) check. Orekhov could have bought $17 million USDt, and sent it to the Venezuelan broker, and neither of the two would have had to show the owner of the platform, Tether, their ID or fill out any forms. It's like using the "shittiest bank in the Emirates," except with even fewer hassles.<br /><br />Delving further into the indictment, we learn that another key benefit of Tether is that it provides a degree of protection from the legal hazards of a traditional bank wire transfer. If you scroll down to the part of the indictment where charges are being laid, particularly <i>Count Two</i>, it is the bank wires that are at the root of Orekhov and Serrano's legal woes, not the Tether transactions.<br /><br />Among many other crimes, Orekhov and his Venezuelan counterpart, Serrano, are accused of sanctions evasion, more specifically conspiring to violate the <i>International Emergency Economic Powers Act</i> (IEEPA). The IEEPA is the <a href="https://en.wikipedia.org/wiki/International_Emergency_Economic_Powers_Act">bit of legislation</a> that contains U.S. sanctions law. <br /><br />What specific actions incriminated them? This is a good question, because on first glance the defendants seem to be beyond the pale of U.S. jurisdiction. Both men were foreign nationals operating outside of the U.S. They connected a non-US buyer to a non-US seller. The product is not made in the America. Without a U.S. nexus, it would appear that Serrano and Orekhov are safe from the long reach of U.S. law enforcement.<br /><br />The ultimate hook that catches Orekhov and Serrano is that part of their dealings were deemed to have occurred on U.S. soil. They made wire transfers using the "shittiest bank in the Emirates," and those wire transfers were ultimately processed through correspondent banks based in the New York metropolitan area.<br /><br />To understand how New York-based banks touched the transaction, you need to know a little bit about how wire transfers work. To be capable of making a U.S. dollar wire transfer, the "shittiest bank in the Emirates" needed to have an account with a large U.S.-based <i>correspondent bank</i>, like JP Morgan. Likewise, the bank that the PDVSA shell companies were using would have also had accounts at a U.S. correspondent bank in order to accept U.S. dollar wires. A correspondent bank is a bank that, in addition to conducting regular banking business, specializes in serving foreign financial institutions.<br /><br />So long story short, when U.S dollar funds moved from the Egyptian bank to the PDVSA shell accounts, much of the underlying activity to support this fund transfer occurred back in the U.S. the on the books of a bank such as JP Morgan. <br /><br />That's the Department of Justice's smoking gun. Serrano and Orekhov are accused of having "caused" a U.S.-based financial institution to process tens of millions in U.S. dollar-denominated payments in violation of the IEEPA. <br /><br />The Tether transactions, by contrast, do <i>not </i>provide the Department of Justice with anything incriminating. USDt transfer occurs on the books of Tether (which is registered in the British Virgin Islands), completely bypassing the New York correspondent banking system. So when they paid with USDt, Serrano and Orekhov didn't "cause" a U.S-based actor to do anything wrong.<br /><br />Put differently, if the Russians and Venezuelans had conducted all their transactions with Tether and cash, and avoided bank wires altogether, it would have been impossible for the U.S. to indict them for violating the IEEPA. Thus, not only is Tether "quick like SMS," it also provides a degree of safe harbour from sanctions law.<br /><br />But not for long?<br /><br />In <a href="https://twitter.com/CampbellJAustin/status/1729693581235892652">a recent letter to Congress</a>, the U.S. Treasury says that stablecoins such as Tether pose a sanctions risk, and requests legislation to close this loophole. The Treasury notes that while it already has jurisdiction over offshore wires transfers because they "transit intermediary U.S. financial institutions," or correspondent banks, it does not have the same authority over "equivalent-value stablecoin transactions, because certain stablecoin transactions involve no U.S. touchpoints." (That's the core of what we were talking about in the previous paragraphs.) <br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYV26Rh5ay_a_-jNXK_7-o6sbCdn1NPNS2yLHMz7qq-vQ4WekIBVEaAIqyJAK-QGlDKE7QBRk76_7eG6GhQQJwXBIz4N4Lfrw1JabxvD2W4T4u68FAz9i3U1WbvnkJxAqEBYQh26LrJFtAxyVw36nNmay-7tAhuWl-Ij0glCz-su389y2f6EFaWrIYuFU/s604/extraterritorial.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="315" data-original-width="604" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYV26Rh5ay_a_-jNXK_7-o6sbCdn1NPNS2yLHMz7qq-vQ4WekIBVEaAIqyJAK-QGlDKE7QBRk76_7eG6GhQQJwXBIz4N4Lfrw1JabxvD2W4T4u68FAz9i3U1WbvnkJxAqEBYQh26LrJFtAxyVw36nNmay-7tAhuWl-Ij0glCz-su389y2f6EFaWrIYuFU/s16000/extraterritorial.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">"...stablecoin transactions involve no U.S. touchpoints"</span><br /></td></tr></tbody></table><p></p><p><br />To remedy this, the Treasury wants Congress to update its sanctions toolbox to give it "extraterritorial jurisdiction" over U.S. dollar-pegged stablecoin transactions. In brackets, it also adds "other U.S dollar-denominated transactions" to its wish list. What this appears to be conveying, and I could be wrong, is that the Treasury wants the ability to leverage the U.S. dollar symbol, more specifically the dollar's role as the dominant <i>unit-of-account</i>, as a new nexus for controlling transactions made by foreigners. </p><p>If such a law were to pass, folks like Serrano and Orekhov could now be indicted not only for the traditional crime of making offshore U.S. dollar wire transfers that "cause" New York banks to violate sanctions law, but also for paying with Tether, because the latter invokes the U.S. dollar trademark. </p><p>Leveraging the unit-of-account role of the U.S. dollar to get authority over foreign transactions is a huge step to take, certainly much broader than relying on correspondent banking as authority. Doing so would extend U.S. sanctioning power to a much wider set of foreign economic activity, not just U.S. dollar stablecoin-based transactions, but also potentially to U.S. cash payments, since those too make use of the U.S. dollar accounting unit. Congress will have to think hard before it grants the Treasury's request.<br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com6tag:blogger.com,1999:blog-6704573462403312459.post-72944570315777846392023-12-01T09:12:00.002-05:002023-12-01T09:17:25.636-05:00Even crypto mixing deserves a threshold<p>Many of you may not realize this, but in most parts of the developed world, banks automatically record and report our transactions to law enforcement. The logic behind this is that by giving up our personal data, we get more security, albeit at the cost of 1) losing our privacy, and 2) adding an extra layer of costly red tape into financial life.</p><p>It's <a href="http://jpkoning.blogspot.com/2023/11/in-praise-of-anti-money-laundering.html">a pragmatic compromise</a>, and one hopes that the benefits outweigh the costs. The way that we've been balancing this compromise up till now is by using <i>thresholds</i>, so as to reduce the cost side of the equation. Below a certain dollar threshold (i.e. $10,000 for cash), transactions don't get reported. The folks making these sub-threshold transactions thus enjoy the dignity of not having their privacy invaded, nor
do they add to the financial sector's administrative burden. However, they also don't contribute to the effort to improve security and safety. </p><p>Anyways, last month, the U.S. government <a href="https://www.fincen.gov/sites/default/files/federal_register_notices/2023-10-19/FinCEN_311MixingNPRM_FINAL.pdf">announced</a> a new anti-money laundering reporting requirement, one for crypto mixing. In doing so it broke with a long tradition of not including a threshold. That got my hackles up. Thresholds have always been key to balancing the costs and benefits of automatic reporting requirements.<br /></p><p>In short, the government thinks that mixing of cryptocurrency is of <i>primary money laundering concern</i>.
Any U.S. financial institution that knows, suspects, or has reason to
suspect that a customer's incoming or outgoing crypto transaction, in any amount,
involves the use of a mixer will have to flag it and send a report to
the government. That report must include information like the customer's
name, date of birth, address, and tax ID. </p><p>I <a href="https://www.regulations.gov/comment/FINCEN-2023-0016-1119">submitted</a> the following comment <span class="css-1qaijid r-bcqeeo r-qvutc0 r-poiln3" style="text-overflow: unset;">on the proposed rule for crypto mixing. If you agree, feel free to copy it and <a href="https://www.federalregister.gov/documents/2023/10/23/2023-23449/proposal-of-special-measure-regarding-convertible-virtual-currency-mixing-as-a-class-of-transactions">add your own comment</a> to the growing pile. </span> </p><p><i>Dear sir/madam,<br /><br />Re: Proposal of Special Measure Regarding
Convertible Virtual Currency Mixing, as a Class of Transactions of
Primary Money Laundering Concern<br /><br />Historically, all U.S.
anti-money laundering recordkeeping and reporting requirements have been
accompanied by a monetary threshold. The current proposal to impose
recordkeeping and reporting requirements for crypto mixing is the sole
exception. This should be fixed.<br /><br />When Treasury Secretary Henry
Morgenthau published an executive order to implement the U.S.'s first
large cash transaction reporting regime all the way back in 1945, for
instance, he established a $1,000 reporting requirement for transactions
in which only bills in denominations over $50 were present. He also set
a $10,000 reporting threshold when small and large denomination bills
were involved in the transaction.<br /><br />Morgenthau's thresholds
remained in place through the 1950s and 1960s. They were eventually
ratified in 1972 with the implementation of a $10,000 cash reporting
threshold for the purposes of implementing the Bank Secrecy Act.<br /><br />When
suspicious activity reports were introduced in 1996, the government's
initial proposal did not include a reporting threshold. But after
receiving public comments, the government admitted that its first
version of the rule would impose a "burden of reporting." In its final
version it introduced a $5,000 threshold for filing a suspicious
activity report, which remains to this day.<br /><br />In addition to
reporting thresholds for cash transactions and suspicious activity, the
government has set a number of thresholds for recordkeeping
requirements. For instance, financial institutions are required to keep a
log of all cash purchases of monetary instruments between $3,000 and
$10,000.<br /><br />The government's long history of twinning reporting and
recordkeeping requirements with thresholds is a pragmatic compromise. It
balances law enforcement's need for information against the
administrative burden imposed on the private sector as well the invasion
of privacy imposed on civil society. It only seems fair and prudent to
extend this pragmatic compromise to cryptocurrency mixing recordkeeping
and reporting requirements, especially in light of the fact that, as
FinCEN admits, there are "legitimate purposes" for mixing.<br /><br />I would suggest a threshold of at least $10,000, which is in-line with the cash transaction reporting threshold.<br /><br />Sincerely,<br />JP Koning<br />Moneyness Blog</i></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com0tag:blogger.com,1999:blog-6704573462403312459.post-76573665749734136122023-11-28T12:26:00.010-05:002023-11-30T10:37:51.406-05:00Are central banks too reliant on SWIFT for domestic payments?<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_nhhPypfNGy33MOOfrT-2Dau5BUlSn7WBNEJmt4yQCVBRalKnHTnA0p6nBswhK9YotcQ1rXge9aDi-V4utn3a4lqVF1ZhK_Fz_HomRgN73hBoVGIRcOT3BPob3_JuLpU3m61qIaaSqbppaLY9AtGj_MP8HWddsbZi1nd8axsZMRor1gUsqVkT9zDBDKo/s1425/swiftlogo.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="511" data-original-width="1425" height="230" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_nhhPypfNGy33MOOfrT-2Dau5BUlSn7WBNEJmt4yQCVBRalKnHTnA0p6nBswhK9YotcQ1rXge9aDi-V4utn3a4lqVF1ZhK_Fz_HomRgN73hBoVGIRcOT3BPob3_JuLpU3m61qIaaSqbppaLY9AtGj_MP8HWddsbZi1nd8axsZMRor1gUsqVkT9zDBDKo/w640-h230/swiftlogo.png" width="640" /></a></div><br /><p></p><p>Central bank settlement systems are the the tectonic plates of the payment system: they are vitally important to our lives, but we never see them in action. All of a nations' electronic payments are ultimately completed, or settled, on these systems. If they stop working, our financial lives go on pause, or at least regress to older forms of payment.<br /><br />In this post I want to introduce readers to a crucial feature of these payments tectonic plates: their reliance for domestic settlement on <b>SWIFTNet</b>, a financial messaging network used by banks and other financial institutions to communicate payments information. Think of SWIFTNet as a WhatsApp for banks, but exclusive and very secure. </p><p>This reliance <span>–</span> or over-reliance <span>–</span> is best exemplified by a recent decision by the European Central Bank. The <i>Target2 settlement system</i> has long been the bedrock layer of the European payments universe. All domestic payment ultimately get tied-off on the system. Since it was introduced in 2007, Target2 has been solely reliant on SWIFTNet for sending and receiving messages. </p><p>When the European Central Bank replaced Target2 with T2 <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.pr230321~f5c7bddf6d.en.html">earlier this year</a>, it modified the system to have two access points: it kept SWIFTNet but added a competing messaging network, SIAnet, to the mix. As one commentator <a href="https://www.cpg.de/en/t2-t2s-the-new-market-ecb-infrastructure/">triumphantly put it</a>, "SWIFT’s monopoly for access to the T2/T2S system is broken." <br /><br />SWIFTNet is owned by the Society for Worldwide Interbank Financial Telecommunication, or <a href="https://www.swift.com/">SWIFT</a>, which is structured as a cooperative society under Belgian law and is owned and governed by its 11,000 or so member financial institutions. Whenever SWIFT gets mentioned in conversations, it tends to be associated with cross-border wire payments, for which its messaging network is dominant. However, for many jurisdictions, including Europe, SWIFT is also integral to making domestic payments. It's this little-known local reliance that I'm going to explore in this post.<br /><br />The dilemma faced by central banks such as the European Central Bank is that SWIFTNet is an incredibly useful messaging network. It is ubiquitous: most banks already use it for cross-border payments. And so the path of least resistance for many central banks is to outsource a nation's domestic messaging requirements to SWIFT, too. However, this reliance exposes national infrastructure to SWIFTNet-related risks like foreign control, sanctions, snooping, and system outages.<br /><br /><b>Financial messaging 101</b></p><p>Before going further, we need to understand why financial messaging is important. For a single electronic payment to be completed, a set of databases owned by a number of financial institutions, usually banks, must engage in an intricate dance of credits and debits. To coordinate this dance, these banks need to communicate, and that's where a messaging network is crucial. <br /><br />Say, for example, that Google needs to pay Apple $10 million. Google tells its banker at Wells Fargo to make the payment. Wells Fargo first updates its own database by debiting Google's balance by $10 million. The payment now has to hop over to <strike>Google</strike> Apple, which banks at Chase. For that to happen the payment flow must progress to the core of the U.S's payments system, the database owned by the Federal Reserve, the U.S.'s central bank. <br /><br />Along with most other U.S. banks, Wells Fargo has an account at the Federal Reserve. It communicates to the central bank that it wants its balance to be debited by $10 million and the account of Chase to be credited by that amount. Once Chase's account at the Federal Reserve is updated, Chase gets a notification that it can finally credit Apple for $10 million. At that point Apple can finally spend the $10 million.<br /><br />This entire process takes just a second or two. For this "dance of databases" to execute properly, the Federal Reserve, Chase, and Wells Fargo need to be connected to a communications network.<br /><br />The sort of messaging network to which the central bank is connected, and the stewardship of that network, is thus crucial to the entire functioning of the economy.<br /><br /><b>Proprietary messaging networks or SWIFTNet? </b><br /><br />The Federal Reserve is somewhat unique among central banks in that it has built its own proprietary messaging network for banks. All of the 9,000 or so financial institutions that use the Federal Reserve settlement system, <a href="https://www.federalreserve.gov/paymentsystems/fedfunds_about.htm">Fedwire</a>, must connect to the Fed's proprietary messaging network to make Fedwire payments. To make international payments, however, U.S. banks must still communicate via SWIFTNet. <br /><br />Let's flesh the story out by trekking north of the border. Whereas the Federal Reserve has no reliance on SWIFTNet, Canada's core piece of domestic settlement infrastructure, <a href="https://www.payments.ca/systems-services/payment-systems/high-value-payment-system-lynx">Lynx</a>, relies entirely on SWIFTNet for messaging. <br /><br />For example, if Toronto Dominion Bank needs to make a $10 million to Scotiabank, it enters this order into SWIFTNet, upon which SWIFT forwards the message to Lynx, which updates each banks' accounts by $10 million and sends a confirmation back to SWIFTNet, which tells Scotiabank that the payment has settled. <br /><br />For payments nerds, this network setup is called a <i>Y-copy</i> topology. The network looks like a "Y" because the originating bank message is relayed from the sending bank via SWIFTNet, the pivot at the center of the Y, down to the settlement system, and then back up via SWIFTNet to the recipient bank. It is illustrated below in the context of the UK's payment system, with the CHAPS settlement system instead of Lynx, but the idea is the same.<br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDqfwvG2PBHCLAdLcOyZJV42wgtTwT-2zfxsTwsOCE12NJM6MG7_wPssIiDTy8TXtuWQ2rHZCvUoYT04rA146ffzFe3rURH0el3VbqwuuX5ZR4Tn3PuNffY8Bq3QrFkhRDVcjsco9wuP3dOe49JP1mIutSQ7noLtPVFsC97vqhIxMR7K_nQRajTbxVyRE/s481/ycopy.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="373" data-original-width="481" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDqfwvG2PBHCLAdLcOyZJV42wgtTwT-2zfxsTwsOCE12NJM6MG7_wPssIiDTy8TXtuWQ2rHZCvUoYT04rA146ffzFe3rURH0el3VbqwuuX5ZR4Tn3PuNffY8Bq3QrFkhRDVcjsco9wuP3dOe49JP1mIutSQ7noLtPVFsC97vqhIxMR7K_nQRajTbxVyRE/s16000/ycopy.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">A Y-copy network topology for settling central bank payments in the UK [<a href="https://www.bankofengland.co.uk/-/media/boe/files/payments/chaps/chaps-technical-requirements.pdf">source</a>]</span><br /></td></tr></tbody></table><br />The upshot is that the Federal Reserve controls the messaging apparatus on which its domestic settlement depends, whereas Canada outsources this to a cooperative on the other side of the ocean.<br /><br />Many of the world's small and middle-sized central banks have adopted the same Y-copy approach as Canada. This list includes Australia, Singapore, New Zealand, Nigeria, UK, Sweden and South Africa. However, some members of this group are starting to have second thoughts about fusing themselves so completely to SWIFT.<br /><br /><b>Removing the single point of failure</b><br /><br />The European Central Bank is at the vanguard of this group. Prior to 2023, the European Central Bank was in the same bucket as Canada, relying entirely on SWIFTNet to settle domestic transactions. <p></p><p>With its upgraded T2 system, Europe doesn't go quite as far the Fed's model, which is to build its own bespoke messaging network. Rather, European banks now have the option of either sending messages to T2 using SWIFTNet, or they can <a href="https://www.nexigroup.com/en/business/banks-and-financial-institutions/network-services/">use SIAnet</a>, a competing network owned by <a href="https://www.sia.eu/en">Nexi</a>, a publicly-traded corporation. SIAnet stands for <i>Societa Interbancaria per l'Automazione</i>, a network that originally connected Italian banks but has now gone pan-European.<br /><br />The reason for this design switch is that European Central Bank desires "network-agnostic connectivity." This dual access model will make things more complex for the European Central Bank. If a commercial bank originates a SIAnet message, the central bank will have to translate this over to a SWIFT message if the recipient bank uses SWIFTNet. Nevertheless, the European Central Bank believes this dual structure will offer more choice to domestic banks. <br /><br />The ECB <a href="https://www.ecb.europa.eu/paym/intro/publications/html/ecb.targetsecar202205.en.html">also hints</a> at the enhanced "information security" that this new setup will provide, without providing much detail. The UK's recent efforts to update its core settlement layer sheds some extra insights into what these security improvements might be. Right now, the UK's core settlement system, CHAPS, can only be accessed by SWIFTNet, much like in Canada, so that all domestic UK payments are SWIFT-reliant.<br /><br />In its <a href="https://www.bankofengland.co.uk/paper/2023/roadmap-for-the-real-time-gross-settlement-service-beyond-2024">roadmap for updating</a> CHAPS, the Bank of England is proposing to allow banks to access the system via either SWIFTNet or a second network, which doesn't yet exist. The idea is to enable "resilient connectivity" to the core settlement layer, especially in periods of "operational or market disruption." Should SWIFTNet go down there would be no way for financial institutions to communicate with CHAPS, and the entire domestic economy would grind to a halt. A second network removes the "single point of failure" by allowing banks to re-route messages to CHAPS.<br /><br />The Bank of England also highlights the benefits of competition, which would reduce the costs of connectivity.<br /><br />This sounds great, but there are tradeoffs. Using a a single network for both domestic and international payments is valuable to the private sector because it offers standardization and efficiencies in banks' processing. Adding a second option will also complicate things for the Bank of England, since it will have to design and build a system from scratch, much like the Fed did, which could be costly. Either that or it will have to find another private option, like the ECB did with SIAnet. This second network may not be as good as SWIFTNet which, despite worries about resiliency, has been <a href="https://www.swift.com/myswift/availability-statistics">incredibly successful</a>. <br /><br />When CHAPS <a href="https://jpkoning.blogspot.com/2023/08/uks-core-payments-settlement-system.html">went down earlier</a> this year for a few hours, for instance, it wasn't SWIFT's fault, but the Bank of England's fault. The same goes for a full day outage in 2014. </p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiW-Wy2gS1zJhyphenhyphenphqIOAzzwQ4YrZnqjOG9hs-zwjkc3KL1ztov5z0vpszqLHu0aAbm5EWVOAR6ME5oMNUX4LwmklcQHdwnqEvQmugjCRLnvU8X-TW3d5WM9LnQItlxQolbrzo7Gp5jvoaMw39h9B1_Q4UZkWigJ7os6SvU0tv74OHxNcZ5rRlEs3JLiKnw/s996/ycopyandvshape.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="294" data-original-width="996" height="188" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiW-Wy2gS1zJhyphenhyphenphqIOAzzwQ4YrZnqjOG9hs-zwjkc3KL1ztov5z0vpszqLHu0aAbm5EWVOAR6ME5oMNUX4LwmklcQHdwnqEvQmugjCRLnvU8X-TW3d5WM9LnQItlxQolbrzo7Gp5jvoaMw39h9B1_Q4UZkWigJ7os6SvU0tv74OHxNcZ5rRlEs3JLiKnw/w640-h188/ycopyandvshape.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Comparing a V-shaped network topology to Y-Copy in an Australian context [<a href="https://www.rba.gov.au/publications/consultations/201904-iso-20022-migration-for-the-australian-payments-system/">source</a>]</span><br /></td></tr></tbody></table><br /><br />The type of settlement topology that the UK is proposing is known as "V-shaped," since all messages are sent directly to the central bank settlement system for processing via any of a number of messaging networks, and then back to the recipient bank. The difference between a V-shaped topology and Y-copy is visualized in the chart above in an Australian context, but the principles apply just as well to the UK.<br /><br /><b>Sanctions and "the SWIFT affair"</b><br /><br />The decision to make domestic payments less dependent on SWIFTNet is much more easy to make for outlier nations like Russia. SWIFT is based in Belgium and <a href="https://www.swift.com/about-us/organisation-governance/swift-oversight">is overseen</a> by the Belgian central bank, along with the G-10 central banks: Banca d’Italia, Bank of Canada, Bank of England, Bank of Japan, Banque de France, De Nederlandsche Bank, Deutsche Bundesbank, European Central Bank, Sveriges Riksbank, Swiss National Bank, and the Federal Reserve. That put SWIFT governance far out of Russian control. <br /><br />You can see why this could be a problem for Russia. Imagine that only way to settle domestic Russian payments was by communicating through SWIFTNet. If Russia was subsequently cut off from that network for violating international law, that would mean that all Russian domestic payments would suddenly cease to work. It would be a disaster. <br /><br />Needless to say, the Central Bank of Russia has ensured that it doesn't depend on SWIFTNet for communications. It has its own <a href="https://www.cbr.ru/eng/Psystem/fin_msg_transfer_system/">domestic messaging network</a> known as <i>Sistema peredachi finansovykh soobscheniy</i>, or System for Transfer of Financial Messages (SPFS), which was built in 2014 after the invasion of Crimea. Prior to then, it appears that "<a href="https://iz-ru.translate.goog/news/601876?_x_tr_sl=fr&_x_tr_tl=nl&_x_tr_hl=en&_x_tr_pto=wapp">almost all</a>" domestic Russian transactions passed through SWIFTNet <span>–</span> a dangerous proposition for a country about to face sanctions.<br /><br />Mind you, while Russia has protected its domestic payments from SWIFTNet-related risk, it can't do the same for its international payments. SWIFTNet remains the dominant network for making a cross border wire. There is no network the Russians can create that will get around this. <br /><br />I'm pretty sure that most larger developing states and/or rogue nations have long-since built independent domestic financial messaging systems to avoid SWIFTNet risk. I believe China has done so. Brazil has the National Financial System Network, or <i>Rede do sistema financeiro nacional</i> (RSFN). India also has its own system, the <a href="https://en.wikipedia.org/wiki/Structured_Financial_Messaging_System">Structured Financial Messaging System</a> (SFMS), built in 2001. India is even <a href="https://inc42.com/buzz/rbi-plans-to-take-financial-messaging-system-swifts-homegrown-alternative-sfms-global/">trying to export</a> SFMS as a SWIFT competitor.<br /><br />The Japanese were typically way ahead on this. The Bank of Japan <a href="https://www.zengin-net.jp/en/zengin_net/pdf/pamphlet_e.pdf">built its</a> messaging network, the Zengin Data Telecommunication System, back in 1973, several years before SWIFT was founded.<br /><br />The last SWIFTNet risk is snooping risk. This gets us into the so-called <i>SWIFT affair</i>. After 9/11, the U.S. intelligence agencies were able to pry open SWIFT through secret <a href="https://www.nytimes.com/2006/06/23/washington/23intel.html">broad administrative subpoenas</a>. They had the jurisdiction to do so because one of SWIFT's two main data centres was located in the U.S. <br /><br />To ensure data integrity, SWIFT had been mirroring European data held in its data centre in Belgium at its U.S. site. That effectively gave U.S. intelligence access to not only SWIFT's U.S. payments information, but also information on foreign payments sourced from Europe or directed to Europe. Worse, it also provided spooks with data on domestic European payments. Recall that the European Central Bank's Target2 settlement system, which settles all digital domestic payments in Europe, was entirely reliant on SWIFTNet for communications.<p></p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1eAPuLgOYz8ANwiQiszRseeZ2wT2iKYv9B29sXvUz44PBZ3vVDYnskXdT8fgQTlDeRXnm-FcBQXm89fkd8agVRIZDsDPm7YWa-jOFyt_ePAIbcwlEaO5AVAHnsleinbq4JFzxF01ofYpCMXzYH1yT_hDyXBwgNZhXNmBu3NmSb6IX_qQwSFDXwuofKbw/s704/swiftNYT2006.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="495" data-original-width="704" height="281" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1eAPuLgOYz8ANwiQiszRseeZ2wT2iKYv9B29sXvUz44PBZ3vVDYnskXdT8fgQTlDeRXnm-FcBQXm89fkd8agVRIZDsDPm7YWa-jOFyt_ePAIbcwlEaO5AVAHnsleinbq4JFzxF01ofYpCMXzYH1yT_hDyXBwgNZhXNmBu3NmSb6IX_qQwSFDXwuofKbw/w400-h281/swiftNYT2006.PNG" width="400" /></a></div><br />When the U.S.'s snooping arrangement was <a href="https://www.nytimes.com/2006/06/23/washington/23intel.html">made public</a> by the New York Times in 2006, it caused a huge controversy in Europe. SWIFT tried to placate Europe by <a href="https://www.computerweekly.com/news/2240149275/Swift-building-underground-datacentre">building a third data warehouse</a> in Switzerland to house Europe's back-up data. But the precedent was set: SWIFT is not 100% trustworthy. And that may be part of the reason why the European Central Bank chose to downgrade its reliance on SWIFTNet when it introduced its new system, and is surely why other nations want to entirely hive their domestic systems off from it.<p></p><p style="text-align: center;">--- <br /></p><p style="text-align: left;">In sum, central banks face a host of complicated decisions in how to bolt on messaging capabilities to their key settlement systems. SWIFTNet is a top notch network. However, too much SWIFT-related risk may be perceived as having negative implications for national security. For large nations with extensive banking industries, building a proprietary domestic messaging alternative seems to be the preferred option. It also seems to be the default choice for rogue states like Russia.<br /><br />Another alternative is to fallback on using multiple independent networks for access, of which one is SWIFTNet, and thus mitigating exposure to SWIFT-related problems. This is the approach taken by Europe and the UK.<br /><br />For smaller nations that comply with the global consensus, like Canada, the calculus is different. Building an alternative communications network is likely to be costly. The risk of sanctions and censorship are negligible while the benefits of using a high-quality ubiquitous network for both domestic and foreign payments messaging are significant. Given these factors, it may be worthwhile to bear all SWIFT-related risks and adopt the Y-copy model. </p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com5tag:blogger.com,1999:blog-6704573462403312459.post-48147238813057505062023-11-20T06:57:00.007-05:002023-11-20T07:07:12.039-05:00 Is it legal to mix cash in a jar?<p>Chris Blec asks the following question:</p><p></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIzz1jRPGeDBxFYrjZM8gYH3GQw_1JAKbaipwrMjQmybDPDjAy36fbTU_N7uGrk7jtfHOgDLE8QxXi7Zx0HnOljLCi4FvfeMxpi-R7UfqHHtoP9wQkpyQEuwzQCKiutXngw7o_ROLw1itmiykKaj0cJCkWEuZuWJoOL0efGdpRkNCcdCzk5Iz6tMHwACA/s595/becchris.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="284" data-original-width="595" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIzz1jRPGeDBxFYrjZM8gYH3GQw_1JAKbaipwrMjQmybDPDjAy36fbTU_N7uGrk7jtfHOgDLE8QxXi7Zx0HnOljLCi4FvfeMxpi-R7UfqHHtoP9wQkpyQEuwzQCKiutXngw7o_ROLw1itmiykKaj0cJCkWEuZuWJoOL0efGdpRkNCcdCzk5Iz6tMHwACA/s16000/becchris.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://twitter.com/ChrisBlec/status/1725256603962876326">Twitter</a></span><br /></td></tr></tbody></table><br />Chris's premise is that it is "not illegal" for him to get together with a bunch of strangers to mix cash. But that's not quite right. It can be legal. It can also be illegal. To determine which it is, we need to understand the motivations of Chris and the other ten strangers. Why are they getting together to mix in the first place? Alas, Chris doesn't mention this in his tweet. <br /><br />There are certainly all sorts of perfectly legal albeit quirky reasons to mix cash. We could imagine that Chris and ten other strangers are waiting for the bus, and to decide who goes first, they all put a $20 note into a jar, remembering their respective serial number. After the notes have been mixed, one note is taken out and whoever it belongs to wins. The notes are then given back. Nothing wrong with that.<br /><br />On the other hand, if Chris and the other 10 strangers are mixing their cash because they want to <i>conceal the source</i>, then they need to be careful. They've taken one step down the path to engaging in money laundering. <br /><br />The U.S. has several money laundering statutes. Below is part of one of the most contravened ones: <p></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM8xzuFpZ6_50EmZNEpj5ssU9hJWdD6l8zh9_bovW7OsvMvt4Nz1u9k_9XaU-LSwgYhXT6J63lTtPCPe9dBE_PvZfHHwj0g5Ltxiiszal_PcKkAOeA81dnvUKy2Kpc27BBeYAWsNij9iAFpBVdxfiPWwEjeoH3eRFg9Nm98kR4AQVLczQvXkXoSKUna9E/s625/1956.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="531" data-original-width="625" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM8xzuFpZ6_50EmZNEpj5ssU9hJWdD6l8zh9_bovW7OsvMvt4Nz1u9k_9XaU-LSwgYhXT6J63lTtPCPe9dBE_PvZfHHwj0g5Ltxiiszal_PcKkAOeA81dnvUKy2Kpc27BBeYAWsNij9iAFpBVdxfiPWwEjeoH3eRFg9Nm98kR4AQVLczQvXkXoSKUna9E/s16000/1956.png" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://www.law.cornell.edu/uscode/text/18/1956">LII</a></span><br /></td></tr></tbody></table><br />As you can see, one of the key triggers for a money laundering conviction is making transactions that are designed to "conceal or disguise." <br /><br />Even if Chris and the other strangers' motivations for mixing is to conceal the origins of their cash, that's not necessarily illegal. Before they reach the point at which they can be accused of having crossed the line over to money laundering, at least one of the strangers needs to contribute banknotes to the jar that are the "proceeds of specified unlawful activity." For argument's sake, let's say that one of the strangers contributes cash that they've earned from contract killing. Chris and the other 10 strangers are now a step closer to a potential money laundering indictment. <p></p><p>Only one last criteria is lacking. Chris and the other strangers must participate in a "knowing" way. They must be aware that the property involved is criminally-derived. The most obvious example would be if one of the 10 strangers were to loudly announce just prior to putting their notes in the jar that the notes come from contract killing, and everyone hears this yet still participates. </p><p>At this point, the three triggers have been met. Chris and the other strangers have acted in 1) a knowing way 2) to conceal 3) the actual proceeds of unlawful activity.<br /><br />The state of "knowing" needn't be established in such an explicit fashion as the criminal announcing it loudly. For instance, even if the criminal says nothing, but Chris and the other participants <a href="https://journals.library.wustl.edu/lawreview/article/2264/galley/19097/view/">suspect the possibility</a> that dirty money is entering the jar, but they don't do due diligence, then they could be found guilty of money laundering. To demonstrate that they aren't knowing participants, Chris and the other strangers may have to take proactive measures, say like checking ID. <br /><br />So Chris is right to say that mixing cash in a jar can be legal, but he incorrectly omits to say that it can also be illegal.<br /><br />Having fleshed out Chris's premise, what about his conclusion? Can the jar-of-cash thought experiment teach us about the legality of crypto mixing methods such as custodial mixers, Tornado Cash, or CoinJoin? I'll let the readers work that one out on their own. </p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com10tag:blogger.com,1999:blog-6704573462403312459.post-89681683692192597302023-11-16T12:33:00.008-05:002023-11-21T11:03:15.045-05:00Kraken v Kraken, or how to protect the public from crypto exchange failures<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEizrEnv4FKnHtBdTEDUPVGSPUAa_a6nvBbhi_gJ6flbRUKidNBjrkpzyQ-aJYeWg0GCgyB__mrK2RnOE9qdnGydiJ_S_uCClT0N7mMquyY4GVUVDnaxDGfLiMVGyVsWSOWsVd3mZddkCmYgkS1JNFWHEEJWIjwS00XqSCmqyOBTR8GOeVQNqlk7gX8h2Pk/s912/krakens.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="517" data-original-width="912" height="362" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEizrEnv4FKnHtBdTEDUPVGSPUAa_a6nvBbhi_gJ6flbRUKidNBjrkpzyQ-aJYeWg0GCgyB__mrK2RnOE9qdnGydiJ_S_uCClT0N7mMquyY4GVUVDnaxDGfLiMVGyVsWSOWsVd3mZddkCmYgkS1JNFWHEEJWIjwS00XqSCmqyOBTR8GOeVQNqlk7gX8h2Pk/w640-h362/krakens.jpg" width="640" /></a></div><br /><p></p><p>It's been a full year since FTX International and FTX-US collapsed, and the shocking thing is <span>–</span> <i>there is still no regulated crypto venue in the U.S.!</i> You'd think some lessons would have been learnt. <br /><br />To best protect the public from the Sam Bankman-Frieds of the world, what the U.S. requires is securities-level oversight of crypto exchanges. Exchanges like Coinbase and Kraken are offering the sorts of investment services to the public that the U.S.'s main securities regulator, the SEC, is ideally positioned to regulate, such as trading, margin, custody, and market making. But one year after FTX's collapse, there doesn't appear to be a single SEC-regulated exchange. <br /><br />The exchanges blame this on the SEC's lack of clarity. The SEC blames this on exchanges refusing to come in and register. God knows who's telling the truth.<br /><br />Whatever the case, this intransigence only increases the odds that there'll be another U.S. crypto exchange collapse in the next few years, one that appropriate regulation could have otherwise prevented, or at least sheltered investors from the fallout. <br /><br />What sort of protections am I talking about? After Canada suffered through <a href="https://en.wikipedia.org/wiki/Quadriga_Fintech_Solutions">the collapse of QuadrigaCX</a> a few years back, and a bunch of Canadians like myself lost money, crypto exchanges were brought under the auspices of our existing securities regulatory framework, with a few nips and tucks to the rules to make them fit. This has led to a lot of changes that make Canadian crypto customers safer. I'm going to share the best example in this blog post.<br /><br />Kraken is a well-known crypto exchange that serves both American and Canadian customers. However, if you're an American customers who uses Kraken, you possess <i>a very different sort of asset</i> than Canadian customers do. <br /><br />Let's look at the fine print of the U.S. platform:<br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPkVE4CcWsrprdz91zCzo84a_E610z1YF4cbGZrHN0JDF-COmn92LkPPY5z2ewgyGUEUxgMyUCPptV3OJmDVofZSwAm31DkSntlzNhGP30Y1TUL4FDRKROWAke_FMCCoPLWeMg-gZ2dRZpnw1jt1auq8TWyo-i0YnJAf8uiq-eCKjsV5me63VV8Oxup98/s693/krakenUS.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="370" data-original-width="693" height="342" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPkVE4CcWsrprdz91zCzo84a_E610z1YF4cbGZrHN0JDF-COmn92LkPPY5z2ewgyGUEUxgMyUCPptV3OJmDVofZSwAm31DkSntlzNhGP30Y1TUL4FDRKROWAke_FMCCoPLWeMg-gZ2dRZpnw1jt1auq8TWyo-i0YnJAf8uiq-eCKjsV5me63VV8Oxup98/w640-h342/krakenUS.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: Kraken's <a href="https://www.kraken.com/legal">terms of service</a> for U.S. customers<br /></td></tr></tbody></table><br />So in the U.S., asset are held "by us for you." That is, Kraken itself is doing the holding, safekeeping, or
providing custody of crypto for its customers. <br /><p></p><p>A key observation I want to
make here is how <u>fundamentally different</u> this is from how standard
regulated marketplaces function like the NASDAQ or the Toronto Stock
Exchange. Traditional marketplaces offer a venue to trade assets, but
they don't offer custody. If they tried to introduce this, their regulator would very
quickly say no. I'll explain why below.<br /><br />But first, let's head over to Kraken Canada. Once again, here's the fine-print:</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEibCduOuHaecFoh6gI_bZA-qlZ0JQA15YXU9xtMIXql3BIEeNVDfyoAYR2nnK3LKXZhZFn6VIjIziA-mpaJj6nEhJfD9ZSfsFo48dUClBjjs3owtclWvyPJxxgUXJ1XCsSGV0d_REGZlCrwxz8HJ2md05RKsPaVCpp71DXAvC8OFqz9u_cNDEOhXoCWBfs/s667/krakenCanada.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="379" data-original-width="667" height="364" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEibCduOuHaecFoh6gI_bZA-qlZ0JQA15YXU9xtMIXql3BIEeNVDfyoAYR2nnK3LKXZhZFn6VIjIziA-mpaJj6nEhJfD9ZSfsFo48dUClBjjs3owtclWvyPJxxgUXJ1XCsSGV0d_REGZlCrwxz8HJ2md05RKsPaVCpp71DXAvC8OFqz9u_cNDEOhXoCWBfs/w640-h364/krakenCanada.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: Kraken's <a href="https://www.kraken.com/legal/ca-terms">terms of service</a> for Canadian customers<br /></td></tr></tbody></table><br />What the underlined wording says is that if you're a Canadian, Kraken does <i>not </i>hold your crypto for you. That's very different from the U.S. Instead, Kraken says that customer crypto is deemed to be "custodial assets" and delegates your crypto to a "designated trust account at a Crypto Custodian." <i>Bingo</i>. There's the separation of trading from custody that I was talking about earlier, which aligns with standard practices for marketplaces.<br /><br />Scan further through the fine print and you learn who that crypto custodian is: <i>Anchorage Digital Bank</i>:<br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8XFUXeNXNNrlRcRGaKn6EreUuQW06XR4p_ICbG0wBEkfDT6mvp5Z-pmh-hWkNr0lWARfBd7xpZn_H4MqshgQjCHZ3MKgUWiNmKfqma1IpyeTQsI-4JN-tETsgrfSYRlzF6aOLx84JOgt38nmOv1-qOTymDEPVd7WGT0kgBSeisRDT2n8LUrrnhPMaJ0w/s671/krakenCanada2.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="116" data-original-width="671" height="110" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8XFUXeNXNNrlRcRGaKn6EreUuQW06XR4p_ICbG0wBEkfDT6mvp5Z-pmh-hWkNr0lWARfBd7xpZn_H4MqshgQjCHZ3MKgUWiNmKfqma1IpyeTQsI-4JN-tETsgrfSYRlzF6aOLx84JOgt38nmOv1-qOTymDEPVd7WGT0kgBSeisRDT2n8LUrrnhPMaJ0w/w640-h110/krakenCanada2.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: Kraken's <a href="https://www.kraken.com/legal/ca-terms">terms of service</a> for Canadian customers</td></tr></tbody></table><p><br />Who is Anchorage? Anchorage is a federally-charted trust <a href="https://www.occ.treas.gov/institution-search/details?q=anchorage%20digital%20bank&charter=25243&name=Anchorage%20Digital%20Bank%20National%20Association&city=Sioux%20Falls&state=SD&info=ner">that is overseen by</a> the <i>Office of the Comptroller of the Currency</i>, one of the key U.S. federal banking regulators. So if you hold some coins on Kraken, and you are an American, you own what is essentially a Kraken IOU, and you have to trust Kraken, but if you are a Canadian, you're effectively putting most of your trust in a federally charted financial institution. That's pretty stern stuff. </p><p>Canadian securities regulators <a href="https://www.osc.ca/sites/default/files/2023-02/csa_20230222_21-332_crypto-trading-platforms-pre-reg-undertakings.pdf">require all crypto exchanges</a> operating in Canada to delegate at least 80% of customer crypto to a third-party custodian. (The other 20% can be held in a hot wallet for liquidity purposes.) Kraken doesn't appear to be doing this for its American customers, and that's because there's no U.S. regulator prompting it to do so. On top of requiring this separation, Canadian regulators stipulate that third-party custodians must be <i>qualified</i>. That is, they can't just walk in off the street. The custodian has to meet the regulator's standards, which <a href="https://www.osc.ca/sites/default/files/2023-02/csa_20230222_21-332_crypto-trading-platforms-pre-reg-undertakings.pdf">requires having</a> a Systems and Organization Controls (SOC) designation, and a bunch of other stuff too.<br /><br />You can probably see by now that if you're a customer of Kraken, it's better to be Canadian than American, for the following reasons:</p><p></p><p style="margin-left: 40px; text-align: left;"><span>•</span> Anchorage is a federally-regulated financial institution and subject to strict oversight. Kraken U.S. is for the most part unregulated. No one is peering over its shoulder to check whether it is doing a good job safekeeping your coins.<br /><span>•</span> Kraken has its fingers in a lot of different businesses, but Anchorage specializes on custody, and so it's probably better at the task. <br /><span>•</span> Anchorage is independent from Kraken. This separation mitigates the risk of loss, theft, or misuse of assets by Kraken management. This is particularly salient in Kraken's case because it engages in many other business activities, such as trading or market-making, and these pose potential conflicts of interest.<br /></p><p>In the future, one hopes that Kraken's U.S. exchange provides the same level of customer protection as Kraken's Canadian platform. But that's only go to happen if and when the SEC dictates a fundamental separation of crypto trading from custody, and whether U.S. crypto exchanges actually listen to the SEC.</p><p><i>Addendum (Nov 21): Talk about good timing. The SEC <a href="https://www.sec.gov/files/litigation/complaints/2023/comp-pr2023-237.pdf">just announced</a> that it is suing Kraken's U.S. entity for, among many other things, failing to <u>segregate </u>customer crypto assets and dollar balances. Segregation is different than third party custody. It basically means that customer property is kept separate from corporate property. This helps to</i><i> prevent double-dipping. An exchange can make use of a third party custodian, for instance, but not segregate those funds into corporate and customer buckets. The combination of segregation and third-party custody is optimal. <br /></i></p><p><i>By contrast, Canadian securities law clearly specifies that </i><i>Kraken and any other Canadian exchange must
already be</i><i> segregating customers crypto and funds from corporate funds. In the regulators' <a href="https://www.osc.ca/en/securities-law/instruments-rules-policies/2/21-332/csa-staff-notice-21-332-crypto-asset-trading-platforms-pre-registration-undertakings-changes">own words</a>, exchanges must keep customer property "separate and apart from its own property." </i><i>This is in addition to the requirement that they use a third party custodian to store customer crypto
and fiat. </i><i>We can verify by reading Kraken's <a href="https://www.osc.ca/sites/default/files/2023-04/pru_20230324_payward-canada.pdf">undertaking</a> with Canadian regulators, in which it promises that it will be keeping customer crypto "separate and apart from its own assets." </i></p><p><i>Segregation is just one other low-hanging bit of customer protection that U.S. crypto exchanges should already have implemented, but probably won't until prodded by the government.</i><br /></p><p></p><hr /><p></p><p><span style="font-size: x-small;">The next section is for pedants only, of which I'm embarrassed to be, which is why I'm putting this in very small print:</span></p><p><span style="font-size: x-small;">Kraken <a href="https://www.kraken.com/learn/finance/spdi-bank-charter">owns a U.S. bank</a>. How does this fit into the story? Here are the details: In the U.S., the Kraken crypto exchange is really just the trade name for Payward Ventures. Payward Ventures is in turn a subsidiary of Payward, Inc. Payward, Inc has another subsidiary, Payward Financial, Inc, that owns a state-charted bank -- Kraken Bank. Notably, when you sign up as a customer of the Kraken crypto exchange, you are entering into a relationship with Payward Ventures, not Payward Financial. There is no indication in the exchange's terms of service that Kraken Bank is in any way involved in custody. Which seems... odd? Why wouldn't Kraken use its bank for custody?<br /></span></p><p><span style="font-size: x-small;">When Kraken first applied to do business in Canada earlier this year, it said <a href="https://www.osc.ca/sites/default/files/2023-04/pru_20230324_payward-canada.pdf">it wanted to use</a> Kraken Bank as its custodian. Given that Kraken is in fact using Anchorage Bank as we speak, I suspect that Canadian regulators told Kraken: "Hey, guys. Kraken Bank is not sufficiently independent, you're going to have to use a third-party." And I suspect they were right about this.<br /></span></p><p><span style="font-size: x-small;">Meanwhile, what about Canada's most popular exchange, Coinbase? Coinbase's Canadian <a href="https://www.coinbase.com/legal/user_agreement/canada">terms of service</a> doesn't indicate that it is using a qualified custodian. Customer assets are "held by the Coinbase Group for your benefit." Yeah, that's not going to fly with the regulators. I suspect that within a few months you're going to see it using a third-party like Anchorage, or its just going to leave Canada.</span><span style="font-size: x-small;"> </span></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com5tag:blogger.com,1999:blog-6704573462403312459.post-53981412489624902232023-11-14T15:19:00.005-05:002023-11-14T16:41:27.403-05:00In praise of anti-money laundering thresholds<p>Two seemingly separate stories, a crypto and a banking story, have a common thread in anti-money laundering thresholds.<br /><br />In the first story, the New York Times <a href="https://www.nytimes.com/2023/11/05/business/banks-accounts-close-suddenly.html">shows how</a> regular folks are increasingly losing their bank accounts because their bank perceives them to be engaging in risky behaviour. In the second, the U.S. government <a href="https://www.coindesk.com/policy/2023/10/19/us-treasury-seeks-to-name-crypto-mixers-as-money-laundering-concern/">has proposed an expansive new rule</a> that would require financial institutions to report all customers who use <i>cryptocurrency mixers </i>to the government.<br /><br />Anti-money laundering thresholds underpin what I'll call the<i> Pragmatic Compromise </i>between the government and citizens, albeit a tenuous compromise, for reasons I'll explain. <br /><br />The U.S. government and its various law enforcement agencies have the ability to get full access to bank records for the purposes of fighting crime. They can do so directly, that is, without having to proceed through the standard process of convincing a judge to approve a warrant. This is an incredible amount of power to have. To counterbalance this, a compromise of sorts has been agreed to that limits the government's access to bank records. A number of key financial thresholds have been established, below which transactions are protected from surveillance.<br /><br />The most well-known method the government has for accessing your personal financial information is the requirement that banks submit <i>currency transaction reports</i>, or CTRs (see below), every time someone withdraws or deposits paper money. Banks don't submit a report for all cash transactions. The threshold for submitting is set at $10,000. So if you withdraw $9,999, your name and address won't be reported to the government. If you withdraw $10,001, you'll lose the threshold's protection and will be reported.<br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQwi3DFOlrjAPh524YFwueoDwMQ_LedK9CC_WyuPOJRUQ-UciWGWrkJtOqz-JnTVVYXI1t9SZmxPb28m9efZqnjJDdaRGGAyLSjO2-pxF-GSRSw47NTuUrOS40kM3ndvzAUjHZ119UfpmFCrWvqgeho-mDUGiP3kIWojEyahKBMnCbsZNqzva7L26srm8/s962/ctr1.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="504" data-original-width="962" height="336" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQwi3DFOlrjAPh524YFwueoDwMQ_LedK9CC_WyuPOJRUQ-UciWGWrkJtOqz-JnTVVYXI1t9SZmxPb28m9efZqnjJDdaRGGAyLSjO2-pxF-GSRSw47NTuUrOS40kM3ndvzAUjHZ119UfpmFCrWvqgeho-mDUGiP3kIWojEyahKBMnCbsZNqzva7L26srm8/w640-h336/ctr1.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">The modern U.S. currency transaction report [<a href="https://www.irs.gov/pub/irs-tege/fin104_ctr.pdf">source</a>]</span><br /></td></tr></tbody></table> <p></p><p>The U.S. has a long history of providing direct government access to banking records. The practice began in 1945 when Treasury Secretary <a href="https://en.wikipedia.org/wiki/Henry_Morgenthau_Jr.">Henry Morgenthau Jr</a>, invoking war-time powers, issued <a href="https://tile.loc.gov/storage-services/service/ll/fedreg/fr010/fr010111/fr010111.pdf">an executive order</a> (see below) instructing banks to begin reporting currency deposits and withdrawals made by the public. Known as <a href="https://fraser.stlouisfed.org/files/docs/historical/frbdal/circulars/frbdallas_circ_19690807_no69-200.pdf">TCR-1 forms</a>, these reports were to be forwarded every month to the government with information about the cash amounts involved and the identification of the individual making the transaction. <br /><br />Morgenthau's reporting requirement was motivated by the desire to stamp out black marketeering, <a href="https://www.linkedin.com/pulse/1945-origins-currency-reporting-paul-camacho">writes</a> Paul Camacho, which had emerged as a way to evade war-time rationing programs. But even though the war soon ended and rationing ceased, the practice of cash reporting continued through the 1950s and 1960s, albeit on what must have been legally dubious grounds now that it was peacetime.</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgGnHgxWkOTT4See2hxGwzy_wBtNGkCGZ_J0Wn8FSUD_wvYzMdvmP5p3FLpvAKT7W53OkJXMNCBVC-E40hAzUVefFz6exC7ZrnfQPZj5OIbd9cKyoFvTEA3xZR8WYAP4uBP-GQJ_nj7nN2-b964QMngDme_JosJUL_f0nxH5yNznTgMRVqT6wngxkYNbss/s1159/morgenthau.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="623" data-original-width="1159" height="344" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgGnHgxWkOTT4See2hxGwzy_wBtNGkCGZ_J0Wn8FSUD_wvYzMdvmP5p3FLpvAKT7W53OkJXMNCBVC-E40hAzUVefFz6exC7ZrnfQPZj5OIbd9cKyoFvTEA3xZR8WYAP4uBP-GQJ_nj7nN2-b964QMngDme_JosJUL_f0nxH5yNznTgMRVqT6wngxkYNbss/w640-h344/morgenthau.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Henry Morgenthau's 1945 executive order on currency reporting [<a href="https://twitter.com/jp_koning/status/1723087822045753828">source</a>]</span><br /></td></tr></tbody></table><br /> In 1970, the necessary legal formalization to justify the reporting of bank information was
provided when Congress passed the <a href="https://en.wikipedia.org/wiki/Bank_Secrecy_Act">Bank Secrecy Act</a>, which encoded
directly into law the requirement that banks record and report cash
transactions, as well as legislating a set of extra recordkeeping and
reporting requirements. Over the years, additional recordkeeping and reporting standards were added by Congress to the Bank Secrecy Act, including the 1994 requirement that banks screen for "suspicious" transactions and report them to the government by submitting a <i>suspicious activity report</i>, or SAR (see below).<br /><br />While there's certainly a law & order case to be made for providing governments with direct (i.e. warrantless) access to financial records, there's a pretty clear set of reasons why society should want to limit this power. Allow too much access and banks will inevitably get bogged down in the expensive bureaucracy of filing reports, which can lead to accessibility problems as the accounts of customers deemed to be a compliance nuissance are terminated—especially the ones who tend to make riskier but legal transactions. There's also the crucial question of the public's right not to be be snooped on, especially without a warrant and probable cause.<p></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgyVu0IdHcFeo0K7JdzvcFAS4q4YzWab8WfRsB-Ibf2c-M9b-mL_-n6psY5xcGJxSLckEU2Ixy2XOooT4keHVWOVGNgX79ezF7s4agfNGzvl0MJL3c3Yige2MEfmffV06urt2tqCy3Ol5bZh98lg0Uu4QDPQ_AHUir1KYTmDAfEGcdOhXUPbWByV4cAu0/s961/sar1.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="496" data-original-width="961" height="330" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgyVu0IdHcFeo0K7JdzvcFAS4q4YzWab8WfRsB-Ibf2c-M9b-mL_-n6psY5xcGJxSLckEU2Ixy2XOooT4keHVWOVGNgX79ezF7s4agfNGzvl0MJL3c3Yige2MEfmffV06urt2tqCy3Ol5bZh98lg0Uu4QDPQ_AHUir1KYTmDAfEGcdOhXUPbWByV4cAu0/w640-h330/sar1.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Suspicious Activity Report form, introduced in 1995</span><br /></td></tr></tbody></table><p><br />The first legal challenges to the government's direct access to bank records only came in the mid 1970s. But after hearing these cases (<a href="https://www.cato.org/policy-analysis/revising-bank-secrecy-act-protect-privacy-deter-criminals#california-bankers-association-v-shultz">California Bankers Association v. Shultz</a> and <a href="https://www.cato.org/policy-analysis/revising-bank-secrecy-act-protect-privacy-deter-criminals#united-states-v-miller">United States v. Miller</a>), the Supreme Court allowed the entire data collection apparatus to remain intact. The majority ruled that there was no expectation of privacy in bank records, and that the recordkeeping and reporting requirements imposed by the Bank Secrecy Act do not violate bank customers' constitutional rights.<br /><br />With the public having no constitutional protections against direct government access to bank records, the lone remaining counterbalance is the various anti-money laundering thresholds.<br /><br />Which gets us back to the New York Times article (we'll touch on the cryptocurrency further down). The reasons for the growing debanking problem that the Times article highlights is complicated, but I'd suggest that one driver is a steady deterioration of two key reporting thresholds at the heart of the <i>Pragmatic Compromise</i>. <br /><br />The original $10,000 cash reporting threshold was set back in 1945 by Henry Morgenthau, a level that was ratified in 1972 after the passage of the Bank Secrecy Act. This level has never been adjusted. (Morgenthau also set a second and lower $1,000 threshohold, but this only applied when banknotes in denominations of $50 or higher were involved).<br /><br />Alas, inflation has been steadily eating into each thresholds' real value. When the Bank Secrecy Act was passed, $10,000 was worth $75,000 in today's dollars. In Morgenthau's time it was equal to $173,000. Either way, when the data collection apparatus was first established and the <i>Pragmatic Compromise</i> reached, most people's day-to-day cash withdrawals and deposits would have been sheltered from reported requirements. With the passage of time and inflation, a much wider swathe of civilian cash transactions have lost the protection offered by Morgenthau's $10,000 threshold. That means more snooping. It also means more debanking. Rather than absorbing the growing compliance costs of having "risky" cash-reliant customers, banks are closing accounts. <br /><br />As for suspicious activity reports, when they were first legislated in 1994 the government subjected them to a $5,000 threshold, which is equal to around $10,000 today. With inflation having effectively destroyed half of the value of the threshold, more and more regular transactions are falling under suspicion. As the Times points out, suspicious customers don't make for good customers: "Multiple SARs often — though not always — lead to a customer’s eviction."<br /><br />The <i>Pragmatic Compromise</i> that society came to decades ago is being poorly administered. To restore it, what is needed is a reasonably-sized one-time "catching up" of the various thresholds to account for at least part of the inflation that has occurred over the years, and then periodic adjustments to these levels each year to account for subsequent inflation. Maybe that'll solve some of the problems brought to light by the Times.<br /><br />Now let's turn to the crypto story. In addition to the two classic anti-money laundering reporting requirements, CTRs and SARs, the U.S. government is now proposing a third reporting requirement: one for crypto mixing.<br /><br />Last month, the government <a href="https://www.fincen.gov/sites/default/files/federal_register_notices/2023-10-19/FinCEN_311MixingNPRM_FINAL.pdf">announced</a> that it deems mixing of cryptocurrency to be of <i>primary money laundering concern</i>. Any U.S. financial institution that knows, suspects, or has reason to suspect that a customer's incoming or outgoing crypto transaction involves the use of a mixer will have to flag it and send a report to the government. That report must include information like the customer's name, date of birth, address, and tax ID.</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtkeylLLvE9lrLLCej0ZZU44uV8snutipFU6XPIoaY87ix2vB-l_8DbM6uvjxLTEYD1eu5nEV4yca1tIyPBbB1sPr3A8BDZDjcAHES69J0zwitU9iw2F6LDYiA3Mp1-SOsXwXvihiQbqFWyLGyUqXw7cNpyH6gpAE-r2i7pP4t6aHUkcEK4fSc47R9V7Q/s774/fincenMixing.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="499" data-original-width="774" height="413" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtkeylLLvE9lrLLCej0ZZU44uV8snutipFU6XPIoaY87ix2vB-l_8DbM6uvjxLTEYD1eu5nEV4yca1tIyPBbB1sPr3A8BDZDjcAHES69J0zwitU9iw2F6LDYiA3Mp1-SOsXwXvihiQbqFWyLGyUqXw7cNpyH6gpAE-r2i7pP4t6aHUkcEK4fSc47R9V7Q/w640-h413/fincenMixing.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">The US Treasury's proposed rule for treating crypto mixing as a primary money laundering concern [<a href="https://www.fincen.gov/sites/default/files/federal_register_notices/2023-10-19/FinCEN_311MixingNPRM_FINAL.pdf">link</a>]</span><br /></td></tr></tbody></table><br />Notably, there are no thresholds to this proposed reporting requirement. Any customer crypto transfer with even just a whiff of mixing must be reported by financial institutions to the government.<br /><br />In its proposal (it isn't final, yet) the government grants that there are "legitimate purposes" for mixing. What are they? I think the popular view of crypto is that it is anonymous, but this isn't quite right. Every bitcoin or ether transaction gets recorded on transparent databases. This makes them trackable by anyone. In some respects, crypto may be the least privacy-friendly financial medium ever created. Mixing your coins in a jumble along with other's coins is one of the ways to free oneself from this all-seeing eye, both for criminals who have stolen coins and regular folks who don't want their financial lives displayed for all to see.<br /><br />Given that there can be licit reasons for mixing, and putting this in the context of the decades-old <i>Pragmatic Compromise</i>, precedent would seem to suggest that the government should include a reasonably-sized threshold for reporting crypto mixing. If this was set at, say, $10,000 (and then adjusted yearly for inflation), then a customer could in theory mix $8,000 worth of bitcoins and then deposit them at an exchange, and that exchange would not need to report the transaction and the person who made it. Go above $10,000, and the customer will end up in a government computer.<br /><br />Without a reasonable threshold, the same phenomenon that the Times documents with respect to bank customers will happen to crypto users. A wave of deplatforming will hit as financial institutions close the accounts of any customer that betrays even a hint of risky activity, much of which might only appear to be mixing when it isn't.<br /><br />The government has the capacity for changing its initial stance on thresholds. If you go back to the early 1970s when the Bank Secrecy Act's thresholds were set by executive order, the government <a href="https://www.govinfo.gov/content/pkg/FR-1971-06-10/pdf/FR-1971-06-10.pdf">initially proposed</a> a $5,000 threshold. After the public provided comments and grievances were aired, the <a href="https://tile.loc.gov/storage-services/service/ll/fedreg/fr037/fr037066/fr037066.pdf">final rule</a> compromised and pushed it up to $10,000.<p></p><p></p><p></p><p></p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">Bank Secrecy Act fact of the day. The Act's reporting threshold for currency transactions was originally set at $5,000. After comments were received from the public, the government's final rule upped this to $10,000, which exists to this day. <a href="https://t.co/AAPgxmESmp">pic.twitter.com/AAPgxmESmp</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1724510468067193000?ref_src=twsrc%5Etfw">November 14, 2023</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> Likewise for SARs.<br /><br />The government's <a href="https://www.govinfo.gov/content/pkg/FR-1995-09-07/pdf/95-22223.pdf">original 1995 proposed rulemaking</a> for suspicious activity reporting included no thresholds. So even a $10 or $20 suspicious payment would have been reported to the government. In response to public push-back, the government admitted that its first version of the rule would impose a "burden of reporting," and in <a href="https://www.govinfo.gov/content/pkg/FR-1996-02-05/pdf/FR-1996-02-05.pdf">its final version</a> it introduced a $5,000 threshold for filing a SAR, which the U.S. has to this day. <br /><br />The government also granted in its 1995 SAR decision that the adoption of a threshold was intended to "conform the treatment of money laundering and related transactions to that of other situations in which reporting is required." This seems to me to be a pretty clear admission of the <i>Pragmatic Compromise</i>; that reasonably sized dollar thresholds are a standard element of any anti-money laundering reporting requirement. I don't see any reason why the government's 1995 olive branch for suspicious activity reporting should not be extended to crypto mixing.<br /><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com3tag:blogger.com,1999:blog-6704573462403312459.post-66807651235097634982023-11-08T11:28:00.010-05:002023-11-08T11:42:20.915-05:00How would a cash-only central bank conduct monetary policy?<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5NF-F-92fD5j19-rveKLfM0I6nXZU1pu3S5lkvCMdC4tWWyMUQzQRgzqt762wbT-bfAawHpgBp7cJz6KiIkKw8BzjHpsUCw0oK_NPjierhE1adH0m3oeQ_7xO_ZROs6Tk7h0rKcoRTcqvTfKbA5HJQemNeO4ees9Ec-FlXlx6qiWxCbgf7XmJ1UhsARQ/s881/frnote.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="362" data-original-width="881" height="262" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5NF-F-92fD5j19-rveKLfM0I6nXZU1pu3S5lkvCMdC4tWWyMUQzQRgzqt762wbT-bfAawHpgBp7cJz6KiIkKw8BzjHpsUCw0oK_NPjierhE1adH0m3oeQ_7xO_ZROs6Tk7h0rKcoRTcqvTfKbA5HJQemNeO4ees9Ec-FlXlx6qiWxCbgf7XmJ1UhsARQ/w640-h262/frnote.PNG" width="640" /></a></div><br /><p></p><p>What role do changes in the supply of banknotes play in contributing to a central bank's ability to carry out monetary policy? Put differently, to what degree does "printing," or creating new physical currency and issuing it into the economy, contribute to generating a central bank's desired inflation rate of 2-3%?<br /><br />In <a href="https://www.econlib.org/is-currency-forced-into-circulation/">a recent blog post</a> at Econlog, Scott Sumner suggests that printing physical cash and "forcing" or "injecting" it into the economy has been an important part of central banks hitting their inflation targets, albeit less so now than in times past. I'm not so sure.<br /><br />Having imbibed Scott's blog posts for more than a decade, I think I'm 99% on the same page as he is when it comes to thinking about monetary policy. We both agree that a central bank must either reduce the interest rate that it pays on the <i>monetary base</i>, or inject more monetary base into the economy, in order to push up prices. Using either of these two methods, the central bank sets off a <b><i>hot potato</i> <i>effect</i> </b>in which a long chain of market participants do their best to unload their excess money balances, a process that only comes to an end when all prices have risen to a new and higher equilibrium such that no one feels any additional urge to spend away their extra money. Scott <a href="https://www.themoneyillusion.com/the-hot-potato-effect-explained/">once described</a> the hot potato effect as the the "sine qua non of monetary economics."<br /><br />The <i>monetary base </i>is comprised of two central bank financial instruments: physical banknotes (a.k.a. cash) and digital clearing balances, sometimes known as reserves, a type of money used by banks. <br /><br />Reading through Scott's post, I think the one spot where we may disagree is on the relative role played by the two types of base money in the hot potato process.<br /><br />For my part, I don't think that cash has ever had much of a primary role to play in setting off a hot potato effect. All of the initial <i>uumph </i>necessary for driving prices towards target has typically been provided by reserves, either via a change in the interest rate on reserves or a change in their quantity. Once that initial <i>uumph </i>has been delivered, a whole host of other money types <span><span>–</span></span> physical currency, bank deposits, checks, money market funds, and PayPal balances <span><span>–</span></span> helps convey the forces originally unleashed by reserves to all corners of the economy.<br /><br />An example of the hot potato effect in action may help illustrate.<br /><br />Let's start with a central bank that needs to push inflation up to target. It reduces the interest rates on reserves. The first reaction to lower rates is a flight out of reserves into other assets, say shares. <br /><br />As a result, share prices quickly rise. Those existing shareholders who realized their gains by selling at the new and higher price now find themselves with a hot potato on their hands; they have too many monetary balances in their possession and not enough non-monetary things. <br /><br />Some of these ex-shareholders may choose to spend their excess deposits to go on, say, a vacation. As a result, airline ticket prices rise. Others transfer their extra money to their PayPal account in order to send it to friends and family, who may in turn make purchases, pushing up the prices of whatever they buy. Another group of ex-shareholders decides to buy used cars. They withdraw banknotes, their banks in turn asking the Fed to print new banknotes and ship them over. Used car prices rise. <br /><br />The point is, the initial <i>uumph </i>is delivered by the change in reserves, and this gets conveyed to all prices by a daisy-chain of spenders offloading an array of different types of excess money.<br /><br />In this story, note that cash isn't being actively "injected" into the economy by central banks, nor by commercial banks. Rather, people are choosing to draw cash out as their preferred method for getting rid of unwanted money, in response to a set of forces initiated by reserves. Reserves are the central bank's lever for change; cash is merely responsive. <br /><br />Consider too that in a world where cash no longer exists, and has been replaced by digital payments options, monetary policy is still effective. In this world, the response to a reduction in the interest rate on reserves gets conducted to all the economy's nooks and crannies via non-cash types of monies, like fintech balances and bank deposits. (I'd be curious to hear if Scott is of the same opinion about monetary policy in a world without cash.)<br /><br />Here's an interesting thought experiment. Would it be possible to redesign cash and reserves in such a way that cash takes over the initiatory role in monetary policy from reserves? That is, can we turn cash into the active part of the monetary base, the one that drives changes in monetary policy, and relegate reserves to the passive role? <br /><br />One step we could take is to pay interest on cash. This may sound odd, but it's possible to do so by setting up a serial note lottery to pay, say, 3% per year to holders of cash. (I wrote about this idea <a href="https://www.aier.org/article/to-save-cash-from-extinction-consider-banknote-lotteries/">here</a> and <a href="https://jpkoning.blogspot.com/2018/01/paying-interest-on-cash.html">here</a>.) Simultaneously, reserves would be rendered less important by no longer paying interest on them. <br /><br />Now when a central bank needs to raise consumer prices in order to hit its targets, it reduces the interest rate on cash from 3% to 2%. This ignites the hot potato process as the entire economy suddenly tries to offload its unwanted $20 and $100 bills, which at 2% just aren't as lucrative as before. <br /><br />Another change we could enact would be to modify the mechanism by which central banks inject base money into the economy. As it stands now, central banks inject base money by purchasing assets with new reserves. Since reserves are digital, they are a lot more convenient for making billion dollar asset purchases than physical money. These extra reserves become hot potatoes in the hands of asset sellers, which sets off the process of price adjustments described in previous paragraphs. If central banks were to buy assets with cash rather than reserves, that would put cash in the driver's seat, albeit at the expense of convenience. <br /><br />It's an interesting thought experiment, but in the end I don't think it's very helpful to get bogged down over which type of base money has more monetary significance. As Scott says, the key point is that the central bank controls the price level via its control over base money in general. They can raise prices by either adding to the supply of base money, or by reducing the demand for base money with a cut in the interest rate paid on reserves. "It's basic supply and demand, nothing more." <br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com10tag:blogger.com,1999:blog-6704573462403312459.post-23881150236533813602023-10-18T07:17:00.024-04:002023-10-18T14:35:34.329-04:00Crypto adoption in America<p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuFjFFaVyrgKGFwd88NeFwpdL3u3t98OpgHwu9EZNml35vBW0vUL9VYq0NgM7Lb09XCCJUsycx-0iycf_NPjHz6mumo1GgoH3Gy4MEHuS-8xdtr96ShHkXUuDfV6uvklGahIBDno9Rf2w6IO6-ZT1RmmgI33GeHj6kFk8_sUZNelP2tOlu-G2wZ1aCGsY/s1339/americalovescrypto.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="616" data-original-width="1339" height="294" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuFjFFaVyrgKGFwd88NeFwpdL3u3t98OpgHwu9EZNml35vBW0vUL9VYq0NgM7Lb09XCCJUsycx-0iycf_NPjHz6mumo1GgoH3Gy4MEHuS-8xdtr96ShHkXUuDfV6uvklGahIBDno9Rf2w6IO6-ZT1RmmgI33GeHj6kFk8_sUZNelP2tOlu-G2wZ1aCGsY/w640-h294/americalovescrypto.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://www.americalovescrypto.org/">America Loves Crypto</a></span><br /></td></tr></tbody></table><br /><p></p><p>You may have recently come across the <a href="https://www.americalovescrypto.org/">America Loves Crypto</a> marketing campaign, sponsored by Coinbase, the U.S.'s largest crypto exchange. In an attempt to promote the voting power of crypto owners, the website makes the claim that <b>52 million American adults</b> currently hold crypto, which constitutes 20% of the U.S. adult population. If true, that's a massive voting block.</p><p>As the source for its 20% statistic, Coinbase cites <a href="https://assets.ctfassets.net/c5bd0wqjc7v0/WvuOkBwNXZsqhd6EWtkEL/7f94f8b6fbb222f3faf4d0346e473012/Morning_Consult_Cryptocurrency_Perception_Study_Feb2023_Memo__1_.pdf">an online survey</a> of 2,202 adults that it commissioned from Morning Consult last February, which among other questions queried respondents for how much crypto they currently hold.<br /><br />If you've been following other sources for cryptocurrency adoption data, Coinbase's 20% statistic seems... questionable? <br /><br />To see why, let's dig into U.S. crypto adoption data. What follows is a quick rundown of what the best surveys have had to say about Americans crypto ownership. Later on in the article I'll get into who they are, how much they own, and why they hold it. <br /><br />1) The granddaddy of all U.S. payments surveys is the Federal Reserve's <b>Survey and Diary of Consumer Payment Choice</b>, or SDCPC. The SDCPC is a long-running data collection effort that tries to paint a comprehensive picture of U.S. consumers' payment preferences and behavior. It fortuitously began to incorporate crypto-related questions way back in 2014, although crypto is just a tiny portion of the incredible amount of data collected by the SDCPC. <br /><br />The Fed's SDCPC is run through the University of Southern California's <a href="https://uasdata.usc.edu/index.php">Understanding America Study</a> panel. In its 2022 iteration the SDCPC polled more than 4,761 participants. Notably, the SDCPC includes both a survey and a 3-day diary portion. Diaries are more labor intensive to administer than surveys, but provide better information since they minimize recall bias.<br /><br />The SDCPC found that <u>9.6% of American adults owned cryptocurrency in 2022</u>, up from 9.1% in 2021, and far higher than the 0.6% it polled back in 2015. However, that's far less than Coinbase's 20% claim. Only one of these numbers can be right. Which one is it?</p><p>The SDCPC's historical findings are in the <a href="https://www.atlantafed.org/-/media/documents/banking/consumer-payments/survey-diary-consumer-payment-choice/2022/tables_dcpc2022.pdf">table below</a>.<br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlx18XkiVXXvSY6Tf1X0hhjqWu_QLNEsJffP5DQdebv-K29c_eyFY3Qus36JW6x34c7XIFOWWqml8IvFl5lfOnvfciVBMXGhPAh7d_kGKT2rc_8df9tJYjcnZdJ_CkSI_QGokTxCZePVRgXDWpJAaYO4JFpfg5Tw6qIm7Jw0-FdIwefZrq05XmeoWYzXI/s1135/blogcryptoadoption1.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="552" data-original-width="1135" height="312" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlx18XkiVXXvSY6Tf1X0hhjqWu_QLNEsJffP5DQdebv-K29c_eyFY3Qus36JW6x34c7XIFOWWqml8IvFl5lfOnvfciVBMXGhPAh7d_kGKT2rc_8df9tJYjcnZdJ_CkSI_QGokTxCZePVRgXDWpJAaYO4JFpfg5Tw6qIm7Jw0-FdIwefZrq05XmeoWYzXI/w640-h312/blogcryptoadoption1.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">U.S. cryptocurrency adoptions rates. <a href="https://www.atlantafed.org/-/media/documents/banking/consumer-payments/survey-diary-consumer-payment-choice/2022/tables_dcpc2022.pdf">Source</a>: Federal Reserve's 2022 Survey & Diary of Consumer Payment Choice</span><br /></td></tr></tbody></table><br />2) The Federal Reserve publishes <a href="https://www.federalreserve.gov/publications/files/2022-report-economic-well-being-us-households-202305.pdf">another survey</a> that also sheds light on U.S. crypto adoption. The Fed's annual <b>Survey of Household Economics and Decisionmaking</b> (SHED) examines the financial lives of American adults and their families, and is therefore more general than the Fed's SDCPC, which is focused exclusively on payments.<br /><br />The Fed's SHED is administered by Ipsos using Ipsos's KnowlegePanel panel. In 2022, 11,667 participants completed the SHED.<br /><br /> The SHED only began to include questions about crypto in 2021. It finds that 10% of Americans used cryptocurrency during 2022, where "using" is defined as buying, holding, or making a payment or transfer with crypto. This amount was down from 12% in 2021 (see table below). The number of Americans who held cryptocurrency as an investment, a narrower definition than "using", fell to 8% in 2022 from 10%.<br /><p></p><p><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkh0KPJgAeiT4ZJQzbz-mGjBUHZ9ACVDR_7Vt9puf6_S1zpCxt_ZLZ0h_w8CKny5I7y1k2ADabc1Uc8S7nNuwaxZB_30hdlWNFyKLD9A4B1xIsGvyQ6NZttL7aHqK4harhpZHNgmbppG51PM-xZm1Zu5RkKfDf6ll4_Ub4tNTWUIk7TI008kiR7-N_LSM/s645/blogcryptoadoption2.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="456" data-original-width="645" height="283" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkh0KPJgAeiT4ZJQzbz-mGjBUHZ9ACVDR_7Vt9puf6_S1zpCxt_ZLZ0h_w8CKny5I7y1k2ADabc1Uc8S7nNuwaxZB_30hdlWNFyKLD9A4B1xIsGvyQ6NZttL7aHqK4harhpZHNgmbppG51PM-xZm1Zu5RkKfDf6ll4_Ub4tNTWUIk7TI008kiR7-N_LSM/w400-h283/blogcryptoadoption2.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: Federal Reserve's <a href="https://www.federalreserve.gov/publications/files/2022-report-economic-well-being-us-households-202305.pdf">2022 SHED</a></span></td></tr></tbody></table><br />The SHED's 8-10% number neatly confirms the SDCPC's 9.6% finding while disaffirming Coinbase's 20% statistic. <br /><br />3) The next decent source for crypto adoption data is tabulated by a group of four economics and finance researchers <a href="https://www.nber.org/system/files/working_papers/w31284/w31284.pdf">using quarterly surveys</a> of the Nielsen Homescan panel, comprised of 80,000 households. With response rates of 20-25% per survey, that represents data from 15,000 to 25,000 respondents. <br /><br />Weber, Candia, Coibion, and Gorodnichenko (Weber et al) found that at the end of 2022, the fraction of all households owning crypto had risen to 12%. The black dotted line in the chart below shows how ownership rates have changed over time.<br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiel4q98vjch_shGwB0QWSNJq_kbP3h7EfeyGWPh3cuUTjspZxRSvdW2H6mndTZQumruhsHMvT8IhbvS3soZiu8wF32rVpDMlbPG82Ueb_-4v-Px9z258o4i4jkcIxU6omqLHKdoEDg38eI_gwK-JiZWmHt9oKl0Pu1lgL0K2ZQuHwlJZtIs-p2iFIoS6U/s801/blogcryptoadoption3.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="738" data-original-width="801" height="590" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiel4q98vjch_shGwB0QWSNJq_kbP3h7EfeyGWPh3cuUTjspZxRSvdW2H6mndTZQumruhsHMvT8IhbvS3soZiu8wF32rVpDMlbPG82Ueb_-4v-Px9z258o4i4jkcIxU6omqLHKdoEDg38eI_gwK-JiZWmHt9oKl0Pu1lgL0K2ZQuHwlJZtIs-p2iFIoS6U/w640-h590/blogcryptoadoption3.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://www.nber.org/system/files/working_papers/w31284/w31284.pdf">Weber et al (2023)</a> using Nielsen Homescan Panel data</span><br /></td></tr></tbody></table> <p></p><p>4) The fourth in our survey of crypto surveys was conducted by the Pew Research Center using its American Trends Panel. In a <a href="https://www.pewresearch.org/short-reads/2023/04/10/majority-of-americans-arent-confident-in-the-safety-and-reliability-of-cryptocurrency/">March 2023 survey</a> of 10,701 panelists, Pew found that 17% of American adults have "ever invested in, traded, or used" a cryptocurrency. This is a very broad category, and would presumably include someone who casually bought $25 worth of bitcoin back in 2015 and sold it three days later, and has never touched it again.</p><p>Drilling in further, of the 17% who have ever owned or used crypto, <a href="https://www.pewresearch.org/wp-content/uploads/2023/04/sr_2023.4.10_crypto_topline.pdf">69% report</a> that they <i>currently </i>hold some, which works out to a 2023 ownership rate of 11-12% among American adults. That's not too far off the two Fed surveys and Weber et al, but significantly different from the Coinbase result.<br /><br />5) A fifth source of data comes from Canada, which serves as a decent cross-check against U.S. data given that both countries are quite similar in terms of culture and geography. Of the two key Canadian surveys, the first is the Bank of Canada's long-running <b>Bitcoin Omnibus Survey</b> (BTCOS), administered by Ipsos, which amalgamates participants from three different panels. <br /><br />The 2022 BTCOS polled 1,997 Canadians and found an ownership rate of 10%, down from 13% the year before (see chart below). This constitutes a lower bound to ownership rates since it only includes bitcoin owners. The 2022 BTCOS also finds that 3.5% of Canadians own dogecoin and 4% own ether. However, it's not possible to add these amounts to the 10% bitcoin ownership number since many respondents own multiple types of crypto. </p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjtmfQZXwfAWJUBm-dRnzUfCHguLlBn6iBhk-2v7STjlH_xWY2hh4PvilLZ4Szn7_sQIg09WXrK3irt9eVzpjN0AESyK1o1f6bk3DByP7bLHw4chSyhxxgBfKOG_ys7TBKjHRP3HPEWUGnZ86raGi5D4VSBH_GuvgY6tGoW0vdabIF2izB23mKNbc-naEk/s512/blogcryptoadoption4.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="494" data-original-width="512" height="386" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjtmfQZXwfAWJUBm-dRnzUfCHguLlBn6iBhk-2v7STjlH_xWY2hh4PvilLZ4Szn7_sQIg09WXrK3irt9eVzpjN0AESyK1o1f6bk3DByP7bLHw4chSyhxxgBfKOG_ys7TBKjHRP3HPEWUGnZ86raGi5D4VSBH_GuvgY6tGoW0vdabIF2izB23mKNbc-naEk/w400-h386/blogcryptoadoption4.PNG" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: Bank of Canada 2022 <a href="https://www.bankofcanada.ca/wp-content/uploads/2023/07/sdp2023-14.pdf">Bitcoin Omnibus Survey</a></span><br /></td></tr></tbody></table><p><br />The second Canadian survey of note <a href="https://www.osc.ca/sites/default/files/2022-10/inv_research_20220928_crypto-asset-survey_EN.pdf">was carried out by</a> the Ontario Securities Commission in 2022 to explore Canadian attitudes towards crypto assets. Conducted with Ipsos, the survey polled 2,360 Canadians in early 2022. It found that 13% of Canadians currently own any type of cryptocurrency, including crypto ETFs, which are legal in Canada but illegal in the US.</p><p style="text-align: center;">-----<br /></p><p style="text-align: left;">So there you have it. The two Federal Reserve surveys put crypto ownership at 9.6% and 8-10% respectively in 2022, while Weber et al peg it at 12% using Nielsen Homescan data. Pew has American crypto ownership at 11-12% by early 2023. And in Canada, the Bank of Canada calculates bitcoin ownership to be at 10% by the end of 2022, while the Ontario Securities Commission pegs total crypto ownership at 13% in early 2022, before much of crypto imploded.<br /><br />Given this range of data, the 20% adoption rate that Coinbase's Morning Consult survey trots out is a glaring outlier and probably deserves to be thrown out. The American crypto owner is a potentially sizeable voting group, but not as big as Coinbase would like us to believe. <br /><br />For what it's worth, I've found a few other odd things with Coinbase's Morning Consult survey that further adds to my skepticism. Morning Consult <a href="https://pro.morningconsult.com/trackers/cryptocurrency-adoption-and-perspectives">reports that</a> 8% of respondents currently own a cryptocurrency called USDC, down from 10% the quarter before (see <a href="https://twitter.com/jp_koning/status/1708847384682180691">here</a> for more). The survey also says that 5% currently own Tether. USDC and Tether are stablecoins. To anyone who follows crypto closely, the idea that 1 in 10 Americans own any particular stablecoin is absurd. Given that Morning Consult has surely got this wrong, perhaps through a sampling error, that makes you wonder about the quality of their overall work.<br /><br />However, even if we ignore Coinbase's Morning Consult survey, the 9.6% adoption rate found in the bellwether SDCPC is still breathtakingly high. In just fifteen years, crypto has gone from a strange niche product to something that is being held by tens of millions of Americans.</p><p>What additional facts do we know about America's crypto owners?</p><p></p><p><b>Size of holdings </b><br /><br />Going through the SDCPC data, the majority of Americans who own crypto only have a little bit of the stuff. Out of all U.S. crypto owners surveyed, 45% owned just $0-200 worth of crypto in 2022. This is illustrated in the chart below. The median quantity of crypto held was $312. Given such small amounts, I doubt that these crypto owners qualify as durable crypto adopters, as opposed to folks who've jumped on the bandwagon when they saw a Superbowl ad from Coinbase, bought some dogecoin, and have since stopped paying any attention.</p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPaEE_DdfvGkqcoVNWXgae2Qzv248B0XWol8fevEI8WYSNguOufj1p7RXYDj1XCPhPix_xA9Aeeb-6xCKyoR2goq42XTWx2FXv9Cn3ZxGnVL-fChqJc9WpzQFzHXTwkQ4W0u54pKa6X6lTnDBJDvm7_5GPUVy3lFTJXo3IYsUrWk6i7S4ypEgfWB5CK48/s531/blogcryptoadoption5.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="481" data-original-width="531" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPaEE_DdfvGkqcoVNWXgae2Qzv248B0XWol8fevEI8WYSNguOufj1p7RXYDj1XCPhPix_xA9Aeeb-6xCKyoR2goq42XTWx2FXv9Cn3ZxGnVL-fChqJc9WpzQFzHXTwkQ4W0u54pKa6X6lTnDBJDvm7_5GPUVy3lFTJXo3IYsUrWk6i7S4ypEgfWB5CK48/s16000/blogcryptoadoption5.PNG" /></a></div><br />The SDCPC data suggests that 1 in 4 crypto owners are what I call <i>crypto fundamentalists</i>, holding more than $2,000 worth of crypto. Given that 90% of Americans don't hold any crypto at all, two in every 100 Americans qualifies as a crypto fundamentalist.<br /><br />This skewed distribution of crypto ownership is confirmed by survey results from Weber et al and the Nielsen Homescan panel. An outlier group of hard-core owners, representing around 8% of all crypto owners, allocates their entire portfolio to crypto (see chart below). By far the largest group of crypto owners is comprised of small dabblers who put just 0-5% of their portfolios into crypto.<p></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEnVbs61XSdT07RHNZvS8qXK-w80k9pH_fhW9XUJXkZ2Vvs4w3QloI2Xog_BiHJDJtuJEWarCqyckDnS5l418i_WcTMm4cSAJN4MteJoVsWDiN9Ynn01Rp63O3tsWU-k24pSSKBI-LZ8SrjBhKgm2xy4CJ33OkANxxFhVaZVTqNz3vEUJ7V76SoZQ1udc/s606/blogcryptoadoption6.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="469" data-original-width="606" height="310" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEnVbs61XSdT07RHNZvS8qXK-w80k9pH_fhW9XUJXkZ2Vvs4w3QloI2Xog_BiHJDJtuJEWarCqyckDnS5l418i_WcTMm4cSAJN4MteJoVsWDiN9Ynn01Rp63O3tsWU-k24pSSKBI-LZ8SrjBhKgm2xy4CJ33OkANxxFhVaZVTqNz3vEUJ7V76SoZQ1udc/w400-h310/blogcryptoadoption6.PNG" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://www.nber.org/system/files/working_papers/w31284/w31284.pdf">Weber et al (2023)</a> using Nielsen Homescan Panel data</span></td></tr></tbody></table><br /><p></p><p><b>Reasons for ownership </b><br /><br />Why do Americans own cryptocurrency? Despite being labelled as "currencies," cryptocurrencies are not generally used as a medium for making payments. Price appreciation is the dominant motivation for owning them.<br /><br />When the SDCPC survey queried participants in 2022 for their "primary reason for owning virtual currency," the most popular answer (at 67%) was investment (see chart below, orange rows). The second most popular reason (21%) was "I am interested in new technologies." It was rare for respondents to list any sort of payments-related use case as their primary reason for ownership. As for lack of trust in banks, the government, or the dollar <span><span>–</span></span> all of which are common cryptocurrency themes <span><span>–</span></span> these were rarely mentioned in 2022 as a primary reason for ownership.<br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5MEKrgfMOUcMO6K5yFB6nJLtJVB4Ch1dq1Xs4Z-Dm6mG_0ORbtQnIH0CYNCxU8r9hVA2MqA4pwCyQNBfwQD7xjfw75FxNshZ-4epXCOhnOSg2nvCcrYcqd2z0pbbJXiBlU6INZQaorc0o0vFvTZAWUB0QERbTRB-r7WxDWpWl2QU9vFp6EFQ_K09eIMw/s623/blogcryptoadoption7.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="428" data-original-width="623" height="275" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5MEKrgfMOUcMO6K5yFB6nJLtJVB4Ch1dq1Xs4Z-Dm6mG_0ORbtQnIH0CYNCxU8r9hVA2MqA4pwCyQNBfwQD7xjfw75FxNshZ-4epXCOhnOSg2nvCcrYcqd2z0pbbJXiBlU6INZQaorc0o0vFvTZAWUB0QERbTRB-r7WxDWpWl2QU9vFp6EFQ_K09eIMw/w400-h275/blogcryptoadoption7.PNG" width="400" /></a></div><p><br />Interestingly, Americans crypto owners were not always so obsessed with price appreciation. In 2014, the SDCPC found that American crypto currency owners tended to offer a much broader set of motivations for owning crypto, including lack of trust, cross-border payments, and to make purchases of goods and services (see chart above, blue rows).</p><p>The dominance of investment as the motivating reason for owning crypto is echoed in Weber et al's analysis of Nielsen Homescan survey data. Respondents were allowed to give multiple reasons for owning cryptocurrency, the most popular reason (see chart below) being to take advantage of "expected increase in value." The desire to use cryptocurrencies for international transfers was almost nonexistent, as was the desire to be "independent of banks."<br /></p><p></p><p></p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">Crypto owners don't care about making international transfers, private purchases, or being "independent of banks," as the chart shows.<br /><br />What they want is "increase in value."<br /><br />This is a fairly reliable data source: 80,000 households participating in the Nielsen Homescan Panel. <a href="https://t.co/0oBfATgFoY">pic.twitter.com/0oBfATgFoY</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1671996948323106820?ref_src=twsrc%5Etfw">June 22, 2023</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> <p></p><p>The Fed's SHED survey isolates the same pattern as the other two surveys (see table below). Of the 10% of Americans who report using cryptocurrency in 2022, most do so as an investment. One small difference is that the SHED reports that around 2% of all survey participants used crypto to send money to friends of family in 2022. This suggests the transactional motive, while not primary, may be somewhat more prevalent than the previous two surveys suggest.</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhahQcrtA1m_VxWn6wxHkGlrSWjKtF19EPq-RQnCf0kvNfDoGRaTpbqfNk1lvPH4fTlkwiPE9UsTIdmxWaS4nw9q1dkbAyyISxorZAtqku8crEyWzoyQB19gm2KJXabBjHolw6eJlE3Ti1Wa-bqMEiOZSAS_zJHV8onFVjHjDa6h-Ujd5GPzrRNGxw8mBQ/s434/blogcryptoadoption8.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="334" data-original-width="434" height="308" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhahQcrtA1m_VxWn6wxHkGlrSWjKtF19EPq-RQnCf0kvNfDoGRaTpbqfNk1lvPH4fTlkwiPE9UsTIdmxWaS4nw9q1dkbAyyISxorZAtqku8crEyWzoyQB19gm2KJXabBjHolw6eJlE3Ti1Wa-bqMEiOZSAS_zJHV8onFVjHjDa6h-Ujd5GPzrRNGxw8mBQ/w400-h308/blogcryptoadoption8.PNG" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: Federal Reserve's <a href="https://www.federalreserve.gov/publications/files/2022-report-economic-well-being-us-households-202305.pdf">2022 SHED</a></span></td></tr></tbody></table><br /><p></p><p><b>Types of cryptocurrency held </b><br /><br />What sorts of crypto were popular with Americans? Using Nielsen Homescan data, Weber et al found that of the 11% of survey
respondents who are crypto owners, 70% held bitcoin while just over 40%
held ether and dogecoin respectively.</p><p></p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">Around 11% of American households owned crypto in 2021, according to a Nielsen Homescan survey of 80,000 households.<br /><br />Of this 11%, 4 out of 10 households held Dogecoin.<br /><br />So around 6 million US households owned Dogecoin in 2021, which is just nuts. <a href="https://t.co/31FjTbfqBE">pic.twitter.com/31FjTbfqBE</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1676255985738940416?ref_src=twsrc%5Etfw">July 4, 2023</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> <p></p><p>This distribution is echoed in the Fed's 2022 SDCPC. Almost 65% of all crypto owners surveyed held bitcoin (the data is <a href="https://www.atlantafed.org/-/media/documents/banking/consumer-payments/survey-diary-consumer-payment-choice/2022/dcpc2022_codebook.pdf">here</a>), making it the most popular type of cryptocurrency. Meanwhile, 44.8% held ether and 38% held dogecoin, a coin that was originally created as a joke in 2013. That works out to around 4-5% of all Americans who are in on the joke.<br /><br /><b>Crypto bros</b></p><p>There's a reason that people throw around the term "crypto bro." Without exception, all of the U.S. surveys find that cryptocurrency owners tend to be young, male, and have a high income. </p><p>The same goes for Canada, where in 2022 there were three male bitcoin owners for every female. The Bank of Canada has also regularly tested bitcoin owners for their degree of financial literacy using the <a href="https://gflec.org/wp-content/uploads/2015/04/3-Questions-Article2.pdf">Big Three</a> questions method, and finds that they tend to have lower financial literacy than non-bitcoin owners.</p><p></p><blockquote class="twitter-tweet" data-conversation="none"><p dir="ltr" lang="en">The prototypical Canadian bitcoin owner in 2022 was a young university-educated male, employed at a high-income job, and lacking financial literacy. <a href="https://t.co/N3hQX4AWes">pic.twitter.com/N3hQX4AWes</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1707432713781760256?ref_src=twsrc%5Etfw">September 28, 2023</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> Interestingly, in addition to isolating the <i>crypto bro</i> pattern <span><span>–</span></span> the tendency for crypto owners to be young, male, and wealthy <span><span>–</span></span> both the Pew survey and the Fed's SHED (see table below) find that U.S. crypto owners are more likely to be Asian, followed by Black and Hispanic, and least likely to be White. <br /><br />The Fed's SHED survey dug deeper into usage by demographics, and found that while "investment" remains the driving case for owning crypto, and that the rich use the stuff proportionally more than the poor, certain demographic groups tend to rely on it more than others for making transactions. Specifically, the SHED finds that among low income families, 5% report an investment motivation for holding crypto while 4% report a transactional motivation.<p></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEKh4VHYp-oPtnSbKtsXkZVmcCR3oqtkbLE0-whIp73Rtue-OwI06Y-k_9cHwdgI8FGSUfN6MYK6ir3cZ7-7uR3a75NqlN9X4YQ7qZpBlaAzohAEnAJi_VuEF0msu_A-dHdRknR8nd-9_2t8GFwhBjgByFra8RcBzfsdG00tymAn81GH08lzLNCjzyld0/s624/blogcryptoadoption9.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="495" data-original-width="624" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEKh4VHYp-oPtnSbKtsXkZVmcCR3oqtkbLE0-whIp73Rtue-OwI06Y-k_9cHwdgI8FGSUfN6MYK6ir3cZ7-7uR3a75NqlN9X4YQ7qZpBlaAzohAEnAJi_VuEF0msu_A-dHdRknR8nd-9_2t8GFwhBjgByFra8RcBzfsdG00tymAn81GH08lzLNCjzyld0/s16000/blogcryptoadoption9.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: Federal Reserve's <a href="https://www.federalreserve.gov/publications/files/2022-report-economic-well-being-us-households-202305.pdf">2022 SHED</a></span></td></tr></tbody></table><p><br />All of this data suggests to me the existence of three American crypto archetypes. </p><p>The most dominant crypto archetype is the young wealthy male crypto dabbler, most likely non-white, who holds a few hundred bucks worth of doge or some other coin in order to gamble on prices going up. Coinbase's America Loves Crypto campaign makes the claim that "the crypto owner is a critical voter," but I suspect this doesn't hold for the dominant dabbler archetype, who probably doesn't have much attachment to their casual $50 bet on doge or litecoin or bitcoin, and thus can't be assembled into a voting block for crypto-related cause.</p><p>Another archetype is the much rarer crypto fundamentalist, a young male who has committed most of his savings to crypto. I suspect these are the types I encounter on Twitter, who evangelize and debate crypto to anyone who'll listen. This may be a small group, but they are also the most likely to vote for crypto-related causes.<br /></p><p>Lastly, there seems to be a very small group of low-income people who are using crypto for actual transactions, the original use-case that Satoshi Nakamoto intended when he introduced the first cryptocurrency back in 2008.</p><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com2tag:blogger.com,1999:blog-6704573462403312459.post-84087553060881288212023-10-13T14:00:00.022-04:002023-10-13T16:43:56.939-04:00Inflation as a tax<p>Last week <a href="https://jpkoning.blogspot.com/2023/10/how-to-debase-coinage-in-order-to-pay.html">I explored</a> how Henry VIII resorted to coin debasement as a way to raise revenues in order to fight his wars. This provided Henry with the financial firepower <a href="https://www.cambridgeblog.org/2019/07/henry-viiis-final-war-conquest-colonialism-and-violence/">to annex</a> the city of Boulogne from the French in 1544, albeit at the price of England experiencing one of its greatest inflations ever.<br /><br />Zoom forward five hundred years and Rishi Sunak, the Prime Minister of the UK, has ignited a controversy by referring to inflation as a tax, and further suggesting that the "best tax cut I can deliver for the British people is to halve inflation." His BBC interviewer disputed the claim, saying that inflation isn't a tax, a stance that the BBC upholds on its <a href="https://www.bbc.com/news/uk-politics-66993211">fact checking page</a>.</p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">Rishi Sunak, "The best taxt cut that I can deliver for the British people is to halve inflation."<br /><br />Laura Kuenssberg, "Inflation is not a tax"<br /><br />Rishi Sunak, "Inflation is a tax" <a href="https://t.co/6LgMbeaprY">pic.twitter.com/6LgMbeaprY</a></p>— Farrukh (@implausibleblog) <a href="https://twitter.com/implausibleblog/status/1708430213686628479?ref_src=twsrc%5Etfw">October 1, 2023</a></blockquote><p> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> If you recall, my previous article showed how Henry VIII's debasement functioned very much like a tax, say a new customs <a href="https://en.wikipedia.org/wiki/Tonnage_and_poundage">duty on wine</a> or a <a href="https://www.historic-uk.com/HistoryUK/HistoryofEngland/Henry-VIII-Beard-Tax/">beard tax</a>. It did so by incentivizing people to flock to English mints to have their precious metals turned into coinage, Henry extracting a small fee on each coin. But the 21st century monetary system is very different from that of the middle ages. Is Rishi Sunak right to characterize inflation as a tax?<br /><br />First, we need to better define our terms. <br /><br />What do the BBC interviewer and Sunak mean by inflation? In the western world, prices have been rising at a regular pace of 2-3%
each year for decades as result of central bank policy, which targets a
low and steady inflation rate. Is this the definition they are using? Alternatively, Sunak and his interviewer may be referring to inflation as a *change in the change* in price. Since 2022 or so, that 2-3% rate has leapt to 8-9% all over the western world. Is it this jump that Sunak and his interviewer are talking about?<br /><br />For the sake of this article, we'll assume that the conversation between Sunak and the BBC refers to the latter, a spike in the rate of inflation.<br /><br />Secondly, what is meant by the word <i>tax</i>? Sometimes when we say that something is a tax we mean that it causes suffering. That is, inflation is <i>taxing</i>: it makes people's lives harder by increasing the cost of living, with salaries failing to keep up. It creates unfair changes in winners and losers.<br /><br />Fair enough. But the more precise view I want to broach in this article is that inflation is actually a tax, where we define a tax as a formal charge or levy, set by the political process, that leads to cash flowing from the population to the government.<br /><br />What does the data show?<br /><br />Interestingly, a surprise jump in inflation leads to the <i>very same effects as a new tax</i>. All things staying the same, a new tax leads to an increase
in government revenues. This improves the government's fiscal balance,
or the difference between its revenues and expenses. A <a href="https://www.imf.org/en/Publications/WP/Issues/2023/05/05/The-Effects-of-Inflation-on-Public-Finances-533099">recent IMF paper</a> by Daniel Garcia-Macia using data from 1962 to 2019 shows how an inflation shock typically achieves this exact same end result, boosting government revenues and improving its fiscal balance. This effect lasts for a few quarters, even up to two or three years, then recedes.<br /><br />The IMF's chart below breaks down exactly how an inflation shock tends to improve government finances using quarterly data going back to 1999:</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit2irU4z1F8JR3IS7uCWW84L7PQJE_U_IIv2q2jWyVe-9Phr4EZmNXjD_lQqzciqDJQ6oF0bqdLoRdC0hQeFChI-32_7hP3Gud4BPZ1ZgPM1ELmEpWXaTsFSCHHyPh2_OBY6J7gxxBwPskuHPL7t05RF0bWHmh6Zh_aJkbHPKAhDe-HyD0uTx7nIvMqmM/s604/imf1.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="573" data-original-width="604" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit2irU4z1F8JR3IS7uCWW84L7PQJE_U_IIv2q2jWyVe-9Phr4EZmNXjD_lQqzciqDJQ6oF0bqdLoRdC0hQeFChI-32_7hP3Gud4BPZ1ZgPM1ELmEpWXaTsFSCHHyPh2_OBY6J7gxxBwPskuHPL7t05RF0bWHmh6Zh_aJkbHPKAhDe-HyD0uTx7nIvMqmM/s16000/imf1.PNG" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Charts source: <a href="https://www.imf.org/en/Publications/WP/Issues/2023/05/05/The-Effects-of-Inflation-on-Public-Finances-533099">IMF</a></span><br /></td></tr></tbody></table><p><br />Total tax revenue (the first panel) immediately begins to rise after the inflation shock at about the same rate as inflation.That's because most taxes are set by reference to values or prices, say like the prices of goods and services, or the price of labor, or the value of corporate profits. Since inflation pushes these amounts higher, this gets quickly reflected in tax revenues.<br /><br />Income taxes and profits taxes (the second panel) rise particularly fast. Inflation is presumably pushing tax payers into higher income tax brackets, a process known as "bracket crreep," and so the government very quickly starts to collect a proportionally-larger amount of income tax.<br /><br />Meanwhile, the government's total expenditures, the third panel, typically stay flat or only marginally rises in the quarters after the inflation shock hits. Notably, the amount of wages that are paid to government employees and social benefits (panels 4 & 8) tend to fall.<br /><br />The net effect is an improvement in the government's fiscal balance. More specifically, for a 1% increase in inflation, the government's overall balance tends to improve by about 0.5% of GDP. And so an inflationary shock ends up at the same endpoint as a new tax: higher revenues and a better budget. That doesn't necessarily mean that inflation is itself a tax. Taxes have a degree of intentionality. They get implemented through a political process that has a certain set of goals in mind. By contrast, the extra revenue that an inflation shock raises is often (though not always) accidental, the result of external forces rather than political decision making.<br /><br />So while it may not fall under the dictionary definition of a tax, the tax implications of a modern inflation shock resemble that of a new tax.<br /><br />Everything I've written above applies to an inflation shock, say a rise from a 2-3% to 8-9%. Next I want to show that even constant 2-3% inflation can have the same revenue implication as a tax. Here's how.</p><p><b>Banknotes and seigniorage</b><br /><br />Governments usually have a monopoly over the issuance of two key financial instruments: <i>banknotes</i> and <i>settlement balances</i> (also known as reserves). We all know what banknotes are, but what are settlement balances? Commercial banks find it useful to keep a stock of settlement balances on hand to make crucial large-value payments to other banks. The central bank, which the government controls, is the monopoly provider of these balances. (Sometimes banks are required by law to keep a a fixed number of settlement balances on hand, often above and beyond their day-to-day needs, a policy referred to as required reserves.)<br /><br />Historically, interest rate on both types of central bank-issued money have been set at 0%. At the same time, the rates on short-term credit instruments (Treasury bills, commercial paper, bankers acceptances, etc) are determined by the market, typically hovering at a positive rate ranging between 0.25% to 5% over the last thirty years. These yields are priced to compensate investors for inflation.<br /> <br />The interest rate gap this gives rise to allows central banks to earn a steady stream of revenues, borrowing at an artificially cheap rate of 0% from both the banknote-using public and banks, and reinvesting at, say, 3%. Most of the revenues that the central bank collects from this interest margin flows back to the government. Economists usually refer to these revenue stream as <i>seigniorage</i>. <br /><br />So seigniorage performs the same function as a consumption tax or an income tax: it takes resources from the public and gives it to the state. Likewise, a reduction in seigniorage would be very much like a tax cut.<br /><br />If politicians wanted to, they could do away entirely with this form of raising government revenues. They have two ways of going about this. One way would be to have the central bank reduce price inflation to zero. By doing so, the interest rate on short-term credit instruments like Treasury bills would also fall to 0%, or thereabouts, since these instruments no longer need to compensate investors for inflation. And so the gap between the 0% rate at which central bank fund themselves and the rate at which they reinvest would cease to exist, seigniorage effectively shrinking to zero.<br /><br />Over the last few decades, governments have taken a second route to removing seigniorage: they have begun to pay a market-linked yield on settlement balances. Canada, for instance, adopted this policy in 1999, and the Bank of England did so <a href="https://www.lancaster.ac.uk/staff/whittaj1/MonOps15.pdf">in 2006</a>. By paying a market-based return, central banks no longer extract seigniorage from banks by forcing them to hold 0% assets. </p><p>However, that still leaves banknotes as a significant source of seigniorage. We can calculate how much the UK government roughly earns from banknote seigniorage. With <a href="https://www.bankofengland.co.uk/boeapps/database/fromshowcolumns.asp?Travel=NIxAZxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2010&TD=11&TM=May&TY=2025&FNY=Y&CSVF=TT&html.x=66&html.y=26&SeriesCodes=LPWBF82&UsingCodes=Y&Filter=N&title=LPWBF82&VPD=Y">£95 billion in banknotes</a> outstanding in October, and interest rates at 5.1%, the Bank of England's banknote-related seigniorage comes out to around £5 billion per year, much of which flows back to the government. That sounds like a lot, but it's only a small chunk of the £790 billion in taxes the UK government collected last year.</p><p>Banknote seigniorage isn't set in stone. It's a policy choice. If governments wanted to, they could reduce this form of seigniorage by paying interest on banknotes. One way to go about this would be to introduce a <a href="https://jpkoning.blogspot.com/2018/01/paying-interest-on-cash.html">banknote serial number lottery</a>. This lottery would offer around £5 billion in cash prizes to holders of winning banknote serial numbers, equating to a 5% interest rate on banknotes. Doing so would be akin to enacting a tax cut on British citizens.</p><p>To sum up, the fact that both an inflation shock and steady 2-3% inflation have implications for government revenues suggests that while inflation may not quite qualify as a tax, it is certainly tax-like.<br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com4tag:blogger.com,1999:blog-6704573462403312459.post-90483616337373425662023-10-05T14:36:00.005-04:002023-10-05T14:53:50.309-04:00 Top 13 blog posts<p>I've been writing on this blog for a while now <span><span>–</span></span> over ten years. Many of those posts are now forgotten (by myself included), but some were pretty popular at the time, and a few still get a steady stream of readers. Someone recently asked me for a list of my top ranked posts according to traffic volume, in order to (presumably) get a better taste for my writing.<br /><br />Well, here they are. Enjoy!<br /><br /><b>1.</b> <a href="https://jpkoning.blogspot.com/2019/08/starbucks-monetary-superpower.html">Starbucks, monetary superpower</a> (2019)<br /><br />Starbucks has a gift card program that provides it with fantastic amounts of 0% interest funding. This is by far the most popular thing I've ever written.<br /><br /><b>2.</b> <a href="https://jpkoning.blogspot.com/2019/11/bitcoin-11-years-in.html">Bitcoin, 11-years in</a> (2019)<br /><br />Bitcoin isn't a commodity or a currency, it's a game.<br /><br /><b>3. </b><a href="https://jpkoning.blogspot.com/2017/03/bringing-back-somali-shilling.html">Bringing back the Somali shilling</a> (2017)<br /><br />If the Somali government wants to bring back the official Somali shilling, it'll have to buy back all the counterfeit shillings issued by warlords.<br /><br /><b>4.</b> <a href="https://jpkoning.blogspot.com/2020/05/one-country-two-monetary-systems.html">One country, two monetary systems</a> (2020)<br /><br />How the Yemeni rial split into two different rials when war tore the country apart.<br /><br /><b>5.</b> <a href="https://jpkoning.blogspot.com/2023/09/there-are-now-two-types-of-paypal.html">There are now two types of PayPal dollars, and one is better than the other</a> (2023)<br /><br />A spotlight on PayPal's new stablecoin and how it reveals America's monetary fragmentation.<br /><br /><b>6.</b> <a href="https://jpkoning.blogspot.com/2013/02/ripple-or-bills-of-exchange-20.html">Ripple, or Bills of Exchange 2.0</a> (2013)<br /><br />An analysis of Ripple, back when it was still cool.<br /><br /><b>7. </b><a href="https://jpkoning.blogspot.com/2017/07/the-gold-trick.html">The gold trick</a> (2017)<br /><br />The very strange fiscal effects of changing the US's official gold price from $42.22. If you google around you'll see I've written about this in a few other venues. Always popular with the gold bugs.<br /><br /><b>8.</b> <a href="https://jpkoning.blogspot.com/2014/10/fedcoin.html">Fedcoin</a> (2014)<br /><br />First thoughts on a Fed-issued blockchain-based dollar.</p><p><b>9.</b> <a href="https://jpkoning.blogspot.com/2020/01/what-happens-when-96-bitcoin-ransom.html">What happens when a 96 bitcoin ransom payment ends up on Bitfinex</a> (2020)<br /><br />Shopkeepers get to keep stolen cash. Does the same apply to stolen bitcoins?<br /><br /><b>10.</b> <a href="https://jpkoning.blogspot.com/2019/05/kyle-basss-big-nickel-bet.html">Kyle Bass's big nickel bet</a> (2019)<br /><br />In which I try to calculate the storage costs of hoarding 5-cent coins... 44 million of them!<br /><br /><b>11.</b> <a href="https://jpkoning.blogspot.com/2017/07/dictionary-money.html">Dictionary money</a> (2017)<br /><br />A very wonky monetary system in which the unit-of-account and medium-of-exchange are separated from each other.<br /><br /><b>12. </b><a href="https://jpkoning.blogspot.com/2020/07/bitcoin-is-more-like-ham-radio-than.html">Bitcoin is more like ham radio than the early internet</a> (2020)<br /><br />Searching for a better analogy for bitcoin, landing on ham radio.<br /><br /><b>13</b>. <a href="https://jpkoning.blogspot.com/2017/09/the-siren-call-of-t0-or-real-time.html">The siren call of T+0, or real-time settlement</a> (2017)<br /><br />Instant securities settlement is no panacea, folks.<br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com0tag:blogger.com,1999:blog-6704573462403312459.post-79348086965751346942023-10-03T11:30:00.010-04:002023-10-11T15:52:32.835-04:00How to debase the coinage in order to pay for wars<p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMo95ztD1nIrPdZofpmt6Dugozch63P_n4onHDeL7R0g2xiGPG2EIb1-3KnRsMAZJVF-MlrTPU2nvvWxnx2DWFun2lm66BZ4HK7cmpu2D53UqdbdrKHe7Q2Dbjo2O9vwFeLdpXafIEfxk06d1fohoY3QB7xh6v4bvsEvc6HzeskGcbbOiPgBpzVYsAU-8/s976/henryVIII.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="510" data-original-width="976" height="334" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMo95ztD1nIrPdZofpmt6Dugozch63P_n4onHDeL7R0g2xiGPG2EIb1-3KnRsMAZJVF-MlrTPU2nvvWxnx2DWFun2lm66BZ4HK7cmpu2D53UqdbdrKHe7Q2Dbjo2O9vwFeLdpXafIEfxk06d1fohoY3QB7xh6v4bvsEvc6HzeskGcbbOiPgBpzVYsAU-8/w640-h334/henryVIII.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Henry VIII, after <a class="mw-redirect" href="https://commons.wikimedia.org/wiki/Hans_Holbein_the_Younger" title="Hans Holbein the Younger">Hans Holbein the Younger</a></span></td></tr></tbody></table><br />It's fun to imagine traveling back in time and engaging with the then-prevailing technologies. Would you be able to ride a <a href="https://en.wikipedia.org/wiki/Velocipede#Boneshaker">boneshaker</a> or use a <a href="https://en.wikipedia.org/wiki/Counting_board">counting board</a>? It's probably harder than you think: kids today can't even use a 1980s rotary phone. In this post I'm going to write about one specific techno-institution, the mint, and a particular function that it sometimes played many centuries ago; funding wars.<br /><br />If you had to go back to 16th century Europe, and you were asked to operate the mints in a way such that they raised enough revenues so that your patron, the king, could wage war against a neighbouring country, how would you go about that?<br /><br />I think the general sense that most of us have is that you'd need to somehow "debase" the coinage. The majority of coins back then were made of precious metals. If you could sneakily remove some of the silver and gold from each coin, and replace it with cheaper copper, then you'd be able to amass a hoard for the king (albeit at the expense of the public), and he could use that to hire an army. <br /><br />Now, if you went back in time with the above hazy notion of debasement, you wouldn't have much luck, and might even get your head chopped off. There's a grain of truth to it, but much of it won't work.<br /><br />So before you head off in a time machine, here's what you need to know about the business of minting.<br /><br />The first thing you need to know is that the King (or Queen) owns the royal mints, which they rent out to private parties to operate. Another important fact is that the public brings their own personal supply of precious metal <span><span>–</span></span> raw silver, silver cutlery and dishes, old coins, etc <span><span>–</span></span> to the mint, and then after waiting a week or two for the order to be processed, walks out with the final product; newly-minted coins. <br /><br />But the mint's customers don't leave with as much silver (or gold) as they arrived. For each ounce of precious metals that gets minted into coin, the King collects a fee, known as "seigniorage", usually around 5% in the case of silver. The private individual who runs the mints gets a much smaller cut too, called <i>brassage</i>. <br /><br />If you're scrambling for a modern analogy, I suppose you could think of the medieval business of minting as very much like a modern laundromat, where customers bring their clothes, have them processed, and leave with their clothes, paying a small fee to the laundromat owner, who in turn pays a big chunk of this to the franchisor. <br /><br />Like a laundromat owner, the monarch would have earned a fairly steady stream of revenues from their mints. Coins were more useful and liquid than raw silver, so there was an ever-present demand to convert raw silver into coin for transactional purposes. But remember, the challenge you face isn't just to generate regular profit. The king wants a massive surge in revenue. He's got a war to wage. How are you going to repurpose the mints to provide this gusher?<br /><br />Your first attempt to raise money for the king might be to boost the minting fee from the low single digits to 20-25%. That might work. And you wouldn't be the first to go this route. For centuries, the English seigniorage rate on silver typically hovered around 5%, as illustrated in the chart below from <a href="https://researchdatabase.minneapolisfed.org/downloads/5q47rn915">a paper</a> entitled <i>The Debasement Puzzle</i>, by Rolnick, Velde, and Weber. For gold, the minting fee was typically at 0.5% to 2%. To help fund his war against the Scots and the French, Henry VIII raised the seigniorage on silver to a remarkable 50-60% in the 1540s. Gold fees skyrocketed to 15%. <br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnxm4n69IWB-5GkrI_s0B6m2vlXzQCxPARQ35lRVh6EWtwHXQXeGTivp3YL8lLJjtbKw0enREAjxUlMa8RGWk-H4mxix6GNEf1uDXuUrpoRFhRyCWZx7R_exNKx1RZvX21c5a9OJ9yhQbcyb2YrnMN9E6dOv81BpQXcf3Gz11s1nlcOgop2UwDj-VMwvI/s1241/seigniorage.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="543" data-original-width="1241" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnxm4n69IWB-5GkrI_s0B6m2vlXzQCxPARQ35lRVh6EWtwHXQXeGTivp3YL8lLJjtbKw0enREAjxUlMa8RGWk-H4mxix6GNEf1uDXuUrpoRFhRyCWZx7R_exNKx1RZvX21c5a9OJ9yhQbcyb2YrnMN9E6dOv81BpQXcf3Gz11s1nlcOgop2UwDj-VMwvI/w640-h280/seigniorage.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: Rolnick, Velde and Weber [<a href="https://researchdatabase.minneapolisfed.org/downloads/5q47rn915">pdf</a>]</span><br /></td></tr></tbody></table><br /><br />Mind you, fee hikes alone aren't going to work. Dissuaded by sky-high costs, many people will stop bringing their silver and gold to the mint to be coined, and the King's seigniorage revenues will dry up. A bothersome coin shortage will probably develop, too. Off with your head! says the King.<br /><br />After thinking about it some more, you realize that, like a modern laundromat owner keen to make more revenue, you need to dramatically increase the amount of material going through the mint. How to do so?<br /><br />You've got a few levers to increase throughput. One option is to introduce new products. If you offer new denominations of coins, for instance, people may bring more silver to the mint because those denominations are useful to them. <br /><br />There's certainly precedent for that. To help pay his armies, Henry VIII brought back the testoon, a coin worth 12 pennies (or a shilling) in the hope that there would be significant demand for them, and that this would boost throughput and thus mint revenues. Testoons complemented Henry's silver halfpennies, pennies, groats (4 penny pieces), and sixpence (six pennies), in addition to a range of high denomination gold coins.<br /><br />Below is an example of one of Henry's testoons, first minted in 1542. Because they had so much copper in them (more on that later), many of the testoons that exist today have a greenish tinge (due to copper oxidation). In the 1540s, Henry VIII's silver coins still hadn't turned green, but had a reddish tinge, which tended to reveal itself on his nose. Which is why Henry's nickname was Old Coppernose.<br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyhxyq3baJyrp7nhuP94oueHmnyPEUhV5-dTDLO1f7PdedagSH_axTzzGgni2dufB6aZcB5GwdvqSx4meXm9a-x0EvIU8506kds1XWNnKypsPaNQpdkuqYFFW5sDdRPuTfGAnpNzql5NCkMXGLD2cYHTPGnU6ZOrayyeTPPlyeZ8XA80uRoRMM2tNq-J0/s2401/746373001(1).JPG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="1238" data-original-width="2401" height="206" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyhxyq3baJyrp7nhuP94oueHmnyPEUhV5-dTDLO1f7PdedagSH_axTzzGgni2dufB6aZcB5GwdvqSx4meXm9a-x0EvIU8506kds1XWNnKypsPaNQpdkuqYFFW5sDdRPuTfGAnpNzql5NCkMXGLD2cYHTPGnU6ZOrayyeTPPlyeZ8XA80uRoRMM2tNq-J0/w400-h206/746373001(1).JPG" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">English groat (4 pence) issued 1547-49. Source: <a href="https://www.britishmuseum.org/collection/object/C_1908-0111-22">The British Museum</a></span><br /></td></tr></tbody></table><br />But introducing new denominations probably isn't going to generate a huge rush to the mints, since a new denomination will to some extent cannibalize existing demand for other denominations. Anyone who orders more testoons is likely to order fewer groats, for example. You'll have to do more.<br /><br />In addition to introducing new coins, another strategy you might try is to cancel old ones. By having the King demonetize a popular coin, or declare it to be "no longer current," those coins will cease being legal tender or acceptable for taxes. The public will be forced to bring their demonetized coins to the mint to be converted into legal coins, the rush to do so creating a revenue windfall for the King.<br /><br />And indeed, Henry VIII's successor Edward VI (who continued his father's wars) did this exact same move in 1548, declaring the testoons his father had reintroduced just four years before to be no longer current, as recounted <a href="https://www.jstor.org/stable/2593065">in a paper</a> by C.E. Challis (1967). I've clipped the relevant part below:<br /><p></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEij-T-E2Ok4EDQimGxtNZLY9QGrwdhyphenhyphenUkPdkT-pnvQC16zSDlMbD3O1XzfjvlnNf3mcxUs_44ALbwYwxOLjiBf-RgX1-k9ILIKlJo5VIuBaEPdtQLCvLPsx7L8tyry_JuamM4g6VlznlDkHaN5GGvttZqVssSP82dmM2D_vpaDN3lgnNIt6rBUBoya3KRU/s758/challis.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="343" data-original-width="758" height="290" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEij-T-E2Ok4EDQimGxtNZLY9QGrwdhyphenhyphenUkPdkT-pnvQC16zSDlMbD3O1XzfjvlnNf3mcxUs_44ALbwYwxOLjiBf-RgX1-k9ILIKlJo5VIuBaEPdtQLCvLPsx7L8tyry_JuamM4g6VlznlDkHaN5GGvttZqVssSP82dmM2D_vpaDN3lgnNIt6rBUBoya3KRU/w640-h290/challis.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">The demonetization of testoons is announced. Source: <a href="https://www.jstor.org/stable/2593065?seq=7">C.E. Challis</a></span><br /></td></tr></tbody></table><br />But we still haven't broached the main method: debasement. This is where the gusher begins.<br /><br />Together with the King, you announce to the public that anyone who brings precious metals to the mint will now get more coins than before, for the same weight of precious metal. So for example, if someone used to be able to bring, say, 10 grams of pure silver to the mint and got 100 pennies minted, now they can bring 10 grams and get, say, 200 pennies. Same amount of silver, more coins.<br /><br />As the operator of the mint, you could enact this change by cutting the weight of each penny by half, or, if you wanted to be more clever, maintain the same weight but reduce its fineness by 50%, by introducing more cheap copper to the mix. Either way, you've just debased the currency.<br /><br />But how exactly does this raise revenues for the King? <br /><br />Let's think about this change from a merchant's perspective. Say that our merchant owes a supplier 1 pound (a pound is 240 pennies). He's about to pay his debt off with everything he has, 240 pennies, when the debasement is announced. He can now bring his 240 pennies to the mint and have them recoined into 480 pennies. That allows him to pay off his debt, which is still denominated at 1 pound, and still have 240 pennies for himself. What a great opportunity! The merchant heads off to the mint with his silver.<br /><br />Or imagine our merchant need to buy some property that's priced at 10 pounds, or 2,400 pennies. If he has only 1,200 pennies on hand, he can't afford it. But with the debasement having just been announced, the merchant can now convert those 1,200 pennies into 2,400 pennies and make the purchase.<br /><br />Congratulations, you've created a revenue gusher! What you've effectively done is offer a short-term arbitrage opportunity to those who are paying attention, most likely the rich and well-connected, at the expense of the not-so-aware. To take advantage of a profitable situation, these enterprising individuals will immediately bring all their silver and gold to the mint. And you'll collect a toll on all that metal as it passes through.<br /><br />But that arbitrage opportunity won't last forever. Debts will be recalibrated to account for the 50% decline in the penny's silver content. Prices of things like property will eventually double to reflect the new true value of the penny. At that point it will no longer be advantageous to bring one's silver to the mint to be recoined, and the revenue gusher you've created will subside. <br /><br />You might try announcing debasements every few years or so, thus milking your mint's throughput on a continual basis. Too many debasements, though, and this trick will stop working, since that portion of the population that is the victim of the arbitrage you've created <span><span>–</span></span> the less aware <span><span>–</span></span> eventually wises up and protects itself by quickly increasing prices whenever a debasement occurs.<br /><br /><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJ_ZvPrL-vGb475FaGWxcMo1F79LK5hTX-KhMGNrBm5Uc9P81iABnrJhecDNg-WXaNWYCvADPcuJb0jml-6-4GsE_H3dEoKuYFnk4LV7is1EQ4HAH-T3eo8sWcgJJk2xRM6EaQU9gQZNzVzJhI1iPBIG_Kh-kg_1BQuR_wveqnntfkM8lhlJcGyTbnvaA/s579/silvercontent.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="389" data-original-width="579" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJ_ZvPrL-vGb475FaGWxcMo1F79LK5hTX-KhMGNrBm5Uc9P81iABnrJhecDNg-WXaNWYCvADPcuJb0jml-6-4GsE_H3dEoKuYFnk4LV7is1EQ4HAH-T3eo8sWcgJJk2xRM6EaQU9gQZNzVzJhI1iPBIG_Kh-kg_1BQuR_wveqnntfkM8lhlJcGyTbnvaA/s16000/silvercontent.PNG" /></a></div><p><br />A constant series of debasements is exactly what Henry VIII and his son
Edward enacted between 1542 and 1551 to keep paying their soldiers.
Using data from<a href="https://www.economics.utoronto.ca/public/workingPapers/tecipa-417.pdf"> a paper by</a> John Munro, <i>The Coinages and Monetary Policies of Henry VIII</i>,
I've charted out (above) how the penny's silver content changed over that time
period. Going into the 1500s, an English penny contained 0.72 grams of
pure silver. At the end of the <i>Great Debasement</i>, (the term used for
Henry VIII's operations on the coinage) the penny contained just 0.11
grams of silver, constituting an 85% reduction in silver content.</p><p>We can further split out how Henry VIII's debasements were distributed between changes in <i>fineness </i>and changes in <i>weight</i>. Going into 1542, the English penny was 92.5% fine. Nine years later its purity stood at just 25% silver, the other 75% being base metal such as copper. As for weight, a penny weighed 0.79 grams in the early 1500s, but only 0.43 grams by 1551. </p><p>These changes are illustrated in the chart below. <br /></p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhBWAIcZVtX9Rc29R7y4Tzigo8tykDTWU8PdSNF-g6Qf2HjIEok0OLvGjJbMzwGiy-a7imGX36ZDHPRaY-MHtCd-3hSav8mZHfOQ-_C35ZdWNBEDHoDtL1lZK8mY_Llq9drXkPzJPtyNCZR23qqKg24YpjadM_zIRYdyt4KrT5MI1JSOQuj_N7IKW-Q5os/s681/silvercontent2.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="343" data-original-width="681" height="322" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhBWAIcZVtX9Rc29R7y4Tzigo8tykDTWU8PdSNF-g6Qf2HjIEok0OLvGjJbMzwGiy-a7imGX36ZDHPRaY-MHtCd-3hSav8mZHfOQ-_C35ZdWNBEDHoDtL1lZK8mY_Llq9drXkPzJPtyNCZR23qqKg24YpjadM_zIRYdyt4KrT5MI1JSOQuj_N7IKW-Q5os/w640-h322/silvercontent2.PNG" width="640" /></a></div><p><br />Thus it was diminutions in purity, not weight, that drove the biggest chunk of the penny's debasement, although weight did have a role to play.</p><p>How successful were these policies in creating a financial gusher for Henry and his son?</p><p></p><p>The charts below from Rolnick, Velde, and Weber (which I've clipped from <a href="https://www.minneapolisfed.org/research/quarterly-review/the-debasement-puzzle-an-essay-on-medieval-monetary-history"> a second paper</a> authored by the trio) show how the combination of mintage policies enacted in the 1540s <span><span>–</span></span> debasement, new testoons, and a demonetization of the testoon <span><span>–</span></span> led to a large influx of silver and gold to the English mints.<br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDcb1PYXbGStW6bt1joQn-RZDSmZEMDppm0XDM-CUpud5ZODDsnex2sfnSDk1WMLqhNQfgAlGZKUdmItviGM2Ne2yiOHmH6QvZUOTayxAGioYRRCQ98M0xzfNBvFNE90Fm4xJ_icnoB6c4omgyfWHumt9ByLYMuPIUtrV6JPga-hpNbVfNJ0LB0QQH55U/s898/rolnicketal.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="494" data-original-width="898" height="352" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDcb1PYXbGStW6bt1joQn-RZDSmZEMDppm0XDM-CUpud5ZODDsnex2sfnSDk1WMLqhNQfgAlGZKUdmItviGM2Ne2yiOHmH6QvZUOTayxAGioYRRCQ98M0xzfNBvFNE90Fm4xJ_icnoB6c4omgyfWHumt9ByLYMuPIUtrV6JPga-hpNbVfNJ0LB0QQH55U/w640-h352/rolnicketal.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://www.minneapolisfed.org/research/quarterly-review/the-debasement-puzzle-an-essay-on-medieval-monetary-history">Rolnick et al</a></span><br /></td></tr></tbody></table><p><br />According <a href="https://www.jstor.org/stable/2593065?seq=7">to Challis</a>, the combination of these inducements, along with a big boost in fees, resulted in minting profits of £1.3 million for the two kings from 1542 to 1551. This would have paid for a big chunk of the £3.5 million in military expenditures over that same period, much more than actual taxation, which only yielded £976,000.</p><p>Of course, the final result of all this was a significant number of deaths, and what <a href="https://www.cambridgeblog.org/2019/07/henry-viiis-final-war-conquest-colonialism-and-violence/">one account</a> describes as "an episode of sixteenth-century ethnic cleansing which in its aims and
implementation was not dissimilar from ...the former Yugoslavia in the 1990s or, most recently, with the Myanmar government’s actions against the Rohingya." It also caused one of the worst episodes of price inflation that England had ever seen. According to Munro, the English consumer price level rose by 123% between 1541 and 1555.<br /><br />So there you have it. If you had a time machine, you now know how to go back to medieval Europe and operate the royal mints in order to fund big ticket items like wars. (Whether you should actually do so is another question.)</p><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com5tag:blogger.com,1999:blog-6704573462403312459.post-73760215340456565262023-09-26T13:05:00.010-04:002023-09-26T13:20:42.476-04:00Thoughts on Privacy Pools and the law<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjstFmfa5qg2LLg3ofuoi6XnP9gcnYgi9DzIz-MAT8Kd8Rzg7KSYbIMI2FtQEVvf6JTuOdau4LVTUKW-wFDzGSTqarlGGvXm4sx7EYwwXRJLR7wPlMSx61QfBqsl6KYJOvcX_sDKCJ5OPqLIYlcOd05E8YCETPeDT1iC6UzZPLvK7UzQNSfBEqkxuDLIDk/s3584/privacypools.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="2240" data-original-width="3584" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjstFmfa5qg2LLg3ofuoi6XnP9gcnYgi9DzIz-MAT8Kd8Rzg7KSYbIMI2FtQEVvf6JTuOdau4LVTUKW-wFDzGSTqarlGGvXm4sx7EYwwXRJLR7wPlMSx61QfBqsl6KYJOvcX_sDKCJ5OPqLIYlcOd05E8YCETPeDT1iC6UzZPLvK7UzQNSfBEqkxuDLIDk/w640-h400/privacypools.jpg" width="640" /></a></div><br /><p></p><p>Here's my quick first-pass take on <a href="https://www.privacypools.com/">Privacy Pools</a>, the heir apparent to privacy tool Tornado Cash. My comments are on the legal side, and less so the technical side, although the two aren't mutually exclusive. </p><p>I've already <a href="https://jpkoning.blogspot.com/search?q=tornado+cash">written a bunch of times</a> about Tornado Cash on this blog. Financial privacy <span>is</span> an important topic. </p><p>The quick story is that after attracting a few billion in criminal funds, the Tornado Cash "stack" was <a href="https://home.treasury.gov/news/press-releases/jy0916">sanctioned by</a> the <b>Office of Foreign Assets Control</b> (or OFAC, the U.S.'s sanctioning authority). Privacy Pools is the Ethereum community's attempt to offer up an olive branch to OFAC. <i>"We know you didn't like the last attempt, but we're going to make some changes. What do you think?"</i><br /><br />I'm fascinated with the Privacy Pools idea, which will allow users to pick and choose who they associate with, thus excluding potentially bad actors. With fewer bad actors, OFAC may be less hasty to sanction the tool. </p><p>While in theory that sounds great, here's my worry. Privacy Pools still relies on an old Tornado Cash feature: <i>relayers</i>. (For this observation, I'm indebted to Jon Reiter, who wrote <a href="https://www.blockhead.co/2023/09/13/privacy-pools-enable-new-attacks-tornado-cash/">a useful article</a> on Privacy Pools for Blockhead.) It also relies on a new type of third-party: <i>association set providers</i> or ASPs.<br /><br />Relayers and association set providers are a problem, as I'll show below. And the reason has nothing to do with OFAC or sanctions law, but a set of Federal statutes against <i>racketeering </i>found <a href="https://www.law.cornell.edu/uscode/text/18/part-I/chapter-95">in Chapter 95</a> of the U.S. criminal code.</p><p>Let's assume that Privacy Pools gets deployed and begins to successfully screen out bad actors. That'll make it an even more tempting target for dirty money seeking redemption, bad actors devoting ever more resources to sneak into the mix. Inevitably, some of them will get through and when they do, the authorities will have to find an actor in the Privacy Pools stack to blame. I suspect they'll target relayers and ASPs. <br /><br />Let's start with relayers. It's likely that the authorities can show that relayers are engaged in an activity defined under <a href="https://www.law.cornell.edu/uscode/text/18/1960">a key section</a> of U.S. racketeering law, <a href="https://www.law.cornell.edu/uscode/text/18/1960" title="Prohibition of unlicensed money transmitting businesses">§ 1960</a>, as "money transmission." To avoid breaking this law, relayers will need to register with the <b>Financial Crimes Enforcement Network</b>, or FinCEN, the U.S. government's money laundering watchdog. Registration will obligate relayers to set up an iron-clad <i>customer identification program</i>, which involves collecting and verifying user ID cards, as well as filing Suspicious Activity Reports (SARs) with FinCEN, thus undoing much of Privacy Pools' stated benefits.<br /><br />Let's back up a sec. Who are relayers? <br /><br />Doing stuff on the Ethereum blockchain requires paying a small processing fee, and these fees are visible to everyone. When a privacy seeker withdraws from Privacy Pools or Tornado Cash, this fee payment effectively reveals who the user is. To solve this problem, both systems rely on a group of third-party individuals or entities <span>– </span>relayers <span>– </span>to pay this fee on behalf of users, thus restoring privacy, an effort they are remunerated for. But this sounds to me like "transferring funds on behalf of the public," which is Chapter 95's <a href="https://www.law.cornell.edu/definitions/uscode.php?width=840&height=800&iframe=true&def_id=18-USC-1749142274-176177779&term_occur=999&term_src=">definition of money transmission</a>, which leads me to suspect that relayers can be drawn into said law's licensing and registration requirements.*<br /></p><p>Now, <a href="https://www.youtube.com/watch?v=TdeSh3vLvYI ">I'm just a maritime lawyer</a>, so if I suspect that relayers are money transmitters, who really cares, right? But it's not just me who is making this claim. In <a href="https://www.justice.gov/media/1311391/dl?inline">its recent indictment</a> of individuals involved in the Tornado Cash stack, the Department of Justice named relayers as engaging in money transmission.</p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">I can sympathize with the argument that the DoJ is overreaching by charging Tornado Cash frontend owners & token holders with money laundering (and failure to register as a money transmitter), but I think the DoJ nailed it 100% when it accused relayers of those same crimes. <a href="https://t.co/uzJI9AC7g9">pic.twitter.com/uzJI9AC7g9</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1696604700525674832?ref_src=twsrc%5Etfw">August 29, 2023</a></blockquote><p>Let's move on to ASPs. With Privacy Pools, users can build unique <i>association sets</i> that allow them to dissociate from potential bad actors. In <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4563364">a recent paper</a>, the Privacy Pools designers suggest that in practice, professional intermediaries <span>– association set providers</span> <span>–</span> will emerge to set up and curate these sets. Users will in turn subscribe to whatever ASP-provided sets meet their needs.</p><p>It's inevitable that ASPs will make mistakes and let bad actors into their sets, resulting in illicit money being laundered through Privacy Pools. In response, the authorities may try to follow the same script they used for relayers and accuse a faulty ASP of being an unlicensed money transmitter. But that may not stick; unlike a relayer, an ASP doesn't actually transfer any money. The Department of Justice has more up its sleeve than that, though. They can charge faulty ASPs with breaking other laws in Chapter 95, specifically the money laundering statutes <a href="https://www.law.cornell.edu/uscode/text/18/1956">§1956</a> and <a href="https://www.law.cornell.edu/uscode/text/18/1957">1957</a>.</p><p>To avoid a potential money laundering indictment, the intermediaries that curate association sets will have to make a <i>good faith</i> effort to exclude bad actors. Simple blacklists derived from chain tracing tools provided by companies like <a href="https://www.chainalysis.com/">Chainalysis</a> probably won't cut it. ASPs will have to undertake the same level of customer due diligence as banks and other financial institution. That means painstakingly collecting ID, doing background checks, and more. As before, that may unravel some of the purported anonymity of the Privacy Pools system.<br /></p><p>The fact that relayers and ASPs may face FinCEN registration requirements and/or other anti-money laundering obligations isn't necessarily a death knell for projects like Privacy Pools, but it may pose some challenges. <br /><br />1) Relayers and ASPs may try to sidestep U.S. law by operating outside the U.S. and, if possible, set up their operations to exclude Americans. That means cutting off a big chunk of the world from using the tool. With fewer users, the ability of Privacy Pools to obfuscate the tracks of all its non-U.S. users will be limited.<br /><br />2) Some relayers and ASPs may choose to accept American customers in a compliant way. They'll verify their users, submit reports to FinCEN, and more. But at that point an American will probably be <i>roughly </i>indifferent between getting privacy from Privacy Pools <i>or </i>Coinbase, a centralized exchange that already complies with the requirements. Any U.S. user who becomes a customer of Coinbase can deposit ether and withdraw it to a new address, thus removing the outside world's ability to track the transaction, albeit at the expense of disclosing their personal information to Coinbase. Privacy Pools would afford this same level of privacy. It would offer U.S. users privacy from the broader community, but not from the employees of a relayer or ASP.**</p><p>If Privacy Pools is only providing Coinbase-levels of privacy to Americans, what's the point?<br /><br />3) Lastly, perhaps the developers can figure out now <span>–</span> before Privacy Pools is even deployed <span>–</span> how to do away with relayers while still preserving privacy, thus entirely bypassing Federal racketeering law's definition of money transmission. Or maybe they can figure out how to design the relaying system such that it falls out of the definition. </p><p>Whether that's even possible is a technical issue that goes waaay beyond my abilities.</p><p></p><hr /> <p></p><p><span style="font-size: x-small;">* Why can't other elements of the Privacy Pools stack, including the core smart
contracts and the people who develop them, be pulled into being defined as money transmitters? My assumption in this post is that if the smart contracts are: 1) non-upgradeable, that is, they are set in stone from the moment they are published, 2) the developer no longer has any association with the "stack" after publishing the contracts; 3) the system is not governed by a DAO; 4) there is no stream of profits thrown off by the system; and 4) there is no token (as was the case with Tornado Cash's TORN), then it is probably less likely that the smart contracts and/or their designers would fall under the definition of a money transmitter. But <a href="https://twitter.com/jp_koning/status/1694715640186335577">I could be wrong</a>.<br /></span></p><p><span style="font-size: x-small;">**</span><span style="font-size: x-small;"> Mind you, Coinbase and a fully-compliant Privacy Pools wouldn't be
perfect substitutes. Whereas Coinbase takes ownership of one's ether,
thus subjecting privacy seekers to the risk of Coinbase going bankrupt,
Privacy Pools is just a smart contract, and not subject to that same
risk. For a sub-group of privacy seekers who worry about Coinbase going
bust, FinCEN-compliant relayers and ASPs may be strictly superior to Coinbase. <span> </span></span> </p><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com0tag:blogger.com,1999:blog-6704573462403312459.post-53593275103869016832023-09-22T12:12:00.012-04:002023-09-23T10:25:24.112-04:00Coinbase: "What if we call them rewards instead of interest payments?"<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaqRDvNC45a7gYfDAVyp9ZslRb_X8FAkc7lF1kYkQ-ccNObcDZlMeSnUqhAsJCsC-ylRLsnHBNvE0YB8w9iBxey-u7jpqJpgNWX9bmCkup4MZSc07kajyG9hIwpgYBsaywEK-Ia0LOYVLWhGfET7pMPp0OtJcyc3VGZYKP5c_tv-kguCL-1I1AdO1sznI/s596/rewards.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="503" data-original-width="596" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaqRDvNC45a7gYfDAVyp9ZslRb_X8FAkc7lF1kYkQ-ccNObcDZlMeSnUqhAsJCsC-ylRLsnHBNvE0YB8w9iBxey-u7jpqJpgNWX9bmCkup4MZSc07kajyG9hIwpgYBsaywEK-Ia0LOYVLWhGfET7pMPp0OtJcyc3VGZYKP5c_tv-kguCL-1I1AdO1sznI/s16000/rewards.PNG" /></a></div><br />Here's a question for you: which U.S. financial institutions are legally permitted to pay interest to retail customers? <p></p><p>We can get an answer by canvassing the range of entities currently offering interest-paying dollar accounts to U.S. retail customers. It pretty much boils down to two sorts of institutions:</p><ul style="text-align: left;"><li>Banks </li><li>SEC-regulated providers like money market funds.</li></ul><p>There seem to be a few exceptions. Fintechs like PayPal and Wise are neither of the above, and yet they offer interest-yielding accounts to retail customers. But if you dig under the hood, they do so through a partnership with a bank, in <a href="https://jpkoning.blogspot.com/2023/05/if-wise-can-pay-interest-why-cant-usdc.html">Wise's case</a> JP Morgan and in <a href="http://jpkoning.blogspot.com/2023/09/there-are-now-two-types-of-paypal.html">PayPal's case</a> Synchrony Bank. (Back in the 2000s, PayPal <a href="https://www.sec.gov/Archives/edgar/data/1088143/000095015607000293/paypal-485bpos_tagged.htm">used a money market mutual fund</a> to pay interest). So we're back to banks and SEC-regulated entities.<br /><br />And then you have Coinbase. <br /><br />Coinbase will pay 5% APY to anyone who holds USD Coins (USDC), a dollar stablecoin, on its platform. (Coinbase co-created USDC with Circle, and shares in the revenues generated by the assets backing USD Coin.) The rate that Coinbase pays to its customers who hold USDC-denominated balances has steadily tracked the general rise in broader interest rates over the last year or so, rising from <a href="https://twitter.com/jp_koning/status/1587550768059621376">0.15% to 1.5%</a> in October 2022, then <a href="https://twitter.com/coinbase/status/1669480042924228609">to 4%</a> this June, <a href="https://twitter.com/coinbase/status/1686848400875200512">4.6% in August</a>, and <a href="https://twitter.com/coinbase/status/1701990476755144712">now 5%</a>.<br /><br />Coinbase isn't a bank, nor is it an SEC-approved money market mutual fund. And unlike Wise and PayPal, Coinbase's interest payments aren't powered under the hood by a bank. <br /><br />So how does Coinbase pull this off?<br /><br />In short, Coinbase seems to have seized on a third-path to paying interest. It cleverly describes the ability to receive interest as a <a href="https://help.coinbase.com/en-au/coinbase/coinbase-staking/rewards/usd-coin-rewards-faq">"loyalty program"</a>, which puts it in the same bucket as Starbucks Rewards or Delta's air miles program. The program itself is dubbed <b>USDC Rewards</b>, and in its FAQ, customers <a href="https://help.coinbase.com/en-au/coinbase/coinbase-staking/rewards/usd-coin-rewards-faq">are consistently described</a> as "earning rewards" rather than "earning interest." <br /><br />This strategy of describing what otherwise appears to be interest as rewards extends to Coinbase's financial accounting. The operating expenses that Coinbase incurs making payments on USDC balances held on its platform is categorized under <i>sales and marketing</i>, not <i>interest expense</i>. </p><p>Oddly, this key datapoint isn't disclosed in Coinbase's financial statements. Instead, we get this information from a conference call with analysts last year, in which the company's CFO described its reasoning for treating USDC payouts as rewards:</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjohLl7nFolNGuiHGGgzJwGzsHzyb3qechH0IjJrkjuTxLdXlZpc90njzOQ5jU1susMMHorpS4hKd87WTX6HJH5chnXJhmvXhPLqFKOonZZwkptLpkhELA4bVzZlTMC53DPOxSJXiBRaXU7qGAffwORnequoeT4H_0tuaXOwoqwKROjofpoFuMYo0EdZEM/s863/coinbasecc.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="524" data-original-width="863" height="388" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjohLl7nFolNGuiHGGgzJwGzsHzyb3qechH0IjJrkjuTxLdXlZpc90njzOQ5jU1susMMHorpS4hKd87WTX6HJH5chnXJhmvXhPLqFKOonZZwkptLpkhELA4bVzZlTMC53DPOxSJXiBRaXU7qGAffwORnequoeT4H_0tuaXOwoqwKROjofpoFuMYo0EdZEM/w640-h388/coinbasecc.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: <span style="font-size: x-small;"><a href="https://s27.q4cdn.com/397450999/files/doc_financials/2022/q4/Coinbase-Q4%2722-Analyst-Call-Transcript.pdf">Coinbase Q4 2022 conference call</a></span><br /></td></tr></tbody></table> <p></p><p>The flow of "rewards" that Coinbase is currently paying out is quite substantial. Combing through its recent financials, Coinbase discloses in its <a href="https://s27.q4cdn.com/397450999/files/doc_financials/2023/q2/Shareholder-Letter-Q2-2023.pdf">shareholder letter</a> that it had $1.8 billion of USDC on its platform at the end of Q2. Of that, $300 million is Coinbase's corporate holdings, as disclosed on its <a href="https://s27.q4cdn.com/397450999/files/doc_financials/2023/q2/9dcd01f7-3e99-4ad7-8d9c-fb39e00db165.pdf">balance sheet</a>. So that means customers have $1.5 billion worth of USDC-denominated balances on Coinbase's platform.<br /><br />At a rewards rate of 5%, that works out to $75 million in annual marketing expenses. (Mind you, not everyone gets 5%. We know that MakerDAO, a decentralized bank, <a href="https://twitter.com/jp_koning/status/1704613562616828107">is only earning 3.5%</a> on the $500 million worth of USDC it stashes at Coinbase). In any case, the point here is that the amounts being rewarded are not immaterial.<br /><br />Interestingly, Coinbase does <i>not </i>pay rewards on regular dollar balances held on its platform. It only provides a reward on USDC-denominated balances. This gives rise to a yield differential that seems to have inspired a degree of migration among Coinbase's customer base from regular dollar balances to USDC balances. </p><p>For instance, at the end of Q1 2023, Coinbase held $5.4 billion in U.S. dollar balances, or what it calls customer custodial accounts or fiat balances. (See below). By Q2 2023 this had shrunk to <a href="https://s27.q4cdn.com/397450999/files/doc_financials/2023/q2/9dcd01f7-3e99-4ad7-8d9c-fb39e00db165.pdf">$3.8 billion</a>. Meanwhile, USDC-on-platform rose from $0.9 billion (see below) to $1.5 billion.</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvYLjM1uDUyN6NwJNl4CX-sr2WsW6JzF6G0X2y3M6EBuFfAvh2IR_RvewtScHVSnXFVN_mbD4lHfKdma21MLps7NJ62CwKgA-a2stDDpbwerbiH5AafQ6yGvWUUyIvlA62gxbiE8QfXY4GMVIFzMjY4Tpl5U3auaK9ZeANeBAvNumdMT4eBRlwfT1ygBM/s943/coinbaseq1.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="336" data-original-width="943" height="228" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvYLjM1uDUyN6NwJNl4CX-sr2WsW6JzF6G0X2y3M6EBuFfAvh2IR_RvewtScHVSnXFVN_mbD4lHfKdma21MLps7NJ62CwKgA-a2stDDpbwerbiH5AafQ6yGvWUUyIvlA62gxbiE8QfXY4GMVIFzMjY4Tpl5U3auaK9ZeANeBAvNumdMT4eBRlwfT1ygBM/w640-h228/coinbaseq1.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://s27.q4cdn.com/397450999/files/doc_financials/2023/q1/Shareholder-Letter-Q1-2023.pdf">Coinbase Q1 2023 shareholder letter</a></span><br /></td></tr></tbody></table><p><br />As the above screenshot shows, Coinbase has tried to encourage this migration by offering free conversions into USDC at a one-to-one rate. It has also extended the program to non-retail users like MakerDAO, although <a href="https://twitter.com/CoinbaseInsto/status/1681698045136650241">its non-retail posted</a> rates are (oddly) much lower than its retail rates. Institutional customers usually get better rates than retail.</p><p>Incidentally, Coinbase isn't the only company to have approached MakerDAO to sign up for its fee-paying loyalty program. Gemini currently pays MakerDAO monthly payments to the tune of around <a href="https://makerburn.com/#/collateral/PSM-GUSD-A">$7 million</a> a year, but <a href="https://forum.makerdao.com/t/gusd-makerdao-partnership-announcement/18140">calls them</a> "marketing incentives." Paxos has <a href="https://forum.makerdao.com/t/paxos-makerdao-partnership-usdp-psm/19469">floated the same idea</a>, referring to the payments as "marketing fees" that would be linked to the going Federal Funds rate. The aversion to describing these payments as a form of interest is seemingly widespread.<br /><br />There's two ways to look at Coinbase's USDC rewards program. The positive take is that in a world where financial institutions like Bank of America <a href="https://www.bankrate.com/banking/savings/bank-of-america-savings-rates/">continue to screw their customers over</a> by paying a lame 0.01% APY on deposits when the risk-free rate is 5.5%, Coinbase should be applauded for finding a way to offer its retail clientele 5%. <br /><br />The less positive take is that USDC Rewards appear to be a form of <i>regulatory arbitrage</i>. Given that Coinbase uses terms like "APY" and "rate increase" to describe the program, it sure looks like it is trying to squeeze an interest-yielding financial product into a loyalty points framework, which is probably cheaper from a compliance perspective. If Coinbase was just selling coffee, and the rewards were linked to that product, then it might deserve the benefit of the doubt. But Coinbase <a href="https://medium.com/the-coinbase-blog/the-coinbase-mission-vision-strategy-a3d68b0a7d6a">describes itself</a> as on a mission to "build an open financial system," which suggests that these aren't just loyalty points. They're a financial product. And financial products are generally held to strict regulatory standards in the name of protecting consumers.</p><p>We've already seen hints of regulatory push back against the <i>rewards-not-interest</i> gambit so popular with crypto companies. In the SEC's <a href="https://www.sec.gov/files/litigation/complaints/2023/comp-pr2023-101.pdf">lawsuit</a> against Binance, it named Binance's <b>BUSD Rewards</b> program as a key element in Binance's alleged effort to offer BUSD as a security, putting it in violation of Federal securities registration requirements. Like Coinbase's USDC Rewards program, BUSD Rewards offered payments to Binance customers who held BUSD-denominated balances at Binance. BUSD is a stablecoin that Binance offered in conjunction with Paxos. <br /><br />Coinbase's lawyers seem to have anticipated this argument and <a href="https://www.sec.gov/Archives/edgar/data/1679788/000000000021001522/filename1.pdf">have already prepared</a> the legal groundwork to rebut it. The SEC <a href="https://www.sec.gov/Archives/edgar/data/1679788/000000000021001522/filename1.pdf">sent a letter</a> to Coinbase in 2021 that asked why USDC Rewards was not subject to SEC regulation. In its response, Coinbase had the following to say:</p><p></p><p></p><blockquote class="twitter-tweet" data-conversation="none"><p dir="ltr" lang="en">Here's an interesting bit in which Coinbase goes into some detail why it believes USDC Rewards isn't a security: <a href="https://t.co/ZzXxvNkBsv">https://t.co/ZzXxvNkBsv</a> I think it bears out the idea that once a firm starts offering a return, it risks straying into other regulatory frameworks. <a href="https://t.co/DMC7l3Et33">pic.twitter.com/DMC7l3Et33</a></p>— John Paul Koning (@jp_koning) <a href="https://twitter.com/jp_koning/status/1555280821392646144?ref_src=twsrc%5Etfw">August 4, 2022</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> Now, I have no idea whether this is a good argument or not. Having observed securities law from afar over the last few years, I'm always a bit flummoxed by the degree of latitude it offers. It seems as if a good lawyer could convincingly argue why my Grandma's couch is a security, or that Microsoft shares aren't securities.<br /><br />If you think about it more abstractly though, loyalty points and interest are kind of the same thing, no? In an economic sense, they're both a way to share a piece of the company's revenue pie with customers. Viewed in that light, why shouldn't a program like USDC Rewards inherit the same legal status as Starbucks Rewards or air miles? <br /><br />If Coinbase's effort to shape its USDC payouts as rewards ends up surviving, others will no doubt copy it. Wise and PayPal might very well stop using a bank intermediary to offer interest-paying accounts, setting up their own loyalty programs instead. A whole new range of investment opportunities marketed as loyalty programs might pop up, all to avoid regulatory requirements.<br /><br />But it's possible to imagine the opposite, too. In a column for Atlantic, Ganesh Sitaraman <a href="https://www.theatlantic.com/ideas/archive/2023/09/airlines-banks-mileage-programs/675374/">recently described</a> airlines as "financial institutions that happen to fly planes on the side." If loyalty points and interest are really just different names for the same economic phenomena, then maybe airline points, Starbucks Rewards, and USDC Rewards should all be flushed out of the loyalty program bucket and into stricter regulatory frameworks befitting financial institutions.<br /><p></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com2tag:blogger.com,1999:blog-6704573462403312459.post-15668942693878291722023-09-19T12:38:00.010-04:002023-09-19T13:07:30.353-04:00How did Zcash avoid getting OFAC'ed?<p>The 2022 <a href="https://jpkoning.blogspot.com/2022/10/how-to-stop-illegal-activity-on-tornado.html">sanctioning of privacy tool Tornado Cash</a> by the<b> Office of Foreign Assets Control</b> (or OFAC, the U.S.'s sanctioning authority) has inspired a new privacy idea: <i>Privacy Pools</i>. </p><p>An olive branch to OFAC, Privacy Pools <a href="https://www.privacypools.com/">will let users choose</a> who they associate with, the idea being that proactive filtering will quickly expose bad actors who try to use the tool, and so OFAC may be less hasty to apply sanctions to Privacy Pools smart contracts. I think it's a neat idea. We'll see where it goes.<br /><br />Zooko Wilcox, the creator of the original anonymous cryptocurrency, Zcash, doesn't like the notion of bending a knee to OFAC. In <a href="https://www.youtube.com/watch?v=52DlSLx0_lY">an interesting conversation</a> with Vitalik Buterin, one of the creators of Privacy Pools, Wilcox argues that the Privacy Pools regulatory dance is "unnecessary" because OFAC simply doesn't have the authority to sanction a protocol to death. And he puts forward Zcash as an example of a privacy technology that coexists peacefully with OFAC. Which is a fair point. Zcash has been around for seven years now, and OFAC hasn't shut it down.<br /></p><p>This piqued Vitalik's interest, who later on in the podcast goes on to ask Zooko why Zcash hasn't been OFAC'ed, given that it does exactly what Tornado Cash does: provide privacy.<br /><br />I don't think it's a great idea for folks like Vitalik who are designing tools like Tornado Cash and Privacy Pools to take lessons from Zcash's experience with OFAC. And that's because Zcash is a very different beast than Tornado Cash/Privacy Pools. The two just don't land in the same regulatory bucket.<br /><br />If you've been watching OFAC's dealings with crypto over the years, you'll notice that Zcash falls in the same OFAC bucket as other base layers like Bitcoin, Ethereum, Monero, Ripple, and more. When OFAC catches a sanctioned actor who controls an address on one of these base chains, it updates its list of sanctioned entities with the relevant address. This is how things have worked since 2018, when <a href="https://home.treasury.gov/news/press-releases/sm556">the first two bitcoin addresses</a> were added to OFAC's list. But OFAC has always left the functionality of the chain itself unhindered, nor does it impinge on the ability of the chain developers to do their job by sanctioning them. <br /><br />In fact, I've found a handful of Zcash addresses designated by OFAC, including one associated with the disinformation campaigns set up by recently-deceased Russian mercenary leader/oligarch Yevgeniy Prigozhin:<br /></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRAKP2Ds6NMIHfJ_9x6_VbiMxw_OIUb5gdOHKDmqs2vQDJ64grmzbgXo1FjMa840MMokkXYzsdMeIDpGdIA_IuTQC3--G-kg454JiQxbA8Ba54TGkGP07Rma9Af6DVOXDtaSI_AkcyuWW3k-5kUxaNYRJWesYcmwPMFDJpvozwcxpcAZHShgXnPWiZv34/s694/ofacZcash.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="191" data-original-width="694" height="176" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRAKP2Ds6NMIHfJ_9x6_VbiMxw_OIUb5gdOHKDmqs2vQDJ64grmzbgXo1FjMa840MMokkXYzsdMeIDpGdIA_IuTQC3--G-kg454JiQxbA8Ba54TGkGP07Rma9Af6DVOXDtaSI_AkcyuWW3k-5kUxaNYRJWesYcmwPMFDJpvozwcxpcAZHShgXnPWiZv34/w640-h176/ofacZcash.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://ofac.treasury.gov/recent-actions/20210415">OFAC</a></span><br /></td></tr></tbody></table><br /><br />Here are a <a href="https://ofac.treasury.gov/recent-actions/20200916">few</a> <a href="https://ofac.treasury.gov/recent-actions/20200910">more blocked addresses</a>. But that's it. Zcash still works fine.<br /><p></p><p>With the arrival of Tornado Cash/Privacy Pools, we've entered into completely new territory of smart contract-based tools built on programmable chains. How OFAC deals with these tools is going to be much more complex and tricky than how it deals with base chain addresses controlled by sanctioned entities. The Tornado Cash sanctions represent OFAC's first attempt, perhaps a clumsy one. Privacy Pools is a riposte from developers that, after being eyeballed by OFAC, might end up at a different equilibrium. <br /><br />Zcash's regulatory experience just doesn't translate over to the sorts of things Vitalik is working on. It's in smart contact-space where the current evolution of OFAC's prodding of crypto is occurring, but Zcash doesn't have smart contract-based tools.<br /><br />So from the perspective of a Zcasher like Zooko, it's just not necessary for him to play games with OFAC. The last five years of OFAC behavior suggests that OFAC can't and/or won't sanction Zcash-the-protocol to death, nor Bitcoin-the-protocl or Ethereum-the-protocl. </p><p>But the fact remains that the sanctioning of Tornado Cash (which has <a href="https://www.coindesk.com/policy/2023/08/17/coinbase-backed-group-loses-lawsuit-arguing-tornado-cash-sanctions-overstepped-us-treasurys-authority/">already survived</a> one court challenge) suggests that OFAC <i>does </i>seem to have the authority to enact such a ban at the emerging smart contract level. That may not be concerning to Zooko now, but one day it might be possible to build all sorts of automated tools on top of Zcash. And at that point Zcash developers may have to play the same "unnecessary" olive branch game with OFAC that Ethereum smart contract developers like Vitalik are engaged in now. <br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com2tag:blogger.com,1999:blog-6704573462403312459.post-53301838633643184652023-09-12T06:56:00.004-04:002023-10-06T09:31:08.646-04:00There are now two types of PayPal dollars, and one is better than the other<p>PayPal now offers its customers two types of U.S. dollars. In addition to having the option of opening a traditional PayPal account to maintain a balance of dollars, PayPal customers can now hold <a href="https://newsroom.paypal-corp.com/2023-08-07-PayPal-Launches-U-S-Dollar-Stablecoin">something new</a> called <b>PayPal USD</b>, a crypto version of a dollar. Whereas PayPal USD uses a crypto database, Ethereum, to host U.S. dollar balances (which in industry-speak is sometimes known as a <i>stablecoin</i>), the first sort of dollar relies on a conventional database.</p><p></p><p>There are currently around $45 million worth of PayPal USD in circulation, as the chart below illustrates:</p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgAbjnJnOtZ_V0SgCl1WLuiSVQkHm0-yTCMxnMYOohTLsePIXFP1KVMUxb69698jEzNM7TxAg3KKhnl17Gg8IakSHPBC8T1RRuKtZuvf2VThXNwi9Cqao7C21sFelWs-nFS7UE0_2USN-9CV1-ZYRXFRAeclba0LmwYw9jOvXFj7U_a-0QJLzxbyOMuzl0/s765/paypalusdmkap.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="464" data-original-width="765" height="388" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgAbjnJnOtZ_V0SgCl1WLuiSVQkHm0-yTCMxnMYOohTLsePIXFP1KVMUxb69698jEzNM7TxAg3KKhnl17Gg8IakSHPBC8T1RRuKtZuvf2VThXNwi9Cqao7C21sFelWs-nFS7UE0_2USN-9CV1-ZYRXFRAeclba0LmwYw9jOvXFj7U_a-0QJLzxbyOMuzl0/w640-h388/paypalusdmkap.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: <a href="https://coinmarketcap.com/currencies/paypal-usd/">CoinMarketCap</a><br /></td></tr></tbody></table><br /><br />Which type of PayPal dollar is safer for the public to use?<br /><br />If you listen to Congresswoman Maxine Waters, who in response to PayPal's announcement <a href="https://democrats-financialservices.house.gov/news/documentsingle.aspx?DocumentID=410725">fretted that</a> PayPal's crypto-based dollars would not able to "guarantee consumer protections," you'd assume the traditional non-crypto version is the safer one. And I think that fits with most peoples' preconceptions of crypto.<br /><br />Not so, oddly enough. It's the PayPal dollars hosted on crypto databases that are the safer of the two, if not along every dimension, at least in terms of the degree to which customers are protected by: 1) the quality of underlying assets; 2) their seniority (or ranking relative to other creditors); and 3) transparency. <br /><br />Here is a bit of commentary on each factor:<br /><br /><b>The quality of underlying assets</b><br /><br />PayPal's crypto dollars, which are managed by <a href="https://paxos.com/pyusd/">a third-party called Paxos</a>, are 100% backed by the safest sorts of short-term collateral: U.S. Treasury-bills, reverse repo (backed by U.S. government securities), and commercial bank deposits. In finance lingo, these assets are known as <i>cash and cash equivalents</i>. A big reason for this conservative investment approach is that Paxos is subject to a set of strict investment limits as determined by its regulator, the <i>New York State Department of Financial Services</i> (NYDFS). You can read about the NYDFS's stablecoin regulatory framework <a href="https://www.dfs.ny.gov/industry_guidance/industry_letters/il20220608_issuance_stablecoins">here</a>.<br /><br />By contrast, PayPal's regular dollars, which are regulated piecemeal under each U.S. states' own peculiar version of a <i>money transmitter</i> license, can almost always be legally backed by riskier assets. (<a href="https://www.paypal.com/us/webapps/mpp/licenses">Here</a> is PayPal's list of state-issued licenses.)<br /><br />For instance, if you comb <a href="https://s201.q4cdn.com/231198771/files/doc_financials/2023/ar/PayPal-Holdings-Inc-Combined-2023-Proxy-Statement-and-2022-Annual-Report.pdf">through the fine print</a> at the back of PayPal's annual report, the total amount of customer funds held in the form of regular PayPal dollars comes out to $36 billion at year-end 2022. Of this $36 billion, PayPal has invested $11 billion in "cash & cash equivalents." Put differently, just 30% of its dollars are backed by top notch assets, far less than the 100% ratio for PayPal's crypto dollars. PayPal invests another $17 billion of its customer's billions in something called <i>available-for-sale debt securities</i> which, if you dig further, is made up of stuff like government bonds, commercial paper, corporate debt securities, and more. See the list below:<br /><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEihuH9bp6mcPS-ZjXJ49joA0dc70f6-G_qw96xoX4dS534xwPEzk26_xOUAT92preBs6t-a5SKo5i79KxaxDVa9BmShnWVHzdpzZ3_9OnOKp3tZSYPR3q1DzbYxXNKMM35nn5U_kfpdDQitYp3dKuMAK4HJGrlHD0XzwZ-RVL5sxaqfBevfVRmzXKCtHt4/s864/paypalAFS.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="560" data-original-width="864" height="414" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEihuH9bp6mcPS-ZjXJ49joA0dc70f6-G_qw96xoX4dS534xwPEzk26_xOUAT92preBs6t-a5SKo5i79KxaxDVa9BmShnWVHzdpzZ3_9OnOKp3tZSYPR3q1DzbYxXNKMM35nn5U_kfpdDQitYp3dKuMAK4HJGrlHD0XzwZ-RVL5sxaqfBevfVRmzXKCtHt4/w640-h414/paypalAFS.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="font-size: x-small;">Source: <a href="https://s201.q4cdn.com/231198771/files/doc_financials/2023/ar/PayPal-Holdings-Inc-Combined-2023-Proxy-Statement-and-2022-Annual-Report.pdf">PayPal 2022 annual report</a></span><br /></td></tr></tbody></table><br />These available-for-sale securities assets are not as reliable as <i>cash and cash equivalents</i>, particularly treasury bills. First, they have riskier issuers, as is the case with commercial paper and corporate debt, both of which are emitted by companies. Second, they are characterized by longer terms-to-maturity, as is the case with government bonds and corporate debt securities. Prices of long-term debt are much more volatile than short term debt. <p></p><p>It would be illegal for PayPal to back its new crypto-based dollars with the assets listed above, yet for some reason it is fine if it backs its traditional dollars with them. <br /><br /><b>Customer's ranking relative to other creditors</b><br /><br />The second drawback of PayPal's regular dollars is that the assets underlying them don't really "belong" to customers in any strong sense of the word. They belong to PayPal. </p><p>More precisely, PayPal's <a href="https://www.paypal.com/us/legalhub/useragreement-full?locale.x=en_US">terms of service</a> has this to say: "...any balance in your Balance Account and any funds sent to you which have
not yet been transferred to a linked bank account or debit card if you
do not have a Balance Account, <b>represent unsecured claims against PayPal...</b>"). The bold is my emphasis.<br /><br />To understand what this means, let's say that PayPal goes bankrupt. You, a long time PayPal customer, hold $1000 worth of PayPal dollars. You might think that you are guaranteed to be made whole because there exists a corresponding set of underlying customer assets that has been specially earmarked for you and other PayPal customers. But that's not the case. Customers are what is referred to in finance as an <i>unsecured creditor </i>of PayPal, which means you'd be relegated to having to fight with PayPal's other creditors (banks, bond holders, etc) to get a piece of the pie, and that's only after PayPal's <i>secured creditors</i> – those highest in the pecking order – get first dibs. That could potentially mean getting maybe $600 or $700 instead of your original $1000. <br /><br />The reason for this, as explained <a href="https://www.cornelllawreview.org/wp-content/uploads/2021/02/Dan-Awrey-Bad-Money.pdf">here</a> by Dan Awrey, is the fairly lax state-by-state regulatory frameworks under which PayPal's regular dollars are issued, which "often do not require that permissible investments be held in trust for the benefit of customers—thus potentially forcing customers to compete with an [money services business]’s other unsecured creditors in the event that it is forced into bankruptcy."<br /><br />By contrast, the regulator of PayPal's crypto-based dollars, the NYDFS, specifies that the reserves backing any crypto-based dollar "shall be held at these depository institutions and custodians for the benefit of the holders of the stablecoin, with appropriate titling of accounts." To translate, the assets underlying your $1000 in PayPal USD cryptodollars are not PayPal's assets. Nor are they Paxos's. They are yours. No need to squabble with competing vultures for what's left.<br /><br />But oddly, PayPal is under no legal obligation to extend these very sensible protections to all of its regular PayPal dollars. <br /><br /><b>Degree of transparency</b><br /><br />The last big difference between the two types of PayPal dollars is that the crypto version offers far more transparency to customers. If you want to get current information about the assets underlying your crypto PayPal dollars, all you need to do is open up one of PayPal USD's soon-to-be published <a href="https://paxos.com/pyusd-transparency/">attestation reports</a>. Published monthly, these reports must include market values of the assets backing PayPal USD's, both in total and broken down by asset class. These values must be recorded on two separate days each month, or 24 times per year. Furthermore, these attestation reports must be prepared by an independent auditor.<br /><br />By contrast, the only way to get vetted financial information about the assets backing traditional PayPal dollars is to read its audited financial statements, which come out just once a year. For the rest of the twelve months, customers are left in the dark.<br /><br /><b>So where am I going with all of this?</b><br /><br />This illustrates the absurdity of some of the rules we've created surrounding monetary instruments. The fact that one type of PayPal dollar has robust protections while the other is only haphazardly protected, and only because the first is managed with a crypto database and not a traditional database, seems incredibly arbitrary to me. </p><p>Financial regulations exist, in part, to protect retail customers against shoddy financial providers. Shouldn't all PayPal customers, no matter what database technology they select, get to benefit from the same standard protections? What's the logic behind stipulating that one type of PayPal customer is to have the benefit of monthly attestation reports, for instance, while limiting the other type of customer to a black void of information? </p><p>The problem here isn't just one of having a few bad standards. Doesn't having multiple standards add to people's confusion about how they are protected?<br /><br />Just to make things even more absurd, there's actually a third type of PayPal dollar. It comes in the form of balances held in a <a href="https://www.paypal.com/us/cshelp/article/paypal-savings-faqs-help777">PayPal Savings</a> accounts. </p><p></p><blockquote class="twitter-tweet"><p dir="ltr" lang="en">Now you can save for rainy days and getaways with 0.85% APY*. No fees. No minimum balance. So hit the auto-save and achieve those savings <a href="https://twitter.com/hashtag/goals?src=hash&ref_src=twsrc%5Etfw">#goals</a>. <a href="https://t.co/orHIhRlKX2">https://t.co/orHIhRlKX2</a> <a href="https://t.co/lxivOjqMoT">pic.twitter.com/lxivOjqMoT</a></p>— PayPal (@PayPal) <a href="https://twitter.com/PayPal/status/1534913309744451584?ref_src=twsrc%5Etfw">June 9, 2022</a></blockquote> <script async="" charset="utf-8" src="https://platform.twitter.com/widgets.js"></script> <p></p><p>Unlike the two types of PayPal dollar described above, the third type is insured by the government up to $250,000. PayPal Savings dollars also pay interest, whereas the first two don't, or are prohibited from doing so. PayPal offers this product <a href="https://www.paypalobjects.com/marketing/ua/pdf/US/en/synchrony-deposit-acct-agreement.pdf?locale.x=en_US">in conjunction with</a> a bank, Synchrony Bank, which means this third type of PayPal dollar conforms to an entirely different set or rules than the other two: Federal banking law.<br /><br />But this only reinforces what a Frankenstein of a monetary system we've created. Why are only PayPal Savings dollars protected by deposit insurance, whereas the other two types of PayPal dollars aren't? How does this cacophony of features (or lack of features) help retail customers who, amidst all their other duties in life, simply don't have time to peruse the fine print of each different dollar emitted into the economy?<br /></p>JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.com12