Wednesday, December 20, 2023

Are flatcoins a good idea?

I'll start with the conclusion. I don't think flatcoins are a good idea.

The idea for flatcoins has been around for a while, but it got a wider airing when it popped up in a Coinbase marketing piece from earlier this year. Now, arch-crypto hater Nouriel Roubini has undergone a Damascene conversion and is about to introduce a crypto flatcoin, suggesting that these novel instruments are "the way forward."  

What is a flatcoin?

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.

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 flatbalances which rise by 3-4% a year. Or imagine a flatnote, the issuer indexing the purchasing power of its paper banknotes to inflation by promising to buy them back at progressively higher prices.

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.

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.

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.)

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.

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 once put it, 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."

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.

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.

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.

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.

Saturday, December 16, 2023

The long arm of OFAC and its reach into the Ethereum network

Coinbase, the U.S.'s largest crypto exchange, is openly processing Ethereum transactions involving Tornado Cash, a piece of blockchain infrastructure that was sanctioned by the U.S. government last year for providing mixing services to North Korea. 

Over the last two weeks Coinbase has validated 686 Tornado-linked transactions, according to Tornado Warnings. I've screenshotted the table below:

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: Tornado Warnings by Toni Wahrst├Ątter

This is awkward for everyone involved.

First, it's embarrassing for the agency that administers U.S. sanctions, the U.S. Treasury's Office of Foreign Assets Control, 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.

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.

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.

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 zero 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.

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.

What is validation?

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.

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 was fined by OFAC for processing 826 transactions on behalf of Iranian individuals.

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 validation services business operate.

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 validator 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.

The biggest validators are the ones that own large amounts of ether, 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 Ethereum Staking dashboard. 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.  

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.

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?

OFAC around and find out

For folks who don't know how U.S. sanctions work, a big part of OFAC's job is to blacklist 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.

OFAC also administers comprehensive sanctions. These prevent U.S. individuals or businesses from interacting with entire nations, like Iran.

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 risk-based 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.

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.

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.

Data source: OFAC and Github

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.

While Kraken's approach may appear to be the compliant approach to proposing blocks, it's not. It's half-compliance, or compliance theatre. 

OFAC-compliant blocks as compliance theatre 

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.

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.

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.

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 is exempt from sanctions law.

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.  

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.

There is no easy policy decision for OFAC

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.

So in the end, the very transactions that OFAC wants to discourage would end up happening anyway.

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.

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.

But this is a complicated chess game to play, and you can see why OFAC has been hesitating.  

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.

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?

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.

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.

Tuesday, December 5, 2023

Why do sanctioned entities use Tether?

Tether, a stablecoin, has been in the news for offering sanctioned actors such as Hamas a means to participate in the global payments ecosystem.

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 been controversial, and will instead dissect the U.S. Department of Justice's recent indictment of group of business people who brokered oil purchases from PDVSA, Venezuela's sanctioned state-owned oil company.

Let's get right into things. In this particular case, the buyers  who indirectly represented a sanctioned Russian aluminum company  seem to have used two methods for settling payments with Venezuela: bank wires and cash. (Tether makes an appearance in the second.)  

Before we get to Tether, we need to understand how the bank wires worked.

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."

...the shittiest bank in the Emirates [link]

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.

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.

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.

"The key is cash" [source]

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 Evrofinance in Moscow. Evrofinance is a bank that is controlled by the PDVSA and has been sanctioned by the U.S.

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.

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."

"...quick like SMS" [link]

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.

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."

Going the Tether route also has the benefit of not requiring 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.

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 Count Two, it is the bank wires that are at the root of Orekhov and Serrano's legal woes, not the Tether transactions.

Among many other crimes, Orekhov and his Venezuelan counterpart, Serrano, are accused of sanctions evasion, more specifically conspiring to violate the International Emergency Economic Powers Act (IEEPA). The IEEPA is the bit of legislation that contains U.S. sanctions law.

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.

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.

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 correspondent bank, 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.

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.

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.

The Tether transactions, by contrast, do not 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.

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.

But not for long?

In a recent letter to Congress, 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.)

"...stablecoin transactions involve no U.S. touchpoints"

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 unit-of-account, as a new nexus for controlling transactions made by foreigners. 

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. 

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.

Friday, December 1, 2023

Even crypto mixing deserves a threshold

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.

It's a pragmatic compromise, and one hopes that the benefits outweigh the costs. The way that we've been balancing this compromise up till now is by using thresholds, 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.

Anyways, last month, the U.S. government announced 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.

In short, the government thinks that mixing of cryptocurrency is of primary money laundering concern. 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. 

I submitted the following comment on the proposed rule for crypto mixing. If you agree, feel free to copy it and add your own comment to the growing pile. 

Dear sir/madam,

Re: Proposal of Special Measure Regarding Convertible Virtual Currency Mixing, as a Class of Transactions of Primary Money Laundering Concern

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.

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.

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.

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.

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.

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.

I would suggest a threshold of at least $10,000, which is in-line with the cash transaction reporting threshold.

JP Koning
Moneyness Blog