Are we Cleaning up Money Laundering?

Headline:  What is the Digital Asset Anti-money Laundering Act?

Body:  I remember a pizzeria when I was young with a bunch of video games where you could earn tickets to get prizes.  (There was a plush rat that was the mascot, if you recall.)  One of the games involved holding a ridiculously large mallet, and in front of you were 10 wooden disks which would randomly pop up, and you then had to hammer them down.  The constant struggle between law enforcement and those who would take advantage of new technologies to scam people, is not much different.  When cryptocurrency began to appear, criminals noted that it was an exceptional method to move large amounts of value internationally in an untraceable manner.   It was Christmas and birthday for a decade, all wrapped up in one package.  It was just a matter of time before the regulators got involved, to tamp down the worst of the abuses.  Hence, the Digital Asset Anti-Money Laundering Act of 2023.

OK, so is this REALLY a big deal?

Yeah, yeah, it is a big deal.  Last year saw $20 Billion of illicit use of cryptocurrency.  The Act would do some commonsense things like extending the KYC requirements in the Bank Secrecy Act.  Let’s unpack that one a bit.   KYC stands for Know Your Customer requirements and these include basic information like name, proof of address and proof of date of birth, among other information.    The Bank Secrecy Act (BSA) requires banks to report on cash transactions exceeding $10,000 and reporting other “suspicious” transactions.  They also have to have a board-approved Anti-Money Laundering procedure.  Most importantly, the AML Act would re-cast purveyors of digital assets to be equivalent to banks, and subject to their requirements.  (In your research, you might come across a term, “Money Service Businesses.”   These are financial firms like check cashing services and the like, who are not banks, but per the IRS, transact in amounts exceeding $1,000 per person per day.   The abbrieviation MSB  isn’t so scary now, is it?)

So, this is good, right?

It depends upon your point of view.    The author brings up the point that the lion’s share of money-laundering involves good olde-fashioned fiat currency, not crypto.  He suggests that this is because the blockchain allows all to see the flows of all currency, and if dealing with regular currency, much can be hidden between national borders.  This is almost right, but he misses a few things.    First, the blockchain does allow for people to witness the flows of cryptocurrency, but the identity of persons and groups who own that particular wallet are hidden.  Further, though much confusion can be sowed, using fiat currency, it has been used for hundreds of years and law enforcement is very good at “following the money.”  It is much easier for countries to unwind a fiat currency transaction than one involving cryptocurrency.  The crux of the author’s argument is that by requiring KYC regulation like a bank, the onerous restrictions will entirely constrict the use of any cryptocurrency.   I would argue that if a person or group is so concerned about these KYC regulations, the crypto firm should be equally reticent to transact their business.

The authors did make a good point, though.  Not too long ago, some politicians tried to make a certain medical procedure illegal.  One effect was to push these most desperate people into horrific examples of back-alley operating rooms, and this significantly raised their risk.   In a similar way, if regulation goes too far, some desperate people could go to some unscrupulous people in a desperate effort to find a buyer for a very illiquid asset.  This could spawn a whole new set of problems.

What is this FBAR business I keep hearing about?

Take a breath, it’s not that bad, really.  FBAR would require all people who have $10,000 or more in a foreign bank account to declare it.  The current Act would extend this requirement to include the value of digital assets.  See, easy.

So, what’s the status right now?

It is important to note that, though sponsored by 2 Senators from different sides of the aisle, this Act has not been signed into Law.  The politicians pushing it, are beating the drum of national security, but many consider this a false narrative.  Further, almost all politicians are paying all attention to the Presidential election in 2024.    It seems unlikely that this Act will make it to the President’s desk.

The Verdict

The people against passage of this Act seem to be loudest in their action.  But, maybe we should pay more attention to the many more people who could get hurt if this Act doesn’t pass.  Even if this attempt comes to naught, I am  confident that there will be other attempts, as there are senators from both sides who are co-sponsoring this bill.  This level of co-operation has to mean something.   I think we would be foolish not to pay attention.

REFERENCES

https://www.warren.senate.gov/imo/media/doc/Crypto%20AML%20One-Pager_7.26.23.pdf

https://www.coindesk.com/consensus-magazine/2023/05/18/elizabeth-warrens-bill-wont-stop-money-laundering-but-it-could-ban-crypto/

https://cointelegraph.com/magazine/crypto-regulations-us-warren-bitcoin/

https://cointelegraph.com/news/elizabeth-warren-surveillance-legislation-help-big-banks

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

A Dimon Knows His Stuff

Headline:  Why is Jamie Dimon so against cryptocurrency investing?

Body:  So, due to physical limitations, I cannot drive.   Therefore, if I confidently told you that Exxon gasoline was qualitatively better than Shell gasoline, I hope that you might second-guess my opinion, as it is not based upon expertise.  But, if the owner of an independent garage told you the same thing, you might be excused for listening to him or her a bit more closely.  The reason is simple; The mechanic knows a lot about cars, and I know nothing.  In a similar way, if your neighbor was repeatedly talking excitedly about exotic kinds of cryptocurrencies, I hope that you might do some extensive research before plunking down a large amount of money.  So, what if a major player on Wall Street, Jamie Dimon, is urging caution about cryptocurrency, I think it might be worth it to hear out his reasoning.

So, who IS Jamie Dimon?

Mr. Dimon is the CEO of JPMorgan-Chase.  He has been working in the financial sector for decades.  His opinion occasionally moves markets.  And his opinion on Bitcoin is negative, calling it a “pet rock.”  Upon reflection, he did say that all useful employments for cryptocurrency were felonies, prosecutable in several jurisdictions.

I thought Bitcoin was used for good… not for evil

Well, no.  Cryptocurrencies have been used extensively in many kinds of schemes, including tax avoidance, money laundering and sex trafficking.  In fact, according to the GAO, 15 of the 27 sex websites they examined accepted digital currencies.  He cites all of these uses of crypto as reasons why it should not even exist.

So, is this a new thing for him?

No, this is not a new thing.  Over the years, he has been known to call investors in cryptocurrency, “stupid” and threaten to fire any employee who invests in it.  Normally conservative BlackRock and Goldman Sachs have both seen the excitement for cryptocurrencies and parted company  with Mr. Dimon on this point.  Mr. Dimon seems to often use language I am uncomfortable to use in print, but, Vanguard seems to agree with his views.   They synthesize their position as follows:

The investment case for cryptocurrencies is weak…Unlike stocks and bonds, most crypto assets lack intrinsic economic value and generate no cash flows.

Are there other reasons that Mr. Dimon dislikes cryptocurrencies?

Yes, there are several other reasons he has pointed to over the past few years.  The first argument that he made is that cryptocurrencies are a terrible store of value.  The main reason is, to be a good store of value, the valuation has to be relatively stable, and crypto certainly does not qualify here.  With prices changing thousands of dollars per day, his argument appears to hold water.  Second, he referred to Bitcoin as a fraud.  To a point he is right.    When you buy Bitcoin, what do you get in return?   Ones and zeroes on a computer screen, that’s it.  But, I might take a bit of issue with his thesis here, because cryptocurrencies are not the first new investments.  Imagine showing a stock certificate to a poor farmer in the 1930s.  I suspect what they might be thinking is, “If I eat that paper, will my stomach be full?”  Perhaps a similar thing might be going on here.

So, it’s a hard pass for him, huh?

Well, not quite.  During his time in the big chair, JPMorgan has begun to use blockchain technologies, most notably, to administer their JPM Coin.    Today, this coin is used to make trades of more than $1 Billion every day.   In point of fact, in 2017, he was quoted as saying, “God Bless the Blockchain.”  Blockchain is very attractive to Mr. Dimon, especially the smart contracts that are supported by the Ethereum blockchain.

The Verdict

In researching to write this entry, Mr. Dimon seems to be of 2 minds about cryptocurrencies.  On one hand, he abhors the “pet rock” of Bitcoin, but on the other hand, he has great faith in the smart contracts executable on the Ethereum blockchain.  So, it’s left to us to square that circle and reconcile the opposing views of digital assets.  Then, I read in one of the References, that Mr. Dimon’s expressed feelings about the assets might be “intentionally misleading” given his firm’s use of JPM coin and other blockchain technologies.  I have been swirling this in my mind, and would appreciate any of your comments.   But, my one idea is that he wants his firm to continue using these assets for as long as possible, and the key to this is to forestall government intervention.  By appearing to be negative on cryptocurrency, he might be giving the government a signal that it’s OK to go really slowly with regulation. 

Oh, and by the way, for all of you kids out there, a free tip; If the press does elect to interview you, please, please do not casually curse or refer to your potential investors as “stupid.”

REFERENCES

https://finance.yahoo.com/news/jamie-dimon-tells-davos-bitcoin-172918767.html#:~:text=Fortune-,Jamie%20Dimon%20tells%20Davos%20that%20Bitcoin%20is%20a%20’pet%20rock,with%20fraud%20and%20money%20laundering&text=JPMorgan%20Chase%20CEO%20Jamie%20Dimon,opining%20about%20the%20crypto%20currency.

https://www.investopedia.com/first-he-hates-it-then-he-s-ok-with-it-now-he-hates-it-again-where-does-jamie-dimon-stand-on-crypto-8411584

https://www.thestreet.com/crypto/innovation/jpmorgan-jamie-dimon-uses-harsh-four-letter-word-for-bitcoin

Onyx Joins the Mix

Headline:  JP Morgan has a system called Onyx.   What does this system do for investors in cryptocurrency?

Body:  JP Morgan has been around for a very long time.   Long enough to see many, many types of market conditions and practice reacting to novel types of investments.  So, it stands to reason that they might have a point of view to see the real value of (or lack thereof) cryptocurrency.  So, they developed a system called Onyx with the mission of helping their investors understand and invest intelligently in cryptocurrency.  So, I think it would behoove us to take a careful look at how it works, and we might learn a valuable thing or two.

What IS Onyx?

Onyx appears to be a payment system, that uses cryptocurrency as the measure of liquidity.  Said one of their experts, “Money is electronic today, but what is missing is programmability,” said the head of coin systems for JPMorgan. “That is the holy grail.”  Programmability suggests that this system will allow investors to structure a trade, and then say, execute this trade if and only if these certain market conditions exist.  Mind you, this is not a minor offshoot.   Onyx already has over 100 employees working full-time on it.

“We are launching Onyx because we believe we are shifting to a period of commercialization of those technologies, moving from research and development to something that can become a real business,” Takis Georgakopoulos said in a CNBC interview.

Are they all out to launch?

Well , yes.  The exciting thing here is that satellites are involved.  This speeds up settlement of international transactions greatly.  Before being announced, the system went thru 2 years of testing.   One of the first tests was to use the satellites to bounce information and consummate a simple transaction.  This was a necessary proof of concept.   The next set of tests asked what would happen if the connection to Earth was to be lost, temporarily.  Computers successfully bridged this issue.   Later, the tests were done using Low Earth Orbit (LEO) satellites which also consummated a transaction successfully.  This was very important because there was significantly less human interaction, suggesting the possibility for truly automated transactions, promising lower costs and much greater speeds.

Another thing that you would read about here is that Onyx represents a way to consummate transactions financially and integrate with the Internet of Things (IoT).  OK, a step back here is in order.   The IoT  is where the internet will plug into many of your devices.  For instance, your fridge cold e-mail you a shopping list, and (my favorite thing in the SkyMall) enable a toaster that will toast the forecast on to your, well, toast.  Now, even in the depths of winter, your outlook can be sunny, with a good possibility of bread.  Well, imagine if you could combine the sanctity of the blockchain with the amazing inventions around the house.  Now, when your bank account sees that your parents’ house was sold, it can immediately start your robotic vacuum in preparation of their arrival.  There are hundreds of less facetious (and less fun) examples, but this is one.

Are they encountering any challenges?

“One of the challenges in working with devices is the memory constraints.  This is amplified on a satellite because much of the memory is reserved as a backup for the satellite itself – not for running blockchain software. So we had to get creative to be able to generate the private keys for new accounts – typically a computationally heavy process.”  So, let’s take a step back here too.  We have spoken many times about the gargantuan power requirements for the cryptocurrency hacking rigs here on earth.  Well, in space, all that they usually have is a very inefficient solar panel to power the satellite.    This greatly limits the computational power too.   So, when on Earth, designers utilized a programming language (Rasberry Pi) known to be very efficient in power usage.

Who else is using these systems?

There is an argument to be made that commercial ventures could most benefit from the new systems that are available 24/7 and so easily pass currencies internationally.  In fact, Siemens is one of the earliest adopters and FedEx and Cargill are following closely behind.  One of the first early-adopter banks is the Bahrain-based Bank ABC, which is engaging in a “limited launch.”   (Remember, there is NO FREE Launch, right?)

The Verdict

Onyx appears to be here to stay.  Perhaps we can take some lessons from this semi-precious stone of a system.  Perhaps we can see how to most effectively use computing power to settle transactions quickly at much lower costs.   This alone would help the cryptocurrency space substantially.  And, J.P. Morgan has the power and size to make it back from a lot of mistakes.  Either way, make some popcorn, it’s going to be an interesting  ride.

REFERENCES

Onyx by J.P. Morgan launches blockchain in space (jpmorgan.com)

Bahrain’s Bank ABC using JPMorgan’s Onyx blockchain for cross-border payments (cointelegraph.com)

How JPMorgan is using blockchain to make B2B payments ‘programmable’ (yahoo.com)

JPMorgan Launches Blockchain Divison Onyx After JPM Coin Use (businessinsider.com)

 Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Black Rock with a Coinbase?

Body:  Partnerships can often leave us scratching our heads.   Sometimes we are asking “What were they thinking?”   Sometimes, the question is, “Why didn’t I think of this sooner?”  As we can see in the rearview mirror of time, AOL/TimeWarner was one of the more obvious examples of the former.   But, you know, the partnership between Coinbase and Black Rock seems like one of the latter.  Just think of the possibilities if the SEC were to allow a bank to merge with an exchange.  Well, Black Rock is essentially a Bank, and Coinbase is an exchange.  The possibilities are nearly endless for the right customers.

So, what can they do for one another?

Black Rock can recommend many wealthy clients to Coinbase.  Additionally, as Black Rock invests more of its own assets, other institutional investors will also conclude that cryptocurrency could be a reasonable investment. Potentially, Black Rock could offer an ETF based upon cryptocurrency, and they would have immediate access to execution of their transactions. In return, Coinbase can use their proprietary Aladdin system to better understand the objectives and risks of their individual investments in Bitcoin.  Black Rock is unafraid of the SEC involvement with Coinbase, as it has restricted investments to Bitcoin only.

The CEO of Black Rock seems enamored of cryptocurrency.  He claims that cryptocurrency can be used as a hedge against inflation, and is a wonderful investment because the currencies are not tied to any individual country, as a fiat currency would be.  Even the big thinkers at the World Economic Forum(in Davos, Switzerland) had a hefty dose of cryptocurrency as subject matter.

Are we alone here, in the U.S?

Not hardly.  A division of Societe Generale has tokenized some European bonds and offered them for sale in the Luxembourg Stock Exchange.  In El Salvador, bitcoin is now Legal Tender.   Cryptocurrency is far from dead, and countries would do well to learn about them and decide how to regulate them.

 The Verdict

At least 4 times now, I have seen the term “surveillance partner” being applied to Coinbase.  This would suggest to me that the government is considering allowing Coinbase to largely police its own exchange activities.    To be sure, with at least 2 hot wars going on, in addition to the many other crisis, small and large, our lawmakers have their hands pretty full.  But, still, this bothers me, and strikes me as allowing the fox to guard the chicken coop, just as long as the fox promises not to eat any chickens.

Also interesting to me is the discussion of Central Bank Digital Currencies.  The overarching idea of a cryptocurrency is to have a currency completely separate from an individual nation state.   CBDCs are NOT cryptocurrencies!!  In researching this article, I have seen multiple mistakes, conflating these 2 items.  Please remember the difference.  Cryptocurrencies are issued  by private companies, with the intent to fund some project.   CBDCs are held by a central government and are the same as any fiat currency.  I guess, the lesson here is do not invest in something unless and until you REALLY understand it.

REFERENCES:

BlackRock teams up with Coinbase in crypto market expansion (yahoo.com)

SEC accepts BlackRock’s Bitcoin ETF application, signaling regulatory review (cointelegraph.com)

‘Bitcoin is an international asset’ — BlackRock CEO’s bullish remarks (cointelegraph.com)

“Crypto winter” and renewed confidence in Davos (societegenerale.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Transparency, with a Twist?

Headline:  How is blockchain used in financial service industries (transparency v. anonymity.)

Body:  OK, here’s the rub, in decentralized finance.   Due to the distribution of the ledger, every individual involved can see all transactions, but, the numbered wallets are often kept some distance from a name, so transparency can exist alongside  anonymity.  For this reason, blockchain technology can be of great use within the financial sector.  It can be used to record money transfers, provide automation thru smart contracts, and allow for data storage.  The money transfers can be done much faster, and at much lower fees.  The blockchain technology can add transaction security

Why are blockchains better within the financial services sector?

Most times, when there is a large transaction using fiat currency, there are multiple parties in the middle of the buyer and seller, and each party involved is a risk for fraud.  With only the blockchain, opportunities for fraud are few indeed, due to the cryptography underlying the blockchain.  In a similar manner, the self-executing contracts on that blockchain involve zero middlemen leaving less opportunity for fraud.  Most interesting, though, is that once a person’s data is on a financial blockchain and verified, it can be transferred seamlessly to another financial blockchain.    

A blockchain is also much more efficient.  A transaction can be placed, and seconds later, the payment can be verified and assets transferred.   In point of fact, financial institutions     are on track to save $27 Billion on international transactions by 2030.      Finally, the same records kept by financial institutions can also be used for reporting to governmental entities.                                     

OK, so it’s a nice idea, in theory…

Au contrere.   Some companies are already there, mon frere.  Visa began to use a blockchain for its B2B transactions in 2017, and in 2021 began to settle transactions in cryptocurrencies.  Barclays PLC is a large international bank that uses the blockchain system to streamline the KYC requirements procedures.  Finally, American Express has also been involved partnering with a grocery delivery app called Boxed.  This partnership would allow a cardmember to earn points toward merchandise.  (I can’t help but think that the helmet on that guy would make transmission of data a snap.)  So, why isn’t everybody doing this?

There are some challenges that must be conquered: Ostensibly, Centurions would be used to this kind of challenge?

1.   Having a blockchain is nice but inter-operability of several blockchains is  the real opportunity here.  Polkadot and Cosmos are efforts to make this better.
2. Switching to a blockchain system is expensive in both terms of time and money.  The pool of people who know well, how to do this is quite shallow, much like a kiddie pool you might purchase online.  They are expensive, they will take a while to find, and then get familiar with your legacy systems, and then propose how they could migrate you to a blockchain system.
3. Blockchains are new on the well… block.  Governmental entities will certainly want to regulate them, and since changing them is impossible, nobody wants to be the first mover.  This position will almost certainly be required to do an uber-expensive 2^nd ‘do-over” to comply with governmental requirements.

Solutions are near.

In the U.S. SWIFT has created a KYC registry that its members can participate in, and currently, about 15%  of them do participate.  Overseas in Asia, there seem to be several similar partnerships as well, doing similar things. 

Finally, there needs to be a strategic watershed. Executives need to believe that the long-term benefits of blockchain are worth the cost. That requires taking a long-term view and working with the possibility that blockchain may lead to cannibalization of some revenue streams. The key to countering those concerns is to keep an eye on the prize: lower costs, less friction, and a safer retail banking system.

The Verdict

When cars first came on the scene, there were many who said they were too fast and unsafe.  (There is some evidence that they were not far wrong.)  Then the airplane came along.   Even faster, some people said that the level of speed was irresponsible and unsafe.  I have a difficult time believing that adoption of the blockchain is really any different.  Yes, in the beginning of cars, there were safety problems.  But as time went on, safety belts and air bags were added and these vehicles got safer.

 REFERENCES

How Blockchain Can Impact the Financial Services Industry | The Motley Fool

Blockchain in retail banking: Making the connection | McKinsey

How Blockchain Can Transform the Financial Services Industry (usnews.com)

The Impact of the Blockchain Goes Beyond Financial Services (hbr.org)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Yuan a CBDC?

Headline:  What is Standard Chartered (Bank) doing with China on digital currency?

Body:    Not long ago, the country of China had a restriction against all digital currency (I suspect this was most important to the leadership because this currency got its legitimacy  from somewhere other than the State.)  But, it would seem that the Chinese leadership is considering offering the digital yuan as a central Bank Digital Currency (CBDC).  A British financial institution, Standard Chartered, has been hired to help them.   I had to wonder what Standard Chartered would be expected to do to earn their fees.  So, let’s look at it.

So, what exactly are they doing for China?

China desperately wants to create its own digital currency  Toward this end, China hired PWC and others to work on  a report called “Central Bank Digital Currency.  Recently, Standard Chartered announced that its depositors could purchase these digital assets thru a partner.  It would also appear that Standard Chartered is involved in pilot testing the use of the CBDC in trade.  It would appear that the Peoples Bank of China executed some early  pilot testing, and it seems that Standard Chartered is being included in the later pilot testing to corroborate the international aspects of digital transactions.  Cursory research only was needed to corroborate that Standard Chartered had facilitated financial change within China many times before.  In this current project, the Bank will be a major part of helping customers with digital yuan exchange and redemption.

So, what is the progress so far?

Piece by piece, it would seem that the Chinese government is adding up the puzzle of digital currency.   First, they  engaged outside consultants to write a paper about how the system could be made to work in China.    February saw the distribution of millions of dollars in e-yuan, and March saw $22 Billion in payments using e-yuan.    In May, the Chinese e-commerce app Meituan integrated the asset, and in July, certain air travel services began to accept the digital yuan. PetroChina carried out the first cross-border crude oil trade involving the asset in October.

The Verdict

Up to now, the Chinese government has been almost religiously against all digital currency.  ( Which is interesting given how significantly their “social score” can affect the lives of the people. ) So, the question we are left with is “Why?”    I think this comes back to control.  If the government offered nothing, anybody with a VPN could be buying up digital currencies and stashing these assets in Coinbase or Binance or any other exchange.   By offering the e-yuan, the Chinese government can make it seem to a good number of their populace, that they DO have a digital option that is “harmonious” with  State objectives and  takes a digital format.  You might think this view cynical, but, the history of centuries of centralized financial engineering  informs my bias.  But, it is also my supposition that the Chinese people will soon learn that this is not the cryptocurrency they have heard about, and disharmony will spread significantly.  Put another way, I think it will work for the government in the short term, and blow up on them in the longer term.  The question then becomes, “What’s the length of the short-term?”  This is hard to tell, but, I think it will be sooner than most economists are estimating.

REFERENCES

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

DEBT Box or Out of the Box?

Headline:  What is the DEBT box case against the SEC?

Body:  So, we have an interesting one here.   There is a company with the trade name DEBT Box (by their own choice) and there were 18 principals and the company itself who were found guilty of fraud.  They were all halted from doing business and fined $50 Million and a combination of Bitcoin and Ethereum.  What’s interesting here is that the details are so reminiscent of other frauds through the centuries of Western civilization.  Certainly, we should be able to learn something here.

What happened?

Digital Licensing Inc. (hereinafter DEBT Box) was selling “node licenses” to investors (read, victims.).    There is one blockchain where the limited number of authentic validators are given such a license number.   But, this is on a completely different blockchain, and DEBT Box would simply invent the needed number of licenses on their own blockchain.  The entities involved were also accused of acting like unregistered brokers.  Tracy Combs, director of the SEC’s Salt Lake Regional Office, said:

“We allege that DEBT Box and its principals lied to investors about virtually every material aspect of their unregistered offering of securities, including by falsely stating that they were engaged in crypto asset mining,”

The SEC is seeking permanent injunctions, return of ill-gotten gains and civil penalties against the firm.

Really??  People felt secure enough to invest in a company called DEBT Box??

The company entices investors with promises of daily rewards tied to various industries such as real estate, commodities, agriculture, and technology.  As one can surely understand, when the potential of great returns is waved before an  audience, many are desperate or greedy enough to invest.  Fighting against this greed or gluttony (your choice) the SEC has put together some publications for investor education, focusing on the risk of cryptocurrency investments.  Some of the titles include the following:

The Verdict

This one is a little bit different because the SEC is saying that there is actually a fraud that was committed, and whether or not the node licenses were securities or not, is a side issue.  The question that must be asked is what can we learn from this?  I fear that we need to learn a similar set of lessons, chief amongst them is DO NOT INVEST IN SOMETHING YOU DO NOT UNDERSTAND.  I believe that it was Peter Lynch who counselled to not invest in something unless you can illustrate the value proposition with a crayon.  The value proposition here is murky, at best.  You are not validating transactions, so the value is not a reward for this activity.   You are not directly staking a validator, so there is no value proposition there either.  Further, your license lives on a blockchain controlled by a company.  The Coast Guard station hangs fewer red flags when a hurricane is expected.

It strikes me that I should also say a word about unregistered securities.  There are several categories of securities that are unregistered and still kosher with respect to the SEC.  (Details are beyond the scope of this entry, but, they do exist.)  But each one contains several constraints that work to partially replace the requirements of registration with the SEC.  Some are limited by size, some are limited  to who may invest and some offer a very brief form of the lengthy registration.  Outside these very small examples (if memory serves from the CPA exam, there are only 4) all securities MUST be registered with the SEC.

REFERENCES

SEC.gov | SEC Obtains Emergency Relief to Halt Utah-Based Company’s Crypto Asset Fraud Scheme Involving 18 Defendants

SEC freezes assets of DEBT Box, alleging $50M node license ‘sham’ (cointelegraph.com)

SEC freezes assets of crypto mining firm DEBT Box in $50m fraud case By Crypto.news (investing.com)

SEC says court, not jury, should determine security status of Terra’s crypto assets (cryptoslate.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Is Kraken Itself a Sinking Ship?

Headline:  What happened between Kraken and the SEC?

Body:  For thousands of years, sailors wrote stories of their fears of the giant Kraken, a sea monster with a reputed taste for human flesh and the ability to sink ships with a single thrash.  We now know that  these apocryphal stories were about the giant squid which is usually very content to remain undisturbed in the vast depths of the ocean.  For some reason, a crypto exchange was started with the name Kraken.  (Ostensibly it has its tentacles everywhere?)  Because of the wide spread of its tentacles, the SEC took them to court, claiming that they were working as an unregistered securities exchange. 

I hear yawning!  This is actually really interesting as it gets to some of the thorniest questions concerning cryptocurrency.  In short, without registering with the SEC, Kraken has made hundreds of millions of dollars fostering these deals, acting as broker, dealer, exchange and clearing agency.  (Anybody want to guess a secondary reason that the SEC wanted to be the one who had success against this entity?)  They further claim that poor recordkeeping was an endemic problem.  Finally, they are accusing Kraken of trading in their own interest, and co-mingling customer funds to do so.  Kraken disagrees with all of these assertions, and is prosecuting its own campaign thru social media.

The more complete picture.

The first thing to see is that Kraken was put on the radar of the SEC because they were fulfilling so many roles for their customers.  In normal securities dealing, these functions are kept separate and distinct to ensure that there is limited opportunity for self-dealing.  Making this self-dealing worse, the SEC alleges that recordkeeping is deficient, and this deficiency allows them to use customer funds  in trades for their own profit.   So, let’s unpack this one a bit because it’s important.

Let’s pretend that you had a portfolio of securities with Morgan Stanley.    In this case, several different entities need to interact to make a transaction work.  The company needs to work with another entity that has the securities.  A clearinghouse needs to be involved to prove that all property has been handed properly from one party to another.  Having this many entities involved, each one looks over the work for the others, and the whistle can be blown if there is any wrong-doing.    In this case, the SEC is saying that Kraken was playing all of the different roles, so there was no check on what they were doing.   Now, it’s possible that the brokerage (let’s stay with Morgan Stanley) already has the securities that a customer wants.  All that it has to do is transfer the shares from its portfolio to the account of its customer.  To ensure that this is done correctly, there are onerous recordkeeping regulations to follow, to prove that the transaction was done correctly.   In this case, the SEC is claiming that Kraken’s recordkeeping was so deficient, it was impossible to prove that the transfer was done correctly.

In the words of the SEC,

We allege that Kraken made a business decision to reap hundreds of millions of dollars from investors rather than coming into compliance with the securities laws. That decision resulted in a business model rife with conflicts of interest that placed investors’ funds at risk.  said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “Kraken’s choice of unlawful profits over investor protection is one we see far too often in this space, and today we’re both holding Kraken accountable for its misconduct and sending a message to others to come into compliance.” 

 The Response

Kraken disagrees with all levels of this accusation.  Most interesting I think is the position of Kraken that it is not dealing in securities.

The Verdict

Once again, when a cryptocurrency firm tries to do too many things, it invites a lot of scrutiny.   We’ve seen it in FTX, 3AC, many times over.   Interestingly, one of the major investors in  Kraken is DCG, which we’ve seen before, involved in both FTX and Genesis.  Perhaps this scrutiny is a good thing.  We shall see.

REFERENCES

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Is That a Dollar Bill in your Pocket, or Are You Just Money Laundering?

Headline: Crypto and Money Laundering

Date: 3/8/2022

Body:  DeFi protocols… a confusing name but pretty apt.  DeFi stands for “decentralized finance” and it is the goal of cryptocurrency.    The people who set these economic ecosystems up believed that the central banks of individual countries had way too much power.  In their estimation, there had to be a way to “DeFi” these systems. (See, these guys and gals are pretty darn clever, even with their marketing.)  So, they designed various kinds of cryptocurrency which don’t depend upon a government-controlled Central Bank, and these currencies make it so much easier to move money from one country to another.  Mission accomplished, right?   We can go to bed?

No.   As surely as night follows day, if one designs a system that can anonymously send large amounts of currency internationally in a few keystrokes, money launderers the world over popped champagne, and quickly got to work.

What is the relationship between cryptocurrency and money laundering

It might sound like the trailer for a movie, but I swear, it’s not.  The “Treasure Men” exist!!  And, they are HERE!!

Well, not here, precisely, but, around.   First, they are not mythical creatures.  They are specialists who can turn your cryptocurrency (however you acquired it) into a physical form of payment.   For an extra fee, they’ll leave the gym bag of cash or the purse full of Amazon gift cards somewhere near you, then give you explicit directions of where to pick it up.  These specialists don’t really hide either: If you have access to the Dark Web, they can readily be found at some of the most visited marketplaces, like Hydra.

But I thought that the cryptocurrency blockchain had no identifiable information, the individual was safe.

The crypto world is well, unique.   All of the transactions are open to EVERYBODY to see, but the names are not connected.  So,one has the ability to keep quiet about the identity of counterparties, but the fact of the transaction is known.  Some white-hat hackers have gotten together and opened businesses to help trace these transactions, and these business entities are large.   Two examples are Chainalysis (based in New York) and Elliptic (based in London.)

Is this really a big deal?

Depends on your definition of “big” I guess.   It is estimated that $5 Billion in illicit funds were transferred.  But, move back a bit and you find that this is less than 1% of all cryptocurrency transfers, per Chainalysis.   Cybercriminals laundered about $8.6 billion in cryptocurrency in 2021, Chainalysis said in a partial release of its 2022 cryptocurrency crime report.   And due to fear of regulation, the exchanges are getting much better at understanding their customers.  Against this, there are still plenty of opportunities for those bad actors, including online gambling sites and over 11,000 Bitcoin ATMs globally.  And, it’s getting bigger.  Decentralized finance protocols are playing an increasing role in money laundering, with the total value of cryptocurrency laundered rising year over year by 30% in 2021, according to blockchain data platform Chainalysis Inc.

That said, there is still plenty of opportunity for good old-fashioned money laundering.  For instance, the report cited an estimate from the United Nations Office on Drugs and Crime that between $800 billion and $2 trillion of fiat currency—money issued by governments—is laundered each year.   So, laundering of cryptocurrency is a large problem, but it should be seen in context with the rest of the problem.

What is a criminal to do?

There are two main techniques used by cryptocriminials.   First, they can switch their ill-gotten gains quickly from one currency to another to help obfuscate their trail.  The other option is to pay somebody else to do it for them.  Think of these people as freight-forwarders.   These people take the ill-gotten gains, combine them with massive numbers of transactions of legitimate nature, and then give “clean” currency back to the originator.   Both procedures can be quite expensive, though.   And, if one uses highly trained forensic accountants, the trail CAN be un-twisted.

Have there ever been some really colorful examples of cybercriminals like this?

Well, yes, definitely.  Just a short while ago, the Justice Department arrested a couple and seized over $3.5 Billion in cryptocurrency, and charged them with trying to launder money stolen in 2016 from a cryptocurrency exchange.   The characters are the stars here.   He was a Russian immigrant who came to the U.S. with his parents for religious reasons.   She was a largely unsuccessful “rap artist” who was trying to gain a social media following.   Both had impeccable  relationships with friends and neighbors.  I’m pretty sure we’ve seen this movie before.

The Verdict

“We’re really in a period where there’s so much growth, so many new customers, so many new businesses in DeFi that it’s hard to know which ones are vulnerable and which ones are worth investing in,” said Kim Grauer, head of research at Chainalysis.  “But at the same time, users have ‘FOMO,’ a fear of missing out. So they are willing to maybe forgo some of the typical security checks in favor of investing in new platforms that might offer high yield.”  This seems to sum up the increasing tussle between law enforcement and cybercriminals who are determined to add money laundering to their resumes. 

When I was trained as a Certified Fraud Examiner, they drilled into our heads the Fraud Triangle.     They are Pressure, Rationalization and Opportunity.   In this case, the aspiring money-launderer might see the current situation as follows:

 Pressure – They have bills that they can’t seem to pay.

Opportunity – They already know the cryptocurrency game.  So, moving digital money around is no problem for me, right?

Rationalization – Look, if I don’t do it, somebody else will do it anyway.  I might as well profit personally and help my kids, right?

It’s a siren song in 3-part harmony, and many a vessel has been lured by it.  The new wrinkle is that all it takes is a few keyboard clicks.   Just like this.

REFERENCES

https://www.ft.com/content/4169ea4b-d6d7-4a2e-bc91-480550c2f539

https://baselgovernance.org/sites/default/files/2021-08/QG%20crypto%20money%20laundering%20updated.pdf

https://support.microsoft.com/en-us/office/this-website-doesn-t-work-in-internet-explorer-8f5fc675-cd47-414c-9535-12821ddfc554?ui=en-us&rs=en-us&ad=us

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.