Searching for the Balance
There is an epic struggle going on today regarding privacy, governments, regulators, the banking industry and cryptocurrencies.
The right to privacy in your conversations, your papers and possessions, and your financial activities is a fundamental human right. Most countries recognize this right and most make some effort to protect that right. Of course, some do better than others. In the digital age, few would disagree that the rank and file people of the world have lost a lot of privacy. Many governments justify this intrusion by expressing concerns about the security of the country, our safety from terrorists and so on.
While terrorism is a legitimate concern, if the ordinary people of the world do not restrain their public servants to some degree, it is not a big leap to think our world could end up like George Orwell’s book, 1984. Cryptography and cryptocurrencies will play a role in this struggle for some reasonable balance between security and privacy.
One of the biggest lies ever is the statement that, “If you’ve got nothing to hide, you’ve got nothing to fear.” While this idea has been around for centuries, it is often attributed to Nazi propagandist Joseph Goebbels in 1933. Upton Sinclair complained bitterly about the grotesque violation of his privacy, and the privacy of his extended family and friends. This was in 1918. The idea that we should not object to the invasion of our privacy (if we are innocent) was categorically wrong then and it is still wrong today.
“Not merely was my own mail opened, but the mail of all my relatives and friends—people residing in places as far apart as California and Florida. I recall the bland smile of a government official to whom I complained about this matter: “If you have nothing to hide you have nothing to fear.” My answer was that a study of many labor cases had taught me the methods of the (Pg. 146—ed.) agent provocateur. He is quite willing to take real evidence if he can find it; but if not, he has familiarized himself with the affairs of his victim, and can make evidence which will be convincing when exploited by the yellow press.” -Upton Sinclair
There are three key points to make regarding this epic struggle.
First, The risk to the unbanked.
Are we willing to punish the poorest and most vulnerable segment of the population to get a theoretical small improvement in the security of our nation? I am referring to the 1.4 billion people who live (mostly) in developing countries and have little or no access to banking services that you and I take for granted. We refer to them as the unbanked.
Second, Would it work?
If we did heavily regulate cryptocurrencies (like we do the legacy banking industry), would it actually prevent money laundering?
Third, the Genie is out of the bottle.
The cryptographic genie is out of the bottle. Everyone in the world now has access to powerful cryptography that cannot be broken, even by powerful governments. At this point, trying to prevent cryptographic privacy from spreading to financial transactions and other activities is like trying to stop the sun from coming up tomorrow.
The Risk to the Unbanked
For those who live in developed countries, it is hard to imagine being unable to open a bank account. But for 1.2-1.7 billion people, it is their everyday reality. This produces a terrible economic handicap on both individuals and countries. Without modern banking services it is difficult or impossible to save money, borrow money, send money, start or run a business, or have investments without predatory interest rates and impossible repayment options.
Anything the legacy banking industry does to strengthen AML/KYC (Anti Money Laundering/Know Your Customer) will make it even more difficult for people in developing countries to get access to banking services.
This will hurt people who are refugees. This will hurt people who are poor, underage, those who have no access to a computer or smart phone, those who are not literate enough, those who lack the documents such as a driver’s license, a passport or birth certificate. These are the people who will pay a terrible price to “keep us safe” in our prosperous and developed countries.
Similarly, there are often minimum balance requirements, monthly fees and transaction fees that are an impossible barrier for many millions of people.
Imagine how limited you would be if your checks, credit cards and online banking services stopped working today. Your entire life would get put on hold until you resolved the problem.
But imagine further, you can’t resolve the problem. The barriers are too high.Your life as you know it…is over. The world wide problem of unbanked people produces an enormous economic penalty. The cost to the world’s economy is difficult to estimate, but is likely trillions of dollars.
Being unbanked disproportionately affects women and people of color. There is a compelling argument to be made that the legacy banking system is the fundamental barrier to solving this problem. (watch for a future article on this.) I will give you one compelling resource for further study: an interview between Laura Shin and Fereshteh Forough.
Even in the US, just over 5% of households have little or no access to banking services. This translates to 7+ million households.
Would it even work?
A parallel problem exists in the drive to impose more regulations and supervision and AML/KYC on the cryptocurrency industry. The world has heard frequent calls from governments and the legacy banking industry itself declaring that, “The cryptocurrency industry MUST BE REGULATED to prevent organized crime, terrorists, drug cartels, evil countries like N. Korea, human trafficking groups, child pornography groups, and all the other bad people from getting easy access to money laundering services by using cryptocurrencies.”
I find it illuminating to examine the most regulated industry in the world, the legacy banking industry. How effective have they been at eliminating or at least reducing the problem of money laundering and financial scams? After all, they have been working on it for 50-100 years. Every single country in the world expends enormous resources in the form of time, money and staff to fight money laundering and other financial scams. How successful have those efforts been?
Let’s be totally honest, the results are terrible. Let’s look at a few numbers, quotes and resources.
Q: How much money is laundered every year?
A: Money laundering statistics from the United Nations show that about 2% to 5% of the world’s GDP is laundered every year. That’s approximately $800 billion to $2 trillion.
Q: How much of the laundered money is recovered?
A: Anti-money laundering activities recover only 0.1% of criminal funds.
According to money laundering statistics of 2020, 90% of laundered money remains undetected.
The United Nations Office on Drugs and Crime estimates that as much as $2 trillion is illegally laundered around the world each year — while law enforcement reportedly catches less than 1% of that.
How much money, tax evasion and money laundering was exposed by the Panama Papers? At least 1.24 billion dollars in tax revenue was collected by various countries after the expose. Unless you assume every affected government had 100% success at recovering the money, the actual amount of money laundering was much higher.
Some have described the Libor scandal in 2012 as the crime of the century. The Libor, or London Interbank Offered Rate is used to derive interest rates on a range of financial transactions worth an estimated 800 trillion dollars. This is roughly 12 times the total global GDP. It is estimated that the manipulation of Libor cost cities and municipalities alone at least $6 billion.
A number of the biggest banks in the world colluded to manipulate the Libor value and got caught in 2012.
Rather than list 100 more examples of bank fraud and money laundering to further illustrate the point, I would encourage everyone to do the following google searches:
- Offshore banking scandals
- Bank money laundering scandals
- Bank scandals
I made an attempt to quantify the total money involved, but quit when I crossed well into the trillions of dollars.
Four summary points about the concept of using regulations to reduce money laundering in the crypto industry.
- The most regulated industry in the world (banking) still has trillions and trillions of dollars worth of scandals and money laundering.
- This is the amount that we know about. Undoubtedly there is much more that we don’t know about.
- It seems obvious that adding more supervision and regulations to the crypto ecosystem won’t prevent money laundering, even if the regulations were exactly as extensive as the regulatory apparatus of banking industry.
- Even assuming that these massive regulatory and enforcement efforts were perfect at preventing money laundering, it is a virtual certainty that more than a billion unbanked people would be largely excluded from any modern financial services due to the increased need for identification and verification. This is unattainable for millions in undeveloped areas. Is that a reasonable trade off from a moral, ethical and financial view?
The Genie is out of the Bottle
In a very real sense, it doesn’t matter what the government does. It doesn’t matter what the legacy banking industry does. It doesn’t matter what the cryptocurrency industry does. And it certainly doesn’t matter what any individual crypto project does. The end result will still be the same. Somebody is going to figure out how to combine unbreakable encryption with financial transactions, communications and smart contracts.
Once that occurs, no conceivable effort or actions on the part of one government or all of the governments, will be able to stop privacy for the citizens of the world. This concept of inevitability is perfectly illustrated by the efforts of one man named Phillip Zimmerman, and one product called PGP for Pretty Good Privacy.
Phil Zimmerman developed and published a software project called Pretty Good Privacy. For the first time in history, ordinary people could use so-called military grade encryption that could not be broken. Even with the enormous resources of governments, PGP itself was never broken. Unsurprisingly, the governments of the world are not happy with this development. They made heroic efforts to break it, or at least stop it from spreading to the whole world. They failed miserably.
A few excerpts from the Wikipedia page are very illuminating. I have paraphrased it a bit for clarity, although the whole article is a worthwhile read:
“Shortly after its release, PGP encryption found its way outside the United States, and in February 1993 Zimmermann became the formal target of a criminal investigation by the US Government for “munitions export without a license”. At the time, cryptosystems using keys larger than 40 bits were considered munitions within the definition of the US Export regulation; PGP has never used keys smaller than 128 bits, so it qualified at that time. Penalties for violation, if found guilty, were substantial. After several years, the investigation of Zimmermann was closed without filing criminal charges against him or anyone else.
Zimmermann challenged these regulations in an imaginative way. He published the entire source code of PGP in a hardback physical book….which was distributed and sold widely. PGP was now available to anyone in the world. The principle was simple, the export of munitions—guns, bombs, planes, and encryption software was (and remains) restricted. But the export of books is protected by the First Amendment. Because of the wide and growing presence of the internet, any effort to stop the flow of information is destined to fail sooner or later.
Since then, two federal appeals courts have established the rule that cryptographic software source code is speech protected by the First Amendment.”
The story of PGP will sound familiar to most people in the cryptocurrency world. What Phil Zimmerman did for communications, Satoshi Nakamoto did for money. In the same way that Phil released the source code to the world, Satoshi published the source code for Bitcoin. And once the genie is out of the bottle, there is no going back.
If we fast forward to today, certain truths and conclusions emerge. Bitcoin itself is not private contrary to what many say. Every Bitcoin transaction that has ever occurred is in plain view for the whole world on the Bitcoin blockchain. Not only is Bitcoin not private, it is not even anonymous. Many criminals have been identified and apprehended because they did not understand this fundamental fact about Bitcoin (and virtually all of the cryptocurrencies that are functionally similar like Dash.)
In fact, a new term came into use to describe what Bitcoin brings to the arena of privacy vs. security: pseudonymous. This flows from the idea of using a pen name or pseudonym to write a book or article. Not really private and not really anonymous either. Most of the projects and people involved with the cryptocurrency industry just want the same amount of privacy that anybody with a bank account expects. Without a warrant from a judge, random strangers are not allowed to look at your bank accounts and financial activity. This does not seem unreasonable.
Of course, the cat and mouse game of finding some functional balance between security and privacy never stops. People discovered that there were clever ways of taking Bob’s Bitcoin and Susan’s Bitcoin and mixing them all together before sending them to the recipient Alice. Once mixed, it is really complex to tell who gave what, and to whom. There are many such mixing services available, including the Dash mixing service called CoinJoin.
This is where the story gets very serious for Dash and other similar crypto projects. Bitcoin is not considered a privacy coin and is available on virtually every crypto exchange and in virtually every country in the world. Dash is no more private than Bitcoin.
Other crypto projects that emphasize “always on” privacy like Monero have been banned in a substantial number of countries and crypto exchanges. Also, several large crypto exchanges can identify Bitcoin (which is not private) that has gone through a mixing service like Tornado Cash, CoinJoin or Bitcoin Fog (and has now become private). They describe this as “tainted Bitcoin” and will not accept it. Other exchanges are less discriminating. But Dash has been censored and removed from some exchanges because it could be sent through a mixing process.
Governments will continue to attempt to stop the spread of unbreakable privacy in financial transactions and communications. Based on history it will almost certainly be clumsy and intrusive and it will probably get ugly. There will be mistakes, tragedies and so on.
But in the long run, none of that will change the outcome. It is a 100% certainty that they will fail to stop cryptographic based privacy for the masses. It is the same kind of certainty that once gunpowder was discovered, it would inevitably lead to the development of guns, cannons and bombs. No law, no effort, no crackdown (no matter how severe) and no government can stop it.
- Neither Bitcoin nor Dash are private. In fact, people who use Bitcoin and Dash have less privacy than you have and expect at your bank. It does not seem unreasonable or nefarious that people who use cryptocurrency would want at least the same kind of privacy that they would get at any bank.
- Anything that is done to tighten regulations on banking or cryptocurrency will substantially harm the 1+ billion people in the world who have little or no access to normal banking services.
- Increasing regulations will harm the unbanked substantially, and based on the enormous regulatory bureaucracy of the banking system, will not substantially reduce financial fraud or money laundering.
- Regardless of what the governments of the world do about it, unbreakable privacy for financial transactions and communications is inevitable.