DOJ Cryptocurrency Enforcement Framework

Recently in late 2020 the DOJ released a DOJ framework on “crypto” or digital assets enforcement. Unpacking the recent DOJ on digital asset enforcement results in some needed and helpful insights and concepts and quickly lines out the regulatory Hobson’s choice. The choice presented is stark. Either be with us or against us.

Basically the DOJ has a tough job to do. The DOJ framework is a guide on how to protect America from “Baddies”. Loosely defined as terrorists, child pornographers, drug dealers, human traffickers and rogue states. I will call them Baddies not to belittle the threat, or even to minimize the enormity of the job and threat they pose, but just as a simple all encompassing category of bad actors. Baddies are the enemy, the cancer, the part of society or the world that is the antithesis of society. Much like chemotherapy as a remedy to cancer, the treatment prescribed by the DOJ also sickens and kills healthy cells, fighting a scorched earth war against Baddies damages our own liberal ideals and sensibilities as well.

Much of the commentary to date has been on parsing the definitions of VASPs, AEC’s and money transmitters, and ultra legal definitions for each defined roll these functions have in our monetary system. That is helpful guidance to be sure. But what I see, and what concerns me more, is when the picture zooms out. When zoomed out, the stark Hobson’s choice is presented and the clear authoritarian “nudge” revealed. A state sponsored and global nudge to mandate, shape and mold behaviour that the nation state is comfortable with. That makes their regulatory job easier and with much more powerful tools in the “law and order” toolkit.

What is “nudge” theory? To learn more about the “nudge” there are plenty of examples, but I will start with that of Ben Hunt, from Epsilon Theory fame. The example he uses persuasively is “smiley faced authoritarianism” in the essay Clever Hans. “The secret to smiley-face authoritarianism is a choice architecture that presents a Hobson’s Choice as the most natural thing in the world.” The DOJ Framework focuses on some clear areas of concern which are paraphrased as follows:

Anonymity enhanced cryptocurrencies “AEC’s”

“Other cryptocurrencies, however, use non-public or private blockchains that make it more difficult to trace or to attribute transactions. These are often referred to as “anonymity enhanced cryptocurrencies” (“AECs”) or “privacy coins.” Examples of AECs include Monero, Zcash, and Dash.” Pg 4

The Mission

“Whatever the overall benefits and risks of cryptocurrency, the Department of Justice seeks to ensure that uses of cryptocurrency are functionally compatible with adherence to the law and with the protection of public safety and national security” Pg 5 Very broad mandate indeed.

The Risk — AEC’s, Mixers, tumblers, and chain hopping.

Mixers are like putting your name in a hat, but with money

“Mixers” and “tumblers” are entities that attempt to obfuscate the source or owner of particular units of cryptocurrency by mixing the cryptocurrency of several users prior to delivery of the units to their ultimate destination.” pg 41 Mixers, at least the decentralized version, are basically trusting a smart contract to provide privacy and break or damage the trackable chain of transactions that become apparent on tools like ethtective.com. Public blockchains are very public which is a sword and shield.

The Pressure Points

“Websites or companies offering mixing or tumbling services are engaged in money transmission, and therefore are MSBs subject to the BSA and other similar international regulations. In addition to facing BSA (Bank Secrecy Act) liability for failing to register, conduct AML procedures, or collect customer identification, operators of these services can be criminally liable for money laundering because these mixers and tumblers are designed specifically”

Your nuts on mixers

So maybe it isn’t so much as a nudge, but an actual threat. More of a nudge with consequences. Clearly the DOJ report is making it clear that digital assets, custodians, banks, people, corporations, etc. which touch coins that touch mixers are going to be in the crosshairs. See how impactful SmileyFace ? persuasion can be?

It is clear that the DOJ has a mission to protect its citizens from enemies and criminals. It is indisputable that Baddies may use these networks to do bad things. OK noted, bad people do bad things. There are better, easier and more obscure ways for Baddies to do bad things. As pandemic research, one should watch all episodes of Breaking Bad, Homeland, and Ozark, and many other Netflix dramas and conclude that bad people are capable of doing bad things without “privacy” coins. The clear choice given is the Hobson’s choice between being with us, or with the Baddies.

The central plot of Watchmen is that the world’s smartest man saves humanity from itself by tricking us into choosing a peaceful set of behaviors. This is the pure expression of Nudge. This is the pure expression of smiley-face authoritarianism. By the way, Adrian Veidt is also the world’s richest man.”

But if you have nothing to hide…

The go to argument for many seems to be “if you have nothing to hide” then:

let me look in the trunk
search your backpack
unlock your iphone to crawl through all your data
mine your Facebook social graph
your library card
Citibank transaction history
Verizon call records.

Not subjecting oneself to a search does not make one a criminal. That dispute was settled when some colonists rebelled from their authoritarian regime and they came together to draft a set of rules and laws that are meant to protect the people from said overreach. Yes, the Constitution of the United States. As Patrick Henry said his powerful words, “Give me Liberty, or provide a bubble wrap safe environment to protect me from all possible harms. (emphasis added for satirical impact)”

There is much anger that is current and fresh. Some of the anger is difficult to pinpoint the cause or precisely define. But here is a video example of the dehumanizing and, by all appearances, completely unnecessary search done on a man in Hollywood. The overreach and anger become meshed as people feel the need to either become docile and submissive to stop and frisk, and racial profiling, etc or demonstrate anger. The Breonna Taylor tragedy is one of incompetence, false information being presented to issue no knock warrants with obviously tragic and deadly consequences. The Universal truth is that humans lie, cheat and steal. Even those in charge of judging and policing. Judge worried that detective lied to obtain warrant. A common thread is a human desire to be treated fairly and humanely by the state. In other words, there is an indignity to treating everyone as if they are a criminal, especially when they are acting in a decent and humane manner. To bring this essay back into its lane, the regulatory Hobson’s choice is one of security over privacy.

Choose your lane wisely

As a mental model, picture a three lane highway. The lanes are color coded red, green, and yellow. Early on, all users of the lanes are merrily zipping along. The red lane has privacy windows and they are tinted. Nobody can see the person that is traveling in that lane. The green is the fastest, has no privacy, but has no checkpoints either. The yellow has no privacy, but has a number of checkpoints and screenings.

If there is a Baddie trying to get from Point A to B, it is presumed that they will choose whichever lane is fastest and gives them the least chance for hassles. For Baddies law enforcement is a friction cost. Is the Baddie better at breaking shipments into 1 large transaction or a bunch of small ones, etc? In a market sense, law enforcement just reduces the number of willing market participants and drives up costs and perversely can lead to higher contraband profits for the defector.

Now imagine that law enforcement can’t actually pull the Baddies over in the lane they are traveling. Basically, their recourse is to be caught in the act prior to traveling or after. Also assume the ‘SmileyFace ? Authority’ states that the red lane, because it is “private” and the windows are tinted, is a haven for Baddies. That they can’t do anything to the people traveling in the red lane. But ANY travelers on that lane will be tracked. They will be searched when they get out of the lane, they will be frisked at the grocery store, and detained at the bank, or airport when they get there.

What happens after the SmileyFace Authority ? announces its intentions? The nudge will be successful at driving the honest actors away from the red lane. They won’t want to be profiled, detained and harassed. When given the Hobson choice of being associated with honest folks or the Baddies, they will willingly give up their privacy. Ironically, giving up their privacy exposes them to both Baddies and law enforcement willingly, as they want to avoid the trouble and the stigma. The Baddies won’t really care. They will continue to use the red lane if it suits their interests as they will just blend in with the crowd before and on exit, or use the other lanes, etc. So basically, the nudge of the SmileyFace ? https://geembi.com/ Authority by its own action, can turn the “red” lane into one that is primarily trafficked by the Baddies. It is a self fulfilling prophecy similar to Jane Goodall changing the behaviour of the system she was studying by mere fact of her interactions with the primate system.

What is the best privacy solution for Baddies?

In the book Horse Soldiers about the war in Afghanistan.

“The CIA was doing its part, too. On September 19, paramilitary officer Gary Schroen loaded three cardboard boxes, each packed with $ 3 million in hundred-dollar bills, into an unmarked Suburban, and headed off to see his boss, Cofer Black, at CIA Headquarters in Langley, Virginia. The money was meant to bribe the Afghan warlords that the Special Forces troops were to work with — rough, mercurial characters with names like Abdul Rashid Dostum, Atta Mohammed Noor, and Mohammed Mohaqeq. For the past decade or more, they had fought each other for control of their country. Schroen would be flying to Afghanistan with the money that day, aiming to convince them to work together to kick the Taliban’s ass. He was doubtful of the outcome. You can’t buy an Afghan’s loyalty, he thought, but you sure can try to rent it.” {p. 37}

There is still no better privacy, untraceable coin than paper currency. This quote isn’t to weigh on the morality of the choices made above, but simply to bring light to the fact that the best untraceable bearer instrument in the world is likely the American Dollar. Why would the Baddies use a p2p mixer when they can rationally choose to use cardboard boxes of good old bearer instrument greenbacks?

In the near future, I would expect the nudge to turn to actually using digital assets and away from using paper money. Obviously things are moving fast in Covid era. With China, US and other countries announcing a digital currency in some form or fashion. India has already completed its “demonetization” plan. Basically passing a law that required the quick turn in and exchange of larger denominations before the paper money became worthless. It should also be mentioned that India has a robust biometric database. Blade Runner coming in fast. For more on digital dollarization and policy arguments refer to this great article by Nic Carter, The Crypto-Dollar Surge and the American Opportunity

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Special thanks to Adam J Kerpelman for providing comments and it should be made clear that the thoughts of LexDAO are not represented here. In fact, LexDAOism is a publication meant for arguments of all issues, pros and cons. Would love to have someone argue the counter points.

All links provided are for informational purposes only and not meant as recommendations of the people or products. Nothing herein is legal or financial advice and should not be relied upon without reaching out to your own personal attorney. The linked ABA disclaimer is appended to the blog.

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