Dec 14, 2020 • 9M

KYC and AML Help Bad Actors, Instead of Good Actors

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Anthony Pompliano
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This installment of The Pomp Letter is free for everyone. I send this email to our investors daily. If you would also like to receive it every morning, join the 95,000 other investors today.


To investors,

News broke yesterday that a foreign government has been sponsoring an elaborate scheme to gain access to some of the most sensitive government communication and information. While some of the details are still unknown, it is clear that this activity should cause concern for every American citizen.

David Sanger of the New York Times summarized the situation with the following:

“The Trump administration acknowledged on Sunday that hackers acting on behalf of a foreign government — almost certainly a Russian intelligence agency, according to federal and private experts — broke into a range of key government networks, including in the Treasury and Commerce Departments, and had free access to their email systems.

Officials said a hunt was on to determine if other parts of the government had been affected by what looked to be one of the most sophisticated, and perhaps among the largest, attacks on federal systems in the past five years. Several said national security-related agencies were also targeted, though it was not clear whether the systems contained highly classified material.”

Sanger later went on to explain that this cyber attack could have been underway for a number of months before it was detected:

“The motive for the attack on the agency and the Treasury Department remains elusive, two people familiar with the matter said. One government official said it was too soon to tell how damaging the attacks were and how much material was lost, but according to several corporate officials, the attacks had been underway as early as this spring, meaning they continued undetected through months of the pandemic and the election season.”

This development reminded me of an incredibly detailed investigative report that I read back in September 2020. The report was titled The FinCen Files and was put together by Jason Leopold and his colleagues at BuzzFeed News. The explosive article starts with the following:

“A huge trove of secret government documents reveals for the first time how the giants of Western banking move trillions of dollars in suspicious transactions, enriching themselves and their shareholders while facilitating the work of terrorists, kleptocrats, and drug kingpins.

And the US government, despite its vast powers, fails to stop it.”

This may not be a complete surprise to many people, but the next part is even more damning.

“Laws that were meant to stop financial crime have instead allowed it to flourish. So long as a bank files a notice that it may be facilitating criminal activity, it all but immunizes itself and its executives from criminal prosecution. The suspicious activity alert effectively gives them a free pass to keep moving the money and collecting the fees.

The Financial Crimes Enforcement Network, or FinCEN, is the agency within the Treasury Department charged with combating money laundering, terrorist financing, and other financial crimes. It collects millions of these suspicious activity reports, known as SARs. It makes them available to US law enforcement agencies and other nations’ financial intelligence operations. It even compiles a report called “Kleptocracy Weekly” that summarizes the dealings of foreign leaders such as Russian President Vladimir Putin.”

So whether you are talking about the US Treasury and Commerce departments, or FinCEN, it is becoming abundantly clear that the US government is creating honeypots of data that are acting as prizes for malicious actors.

The thought process goes like this — government organizations are collecting billions of data points on people and organizations in an effort to prevent or solve crimes. The problem is that they are doing a fantastic job of collecting the information, but they’re not doing a good job of stopping majority of the illegal activity. In fact, you could easily argue that governments are collecting so much data that it is actually making them more ineffective, rather than more effective.

The Institute of International Finance and Deloitte LLP actually wrote a white paper on this exact topic, including the following:

“It is a truism to state that that the SARs (Suspicious Activity Report) regime presents challenges to both financial institutions and law enforcement. A significant number of SAR disclosures made to law enforcement are assessed to be of limited intelligence value or are of poor quality. Processing high numbers of low-quality reports which do not improve the investigation of criminal activity diverts already limited FIU resource and is ineffective in driving law enforcement outcomes.”

Think about this for a second. The US government, along with financial institutions and other nation states, have been gathering so much information that they can’t find the high quality information because it is buried in a plethora of low quality information. Pretty scary to think about.

Now many of you are probably wondering why I am writing about cyber attacks and Suspicious Activity Reports, right?

These interconnected situations are directly related to the recent rumor that the US Treasury Department is going to pursue regulation that would requirefinancial institutions to verify identities of recipients and senders for transactions involving self-hosted crypto wallets or wallets that are not provided by a financial institution or service. Examples of such wallets include hardware wallets or a wallet running on a user's computer.

If this legislation was to be adopted, governments around the world would be collecting more and more data, but not actually becoming anymore effective at stopping illegal activities. I’m not the only one who believes this either. Jai Ramaswamy, who was previously Chief of the Asset Forfeiture & Money Laundering Section of the Department of Justice’s Criminal Division and the Global Head of AML Compliance at Bank of America/Merrill Lynch and the Head of Enterprise Risk Management at Capital One, wrote in an op-ed for Coin Center:

“Personal crypto transactions seem to marry the benefits of cash with the convenience of an electronic payment, but without either the physical constraints of the former or the risk controls imposed on the latter. This has led some to describe unhosted wallets as a personal Swiss bank account enhanced by the global reach of the internet—the very same danger which the global standards created by FATF over the past 5 decades was intended to address. Policymakers fear that full maturity of these decentralized protocols could foreshadow a future without financial intermediaries, which would significantly inhibit law enforcement’s ability to identify, prosecute and otherwise disrupt illicit financial networks in an environment when the effectiveness of these tools is already being challenged.

There are however strong reasons to believe that the opposite is true—that personal crypto transactions pose less illicit finance risk than commonly believed. Unhosted wallets are more like a personal billfold than a Swiss bank account; and unlike cash, crypto-assets are not legal tender, and thus still not universally accepted for goods and services in the real economy. While there are some exceptional circumstances such as hyperinflation or severe currency devaluations that allow crypto-assets to take on some of these attributes in specific regions, or “darknet” markets where illicit goods and services are priced and paid for in crypto-assets, these are unlikely to lead to wholesale and global changes in consumer behavior. Practically speaking, even illicit actors—much like legitimate businesses or individuals—must eventually convert between crypto assets and local fiat currencies to meet basic needs and run their operations. One could theoretically imagine a world where crypto assets serve this purpose, however that future remains uncertain and remote—a reality that is all too apparent to entrepreneurs launching crypto-projects, who daily contend with the challenge of achieving organic growth without deep and liquid fiat on and off ramps. Indeed, an important reason for Bitcoin’s continuing market dominance despite proliferation of other crypto-assets over the past decade, as well as the increasing market share of fiat-backed stablecoins, is ready convertibility to fiat currency through regulated intermediaries.”

Ramaswamy went on to then summarize his point beautifully when he said:

“Perhaps most importantly, policymakers must come to terms with a technological shift that is driving the rise of decentralized blockchain protocols. Those changes have the potential to transform the architecture of the internet, collapse the distinction between communication and settlement of value on networks, and rewire some of the ways we think about financial services, particular in driving financial inclusion. Critically, these are primarily technological advances that give rise to financial innovations, and thus policymakers seeking to prohibit or restrict their development and use would be wise to heed King Canute’s warning about the futility of stopping the ocean’s tides from rising. A sober review of the technology explains why such efforts are bound to fail and will only serve to undermine rather than enhance efforts to detect and disrupt illicit financial activity.”

It may be counterintuitive at first glance, but the United States and their peers would be better off resisting the urge to regulate Bitcoin and cryptocurrency transactions. We have already seen the ineffectiveness that exists when we collect as much information as possible, while also drastically violating the financial privacy of hundreds of millions of people. Additionally, governments will merely be creating new honeypots of information that will likely get stolen by nefarious adversaries.

There is a balance between stopping illegal activity and conducting security theater. Just as the TSA practices at an airport are proven to be rather ineffective, the KYC/AML practices of legacy organizations leave much to be desired as well. Instead, our government should be focused on embracing this technology, driving innovation further so we can be the greatest beneficiary, and working intimately with industry leaders to create an environment that allows for financial inclusion, while also deterring malicious behavior.

Let’s hope we have people in positions of power and influence with the courage to do the right thing. Hope each of you has a great start to your week. I’ll talk to you tomorrow morning.

-Pomp


This installment of The Pomp Letter is free for everyone. I send this email to our investors daily. If you would also like to receive it every morning, join the 95,000 other investors today.


THE RUNDOWN:

Fidelity’s Custody Business Around Bitcoin ‘Incredibly Successful’: Fidelity Investments CEO Abby Johnson says the mutual fund giant’s custody business around bitcoin has been “incredibly successful” and has a “tremendous pipeline.” In an interview with Barron’s, Johnson noted that developments in the sector are moving so rapidly it’s hard to keep track of them all and said that things that have long been talked about in the sector are now starting to become reality. Read more.

Bitwise Crypto Trust Jumps 72% Since Debut While Market Sags: The Bitwise 10 Crypto Index Fund has vaulted more than 70% since its debut Wednesday, the latest sign of an insatiable appetite for risk assets in global financial markets. The fund, which is listed under the ticker BITW, jumped about 23% to $44.75 on Friday, bringing gains since its over-the-counter trading kick-off to 72%. About 565,000 shares have changed hands daily on average over that period. Meanwhile, the Bloomberg Galaxy Crypto Index slipped about 3% during the same timespan. Read more.

Sweden Explores Moving to a Digital Currency: Sweden’s government will start exploring the feasibility of having the country move to a digital currency, marking another step into the unknown for the world’s most cashless society. Per Bolund, financial markets minister, said a review launched on Friday is expected to be completed by the end of November in 2022. Anna Kinberg Batra, a former chairwoman of the Riksbank’s finance committee, will lead the inquiry. Read more.

Saylor Hits Back at Claims MicroStrategy’s Bitcoin Trove Makes It an ETF: No matter how it looks, swims or quacks, if the law says it ain’t a duck, then it ain’t one – The Michael Saylor Guide to Waterfowl Identification. No, to our knowledge, Saylor, CEO of business intelligence firm MicroStrategy, has not written any such guide. However, if he did so, one can imagine an entry like this upending the famous “duck test” of observed reality that the poet James Whitcomb Riley is believed to have coined. Read more.

Roblox Delays I.P.O. Until Next Year: Roblox, a gaming company that had been preparing to go public this month, has decided to delay its initial public offering until next year, in a sign that the enthusiastic market for I.P.O.s by DoorDash and Airbnb this past week has made it difficult to price shares accurately.Read more.


LISTEN TO THIS EPISODE OF THE POMP PODCAST HERE


Christian Angermayer is the founder and CEO of Apeiron Investment Group, which serves as his family office. Christian has previously built and invested in numerous multi-billion dollar companies.

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