Bitcoin and Mallory 1

Mostly from Pieter Hintjens’ book: Culture and Empire, with some minor additions and edits for context.

He who controls the gold makes the rules, and anyone who wonders what might happen to new virtual currencies like BitCoin would be wise to read history. The independent banking sector, cash economy, and virtual currencies are not friends to the Spider, thus they are its enemies. If this was not clear before September 11th, it certainly became clear after that. However, we’ll start our money story a few years before 9/11, in the last years of the twentieth century, as governments of the West started to crack down on cash transactions and banking secrecy.

It used to be that you could walk into almost any bank in Europe a check, or cash, and open an account under an assumed name, without ID. “Can I open an account?” “Yes, certainly. Do you have identification?” “No, though I do have this check.” “That’ll do nicely, sir.”

This was a cross-border specialty. For decades, Germans seeking to avoid the high taxes of their country could hop over the border to Austria, open an anonymous numbered account, and put undeclared cash income there. High taxes and old laws left Europe littered with convenient little tax havens: Andorra, Monaco, Luxembourg, Jersey, Malta, Liechtenstein. Even Belgium welcomed tax refugees from the Netherlands, as did Germany from Austria, and Switzerland from anywhere in the world and especially from corrupt foreign dictatorships.

Anti-money laundering (AML) regulations ended such liberties. Ostensibly, the purpose was to catch drug traffickers, by requiring identification for any transaction, and justification for any transfer over $10,000. The real goals were more likely to break the cash economy, stop tax evasion, and allow authorities to correlate banking information across Europe. The real payoff for the banks was increased cash flow.

Arguably though, a single currency and the single European market makes money laundering easier, not harder. Drug money of course didn’t stop flowing in the 1990’s, and it doesn’t take a genius to see how to get around the AML controls.

Say a street dealer sell drugs — sugar-coated croissants, perhaps — in Paris for EUR 1 million in undeclared cash. He drives with this dirty cash in a bag to Vienna, then hops across the border to Bratislava, the capital of Slovakia, famous for its investor-friendly business climate. There he starts a new small high-cash business on paper, say a fashion shop or nightclub. He rings up lots of transactions and creates EUR 1.00 million in new profit. He pays taxes on that, at the flat rate of 19%, after a deductible of EUR 500,000 investment bonus (which cost him only EUR 2,500 in a large envelope).

He now has around EUR 900,000 of clean money, which he wires to his holding company in France, as an “Indefinite business loan.” His French company invests that money in real estate on the Riviera. He does this for a couple of years, then closes his Slovak operation, and starts again in the Czech Republic.

I’m not an expert in international finance, and this is a simple scheme. Slovakia, incidentally, ended its flat tax rate in 2013, and is most definitely not run by crooks. A more elaborate model would use management service fees, patent and trademark licenses, not-for-profit holdings with an educational mission, multiple entities in different jurisdictions and so on. With a little care one could make a net loss every year on gross profits of billions of laundered money. Note clearly that I am not suggesting you do this. It is a theoretical exercise.

My point is to show that stopping the cash economy does nothing to reduce large-scale criminality and tax evasion. It just ensures the large banks will keep more of the cash flows involved. When the banks do get caught breaking those AML rules on real drug money, they are slapped on the wrist for getting caught, and told to behave. In 2011, “Wachovia, accused of laundering about $378 billion from Mexico and facing U.S. criminal charges, got off by paying a $160 million fine,” reported the El Paso Times.

Built for Terrorism

The September 11th attacks and the PATRIOT Act gave the Spider the tools to crack down on independent bankers. The first targets were the Hawala networks, a traditional Muslim system of money transfer based on trusted brokers. The Hawala networks transfer cash from US and Europe to conflict areas like Somalia, which was considered a hot bed of Islamic fundamentalism after the 1998 attacks on the American embassy in Nairobi, and Pakistan.

The correlation of the Hawala networks with conflict zones was enough to justify action against them. In 2001, after 9/11, the US came down hard on the al-Barakat group, calling them “the quartermasters of terror.” TIME magazine shouted, “A Banking System Built for Terrorism”.

In 1991, Somalia saw the exodus of its dictator, the collapse of its formal economy, and a long civil war driven by clan rivalry and inflamed by interference from its larger neighbors Kenya and Ethiopia. The country suffered massive emigration, like Lebanon before it. The stuttering economy depended on groups like al-Barakat for banking and telecommunications and above all, Hawala money transfer. Even into 2013, $2 billion, more than a third of the country’s GDP came as remittances from diaspora communities around the world.

Claiming that al-Barakat financed the attacks on the twin towers and Pentagon, the Spider smashed the company, and hunted down its executives, worldwide. As Wikipedia relates, “several of the captives held in extrajudicial detention in the Guantanamo Bay detainment camps in Cuba are held because Joint Task Force Guantanamo (JTF-GTMO) intelligence analysts asserted they had some kind of connection to al-Barakat.”

After long investigation however, it turned out that al-Barakat was innocent of funding any kind of terrorism. The 9/11 Commission found no evidence of the claims against Al-Barakat. In August 2006, Al-Barakat was removed from the terror watchlist. It took until 2009 to free two Somalis, held for their ties to Al-Barakat, from Guantanamo Bay, and only in early 2012 was the case closed by the UN Security Council.

Millions of Somalis are still waiting for their frozen money back. As far as I know there was never an apology for this, or any kind of change of policy. The Hawala networks are still considered a “threat” in official language, and the UK government implemented the European Union Payment Services Directive (a Europe-wide law) in 2013, forcing Hawala networks to register, or cease operations. Barclays Bank, the last bank to allow accounts to be used for Hawala work, closed them in October 2013.

Attack of the Regulators

Hunting down small independent bankers on trumped-up “financing terrorism” charges lost its charm when Guantanamo Bay got full. It’s not clear there is any constitutional argument against creating virtual currencies, nor against accepting money from one person to hand over to another. Indeed, this has never been cited as an offense.

Rather, the offense is framed as “operating without a money transmitter’s license.” It is on this basis that the UK government is still cracking down on Hawala networks. The first major use of this tactic against a virtual currency was in 2009, against e-gold. In March 2013, the US Treasury Department’s FinCEN (Financial Crimes Enforcement Network), issued these guidelines:

FinCEN’s regulations define currency (also referred to as “real” currency) as “the coin and paper money of the United States or of any other country that [i] is designated as legal tender and that [ii] circulates and [iii] is customarily used and accepted as a medium of exchange in the country of issuance.” In contrast to real currency, “virtual” currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction. This guidance addresses “convertible” virtual currency. This type of virtual currency either has an equivalent value in real currency, or acts as a substitute for real currency.

And, in that same document, FinCEN stated explicitly that: “administrators and exchangers of convertible virtual currencies are money transmitters.”

Later in 2013, the government turned its attention toLiberty Reserve, a digital currency business based in Costa Rica. The Guardian reported said, “Liberty Reserve appears to have played an important role in laundering the proceeds from the recent theft of some $45 million from two Middle Eastern banks. The complaint against one of the Dominican Republic gang members allegedly involved in the theft states that thousands of dollars’ worth of stolen cash was deposited into two Liberty Reserve accounts via currency centres based in Siberia and Singapore.”

As Wikipedia reports, “the indictment charges the seven principal employees, as well as Liberty Reserve itself, with money laundering and operating an unlicensed money transmitting business, and seeks $25 million in damages. The charges were leveled using a provision of the Patriot Act, since Liberty Reserve was not an American company.”

Perhaps I’m just numbed, yet the theft of $45 million seems small peanuts when shutting down a network with a million users, handling over $6 billion since 2006. And the story of Dominican Republic gang members flying to Siberia and Singapore to deposit literally thousands (yes, thousands) of stolen dollars seems straight out of a poor Hollywood script. Way too much precise yet irrelevant detail. Not to mention extraditing foreign citizens for breaking US laws outside of the US. Has the world accepted the role of the US as global policeman, enforcing its own laws anywhere it choses?

Liberty Reserve allowed anyone to create an account without identifying themselves, hence the money laundering accusation. They held funds on behalf of others, hence the “money transmitting without a license” charges. However, I suspect the real reason they were taken down was simply because they refused to give the Spider access to their servers.

Does the Spider ask operators of underground virtual currency exchanges to cooperate? We won’t know for sure unless there is a leak, though we do know that the owner of Lavabit, an encrypted email provider, shut down his service in August 2013 rather than “become complicit in crimes against the American people.” It turned out the FBI had been demanding secret keys from him, with a gag order to stop him talking about it. So it seems fair to assume that the Spider puts pressure on many firms, including US-based BitCoin exchanges.

FinCEN has stated that anyone buying or selling BitCoins for profit (even in tiny amounts will need a license. This includes BitCoin miners, who are key to the BitCoin network, since they process transactions. In May 2013, the largest BitCoin exchange, Mt. Gox, a Japanese business, had its US accounts seized by the Department of Homeland Security, another of the Spider’s many arms, for operating without a money transmitter’s license.

Getting the proper licenses in the US is complex. As Faisal Khan writes, “By varying estimates it will cost an organisation almost US$75 Million in security deposits/bonds and about a 18-24 month process before you are granted a license for each state.” As well as state licenses (covering the whole country), you may also need a federal license.

Despite the cost and the uncertainty, several BitCoin exchanges are starting to get licenses. BitInstant claims tobe licensed in 30 US states. In Europe, Bitcoin-Central is licensed in France, allowing it to operate across the European Union.

How will the Spider deal with BitCoin? It’s a question that many who have invested in BitCoin think about, at 4 A.M. when they wish they were sleeping. Clearly the digital currency presents some real headaches to the Para-state. If it does emerge as a viable decentralized currency with sufficient mass, the whole fight against e-gold, Hawala networks, Liberty Reserve, and such, was for nothing. Yet if the currency is crushed too soon, we’ll see the Dangerous Young Men effect. Cut down one Napster, and a dozen spring up in its place.

Better, the Spider calculates, to buy time and find a way to control BitCoin, and make a profit from it. BitCoin is a surprisingly strong model in some ways, yet it still has several vulnerabilities. It will depend on exchanges for converting BitCoin to other currencies until it gains (if it ever does) a sufficient internal market. BitCoin transactions — the blockchain — are essentially public, and it’s been shown that you can tie transactions back to individual identities.

Lastly, and most importantly, the whole system depends on a distributed network of “miners,” who recalculate transactions, and in the process generate new BitCoin. BitCoin depends on its miners to remain honest. If an attacker controls 51% or more of the miners, they can generate bogus transactions and crash the currency.

The cost of a so-called 51-percent attack is estimated at about $500 million, as I write this, the military budget of Slovenia or Cyprus. It’s still well within reach of the Spider and even if the dangerous young men rallied in huge numbers, they might not be able to save BitCoin from a serious attack. I’d rate the chances of a 51-percent attack as “fairly likely” within the next 3-5 years. However it would probably be possible to counter such an attack by blacklisting offending machines.

What we will see instead is, I think, increasing persecution of BitCoin users, miners, and exchanges in the US, with the message that “BitCoin is favored by cybercriminals and money launderers.” Perhaps some arrests to underscore the seriousness of the accusations. Then, tolerance of a few exchanges, allowing one or two to dominate the market and create a cartel. These will be the ones providing data live to the Spider, as the phone companies and large Web businesses do today. Finally, a series of attacks, from mild to shocking, on the currency when the critical number of black hat miners is reached.

If the BitCoin network survives the different attacks that seem inevitable — and I give it a 50-50 chance of surviving — the crypto currency will get a natural monopoly for on-line commerce. At a certain point buying or selling BitCoin for dollars or Euros will not be so important: people will simply hold and spend BitCoin. If the network does not survive the attack, the currency will die, and other crypto-currencies will take its place. Either way, the Spider will lose this particular fight, and the Para-state will eventually (it may take decades) find itself facing a truly independent financial system.

Licensed to Make a Killing

When I see sustained, multilateral action against systems as organic and valuable as Hawala and BitCoin, my first response is to slice up the official story and look for the lies. The second step is to look for the truth, outside the official tales. And it’s almost always about money, profit, someone’s private benefit.

While the independent money transfer industry was being closed down, other firms grew very large and profitable. One in particular has become a global leader. You will see the yellow and black “Western Union Money Transfer” signs in hundreds of locations in most cities. Western Union is an old firm, familiar with monopoly power. In 1987, having lost its monopoly over telecommunications, it entered a twenty-year restructuring that ended with a new Western Union emerging in 2006, focused on consumer-to-consumer money transfers.

It is simple to see the difference between a monopoly and a cartel in any given market. First, you look at prices. Second, you look for competitors. If the prices are higher than they should be, and there are competitors, you see a cartel. If the prices are higher than they should be, and there are no competitors, you see a monopoly.

Let’s look at the cost of sending money using Western Union. tells us, “The cost of sending money from New York to London in UK cost 13.32 pounds for every 100 pounds.” When you send money to a developing country, the cost is higher. You also pay in expensive “0% commission!” currency conversions, so the real cost can be as much as 20%. This is extraordinary, given that no money is actually being sent anywhere. It’s just electronic messages. The biggest cost is probably the paper form one has to fill in, and the front office that types it in, and takes a copy of your ID “for security purposes.”

Now let’s look at competitors. The largest competitor to Western Union is MoneyGram International, one tenth the size. There is a mathematical “power law” called Zipf’s Law that models the distribution in natural systems such as free markets, earthquakes, cities in a country, and words in a language. Yes, all these follow the same rules of distribution. Normally, you’d expect the largest firm to be twice the size of its next competitor, three times the size of the one after, and so on.

The data shows that Western Union, too large and too costly, has a monopoly over the money transfer market. In 2011 alone, Western Union added 7,500 points of sale by buying the Angelo Costa group for $200 million. It thenbought Travelex’s payments division for $976 million in cash, giving it another 950 stores and 450 ATMs in Europe. Then it bought Finint, giving it 10,000 locations across Europe. Western Union did not say how much they spent on this acquisition.

And MoneyGram, though it appears to be a competitor to Western Union, is according to Wikipedia in fact operated by Western Union since 2006. I could find no other reference for this so it may be more or less accurate.

Usually it’s the job of the government to stop firms getting monopoly positions or creating cartels. They do this by blocking the merger or acquisition of competitors by the market leader. However when a government does nothing, monopolies can form quite rapidly and smoothly. The market sees nothing except the suspension of cost gravity.

One wonders why and how Western Union was given a blank check to gobble up its competitors and create a global monopoly. One might also wonder if the heavy handed crackdowns on informal — and cheap — money transfer systems is connected to WU’s growth. According to the American Bar Association, the 2000-08 Bush administration filed the lowest number of anti-trust cases per year of any administration since 1948 (their earliest figures).

However, WU’s rise to power seems more crispy, more tasty. It smells interesting, and not just because it’s essentially all about money. Remember that part about copying your ID every time you send money? I think what WU is building is something akin to a Facebook for the Undocumented.

The money transfer business is a global map of every brown or black-skinned diaspora migrant who has money and sends it home. A map of who they talk to, who they trust, overseas. A database of senders and receivers of lucre, heads of families, chiefs of villages, people of influence of many colors. This is, I suspect, what Western Union is compiling, because it’s possible, and it’s part of the Spider’s “know everything about everyone” obsession.

Is it accurate and prudent to suggest that Western Union is working hand-in-hairy-leg with the Spider? This is something I’d have to ask my lawyers. However, in his book “The One Percent Doctrine: Deep Inside America’s Pursuit of Its Enemies Since 9/11,” Ron Suskind writes about a meeting between the FBI, CIA, and Western Union at CIA headquarters:

[FBI official] Lormel talked about what a good friend Western Union has been since 9/11. Nervous Phil [a CIA pseudonym] talked a bit about what might be done going forward. Western Union had twelve thousand offices across the globe, thirteen hundred in Pakistan alone. There was no country more important in battling the terrorists.

Everyone nodded, a show of consensus, until one of the Western Union executives had something to say. He looked at Tenet. “Here’s my concern,” he said. “If it seems that Western Union is a global front for the CIA, we’ll go out of business.” Tenet leaned forward in his chair and dropped his ace. “I know we’re asking a lot,” he said. “But this country is in a fight for its survival. What I’m asking is that you and your company be patriots.” After that, it was all about logistics.

One comment on “Bitcoin and Mallory

  1. Pingback: Nice try Mike Hearn, but Bitcoin is just fine - Gareth Hayes

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