The Breakdown - The Treasury Department's Latest Power Grab Has Global Ramifications

Episode Date: December 1, 2023

The US Treasury department is asking for more power to go after bad actors in crypto in ways that many people believe represents a massive overreach with likely negative consequences for the role of the dollar in the world. Today's Sponsor: Kraken Kraken: See what crypto can be - https://kraken.com/TheBreakdown Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, November 30th, and today we are talking about a power grab at the Treasury. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Well, friends, today we are discussing a fiery topic. The U.S. Treasury is campaigning for a massive expansion of power to crack down on bad actors using crypto.

So where did this come from? What have we heard about it and how is the community reacting? Well, in a lengthy proposal sent to the Senate Banking Committee, the Treasury presented a long list of legislative changes designed to expand its enforcement powers over domestic and international crypto firms. The Treasury is asking for a new category of secondary sanctions powers to be used against crypto exchanges that facilitate payments to terrorist groups. This would be broadly in line with how secondary sanctions are applied to traditional financial

intermediaries. Their next ask is to expand the definition of a financial institution under the Bank Secrecy Act to capture a wide range of crypto infrastructure. The proposal would include exchanges, wallet providers, validator nodes, and defy services. The change would make all of these pieces of infrastructure subject to know-your- client and anti-money laundering requirements. Third, is a request to create a new sanctions authority to allow the Treasury to apply sanctions to blockchain nodes and other elements of crypto networks. This appears to be a response to push back on the tornado cash sanctions, which were challenged

on the basis that autonomous smart contracts are not the property of anyone, so can't be the subject of sanctions. Finally, and this is a really big one, the Treasury is asking for clear, worldwide jurisdiction over U.S. dollar-backed stable coins. The proposal is explicitly, calling for Congress to give OFAC, the division of the Treasury which administers sanctions, the ability to, quote, exercise extraterritorial jurisdiction over transactions and stablecoins peg to the USD. This would mirror OFAC's existing ability to apply sanctions to international entities where US dollar infrastructure is being used for transactions. The big issue is that the U.S. government has very little claimed jurisdiction over blockchain infrastructure and even

less over internationally domiciled stablecoin issuers with no connection to the U.S. or U.S.-based customers. Tacked onto this part of the proposal is a request to clarify that sanctions in Bank Secrecy Act jurisdiction applies to international entities with, quote, U.S. touchpoints. Now, this is a massive expansion of extra jurisdictional power. The loosely defined term U.S. touchpoint seems to apply to all transactions conducted with U.S. dollar stable coins. This would functionally expand the Treasury's money laundering enforcement powers across the entire global crypto industry. Taking together, the last part of the proposal would require U.S. dollar stablecoin issuers globally to report suspicious activity to the Treasury and conform with

USKYC and AML requirements. It would also empower OFAC to apply secondary sanctions on any stable coin issuers that allowed sanctioned entities to transact using their tokens. Austin Campbell, the founder of Zero Knowledge Consulting and former head of portfolio management at Paxos, had extensive comments on the proposal, which he called, quote, the broadest expansion of power since the Patriot Act, and in a way that makes a mockery of some of the technical details of modern communication with the side benefit of probably causing major geopolitical conflict due to the overreach. Just in case you wanted to get a flavor for how he's thinking about this. Now, regarding the expansion of the Treasury's power to all U.S. dollar stablecoins worldwide, he wrote,

this is how you start a trade war, asserting U.S. jurisdiction over a U.S. dollar stable coin domiciled in a foreign nation, under the rules of that nation, custody debt banks in that nation, with no U.S. customers just because they use the dollar, this is not something we can do. This is a geopolitical declaration of war. You cannot just go to another country with a product there and say, because they used your currency, you control it. Nobody is going to stand for this. What are we doing here, people?

Austin continued, it's hard to describe how bad of a policy this is. Obviously, we should have this authority over U.S.-based stable coins, but asserting it over non-U.S.-based stable coins is wild. The main result of this would be to dramatically accelerate the move away from U.S. dollars in general, but especially U.S. dollar stable coins. Speaking to the proposal overall, Campbell wrote, A proposal this clumsy likely balkanizes the blockchain world, shutting the U.S. off from the rest of the world,

and probably ensures that the currency that will be used going forward on blockchain will be the euro or the yuan at the exact moment when the U.S. needs significantly more funding for our deficit. Oh, and it might create a genuinely horrifying dystopian surveillance state. Now, this proposal was presented by Deputy Secretary of the Treasury Wally Adiamo at the D.C. Policy Summit hosted by the Blockchain Association on Wednesday. He characterized the proposal as, quote, a set of common sense recommendations to expand our authorities

and broaden our tools and resources to go after illicit actors in the digital asset space. Adiamo said that, quote, we cannot allow dollar-backed stable coin providers outside the United States to have the privilege of using our currency without the responsibility of putting in place procedures to prevent terrorists from abusing their platform. A big part of the justification for the sweeping expansion of power was the need to update financial enforcement rules to account for emerging financial technology. Adiamo said, as terrorists and criminals innovate their approach to illicit finance, we need tools to be able to keep up with them.

While Tether was not named specifically as the likely target of these expanded powers, they were clearly present in the subtext. Adiamo said, while some have heated our calls and taken steps to prevent illicit activity, the lack of action by too many firms, both large and small, represents a clear and present risk to our national security. Adiamo referenced the Treasury's recent settlement with finance as an example of the need for new enforcement tools. He explained that the exchange was used by terrorists, drug traffickers, and perpetrators of sexual abuse across over 100,000 transactions. Of note, however, the Treasury's proposal referenced the now discredited Wall Street Journal reporting on the use of crypto by Palestinian terrorist groups, including Hamas.

That issue appears to have been adequately dealt with by a combination of blockchain analytics and existing enforcement powers, so much so that Hamas has now ceased using crypto to accept donations. That didn't stop Adiyamu, however, from hammering home the point with a chilling warning. He said, I want to directly address those within the digital asset industry who believe they are above the law, those that willfully turn a blind eye to the terrorists and rogue states. My message is simple. We will find you and hold you accountable. Now, in a post-speech interview with Twang V. Lei, the head of regulatory and policy efforts at Bain Capital,

Adiamo had little patience for any pushback. When Lai suggested that privacy technology being developed within the crypto industry requires permissive regulation that does not push innovation offshore, Adiamo rejected the notion, stating, when the largest crypto exchange has over 100,000 transactions that were being done by groups like Hamas and other illicit actors, clearly what is happening now doesn't work. Expanding on the topic, Adiyamo said it was time for the crypto industry to be proactive about preventing bad actors from using the technology. In the interview, he said, while you may be different, I do think that the industry needs to step up and take steps here, to think through what you're in for in terms of making sure that

you help work with government to prevent illicit finance, because oftentimes what I hear is the rules currently are unclear. Too hard to understand how they apply to us. We're open to working with you. We're open to talking with you about what we can do together. What we're not open to is the idea that the law should not apply to us because that doesn't work for you in terms of building an industry that is going to be respected and get capital flowing and doesn't work for us from the standpoint of protecting our national security. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best,

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Now, as you might imagine, the industry was not particularly thrilled with this aggressive proposal. Coin Center executive director Jerry Brito said the proposal contains, quote, some very interesting parts that if implemented would be counter to U.S. interests. He added, We understand Treasury's desire for tools to limit the abuse of crypto systems by enemies of the United States like Hamas, and we support efforts to appropriately fill legitimate gaps in law. And indeed, this is a very diplomatic version of the most common take within the industry, which is that many reasonable people recognize that there are challenges in the way crypto networks and firms deal with illicit finance, and that in fact there's generally

no real opposition to responsible expansion of existing laws to cover the crypto industry. However, the concern is that almost every single proposal from this administration has been presented as merely filling gaps in the law, while in point of fact masking a massive expansion of power, often with questionable justifications or legal basis. There's also the issue of tone. After the presentation, Adiamo tweeted, It was a pleasure to speak at today's Blockchain Association Policy Summit, where I focused on the steps we must take to prevent bad actors from using the digital asset ecosystem for illicit activity.

Masari's Ryan Selkis said, Adiyama called crypto a clear and present danger to national security to our faces, with no mention of his boss's open borders or pro-Iran policies, and is asking Congress for expansive new powers that extend the Patriot Act and further erode constitutional rights. I respectfully do not respect his quote-unquote respectful engagement with the industry, and there is only one solution. Vote them out in 2024.

A16Z General Counsel Miles Jennings wrote, Someone should do a series of iterative AI images that amplifies the never-ending expansion and gluttony of U.S. regulatory agencies with each successive image. And this is definitely a genre of takes that you can see on X slash Twitter right now, that this is such a brazen power grab that it's hard to even take it seriously. It's definitely clear from Adiyamo's post-speech interview that this isn't some misstep or misunderstanding. They are very, very focused on getting some serious new powers out of this deal.

Now, people like Austin Campbell are trying to thread the line. Discussing companies' responses to this, he said, this kind of proposal is why they are moving offshore. What keeps people onshore is a smart version of the best aspect of KYC and AML controls. For Austin, the big condition is that definitions are applied sensibly. For example, he's against requiring validators while it's an infrastructure to have KYC and AML record-keeping requirements, which just doesn't make sense for that type of actor. Now, another piece of this is that many feel like it has bigger implications that the Treasury

Department realizes. Oman Malikon, an adjunct professor at Columbia Business School, wrote, the U.S. government keeps betraying its desire to go full North Korea on financial surveillance and control. I know the latest proposals documents aren't just that, but they do betray a specific point of view and intent. What the feds don't seem to appreciate is that the message these proposals keep sending, however unlikely they are to pass, is America wants to tighten its grip on global finance. If it's true for crypto, then it's true for non-crypto, and that's a red flag for every other country on Earth. It calls into question the dollar status as a reserve

currency and makes everyone marginally more likely to adopt an alternative. The problem is that there is no other fiat currency that qualifies. But there is at least one non-fiat currency that does, not as a total replacement, but rather a form of diversification. So thanks for the Bitcoin ad, Uncle Sam. Now, to me, for sure, the thing that is most interesting about this is not just the aggressiveness of the proposal vis-à-vis the crypto industry. We know that Treasury has long been the biggest antagonist in the U.S. government against crypto, and so it's not particularly surprising on that front. I think what's interesting is that it's basically a proxy to try to control the next generation of euro dollars around the world. And it seems very clearly and loudly to be so. There is a lot

being risked on the idea that the U.S. dollar remains the cleanest dirty shirt between using the dollar as a weapon of war and proposals like this. It's hard to imagine countries not looking for some type of alternative or at least hedge. Now, just around this out, driving home the point that they are serious about cracking down on illicit finance and crypto, OFAC announced sanctions on another mixing service on Wednesday. A Bitcoin mixer called Sinbad was added to the sanctions list, banning all U.S. persons from interacting with a pair of Bitcoin addresses. The website, Synbad.io, was also seized in a joint operation between the FBI and law enforcement from Finland and the Netherlands. The Treasury describes Sinbad as, quote,

a virtual currency mixer that serves as a key money laundering tool of the OFAC designated Lazarus group, a state-sponsored cyber hacking group of the Democratic People's Republic of Korea. One of the addresses added to the sanctions list holds only 13,000 in Bitcoin at the moment, but has received over 500,000 in Bitcoin overall. The other address holds only $60 worth of Bitcoin. Blockchain Analytics firm Chainalysis said that Sinbad is a relatively new mixer. It began advertising its services in October 2022, and the wallet's earliest activity began during that November.

Analytics firm Elliptic said that the service has been used to move some of the 35 million stolen from atomic wallet in June of this year. Just over 100 transactions had been conducted by the Sinbad wallets, making it appear to be a fairly small target compared to other mixers previously sanctioned. According to the Treasury's press release, Sinbad also processed funds from the hacks of Horizon Bridge and Axi Infinity. Curious information, as both hacks occurred in the first half of last year. However, in February, Elliptic had claimed that Sinbad was a relaunch of previously sanctioned mixer blender, which could explain the discrepancy and timing. The Treasury also claimed that the mixer had moved funds tied to sanctions evasion, drug trafficking, and Darknet Marketplace sales.

Adiamo said in a statement, The Treasury Department and its U.S. government partners stand ready to deploy all tools at their disposal to prevent virtual currency mix. like Sinbad from facilitating illicit activities. While we encourage responsible innovation in the digital asset ecosystem, we will not hesitate to take action against illicit actors. Look, I don't think anyone's complaining about this particular action. And if the Treasury Department really did encourage responsible innovation in the digital asset ecosystem, I don't think anyone would have proposals or assume bad faith when it comes to them taking action against illicit actors. It's just that unfortunately at this point, good faith is not something that most people in the crypto industry

assume when it comes to the Treasury Department. That makes it real hard to work together on common sense proposals and just leaves things in a pretty contentious place. Anyways, that is the story from here. Like I said, I think it has much bigger implications than just the crypto industry, so a situation that is worth watching with some consideration. I want to say thanks one more time to my sponsor for today's show, Cracken. Go to crackin.com slash the breakdown and see what crypto can be. Until next time, be safe and take care of each other. Peace.