Brought to you by:

Is Nightclub Security Good Enough for Stablecoins?

"USDT works quick like SMS."

That was the assessment of a Russian buyer of Venezuelan oil, as documented in a sanctions-evasion case brought by the US Department of Justice in 2022. 

Unable to accept bank transfers because of sanctions introduced in 2019, Venezuela’s state-owned oil producer, PDVSA, asked buyers to pay with physical cash — a lot of it.

In this particular case, the purchase was for 500,000 barrels of oil, worth $17 million at the time. 

Instead of incurring the checked-bag fees on however many duffel bags it takes to transport 170,000 $100 bills from Moscow to Caracas, the Russian buyer simply sent 17 million USDT to a local broker that was happy to convert it to US dollars, which were then deposited into a PDVSA bank account. 

Not only did that bypass the US banking system, it was faster than the US banking system, too — as fast as sending a text message.

Now, after a brief respite when the US eased sanctions on Venezuelan oil last October, the US is reimposing them, so buyers will have to get creative again — which means more stablecoins again.

This time, though, it appears those buyers will be able to send USDT directly to PDVSA, no broker required. 

Reuters reported this week that “PDVSA since last year [has] been slowly moving oil sales to USDT” and that the coming reimposition of US sanctions “is speeding up the shift.”

Tether has a response to this, of course — the company told Reuters that it’s “committed to working to ensure sanction addresses are frozen promptly."

But is that good enough?

Unlike cash, stablecoins are not bearer instruments — you never take possession of a USDT.

Instead, buying a stablecoin grants you access to an account recorded in a smart contract on a blockchain — access that can be revoked at any time.

Tether has been diligently (and loudly) revoking holders’ access to USDT at the request of US law enforcement: “Tether follows stringent Know Your Customer (KYC) and Anti-Money Laundering (AML) protocols, in line with the Bank Secrecy Act and the best practices of financial institutions.”

But Tether’s KYC checks are strictly after the fact — they will freeze your USDT if law enforcement tells them to, but they won’t know it’s you because they never asked.

Is this “in line with the best practices of financial institutions,” as they claim?

Anyone familiar with the belt-and-suspenders approach to KYC/AML at US banks will likely say that claim is a little disingenuous, at best.

Yes, Tether is complying with KYC rules as they now apply to stablecoin issuers, but this is not comparable to the KYC rules that banks must play by.

Stablecoin issuers are only expected to respond when law enforcement tells them a malicious actor has an account with them — banks are expected to stop malicious actors from opening accounts in the first place.

It’s the difference between nightclub security and airport security.

If you get caught with recreational drugs in the Tether nightclub, the bouncer will escort you out — at a bank, you probably won’t ever have gotten past the sniffer dog and X-ray machine.

Personally, I think nightclub security is good enough for stablecoins and probably for banks, too — there’s a strong case to be made that the benefit of strict KYC/AML regulations (marginally less crime) is far outweighed by their cost (a more expensive and less efficient banking system).

This is probably even more the case with stablecoins, because nightclub security appears to be highly effective —  only 0.05% of transactions in Circle’s USDC are thought to be involved in illicit activity.

Anecdotally, it seems like Tether has a higher percentage of issues than that, so maybe they still have work to do.

But given the evidence from Circle, I’d say that bank KYC probably needs to become more like stablecoin KYC and not the other way around.

It’s unfortunately not what I say that matters, however, it’s what politicians say — and here’s what you will never, ever hear a politician say: “The cost of allowing terrorists and rogue governments to move money through the financial system is outweighed by the benefit of more efficient banking.”

Instead, we’ll be hearing more of what Deputy Treasury Secretary Wally Adeyemo told the Senate Banking Committee earlier this month: “We have seen terrorist groups try to take advantage of innovations in cryptocurrency.”

Adeyemo was speaking at the Senate, lobbying for new powers that the Treasury Department requested in response to reports that Russian and Venezuelan entities are using cryptocurrency to evade US sanctions.

Among other things, the Treasury has asked that the Bank Secrecy Act be updated to make the crypto market subject to the same “type of AML/CFT requirements to which banks and other financial institutions are already subject.”

In other words, they want stablecoins to switch from nightclub security to airport security.

I’m not sure that’s a good idea. But with Venezuela making everyone in their oil club use USDT, it’s increasingly likely that politicians will make it happen.

― Byron Gilliam

Brought to you by:

Bitcoin is more than you think 🟧.

As Bitcoin enters its fully programmable era, layer-2s are leading the way for countless new use cases for the world’s most secure, decentralized and adopted cryptocurrency. Builders are writing the next chapter for Bitcoin with Stacks, the leading L2 for Bitcoin.

The Nakamoto Release, bringing Fast Blocks & Bitcoin Finality to Stacks, is currently being rolled out. Learn more about Stacks projects that are unlocking new use cases to activate the Bitcoin economy, like Arkadiko, StackingDAO and Hermetica Finance.

Inflation Still Isn't Going Back To 2

This week Vincent Deluard returns to the show to discuss the most important topic in markets today... inflation. After joining the show in February 2023, Vincent was an early inflationista making the case that inflation would not return to 2%. Well, one year later that call has been correct as inflation remains elevated above the Fed's 2% target. The question is, what happens next?

Watch or listen to On the Margin on YouTube, Spotify or Apple.