The entry of cryptocurrencies into global finance as a decentralized transaction medium and asset class may offer a new channel for financial secrecy, and many already believe that illicit transactions are behind a large chunk of crypto. But those who are looking to beef-up the value of financial secrecy through cryptowallets and distributed-ledger transactions are likely to be sorely disappointed. If that’s the end game, don’t bother with bitcoin, or its counterparts.
But those who are looking to beef up the value of financial secrecy through cryptowallets and distributed-ledger transactions are likely to be sorely disappointed. If that’s the end game, don’t bother with bitcoin, or its counterparts.
Financial secrecy can be profoundly beneficial by assuring confidentiality for individuals, businesses, banks, governments and many other — some even consider secrecy a “human right.” It plays a vital role as a catalyst in creating economic and social benefits that wouldn’t be possible without the existence of proprietary information. But it also makes possible the dark underbelly of the system — tax evasion, the narcotics plague, human trafficking, organized crime, sanctions-busting and money-laundering, terrorism, corruption, espionage, suborning elections, and an array of other nefarious activities. Classic tools include cash transactions and money laundering through secrecy havens.
Now, along come cryptocurrencies like bitcoin
offering total transparency inside their blockchain platforms along with anonymity between cryptowallets and their real owners.
Is crypto a threat or an opportunity for those looking for financial secrecy? The answer matters for the future of global finance, and it doesn’t look good for those in need of confidentiality.
If financial secrecy has value, there must be a “market” for it. So what’s it worth? That depends on where the secret money comes from and what happens if the cover is blown. And who can be trusted with safeguarding financial secrets? The usual candidates cover a whole coterie of lawyers, bankers, accountants and investment advisers who market trust and discretion. Pick the wrong “secret agent” who leaks or can be made to leak, and game over.
Traditionally, the ultimate gold standard for financial secrecy has been highly reputable financial institutions that are operating beyond national enforcement jurisdictions and are based in politically and economically stable countries with a tradition of tough secrecy laws and blocking statutes.
As in any good market, financial secrecy is bought and sold, and both sides can be happy — often at the expense of someone else. Usually, you get what you pay for. As long as bankers and other agents can convincingly promote secrecy along with professionalism, there’s a treasure trove of fees to be earned and high-paying jobs to be had. This is, after all, a global market with plenty of demand and willing suppliers supporting nice fat profit margins.
Much has changed in the global financial secrecy game in recent years, some of which has caused great misery for ordinary secrecy addicts who happen to come up in the net. In the U.S., that includes the 2001 Patriot Act, the 2010 Foreign Account Tax Compliance Act (FATCA), the creation of the FINCen arm of the U.S. Treasury Department, and a 2015 bilateral tax-evasion deal with Switzerland.
Other countries have their own approaches, but none can equal the ability of the U.S. Department of Justice and the New York State Department of Financial Services to leverage the need for dollar-clearing as the big bazooka in disrupting the financial secrecy game.
Meanwhile, the OECD in 1989 created its own principles with the eventual goal of exchange of key financial information among signatory countries.
Consequently, secrecy addicts have had to look for more questionable venues and take their chances — narrower channels, less reputable countries, less scrupulous middlemen, fewer legal protections, higher fees and degraded investment performance.
With the introduction of cryptocurrencies — an apparent godsend for secrecy-seekers under lots of pressure — transactions are immediate and low cost. Now we have the distributed ledger, which is internally transparent, immutable and verifiable, and does away with central clearing and custody.
No need to trust financial intermediaries or governments. No hold-ups or secret-agent problems. Anonymous cryptowallets are designed to bar prying eyes. Proliferation of initial coin offerings widens choice among crypto competitors. Largely unregulated crypto exchanges in various sovereign jurisdictions create confidential bridges to conventional currencies. In short, we seem to have a miraculous innovation that offers a brand-new channel for those who value financial secrecy.
Plenty of people seem to buy this story today. Nobody knows for sure, but it’s suspected that up to half of crypto transactions are motivated by some kind of illicit activities.
Not so fast. There are drawbacks. Fraudulent Initial Coin Offering (ICO) issuers have found an easy mark among buyers mesmerized by the prospects of confidentiality. Cryptocurrency exchanges (the custodians) have been targeted in cyberattacks and big thefts — with limited or no recourse at all for victims unwilling to reveal their identities. And, on some crypto exchanges, there’s plenty of scope for shady practices like classic pump-and-dump market manipulation and “spoofing” in trading practices. This is on top of higher costs, complexity and potentially risky reliance on programmers and third-party vendors who run the cryptocurrency infrastructure.
But the real show-stopper is the prospect of linking “anonymous” cryptowallets with real identities. Everything rides on this. If prying eyes can make the connection, which some think is not that difficult, it’s all over for crypto as a financial secrecy tool. Exchanges can be arm-twisted to cooperate, and there’s already a cottage industry of consultants to help the enforcers make the connection. Governments certainly have plenty of incentives to make the link, and they have already scored some notable successes.
If financial disclosure is bad news and cryptocurrencies offered hope, dream on. The fast-evolving crypto market is a welcome tool. But it’s hardly free of tricks and traps, and financial anonymity isn’t assured as crypto matures and attracts regulatory attention. It will soon be back to the future, as financial secrecy fans and their enablers will continue to rely on some of the well-trodden but crypto-refreshed paths to financial confidentiality.
Ingo Walter is professor emeritus of finance at New York University’s Stern School of Business.