Maybe the Genius Act isn't so smart after all

Cat and mouse and crypto
Cryptocurrencies lend themselves to criminal behavior. This is not exactly breaking news. The first material ponzi scheme in the crypto world dates back to 2011 when a guy named Trendon Shavers, going under the name pirateat40, ran one he called the Bitcoin Savings and Trust. (TLDR, he was busted by the feds.)

It's not just about the plethora of gullible marks to be found (apologies to any gullible marks reading this). Cryptocurrencies are in some respects excellent portals for moving illicit funds. Money can be moved almost instantly, at virtually no cost, and can be laundered and mixed and obfuscated endlessly. The downside of this is that they create a permanent paper trail, so to speak, which actually makes them a very valuable tool for law enforcement. When the feds can attach a name to a transaction history, they can sew up a case faster than you can say "just the facts, ma'am." For the criminal underworld, it's all about tradeoffs, about getting in and out of a crime and covering your tracks before the feds can get near you.

Which brings me to the stablecoin issuers Circle and Tether. These two companies are the largest issuers of stablecoins. They run the rails, so to speak. Which actually gives them a power that banks do not have. If somebody steals money from an account at a bank, once that money leaves the account, it is out of the bank's control. But because stablecoin issuers control not only the accounts but the currency also, they can freeze tokens in any wallet address, anywhere, at any time.

It is a lot of power when you think about it, and how it gets used is a big part of the recently enacted Genius Act, as our Carter Pape wrote about yesterday. These companies can be compelled by authorities to freeze assets, but can they be compelled to do it on their own, in the middle of a theft? Should they be expected to? The issue came up this month when an defi platform called Drift got rekt (in crypto parlance) to the tune of $285 million. USDC, the stablecoin issued by Circle, was the conduit. Could Circle have stopped the attack? The company said it freezes funds only when compelled legally by authorities, and that is a very defensible position to take, really.

But it raises issues about exactly how much and how often stablecoin issuers should be expected to exercise the considerable power they have over their networks. After all, getting around government authorities was really the whole point of digital money in the first place.

And that impetus won't go away, even if some issuers and exchanges conform to government authority. I wrote earlier this month about some malefactors trying to extort Kraken after bribing some employees to give up access to the company's internal systems. For all the different issues swirling around it, I made one point: "Nobody told them to build a financial system around irreversible crypto transactions." And within that is the crux of a problem with the stablecoin regulations.

The AML requirements of the stablecoin law are limited to stablecoin issuers. Ostensibly that means crypto exchanges wouldn't be subject to the same AML regulations. That means in practice that there would be a lower compliance bar for exchanges than for stablecoin issuers. A reader (he asked not to be named, but trust me he's a sharp pencil, as of course all my readers are) wrote in with this question: "If the crypto exchanges and other intermediaries are subject to a lower AML standard than stablecoin issuers won't bitcoin and other non-stablecoin crypto retain utility for making illicit payments? And, in fact, be more attractive than stablecoins."

It's entirely possible that regulators could craft the right mix of disincentives around stablecoins to get malefactors to abandon them. But that almost certainly means they'll just go looking for alternative rails. And in a world where it costs exactly zero to start a new cryptocurrency – it's all based on open-source software – there will always be options.