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CRYPTOCURRENCY: A solution to financial censorship or fuel to money laundering?

Updated: Jul 13, 2021


In today’s digital world, we can collectively agree with the statement “Privacy is a myth”. Everything you do is under the radar and there is absolutely no way to escape it. This is due to the centralised nature of the system i.e., we need the permission of a centralised authority to undertake our tasks virtually. If we look at this through the financial lens, we increasingly transact by sending digitized information through multiple parties on different payment networks. More visible parties provide consumers gateways to the network with cards and software applications to initiate transactions. Less visible parties -- e.g., intermediary banks and clearinghouses -- authorize, clear, and settle those transactions. For example: When you use Google Pay, there are 3 authorities involved - Google Pay, the bank you have your account in and the central bank above all.

We will call a party on a payment network an authority when it can reliably block transactions on the network. An authority may have a group-centered, entity-centered, or transaction-centered approach to blocking. In group-centered blocking, authorities block transactions from those with a certain feature, whether that’s a political affiliation, religious commitment, career, or level of credit. In entity-centered blocking, authorities might block transactions from a particular organization, like a non-profit watchdog, or a particular person, like the outspoken whistleblower. But instead of blocking all transactions from particular people or organizations, an authority might block certain kinds of transactions, like transactions involving drugs, pornography, or copyright infringement. Since authorities can block transactions on the network, we need their permission to transact. Every single attempted transaction will fail unless authorities grant it permission (which can be revoked anytime) and usher it through their location on the payment network. So, let’s say that a payment network is permissioned when it has one or more authorities.

Authorities on a payment network can abuse their powers in a variety of ways. Transaction settlement over a payment network requires transmitting information about such things as the payer, the payee, and the amount paid. Because authorities on a payment network control the flow of this information, they can block certain kinds of transactions or transactions from or to certain kinds of people and abuse their authority to charge unfair fees. Authorities have abused their power in each of these ways, and their doing so amounts to an underexplored kind of censorship -- financial censorship.

Examples of financial censorship include:

  • Sex. Corporate payment processors censor transactions to protect their reputations or stave off regulatory intervention. In 2012, Paypal pressured the indie publisher Smashwords to stop selling books with adult content. In 2014, JPMorgan Chase terminated the accounts of many involved in the adult film industry. This came on the heels of Chase refusing to process payments for Lovability, an online condom store. And, in 2017, the adult social network FetLife saw its payment services revoked.

  • Remittances. Cross-border payments often involve migrants sending money home in payments routed through fee-extracting authorities. Globally, the average remittance fee is about seven percent for a US $200 payment. But depending on the locations of the sender and the recipient, the fees can climb much higher; the average remittance fee to send US $200 from South Africa to Botswana, for example, exceeds 19%. Expensive remittances arguably count as a form of financial censorship because authorities block, and collect, a higher than necessary percentage of the amount intended for the recipient.

Many will argue that this is important for the larger good as it enables preventing transactions involved in illegal drugs, money laundering, terrorism, copyright infringement, and, more globally, efforts to avoid economic sanctions. While this is true, it is not a good enough reason to let things continue the way they are as the power to block illegal transactions is also the power to block legal transactions.

“Today it may be gun advocates that are targeted, but tomorrow it could be abortion providers that are dropped by financial intermediaries. Groups such as Muslim charities, sexual fetishist communities, and socialist booksellers have already experienced such extra-legal sanctioning.”

Some sources of financial censorship are private does not mean they do no harm or that we ought not look for alternatives. Private censorship may not be as coercive as state censorship, but it may nonetheless be harmful. Second, since large firms are often enmeshed with the state -- patronage, lobbying, loopholes, specialized regulations designed to curb competition, and so on -- it is not always easy to cleanly discern “private” from “state” censorship. Indeed, private firms often have little choice but to engage in financial censorship at the direction of a state. States sometimes pressure private authorities domiciled within their boundaries to engage in financial censorship, whether directly by law or by less direct means. Third, private censorship -- whether of speech or of financial activity -- exhibits some of the same troubling biases and trends that make state-sponsored censorship worrisome. Policing of speech disproportionately affects marginalized or vulnerable actors engaging in controversial or critical speech but not violent speech, for example: No PG scholarship for anti-CAA protestors, says Pondicherry University.

Financial authorities exercise an objectionable degree of control. The root condition is structural and holds across both state and private actors: traditional payment networks rely on trusted and central intermediaries. Banks, states, credit agencies, and so on have the power to censor transactions between two parties because they stand between those parties.


What is the solution?

Cryptocurrencies inhabit payment networks built to lack authorities. Cryptocurrencies that protect financial privacy offer another kind of solution to censorious authorities. It is costly (and in some cases, may be impossible) for states or firms to block individual transactions when the destination, source, and amount are unknown. With shielding and obscurity protections in place, cryptocurrencies force states or firms to attempt a complete ban on the entire payment network -- a ban that may be unworkable either due to politics or practical computer science. They aim to be permissionless. A completely permissionless payment network has no authorities -- no party to the network that can prevent or block transactions reliably. One important question is the precise extent to which cryptocurrencies make good on this promise. A number of factors suggest a mixed answer. Here are just three examples suggesting that Bitcoin is more centralized than it may first appear:

(i) the Bitcoin network is maintained by large pools of miners,

(ii) most users enter and exit the ecosystem through centralized exchanges, and

(iii) most users use just a limited range of software to interact with the Bitcoin network.

Each of these factors make for potential chokepoints: miners, exchanges, or software developers. In evaluating Bitcoin for permissionlessness, it is important to take into account the cost of developing workarounds to chokepoints. It is, for example, trivially easy to modify open-source Bitcoin software as one likes and thus be one’s own bank. This workaround to potential software developer chokepoints (roughly, a few classes on coding, a computer, and internet access) is much less costly than, say, applying for one’s own bank charter. Even though Bitcoin does not score perfectly on permissionlessness, it plainly does far better than legacy financial systems. Not every payment network that aims to be permissionless achieves perfect permissionlessness. Some fail altogether. But the Bitcoin network in particular has achieved a relatively high degree of permissionlessness. Therefore, without using authorities, a typical cryptocurrency network validates, settles, and clears the transaction.

Many cryptocurrencies allow users to transfer value without trusting an authority to act responsibly. But their permissionlessness can extend beyond the realm of sending and receiving value. In Bitcoin and other cryptocurrencies, users together play the roles of banks and clearinghouses. The network as a whole validates, settles, and clears transactions instead of relying on authorities to do these jobs. With nothing but internet access and free, open-source software, anyone may join the network to validate, settle, and clear transactions, including one’s own. So, a network like Bitcoin's takes the trust we normally place in a few authorities and spreads it thinly over the entire network. This prevents giving power to a particular authority to potentially block or misuse power.

However, it is not so simple. Cryptocurrency, which aims to escape the chains of centralisation and financial censorship, can be a victim of the same. Ironically, many Crypto traders in India were receiving notifications from banks asking about crypto-related transactions and warnings that their accounts will be closed. That is, although trading in cryptocurrency is not illegal following the Supreme Court’s order, banks were blocking accounts due to RBI directing the banks to not be involved in cryptocurrency transactions. However, recently the central bank clarified its stance, stating that banks need not block cryptocurrency transactions but should exercise due diligence while dealing with them. Thus, like it or not, centralised authorities and cryptocurrency have to work in tandem. This does not mean it completely defeats its purpose, it solves many problems such as:

  • In India, according to the SCR, Muslims have far less access to credit from banks and other formal financial institutions in proportion to their population share. Even when Muslims are able to get loans sanctioned, the average amount obtained is small in comparison to other social groups. Surjit Singh in his review of credit extended to Dalits and Adivasis by various public sector banks and financial institutions for the period 1997-2005, concludes first that credit and finance is not flowing either fairly or adequately to them and second that their priority sector credit targets are mostly un-met. How do we understand the work of apparently impersonal market institutions (for instance credit agencies) when they practise discrimination and exclusion by making credit available for the higher status client, while constraining liquidity for low status groups – irrespective of their collateral - thereby drastically affecting outcomes in the market in ways which differentiate market-driven social structures?

  • Another example is the roadblock created to women entrepreneurs from finding access to funding and capital for their businesses by financial institutions. They have historically been extremely cautious in extending credit to business women as they still consider women entrepreneurs to be risky borrowers and are not confident in their ability to succeed. Second, the traditional mindset of lending is driven by societal biases. A female borrower is normally asked to have a male guarantor during risk assessment. Discrimination against women due to societal norms occurs when it comes capital assessment in long established institutions. However, even new-age creditors and NBFCs perpetrate this bias and end up putting down women, whose success can transform societies.

Cryptocurrency promises solutions to two problems: borrowing and banking. No bank account or permission is required to hold, receive, or send cryptocurrency. And a number of cryptocurrency lending platforms offer credit to users without so much as a name, much less bias-inducing information about race or neighbourhood. Anyone who can stake enough collateral in cryptocurrency can receive a loan. Cryptocurrencies democratize monetary value in much the same way the internet has democratized information. The internet provides an alternative and difficult-to-censor pathway for valuable information; similarly, cryptocurrencies provide an alternative and difficult-to-censor pathway for monetary value itself. And as the internet has mitigated the effects of book bans and other attempts to censor information, so cryptocurrencies mitigate the effects of payment blockades and other forms of financial censorship. The internet has enabled new modes of wrongdoing, to be sure. But many would accept these as costs outweighed by benefits. The internet contributes to the development of free and open societies. Similarly, although we acknowledge the new modes of malpractices enabled by cryptocurrencies, we expect the benefits of cryptocurrencies to outweigh their costs. Since cryptocurrency networks like Bitcoin’s serve as a censorship-resistant payment system, many around the globe increasingly see them as a hedge and competitive check to traditional payment systems.


Can Cryptocurrency encourage money laundering?

To understand this, we must first address that Bitcoin does not provide users with significant financial privacy. The Bitcoin ledger is public. And its record includes all amounts, destinations, and sources. These destinations take the form of random-seeming strings of characters (addresses) that give a veneer of pseudonymity. The Bitcoin ledger itself does not associate addresses with real-world identities like legal names, phone numbers, birth dates, and so on. But such associations are not difficult for state and corporate entities to establish, especially since regulated exchanges require customers to provide identifying information. Now, identifying information is a part of the protocol of KYC or Know Your Customer. KYC is done on centralised cryptocurrency exchanges. A centralised crypto exchange, is like a third party or a middleman that facilitates crypto-to-crypto or crypto-to-fiat (regular money) transactions between entities or individuals. The irony can be spotted, does not this contradict the idea of bitcoin? Let’s understand this better. In the cryptocurrency ecosystem, there exists two kinds of bitcoin and crypto exchange platforms – regular and peer-to-peer. In regular exchanges, the platform’s algorithm anonymously matches buyers and sellers based on the value of buy/sell orders. But, Bitcoin's original purpose was to enable peer-to-peer transactions. A peer-to-peer transaction means that you have data related to the person or entity you are interacting with. The information you have of that person can range from a bitcoin wallet address, to their forum username, location, IP address, or can even involve a face-to-face meeting.

The difference between the regular and peer-to-peer exchanges are: The former requires KYC, less time, is convenient, no technical expertise required and prevents fraudulent activities. Regular bitcoin exchanges are helpful in the event of malicious activity or fraud. They easily track the source of the attack/theft and can restore the stolen funds. While latter does not require KYC, it requires time and technical expertise. The lack of the KYC procedure, can lead to a serious number of fraudulent incidents while trading on peer-to-peer bitcoin exchanges.

Since centralised exchanges have your details through KYC, they can grant you access to your private keys using multiple factor authentication. However, if you lose your private key (A private key is a cryptographic password that is required to access your cryptocurrency), your crypto asset is lost forever. “While a centralised exchange can lose a few hundred bitcoins in a hack, there is a higher possibility of a thousand people losing 1 bitcoin each if they are unaware of the technology (in a decentralised exchange).”

Therefore, a regular crypto exchange, although defying the idea of absolute decentralisation, still achieves the goal of preventing financial censorship to some extent as well as preventing and tracing illicit activities.

However, it is important to note that the scope of privacy and illicit activities increase when we talk about other cryptocurrencies (or supplementations to Bitcoin). They provide users with two methods for resisting surveillance: shielding and obscurity. These two methods create a network effect that intensifies financial privacy. The more transactions are protected in this way, the stronger that protection becomes. This holds especially for privacy through obscurity. It is precisely the presence of a swarm of indistinguishable transactions (or participants in a ring signature) that makes those transactions private. The bigger the swarm, the better the privacy. There are, accordingly, ethical consequences to joining such a swarm. Users who participate, whether as miners or transactors, are not just securing privacy for themselves -- they are securing it for others as well, including those with potentially nefarious purposes.

In short, the possibility of illicit activities exists but there must be regulations embraced by the system to prevent the same. The possibility of illicit activities exists in every monetary function. If the question is safety of your investment in cryptocurrency, Centralised exchanges are much safer as Individuals trading cryptocurrency through the P2P (peer-to-peer) mode run a much higher risk of getting funds or cryptocurrency derived from crime.


What’s the case in India?

The sceptical view of Indian government comes from the dilemma that the use of virtual currency can lead to many chaotic issues such as money laundering and terror financing. India does not have a sound legal framework regulating the transactions of Cryptocurrency. The fear of illicit activities should not stop the country from recognising cryptocurrency rather the government must take steps to combat potential threats. It is very evident that the nature of the cryptocurrencies is very volatile and it cannot be accepted by the country within the current framework; there is a need to adopt some measures to regulate it and be used in a consumer-friendly way. In 2015, the New York State Department of Financial Services implemented a few guidelines that instruct companies dealing in bitcoins to record the identity of customers, have a compliance officer, and maintain capital reserves. The transactions worth $10,000 or more will have to be recorded and reported. Adopting such regulations to the Indian context can increase the reliability of cryptocurrency in the country.

However, the lack of uniform regulations about bitcoins (and other virtual currency) raises questions over their longevity, liquidity, and universality.


What are cryptocurrency exchanges doing to mitigate this risk in India?

India has no KYC norms for cryptocurrency. But, India’s cryptocurrency exchanges have their own KYC procedures.

“As a matter of course, we ask for ID and address proof like Aadhar and PAN Card. We also insist that money must come from the concerned user's bank account and not some third-party account," says Nishal Shetty, CEO of India’s largest cryptocurrency exchange, WazirX.

Exchanges use methods such as penny drop where a token amount like 1 rupee is transferred to the user’s account to verify their identity. The penny drop system reveals the account holder’s name as registered with the bank. Most large exchanges follow a roughly similar KYC system, with more rigorous checks for corporates. “For corporate clients who are given higher trading limits, more documents like articles of association, board resolutions authorizing crypto investment etc are needed", said Neeraj Khandelwal, co-founder, CoinDCX.

Cryptocurrency exchanges also use softwares such as Chainlink to identify rogue addresses. “We use a globally renowned crypto AML tool to check for blacklisted crypto addresses. If a legitimate user has got crypto from such an address, maybe through peer-to-peer and he or she wants to transact on our exchange, we ask for additional KYC such as source of funds and profession," said Khandelwal.



By now, we must have spotted a number of inconsistencies in the use of cryptocurrency. While battling centralisation needs, the central authorities to agree with the philosophy of cryptocurrency to some extent - they need to operate together using centralised exchanges alongside peer to peer for a wider reach. They need KYC to prevent illicit activities while they battle the ideology of surveillance by state and corporations. We see that the current framework tries to come midway in the chase of centralisation and decentralisation. It promises a distributed network instead of the power resting in a few hands - but, this can be debated again. When an individual tweet by Elon Musk can fluctuate the value of cryptocurrency so drastically, is power is actually distributed?

Regardless, cryptocurrency offers to be a potential solution to financial censorship.



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