Corruption, KYC, and the Cost of Compliance - Jarrad Hope (Logos) @ Ethereum Cypherpunk Congress

I'll be talking to you about corruption kyc and the uh cost of compliance um the reason I did this talk is because I think a lot of us intuitively probably reject uh kyc uh but often people don't really go too much deeper into understanding like why maybe that is the case uh and I wanted to present some information to you and in sort of narrative form I hope you enjoy oh yeah all right so uh pay attention to the date September 10th 2001 Donald Rumsfeld uh the defense secretary of Pentagon um held a press conference uh where he basically outlined that uh 2.3 trillion in transactions by the Department of Defense uh could not be accounted for in fact he went on uh to say that the adversary is actually closer to home it is not uh terrorism per se but the pentag on bureaucracy pretty bold statement now the following year uh Jim miny um basically traveled to the United States of America trying to track down just $300 million of uh this spending uh he knows it's gone but uh they could not find where where they spent it on fast forward until uh 2015 I recall correctly C Katherine Austin Fitz um who is the assistant Secretary of the housing department of uh Housing and Urban Development found that um her Department along with the uh Pentagon uh had in that year6 and A5 trillion of unaccountable adjustments uh for that one year right this was 54 times the approved budget for the Pentagon uh for that year which was 122 billion now Mark Skidmore of MSU thought that she made a mistake um or a typo uh and thought well perhaps she meant $6.5 billion right um so she got he got together with her and did their own independent um uh inquiry into this uh and what they found was quite shocking to be frank uh During the period of 1998 to 2015 uh there was $21 trillion unaccounted for or $1 trillion average per year which this money was just going into the ether nobody knows what was spent on or how much uh and so on now wait now of course none of this would actually be new to Frank C spinny who was probably the first whistleblower on the rampant uh spending of these government agencies uh in 1983 uh he even went on to say that the books are cooked routinely year after year now you might think that uh that's been stemed and we've uh We've addressed that I mean after all uh we announced this problem or the Pentagon announced this problem in 2001 we've had 20 years to do it unfortunately it is still going on right uh just recently this year um 8.2 billion dollars have improper improperly valued material uh has disappeared into the Ukraine now Senator d uh Chuck Grassley has spent a majority of his uh uh time as a senator and his political career tracking this kind of government fraud um and he says when it comes to catching fraud the Department of Defense internal controls are a complete failure and we've known it for decades uh and there he is looking quite grumpy about it quick now how does this happen right like where does this money come from well you might be tickled to find out that uh this happens through the oldest uh living program that is still running today it's written in cobal and it's called mocus Uh mocus is basically established uh for doing tendering of for the government government U but what it also happens to do is uh find uh unearned U oh sorry unspent money in other government programs right uh this is completely illegal for any other governmental agency to do um so it's a wonder why it applies to the dod now to put this in uh proportion right uh on the left hand side here we have uh what we've just been talking about the sort of average of uh the the pentagon's uh annual unaccounted adjustments um at roughly $1.2 trillion or if you wanted to adjust it to inflation for today it's approximately $2.

4 trillion right um now on the right hand side uh we have the United Nations estimate for elicit Financial flows right uh they have a basically a 2 to 5% of the global GDP they estimate is involved with elicit Financial flows um so the lower Bound for that is $1.6 trillion and the upper bound is uh roughly $4 trillion uh the Inner Circle there is from the NASDAQ uh 2024 report uh where they say that their estimate for 2023 at L of financial flows um was roughly around $3.1 trillion right so just to give you a sense of proportion aist of financial flows one government agency okay so the day after uh Donald rumsfeld's uh press conference uh where he um basically announced to go after the Pentagon bureaucracy we had uh unfortunately 911 um this spurred on the establishment of the Patriot Act uh in which it includes policies uh related to kyc and AML uh specifically sections 311 326 351 and 352 um uh it's been a while since I looked at the slide but I mean basically uh this establishes its Authority um it sets forward the standards uh it makes anyone who uh is uh reporting on this uh immune immune to liability for for doing so uh and then outlays the uh anti-money laundering programs for the respective uh Count's financial institutions to implement uh okay uh the other thing here is that um a month after uh the financial action task force actually did uh recommended eight of their nine special recommendations in addition to um the Patriot Act policies what the all right okay so when those Towers fell not only do we uh Implement surveillance capitalism and start having our um surveillance in terms of like our freedom of speech uh but we also had the implementation over our uh Financial surveillance as well uh in fact it reverberated around the entire world uh and landed in Asia uh according to Alexis Nexus resolutions reports the uh the true cost of anti-money laundering compliance survey in 2015 uh now while local regulations were cited as the most frequently of having the greatest impact uh it was us regulation embodied by the Patriot Act that was cited as most frequently overall by respondents uh followed by European regulation right uh this is the US hemony implementing these things or or you know strongly suggesting they should be implemented uh around the world um not directly tied to financial action task force but of course um you know anybody helps so we could conjecture that the hypothesis for implementing uh uh or the narrative uh for implementing this sort of financial surveillance or kyc and AML um could be justified uh through terrorism financing right on this side here uh you already know it can you see the amount that is being uh estimated for financing terrorism glob no how about now oh oh yeah ah there we go 11.5 billion dollars in terrorism financing according to our best estimates of last year right um again this is from the NASDAQ Global Financial clim report pretty small that we sold out our civil liberties for now this is is not to disparage I'm not trying to say that you know terrorism is cool or anything obviously it's a real problem right like I I think it should be addressed but that what I'm trying to convey is a sense of proportionality towards it I hope you understand that now 11 half billion dollar I mean it's still a lot of money it's quite it's quite large but um I maybe I was like well okay maybe it was justified you know 24 years ago when they implemented this uh but if if you go look at that you find that the World Bank and IMF uh estimated the annual flows towards terrorist organizations was less than half a billion dollars right somewhere between 300 million and 500 million um in 2005 the Rand study uh estimated al-qaeda's annual budget was between 30 to 50 million um uh the US Department of Treasury in 2015 uh said that Isis generated approximately 1 billion annually from various sources uh and in 2016 we can see that europol said is had an annual budget of around 2 billion right the the sort of dominant threats that we're talking about um now in contrast uh according to a Stimson study group on counter ISM Terror uh counterterrorism spending uh that averaged uh sorry that came out to roughly $2.8 trillion uh between the period of 2002 and 2017 uh that's an average of $186 billion per year so to contrast that with 11.

5 billion we're talking like 16 times the amount uh of money put into towards counterterrorism uh than the amount that's put into you know financing terrorism um that's a pretty good margin pretty good business if you own both sides so oops um I said list at Financial flows quite a few times what are they well there isn't actually uh a a consensus or agreed upon definition but generally speaking we're talking about um ifs as they relate to tax evasion multinational tax avoidance uh the theft of State assets and the laundering of proceeds of crime right um they cover a broad range of market and Regulatory abuses uh including corruption drug smuggling and human trafficking right um so obviously this is important um I'm again not trying to be little of these uh it's just a sense of proportion now addressing these issues is important right uh according to uh Donato um any uh you know he believes that every dollar that's invested uh into crime then begets more crime right um bjor lomberg uh got together with the top economists um to basically prioritize the United Nations sustainable development goals uh and tried to compare them dollar for dooll uh has a great book prioritizing to development which he goes into a lot of this uh and they did find that elicit Financial flows is one of the top priorities when it comes to uh un's SGS um so why are iOS important right um so from one hand there's a humanitarian aspect right like um drug trafficing and human trafficking are obviously uh crimes against humanity um we don't want those to happen ideally um so there is a humanitarian component to it uh but the financial aspect um can be basically boiled down to um lost GDP right and if there's lost GDP then you have lost tax revenue uh which means that you have poor quality of governance uh is you is basically what the argument boils down uh iffs are basically associated with ineffective State functioning illegitimate use of state power and uh just uh I forget what I meant by International problems but um I it's an international problem right so you might solve uh for elicit Financial flows within your own nation states or your own country but you know if another country um is offering an Arbitrage opportunity on that regard then you can expect uh you know uh money uh Capital flows to move towards uh certain regions it's not entirely true either because actually um when it comes to uh um um when it comes to Capital abuses like you can also view taxation as a capital abuse uh and so you can find like legitimate means of financial flows moving towards restrictions where capital is respected um and you know banking secrecy laws that you would find say some uh in Switzerland for example are a prime example of this in fact you'll find a lot of tax Havens um actually have very high quality of governance uh because you can't provide those kinds of laws if you have forms of corruption because you know if you were sending large Capital amounts of capital there you want to have assurances that it's not going to disappear right or you'll still have you know private property rights over it um anyway so what exactly are a list of financial flows and that depends um because like the definition uh there is no consensus around the method ology for understanding list of financial flows um part of the reason is because the secrecy that's involved right if you can't directly estimate what they are um then like you you have to kind of find indirect means of models to to understand or at least guess what those elicit Financial flows are um so uh on one site you know basically you have 30% going towards criminal activities whatever that means 5% towards corruption 65% towards trade misinvoicing uh in fact 80% towards trade Mis uh misinvoicing in the cardamone uh model right and 20% uh uh towards corruption so what is trade misinvoicing this is what multinational corporations do uh say if they're doing uh natural resource extraction in a developing country um they will uh probably uh fake the costs that are associated with the extraction of that resource uh or and uh the value of which of the resource that they extract as they do Import and Export into another Nation right um and through that uh that is where at least these models estimate the majority of um elicit financials to originate from um the NASDAQ one uh accounts 12% towards T trafficking 25% towards drug trafficking and 63% towards pretty much everything else right for corruption uh and so on um so now even though it was a 202 uh 2001 uh when like uh kyc and follow the money methods were basically forced as a policy issue um the notion of elicit Financial flows didn't really come onto the stage until uh 2015 um through uh Raymond Baker and particularly him Shilling his book capitalism Achilles heel sorry in 2005 right um in fact Peter Roo is quite uh critical of this because all of the information is or uh assumptions that are made are based on prence um and again here highlighting the same problem uh from uh anti-money laundering and effectiv paper although different measures and mo models are used to estimate money laundering no model can quantify uh money laundering is globally acceptable right it's it's an incredibly difficult problem um which is why which is why follow the money methods uh are kind of like the first thing to to try and attempt to to capture right like the idea is if you can have like a full understanding or reveal like remove the privacy constraints around um uh Capital flows then you'll be able to do something about it right um uh this the same slide ah now the interesting thing uh is even the financial action task force methodology for assessing compliance with uh their uh fatf recommendations and the effectiveness also lacks any hard means of actually understanding that they point to General crime statistics um very anecdotal evidence um and so on right subjective conclusions uh so it's really really vague we're talking about now to their credits uh the United Nations has yeah am I doing this or yeah okay um had this UNCC tag pilot program um which is still running right now uh where they're working with a a variety of developing countries um to actually try and capture the most official or best source of elicit Financial flows um and you know we're largely talking about drug trafficking uh here in which um probably the most not noteworthy one is cocaine trafficking in terms of uh inward flows of one and a half bli uh billion dollars um over two years so like it's worth like keeping that also in a sense of proportion if we're talking about like 11 half billion dollars uh towards um uh terrorism financing it's like 10 times less um so are follow the money methods effective right uh we've been running them for two and a half decades nearly um well according to the financial action task force last year less than 1% of global listed Financial flows is recovered right uh according to ronner Paul um anti-money laundering policy intervention has less than 0 1% impact on criminal Finance 0.1 right uh and according to the United Nations uh they believe it's roughly about 0.2% now that's not a lot in other words 99.8% of elicit Financial flows uh are uneffective um now this is a problem uh and the problem is because when you start looking at what you can measure uh and that is the cost of compliance right according to Lexus Nexus um in the United States alone for banks alone for one year we're talking about 26.5 billion doar in just compliance costs right uh that is more than double the global terrorism financing in just America um that's huge in fact Ronald Paul goes to say compliance costs exceed at recovered criminal funds more than a hundred times over uh and Banks taxpayers and the ordinary citizens me and you are the ones who get penalized right all of those costs get pushed onto Us in fact this has been known for a while uh in the B20 and the OC oecd uh they've known that the challenges have existed um with the unintended consequences of financial regulation uh they've been highlighted time and time again um in fact in traditional trade Finance roughly 50 uh 60% of the costs um or more than half the price uh is associated with um extra fees which is a large percentage of is uh compliance and that's charged directly towards you so why does this matter right well there's a um according to institutional economics um if you can do uh reduce the transaction costs and I'm talking in the abstract sense right you know if you go to the DMV or whatever that's and you're waiting in line for governing Services that's a transaction cost right if you can reduce that by 0.

1% you can enable a country uh to quadruple its wealth that's the difference between Argentina in Switzerland right so we're probably better off creating much more in efficient institutions than we are trying to solve this problem directly or at least in the manner that we're trying to solve it right now Michael Levy in the money for crime and um uh and money from crime says that no one could rationally think that AML controls in general or financial investigation in particular will solve organized crime right uh completely or uh eliminate high level offending for that to even be a chance to achieve that there would need to be a step change in transparency and effective action against high level corruption along all possible Supply chains right uh and this is really important this high level corruption right um and we'll talk about that in a minute hopefully okay starting to paint a bit of a picture here I hope you're you're still with me um now there are a whole bunch of other secondary effects that are associated with financial action task force recommendations right um in fact it leads to rushed laws uh so one of the sort of secondary effects of um being included or excluded um from this regime is that if you do not implement the recommendations within the time period uh then you'll be economically locked out from the Global Financial system as a country right which has a massive effect on your economy as you could imagine now this means that certain laws end up getting rushed through their parliaments if they have them um and that means you create bad law and that bad law can then be used to exploit for political gain um Amnesty International has a great uh report called weaponizing counterterrorism I recommend you read it uh in which they show how these recommendations have and their implementations of their law have been used to Target uh uh protesters uh journalists uh and uh academics human right activists and students and they've been doing it since 2010 right um furthermore oh I pressed it twice okay Royal United Services Institute rosi uh a very respectable think tank it's been around for roughly a century if I recall correctly uh they also document this uh on a broader scale uh however they focus on predominantly authoritarian regimes um whether you consider India to be an authoritarian regime or not I personally don't but the point is that it's much broader than authoritarian regimes okay um anyway so what I'm trying to say here what Alex copham says is international uh Financial flows are actually an elite phenomenon right they are the ones uh who have the incentives uh the capital uh to implement or or not Implement these laws in fact they are above the laws when it comes to this uh so they able to transfer this money um at will um beyond the uh the requirements yet for all of us we are beholden to these laws um I was going to talk about Jamie Dion running out of time but uh JP Morgan Chase uh basically was antagonistic towards crypto uh criminals drug trafficers and money laundering uh blah blah blah he wants to shut us all down now the irony of that is that uh I think in the following months um he was charged uh well JP Morgan was charged for $39 billion uh for a bunch of uh uses that are related to listed Financial flows uh that go all the way back to 2003 uh and in fact uh it's not exclusive to JP Morgan Chase in fact almost all of the major banks are involved in these kind of shenanigans um as documented in the finm files uh now I ALS on this slide Financial secrecy index uh I think it's worth looking at the United States and particularly the global scale weight 25.7 eight% right in contrast to Switzerland less than 4% right the US is by far the largest uh um Harbor for financial secrecy I mean okay so and P Roa continues this s of like threat of thoughts asking a kleptocratic state to create an effective AML system is like asking the fox to create a better henh housee it is the governing political Elite that benefits the most substantially from the weakness of existing system of controls um this is all about government trust government trust is declining there was a graph from Bloomberg here um you know whether you wherever you look right if it's the UK any oecd country it's declining um in fact on a global scale the average public trust in governments is just 41% we have a massive kleptocratic and Corruption problem uh yep same thing different data source um yeah and and I mean sure I'm sure you're all aware government debt is growing um and will become unsustainable uh in the next two 25 years as of 2011 so we're pretty deep into that um since the 1800s uh countries with the same debt to GDP ratio as the Us and other countries have Del faled uh so we're pretty close to that and that's according to the CBO um these challenges are Global according to the National Intelligence Council um it's not just the US it's almost every developed country and obviously developing countries are associated uh through their economies um I won't go into that but uh the fatf has a former Sovereign actually I guess we uh has a former sovereignty um that is quite interesting because it's comprised of their member states right um so they're not they're in Paris they're not beholden to France they're not they're in the OCD building not beholding to OCD um and they're basically as member State responsibility and you consensus from all these member states that are involved um that's a huge problem all right so um why does any of this matter why do I care about it well it's because of this report that I read in 200 uh from 2006 from the World Bank where is the wealth of the Nations right they find that um human capital and more importantly the value of Institutions as measured by the rule of law constitute the largest share of wealth in virtually all countries um and so when we're thinking about kyc or follow the money methods or even compliance my argument would be we should be focusing on creating more efficient parallel institutions right ones that actually unlock capital for people uh because this is going to lift more people out of poverty create a higher quality of life um and we can retain our privacy anyway thank you for bearing with me thank you