Why sanctions didn’t stop Russia's Garantex from using stablecoins

Stablecoins, a new type of financial institution, are unique in two ways. First, they use decentralized databases like Ethereum and Tron to run their platforms. Secondly, and more important for the purposes of this article, they grant access to almost anyone, no questions asked. 

I'm going to illustrate this openness by showing how Garantex, a sanctioned Russian exchange that laundered ransomware and darknet payments, has enjoyed almost continual access to financial services offered by stablecoin platforms like Tether and USDC throughout its six year existence, despite a well-known reputation as a bad actor. 

Last month, law enforcement seizures combined with an indictment and arrest of Garantex's operators appear to have finally severed Garantex's stablecoin connection... or not. Evidence shows that Garantex simply rebranded and slipped right back onto stablecoin platforms.  

Stablecoins' no-vetting model is a stark departure from the finance industry's default due diligence model, adhered to by banks (such as Wells Fargo) and fintechs (such as PayPal). We all know the drill—provide two pieces of ID to open a payments account. Requirements for businesses will probably be more onerous. Anyone on a sanctions list will be left at the door. Banks and fintechs must identify who they let on their platforms because the law requires it.

By contrast, to access the Tether or USDC platforms, the two leading U.S. dollar stablecoins, no ID is required. Anyone can start using stablecoin payments services without having to pass through a due diligence process. Sanctioned customers won't get kicked off, as Garantex's long-uninterrupted access shows. Regulators seem to tolerate this arrangement—so far, no stablecoin operators have faced penalties for money laundering or sanctions evasion.

A quick history of the Tether-Garantex nexus

Garantex became notorious early on for its role in laundering ransomware payments. Russian ransomware gangs hacked Western firms, extorted them for bitcoin ransoms, and cashed out at Moscow-based exchanges like Garantex. Garantex also became a popular venue for laundering darknet-related proceeds, particularly Hydra, once the largest darknet market. Reports allege that the exchange's shareholders have Kremlin links and that terror groups Hezbollah and Quds Force have used it.

Founded in 2019, Garantex was connected to Tether's platform by August 2020. We know this because an archived version of Garantex's website from that month show trading and payment services being offered using Tether's token, USDT.

Archived Garantex.org trading page from March 2024 with USDT-to-ruble, Dai-ruble, and USDC-ruble markets [link]

This connection to Tether allowed Garantex's customers to transfer their Tether balances to Garantex's Tether wallet, in the same way that a shopper might use their U.S. dollar account at PayPal to make payments to a business with a PayPal account. This allowed Garantex's users to trade U.S. dollars (in the form of Tether) on its platform for bitcoins or ether, two volatile cryptocurrencies, and vice versa. The Tether linkage also meant that Garantex could offer a market for trading ruble-USD.

By April 2022, Garantex's bad behaviour had caught up to it: the exchange was sanctioned by the U.S. Treasury's Office of Foreign Asset Control (OFAC). U.S. individual and entities were now prohibited from doing business with Garantex. Out of fear of being penalized, most non-Russian financial institutions would have quickly severed ties with it. Yet Tether, based in the British Virgin Islands at the time, permitted its relationship with Garantex to continue without interruption. Archived copies of Garantex's trading page from mid-2022 and 2023 show that Tether-denominated services were still being offered.

The Wall Street Journal reported in 2023 that around 80% of the exchange’s trading involved Tether, despite sanctions being in place. The net amounts were not small. According to Bloomberg, an alleged $20 billion worth of Tether had been transacted via Garantex post-sanctions. A 2024 Wall Street Journal report revealed that sanctions-evading middlemen used Tether to "break up the connection" between buyers like Kalashnikov and sellers in Hong Kong, with Garantex serving as their venue for acquiring Tether balances. 

Finally, analysis from Elliptic, a blockchain analytics firm, alleges that Garantex offered USDT trading services to North Korean hacking group Lazarus in June 2023. This transaction flow is illustrated below:

The Garantex/Tether nexus in 2023: Elliptic alleges that North Korean hackers stole ether from Atomic Wallet, converted it to Tether using a decentralized exchange 1inch, and then sent Tether to Garantex to trade for bitcoin. (Click to enlarge.) Source: Twitter, Elliptic

Tether's excuse for not off-boarding sanctioned entities such as Garantex? A supposed lack of government clarity. 

When Tornado Cash was sanctioned in 2022, for instance, the company said that it would "hold firm" and not comply because the U.S. Treasury had "not indicated" whether stablecoin issuers were required to ban sanctioned entities from using what Tether refers to as "secondary market addresses." Translating, Tether was saying that if bad actors wanted to use Tether's platform to transact with other Tether users (i.e. in the "secondary market"), it would let them do so. Tether's only obligation, the company believed, was to stop sanctioned users from asking Tether itself to directly cash them out of the platform into U.S. dollars (i.e. the "primary market").

This is quite the statement. Imagine if PayPal allowed everyone—including sanctioned actors—to open an account without ID and send funds freely within its system, only intervening when bad actors asked PayPal to cash them out into regular dollars. That was Tether's stance. Or if Wells Fargo let sanctioned actors make payments with other Wells Fargo customers, but only stopped them from withdrawing at ATM. Banks and fintechs can't get away with such a bare bones compliance strategy; they must do due diligence on all their users. But Tether seemed to believe that a different set of rules applied to it.

In December 2023, Tether reversed course. It would now initiate a new "voluntary" policy of freezing out all OFAC-listed actors using its platform, not just "primary market" sanctioned users seeking direct cash-outs. This brought Tether into what it described as "alignment" with the U.S. Treasury. Soon after, Tether froze three wallets linked by OFAC in 2022 to Garantex.

However, this action was largely symbolic. By the time Tether froze those wallets, Garantex had already abandoned them and opened new ones, thus allowing the exchange to maintain access to Tether's platform. Tether's no-vetting model permitted this pivot. Archived versions of Garantex's trading page show that it continued offering Tether services throughout 2024 and early 2025.

The U.S. Department of Justice recently confirmed Garantex's tactic of replacing wallets in its March 2025 indictment of the exchange's operators. It alleges that Garantex frequently cycled through new Tether wallet addresses—sometimes on a daily basis—to evade detection by U.S.-based crypto exchanges like Coinbase and Kraken, which are legally required to block customer payments made to sanctioned entities.

That the relationship between Tether and Garantex continued even after Tether's supposed 180 degree turn to "align" itself with the U.S. government is backed up by several reports from blockchain analytics firm Chainalysis. The first, published in August 2024, found that a large purchaser of Russian drones used Garantex to process more than $100 million in Tether transactions. The second describes how Russian disinformation campaigners received $200,000 worth of Tether balances in 2023 and 2024, much of it directly from Garantex. In a March 2024 podcast, Chainalysis executives allege that "a majority" of activity on Garantex continued to be in stablecoins.

After years of regular access to Tether's stablecoin platform, a rupture finally occurred earlier this month when Tether froze $23 million worth of Garantex's USDT balances at the request of law enforcement authorities. The move came in conjunction with a seizure by law enforcement of Garantex's website and servers. 

Garantex's website was seized in March 2025 by a collection of law enforcement agencies.

In a press release, Tether claimed that its actions against Garantex illustrated its ability to "track transactions and freeze USDt." But if Tether was so good at tracking its users, why did it connect a sanctioned party like Garantex in the first place, and continue to service it for over four years? Something doesn't add up.

Not just Tether: other stablecoins offered Garantex access, too

Tether doesn't appear to have been the only stablecoin platform to provide Garantex with access to its platform. MakerDAO (recently rebranded as Sky) and Circle Internet may have done so, too.

Circle, based in Boston, manages the second-largest stablecoin, USDC. When OFAC put Garantex on its sanctions list in April 2022, Circle was quick to freeze one of the designated addresses. It did no hold any USDC balances. However, like Tether, Circle's no-vetting policy means that it doesn't do due diligence on users (sanctioned or not) who open new wallets, hold USDC in those wallets, and use them to make payments within the USDC system. Circle only checks the ID of users who ask it to cash them out. Thus, it would have been a cinch for Garantex to dodge Circle's initial freeze: just open up a new access point to the USDC platform. Which is exactly what appears to have happened.

On March 30, 2022, Garantex used its Twitter/X account to announce that it was offering USDC-denominated services. Beginning at some point in the first half of 2022, close to the time that the U.S. Treasury's sanctions were announced, Garantex began to list USDC on its trading page (see screenshot at top). The exchange's trading page continued to advertise USDC-denominated financial services through 2023, 2024, and 2025 until its website was seized last month. 

Tether, Circle's competitor, proceeded to freeze $23 million worth of USDT on behalf of law enforcement authorities, as already outlined. However, respected blockchain sleuth ZachXBT says that Circle did not itself interdict Garantex's access to the USDC payments platform, alleging that "a few Garantex addresses" holding USDC had not been blacklisted.

MakerDAO is a geography-free financial institution that maintains and governs the Dai stablecoin, pegged to the U.S. dollar. Archived screenshots show that Garantex added Dai to its trading list by September 2020, not long after the exchange had enabled Tether connectivity. According to blockchain analytics firm Elliptic, Russian ransomware group Conti has used Garantex to get Dai-denominated financial services. Garantex is able to access the Dai platform because MakerDAO uses the same no-vetting model as Tether. In fact, MakerDAO takes an even more hands-off approach than the other stablecoin platforms: it didn't seize any of the original 2022 addresses emphasized by OFAC. That's because Dai was designed without freezing functionality.

Not vetting users is lucrative

Providing financial services to a sanctioned Garantex would have been profitable for Tether and competing stablecoin platforms managed by Circle and MakerDAO. 

All stablecoins hold assets—typically treasury bills and other short term assets—to "back" the U.S. dollar tokens they have issued. They get to keep all the interest these assets generate for themselves rather than paying it to customers like Garantex. If we assume an average interest rate of 5% and that Garantex maintained a consistent $23 million in Tether balances over the 34 months from April 2022 (when it was sanctioned) to March 2025 (when it was finally frozen out), Tether could have earned approximately $3.2 million in interest courtesy of its relationship. 

Not only does their no-vetting model mean that stablecoin platforms get to earn ongoing income from bad actors like Garantex, this model also seems... not illegal? Stablecoin legal teams have signed off on the setup, both those in the U.S. and overseas. Government licensing bodies like the New York Department of Financial Services don't seem to care that licensed stablecoins don't ask for ID, or at least they turn a blind eye. (Perhaps these government agencies are simply unaware?) Nor has the U.S. Department of Justice indicted a single stablecoin platform for money laundering, sanctions violations, or failing to have a compliance program, despite it being eleven years now since Tether's no-vetting model first appeared. The model seem to have legal chops. Or not?

Banks and fintechs are no doubt looking on jealously at the no-vetting model. Had either PayPal or Wells Fargo allowed Garantex to get access to their payments services, the punishment would have been a large fine or even criminal charges. Sanctions violations are a strict liability offence, meaning that U.S. financial institutions can be held liable even if they only accidentally engage in sanctioned transactions. But more than a decade without punishment suggests stablecoins may be exempt.

This hands-off approach benefits stablecoins not only on the revenue side (i.e they can earn ongoing revenues from sanctioned actors). It also reduces their costs: they can hire far fewer sanctions and anti-money laundering compliance staff than an equivalent bank or fintech platform. Tether earned $13 billion in last year with just 100 or so employees. That's more profits than Citigroup, the U.S.'s fourth largest bank with 229,000 employees, a gap due in no small part to Tether's no-vetting access model. 

The coming financial migration?

Zooming out from Garantex's stablecoin experience, what is the bigger picture? 

I suspect that a great financial migration is likely upon us. Financial institutions can now seemingly provide services to the Garantex's of the world as long as the deliver them on a new type of substrate: decentralized databases. If so, banks and fintechs will very quickly shift their existing services over from centralized databases to decentralized ones in order to take advantage of their superior revenue opportunities and drastically lower compliance costs. 

This impending shift isn't from an inferior technology to a superior one, but from an older rule-bound technology to a rule-free one. PayPal recently launching its own stablecoin is evidence that this migration is afoot.

The argument many stablecoins advocates make to justify the replacement of full due diligence with a no-vetting access model is one based on financial inclusion. Consumers and legal businesses in places such as Turkey or Latin America, which suffer from high inflation, may want to hold digital dollars but don't necessarily have access to U.S. dollar accounts provided by local banks, perhaps because they don't qualify or lack trust in the domestic banking system. An open access model without vetting solves their problem.      

What about the American voting public? Do they agree with this migration? The last few decades have been characterized by a policy whereby the government requires financial institutions to screen out dangerous actors like Garantex in order to protect the public. Forced to the fringes of the financial system, criminals encounter extra operating dangers and costs. The effort to sneak back in serves as an additional choke point to catch them. To boot, the additional complexity created by bank due diligence serves to dissuade many would-be criminals from engaging in crime. Is the public ready to let the Garantexes back in by default? I'm not so sure it is.

Tether is available at Grinex, a Garantex reboot. [link]

Garantex's stablecoin story didn't end with last month's seizures and indictment. According to blockchain analytics firm Global Ledger, the exchange has been renamed Grinex and continues to operate. Tether services are already available on this new look-alike exchange, as the screenshot above reveals. Global Ledger says that $29.6 million worth of Tether have already been moved to Grinex as of March 14, 2025. 

This is the reality of an open-access, no-vetting financial system: bad actors slip in, eventually get cut off, and re-enter minutes later—an endless game of whack-a-mole that seems, for now at least, to be tolerated. It will only get larger as more financial institutions, eager to cut costs, gravitate to it.

Don't bank on bitcoin banking the unbanked

Bitcoin evangelist Andreas Antonopoulos thinks that bitcoin can solve the unbanked problem.

If you've spent any amount of time studying the unbanked problem, you'll know that Antonopoulos's claim is wrong for all sorts of reasons. Firstly, the World Bank estimates that there are 1.7 billion people who lack a bank account or mobile money access, not 4 billion. More importantly, the main hurdle to having a bank account isn't lack of ID, as implied in Antonopoulos's tweet. It's that people don't have enough money to open an account.

According to FDIC [pdf], 49% unbanked U.S. households cite “don’t have enough money to meet minimum balance requirements” as a reason for not having an account—the most cited reason. "Personal identification, credit, or former bank account problems" is far down the list of most-cited reasons, coming in at fifth.

In the Philippines, the number of unbanked Filipino adults stood at an incredible 51.2 million in 2019, or 71% of total adult population. The topmost reason for not having an account is "not enough money" as reported by almost half (45%) of the unbanked (see below). Lack of ID documents is the third most cited reason, at 26%.

Bangko Sentral ng Pilipinas 2019 Financial Inclusion Survey [pdf]

The World Bank's 2017 Global Findex survey, which surveys more than 150,000 adults in over 140 economies, found that the most common reason (cited by two-thirds of the unbanked) for not have an account was "having too little money to use an account." Only one-fifth cited "lack of documentation and distrust in the financial system."

So let's not misconstrue the unbanked problem. As Yaya Fanusie put it last year: "People mainly lack financial services because they lack income and not the other way around. So, to effectively bank the unbanked, the key problem to solve is how to help people generate more income." Do read the rest of Fanusie's post, in which he provides level-headed critique of the ability for crypto to bank the unbanked.

Antonopolous really wants bitcoin to solve the unbanked problem. But if a household is too poor to to open a bank account, it's also too poor to buy some bitcoins. (Never mind that the last thing low-income families should be doing is gambling on wild bitcoin price changes.)

Bitcoin does solve a niche type of financial problem. Those who have been cut off from the payments system for political or legal reasons can use bitcoin as an censorship-resistant alternative payment rail. Sanctioned Cubans are using it. So do online shops that sell legal but controversial products like salvia divinorum or kratom. White supremacists cut off from PayPal rely on it for funding. And criminals use the bitcoin network, say to extract ransomware extortion payments or sell kiddie porn.

But this category of "unbanked" is small, and only partially overlaps with the 1.7 billion who are unbanked primarily because of poverty. Antonopolous does a disservice in grouping them together. He is banking on bitcoin solving a problem it's simply not fit to solve.

The unbanked, the post office, and fintech in the 1880s

"A large population of people are excluded from the financial system because they don't have bank accounts. Fintechs compete to connect them and parallel plans emanate from the government to reach the unbanked, including postal banking."

What year am I describing in the above paragraph? 

It could be 2021. But it also describes 1870s. 

It's 2021 and the U.S. still has a large population of unbanked, those who have so little money that banks would rather not serve them. An astonishing 5.4% of Americans—that's 7.1 million households—do not have bank accounts.

Financial technology companies (aka fintechs) like PayPal and Facebook's Libra have well-meaning plans to connect the American unbanked population. Government-run proposals abound too. Postal banking is probably the most popular option, but more exotic solutions like central bank digital currency (CBDC) have also been floated. But many economists are wary that these government efforts will cripple the private sector.

None of this is new. Concerns over the unbanked, fintech, and a government participation in the payment system were all present back in England in the 1880s. Since I enjoy when the past resurfaces in the present, I'll tell the story.

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Britain in the 1870s had a very sophisticated chequing system. Because banks were the only way for people to access cheques, and banks preferred to limit accounts to rich people and wealthy merchants, the poor and middle class were often left out. 

Luckily, the 1870s version of fintech came to the rescue. The PayPal of the day was something called the Cheque Bank. Established in 1873, the Cheque Bank—like PayPal today—was a bank-on-top-of-a- bank. What do I mean by this?

PayPal is a customer of Wells Fargo, a large commercial bank. Wells Fargo provides PayPal with banking and payments services. PayPal in turn passes these services on to PayPal account holders, folks who might not otherwise qualify as customers of Wells Fargo or, if they could, prefer the way PayPal rebundles underlying Wells Fargo services.

Stock certificate for the Cheque Bank, Limited

The Cheque Bank operated on the same principles. It opened accounts at bank branches all across United Kingdom and overseas. Like PayPal, it passed through underlying banking services to its unbanked customers. The Cheque Bank's main product was cheques, which today might seem quaint. But back then they were cutting edge.

Anyone could buy a book of Cheque Bank cheques at a stationer or cigar store, the Cheque Bank redepositing the cash it received with its bankers. The customer could then spend those cheques at stores, send them to family via the mail, or hold them as a form of saving in lieu of cash (which was always at risk of being stolen). People who accepted a Cheque Bank cheque as payment could promptly take the document to any bank and cash it.

Much like PayPal does today, the Cheque Bank held 100% reserves. That is, for every $1 in cheques it issued, it kept $1 locked up with its bankers. And so its cheques were considered to be as safe as cash. Put differently, regular banks engage in both lending and payments. But fintechs like PayPal and the Cheque Bank don't lend at all. They deposit all of their assets at an underlying bank and focus on offering the payments side of the banking business to their customers.

The Cheque Bank attracted the attention of William Stanley Jevons, one of the most important economists of the day and still very much a household name among economists today. Jevons was one of three economists (along with Carl Menger and Leon Walras) to discover the principle of marginal utility, a key economic principal which had eluded even Adam Smith. 

In his 1875 book Money and the Mechanism of Exchange, Jevons devotes a full chapter to the Cheque Bank, describing it as a "very ingenious attempt" to "extend the area of banking to the masses." Here is what one of the Cheque Bank's cheques looks like:

1899 cheque issued by the Cheque Bank [source]

The cheques could only be filled to an amount printed on the document, writes Jevons. So the above cheque, which had been purchased for £5, could be written out for anything up to £5, although in this particular case the cheque writer (H.L. Stevens) chose the sum of 3 pounds 3 shillings. 

Jevons isn't the only notable economist to write about the Cheque Bank. It also pops up over a hundred years later in economist Edward S. Prescott's work, who describes it as a "highly interesting experiment in extending the use of checks to the lower and middle classes." Prescott suggests that the ability to write a specific amount on the face of one of these cheques would have greatly facilitated payments through the postal service since there was no need for change. Unlike a regular cheque, which also offered this flexibility, the recipient of one of the Cheque Bank's cheques needn't worry about it bouncing.

Jevons was excited by the Cheque Bank. But he was not a fan of a subsequent competing payments innovation, the postal order.

The British Post Office, owned by the government, had long been engaged in the business of transmitting money orders, unofficially since 1792 and officially since 1838. A customer would walk into any money order office, put down, say, £2 and 2 shillings, and get a £2 2s money order. The recipient's name was then written on the order. It could then be sent via post to a distant office, upon which the recipient could take the money order to the counter to be cashed. The officer would first confirm the payment by referring to a separate letter of advice. This letter, sent from post office to post office, served an an extra layer of security against fraud. Only then would the £2 and 2 shillings be paid out.

The problem, according to then Postmaster General Henry Fawcett, is that the money order wasn't very useful to people who only wanted to send small amounts. "If a boy wanted to send his mother the first shilling he had saved, he would have to pay twopence for the order and a penny for postage," wrote Fawcett. In other words, to send a 12 penny (i.e. one shilling) money order, three pennies—a massive 25%—had to be sacrificed in fees. (A shilling in 1880 was worth around US$8 today.) And so it would have been an expensive payments option for the poor.

Prior to his appointment as Postmaster General in 1880, Fawcett had been both parliamentarian and the first professor of political economy at Cambridge. And while he wasn't as illustrious an economist as Jevons (he hasn't left us any bits of economic theory), Fawcett did write what was one of the popular textbooks of the day.

But if Fawcett wasn't going to change the study of economics, he did intend to change the payments system. As Postmaster General, Fawcett proposed complementing the money order with a new product called a postal note, or postal order. (The postal order had been earlier conceived of by George Chetwynd, the Receiver and Accountant General of the Post office). Like the cheques issued by the Cheque Bank founded just seven years before, postal orders would have a fixed denomination printed on them. These increments were to start at 1 shilling and go up to 20 shillings (US$8 to US$160 in 2019 dollars).

By contrast the post office's traditional payment product, the money order, was open-faced and had no denomination. Because postal orders would be issued in smaller amounts, the Post Office needn't bother sending separate letters of advice as a security measure, which meant that they would be far cheaper to process. And so the fees could be lower for postal orders than money orders, broadening the pool of customers.

In an 1880 essay, William Stanley Jevons blasted the idea of postal orders, which hadn't yet received legislative assent. Singling out Fawcett, Jevons wrote:

"The fact of course is that not only from the time of Adam Smith, but from a much earlier date, it has always been recognized that a Government is not really a suitable body to enter upon the business of banking. It is with regret that we must see in this year 1880 the names of so great a financier as Mr. Gladstone, and so sound an economist as Professor Fawcett, given to schemes which are radically vicious and opposed to the teachings of economic science and economic experience."

So that lays out the cast of characters in 1880. It includes exclusionary banks, hoards of unbanked, a set of opposed economists in Jevons and Fawcett, fintechs like the Cheque Bank, and a post office on the verge of issuing a novel product; postal orders.

2020 seems very much like 1880. To help connect the large population of American unbanked to the financial system, a number of modern day Fawcetts (Morgan Ricks, Mehrsa Baradaran, Rohan Grey) have floated public payments solutions including a return of postal banking, central bank digital currency (CBDC), or central bank-accounts-for-all.

Our modern day equivalents to the Cheque Bank includes non-banks such as prepaid debit card issuers Walmart and Netspend, both of which are trying to reach unbanked Americans. Online wallet companies like PayPal and Chime are also in the mix. And stablecoin issuers such as Facebook's upcoming Libra project talk a big game when it comes to financial inclusion. To round things out you've got your modern day Jevonses; economists who don't buy the idea that the government should get into banking (Larry White, George Selgin, Diego Zuluaga).

So how did things end up in 1880? Despite opposition from Jevons and the Economist, Fawcett's postal order dream came to fruition. After receiving legislative approval, the world's first postal orders were issued in 1881:

The world's first postal order was issued in 1881 by the British Post Office. The fee of a halfpenny on a one shilling postal order (~4%) was less than two pennies for a regular money order, which meant the not-so-wealthy could finally afford to make small remote payments. pic.twitter.com/KpbyoY0uHj

— John Paul Koning (@jp_koning) December 30, 2020

Postal orders would go on to become very popular. They largely displaced money orders, except for large amounts. Other postal systems including that of New Zealand, Canada, Australia, and the U.S. would go on to copy the idea. The UK's modern day incarnation of the post, the Post Office, still offers a version of the product.

And what about the Cheque Bank? Digging through old documents, Edward Prescott discovered that the Cheque Bank failed in the late 1890s. According to liquidation proceedings reported in the Banker’s Magazine, it was plagued by forgery problems and increased competition for less wealthy depositors from banks. Perhaps the emergence of the postal order also played a part.

I'm not invoking the 1880s as a prediction of what will occur in the 2020s. Rather, it fascinates me because it reveals how old these payments dilemmas are. The same tensions between public and private payments were present then as they are now. And it's also interesting to see how economists have always been engaged in questions of financial inclusion. Not just Fawcett but Jevons too, who we know primarily for his work on monetary theory. 

And over a hundred years later, Edward Prescott delved into the topic, too. In a 1999 paper (which mentions the Cheque Bank), Prescott discusses the idea of opening up an inexpensive type of bank account called an Electronic Transfer Account (ETA) so that all Americans, particularly the unbanked, might receive Federal benefit payments digitally. (Prescott was skeptical that ETAs might work out. The program, introduced in 1999, was discontinued in 2018 and has been replaced with a prepaid debit card program.)

In closing, the topic of how to help the unbanked is a complicated one with many moving parts. Which is why we should explore how things played out in different times. Perhaps history can get us to see the debate in a new light.

Merry Christmas and a Happy New Year!

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P.S. If you're interested in learning more about Jevons's thinking on payments, he was a big champion of the idea of creating an international coin standard. I wrote about it here. Think of it as a proto-version of the Euro. Jevons came up with a "tidy English solution" for fitting Britain into this proposed international coin union. The project never came to fruition.

Dolphin Safe Tuna and Fair Trade bank accounts?

The Royal Bank, Canada's largest bank, says that it won’t lend to clients that get more than 60% of their revenue from thermal coal or coal-fired power generation. Should a bank be able to avoid providing services to businesses just because they don't engage in the sorts of activities the bank, or its depositors, approve of? 

Put differently, should the Royal Bank be able to avoid "dirty" loans so that it can offer its depositors the semblance a Fair Trade, or green, bank account?

Critics would say that the Royal Bank shouldn't be allowed to avoid banking coal-fire dependent companies because it operates within a “regime of privilege.” That is, the Royal Bank benefits from a system of government regulation, central bank lender of last resort benefits, Federal deposit insurance, and direct access to core public payments systems. Given how deeply it is fused with public infrastructure, the Royal Bank is sort of like a utility, and like any utility it has a public duty to consider all customers, even coal energy guzzlers.

A related argument is that because banks must obtain a charter in order to operate, and this is difficult, there are not enough banks competing with each other. And thus it would be unfair for Royal Bank to avoid doing business with coal-fired power generators; financial banishment could doom these businesses to failure.

I draw the above arguments from a recent paper by Brian Knight and Trace Mitchell. Hopefully I have accurately captured their views. Given their specialness, banks should not be permitted to act as "de facto regulators," say the authors.

Now for the counterargument. People should be free to enter whatever contracts they see fit, including avoiding ones they find distasteful or against their beliefs. This freedom shouldn't be available to some people but not others. For instance, say that Sarah and Tom are both worried about global warming and sustainability. Tom is a skilled cook and decides to set up a sustainable restaurant that serves only ethically sourced ingredients. Sarah, for her part, is trained in finance and wants to set up a sustainable bank. Her source material for creating 100% green bank deposits is ethical loans to green businesses.

A law disallowing banks from choosing their customers means that Tom can self-actuate his beliefs by only dealing with green food suppliers, but Sarah cannot do the same by only lending to green borrowers. That hardly seem fair.

So there are two conflicting ideals at play here: the right to receive core services vs the freedom of association.

In the U.S., the Office of the Comptroller of the Currency (OCC), a key U.S. bank regulator, is choosing a side in this conflict. In an effort to stop banks from “politically driven discrimination,” the OCC is proposing a rule that would prevent bankers from using anything other than regular credit and operational criteria for evaluating a company seeking financial services. Were the OCC's "no discrimination rule" to be applied in Canada, it would require Royal Bank to lend to companies hooked on coal-fire energy.

In proposing this rule, the OCC has adopted the same rational as Knight & Mitchell. In an op-ed for the Wall Street Journal, OCC head Brian Brooks and Chief Economist Charles Calomiris argue that government chartering and direct access to the Federal Reserve obligate banks to provide services to all companies.

I recently wrote about this "no discrimination" rule for Coindesk. In that article I took the pro-Royal Bank side, arguing in favour of fair trade bank accounts. The 21st century consumer wants to know more about the provenance of the things they buy. We don’t just want tuna, we want dolphin-friendly tuna. We don’t want our T-shirts to be made in sweatshops with Xinjiang-grown cotton. We want ethical T-shirts. So why shouldn't we get clean bank accounts?

I want to explore this tension a bit more.

If we are going to apply a no discrimination rule to any segment of the banking and payments market, I think it should be placed on the card networks, Visa and MasterCard. The card networks have the power to exercise far more de facto regulation over the economy than any bank. If a bank disconnects a business, that'll certainly a hassle for the debanked business. But at least there are dozens of other banks in Canada to turn to, and thousands in the U.S. Even if no bank is willing to step forward, there is a whole host of non-bank financial institutions that can provide a business with financing or payments services.

Not so if the two card networks disconnect a retailer. Since there is no good alternative to Visa and MasterCard (especially online), a banned business could be in very real jeopardy. For instance, the card companies currently allow gun and porn purchases across their networks. But were they to ban gun and porn sales because they deem them unsavoury, Visa and MasterCard would be doing incredible damage to both industries, far more than if two large banks were to cease providing services to gun retailers or porn sites.

For a demonstration of this power, look at Pornhub's recent reaction to the threat of being deplatformed by Visa and MasterCard. After being accused of hosting child porn, Pornhub completely redesigned its platform to try and keep the two card networks on side (it failed.) 

By the way, I wrote about this incident for the Sound Money Project. Porn is legal, but child porn is illegal. Any financial institution that knowingly allows illegal transactions to cross its platform could be accused of money laundering. So Pornhub's deplatforming wasn't a case of the card networks acting as de facto regulators of content. Rather, they were doing what the actual regulators, i.e. the law, dictate. (That doesn't mean we shouldn't be worried that card networks can engage in de facto regulation. It just means that in this case, they didn't exercise that power).

So to reiterate, card networks have more power than banks. But unlike banks, card networks don't operate within a “regime of privilege” as described by Knight & Mitchell or in Brooks & Calomiris's op-ed. They don't have lender of last resort benefits, Federal deposit insurance, or direct access to core public payments systems. Nor do they have to get to get a bank charter. 

Visa and MasterCard are powerful because they are networks. Once everyone is connected to a network, there is very little reason for any one to leave to a competing network since only the incumbent can offer a large number of connections. (A bank is not a network, it is a member of a network.) 

And so Visa and MasterCard evade—unjustifiably so, in my opinion—all of the criteria for being targeted by the OCC's no discrimination rule. Instead, it is less powerful banks that would be handicapped by it on the basis of their proximity to government infrastructure and their obligation to get a charter.

Which gets me to my final point. The OCC and Knight & Mitchell have proposed that the criteria for triggering a no discrimination rule should be the existence of a "regime of privilege" and chartering. But doesn't a wide swath of the economy operate within a "regime of privilege" and chartering? 

A restaurant, for instance, must get a restaurant license before opening its doors. It also needs to secure building, ventilation, and signage permits. It is encumbered by zoning requirements and needs to secure a license to sell alcohol. Restaurants benefit from a government-funded system of food inspection. The ingredients that a restaurateur purchases has passed through some sort of a food safety regulatory process.

In sum, I do agree that we may need some sort of no discrimination rule for financial institutions. I'm just not sure that the OCC and Knight & Mitchell have found the right criteria for applying this rule. Let's choose whatever criteria get us to a situation that the card network Visa and MasterCard are the prime candidates for a "no discrimination" rule, not banks (or restaurants).

Why are so many Americans content to be unbanked?

Source

Here's a surprising statistic: 5.4% of American households didn't have a bank account in 2019. That's 7.1 million households. Oddly, unbanked households seem fine with this state of affairs. More than 56% of unbanked households say they are "not at all interested" in owning a bank account.  

For us non-Americans looking in, these numbers are very strange. I live in Canada, and bank accounts are pretty much universal here. If you don't have one, you'd probably be quite interested in getting one. Ditto for other developed nations such as Australia, Japan, Sweden, France, and Germany. The banked rate in these countries lies between 99%-100%, much higher than the U.S.'s 94.4%.

In this post I want to try and figure out why there are so many U.S. households without bank accounts, and why so many of them seem uninterested in having one. Lucky for us, the Federal Deposit Insurance Corporation's (FDIC) biannual national survey of bank account usage provides a ton of data on the topic.

Two major reasons for being unbanked

According to FDIC, the most popular reason cited by unbanked households for not having a bank account is don't have enough money to meet minimum balance requirements. 48.9% of all unbanked respondents chose this option. What this indicates is that banks are setting standards that many Americans simply cannot meet, particularly poor households (FDIC data shows that 23.3% of families with income below $15,000 are unbanked compared to an American average of 5.4%). Perhaps the unbanked are "not at all interested" in getting an account because they're tired of being rebuffed.

The second most popular reason that the unbanked give for not having a bank account is don't trust banks at 36.3%. The 2019 survey doesn't provide much colour on what this means. Do unbanked households not trust banks because of surprise fees? Are there cultural explanations?

Why Americans don't trust banks

Luckily, there is a bit more detail on trust in FDIC's 2011 survey. When FDIC statisticians queried those who said they didn't trust banks for follow up reasons, 60% said that they simply didn't trust banks, 20% said banks do not feel welcoming, and another 4% said there were language barriers. This clarifies things a bit, but again the vague notion of trust dominates.

In 2016 FDIC conducted a series of interviews with bank, nonprofits, counselors and consumers in an effort to better understand the lack of trust among the unbanked. Describing the barriers to trust, a bank executive mentioned "a narrative that is built up within [their] mind." Another executive listed a reputation for "trying to pull one on over me." One counselor brought up "uncertainty about the security of funds" and another said "they’re often paranoid about [banks] ... They just think that the bank is a bad institution, and they want to stay away from it... Often, it’s just a lack of knowledge or just like they don’t understand it, so they just stay away."

This last comment is especially interesting. Do people not trust banks for the same reason that they don't trust vaccines, the veracity of the moon landing, or accounts of Elvis's death? Banking, after all, is complex. It's a bit of a black box. And so the public writes its own mythologies about banks. It may be that some of these mythologies prevent people from getting a bank account.

Don't trust vaccines, don't trust banks

For the rest of this post, let's assume that there is a large portion of the population that is unbanked for economic reasons, and another portion that is unbanked for mythological reasons. As banks get better at serving people and the economy improves, the population that is unbanked for economic reasons should contract. But we'd expect the population that is unbanked out of superstition to remain stable over time. Bank haters are always going to hate, even if the economy perks up.

Does FDIC data confirm this hypothesis?

I think it does. The U.S. economy has steadily improved since 2011. At the same time, banks are getting more accessible. According to Bankrate, a company that gathers data about consumer finance products, minimum balance requirements on checking accounts are at six-year lows. Half of all checking accounts are considered free, the highest percentage since 2010. 

And so we'd expect many who were unbanked due to concerns over minimum balance requirements to now have bank accounts. And that is what has happened. Since 2013, the proportion of unbanked households reporting that they are unbanked because of minimum balance-related problems has fallen, as indicated in the chart below. Meanwhile, the proportion who are unbanked because they don't trust banks has risen.

We'd expect bank account openings to be especially marked among poor Americans, since they are more likely to be constrained by minimum balance requirements than middle-class Americans. And that's what FDIC data shows. The unbanked rate for those with less than $15,000 in annual income has improved from 28.2% in 2011 to 23.3% in 2019. The unbanked rates of other vulnerable demographics have improved as well:

Not bad. Take a look at the reduction in unbanked rates among economically-disadvantaged demographics from 2011-2019. U.S. banks aren't getting enough credit for this. pic.twitter.com/lAjdVAzU8e

— John Paul Koning (@jp_koning) November 5, 2020

However, the unbanked rate for households that earn $30,000 to $50,000 has hardly budged (see chart below). It was 4.9% in 2011. In 2019 it was 4.6%. (That's around 1.1 million households in the $30k-$50k bracket that don't have account!) This same invariance over time characterizes households in the $50,000-$75,000 income bracket. Around 1.7% of American households in this category don't have a bank account, the same level as 2013.

What explains the historical stability of unbanked rates among the richer unbanked? Given higher incomes, concerns about minimum account balance requirements may be less important than concerns about trust. And thus the unbanked rate among these groups is unlikely to be affected by improvements in the broader economy.

America's terminally large population of unbanked

Perhaps one day all American households that were unbanked for economic reasons will have bank accounts. The only remaining unbanked would be those households who are philosophically unbanked. Subsequent improvements in the economy or bank accessibility would have no affect on their banking decisions. 

How big might this core group of bank skeptics be?

Say that bank skepticism lies in the same bucket as Elvis belief and moon landing conspiracies. We know that belief in conspiracy theories is not equally distributed across income groups. Low-income people are more likely to believe that there is some evil actor pulling on the strings, and so they may be more prone to be bank skeptics. We already know that the unbanked rate among households who make $30,000 to $50,000 has stabilized at around 5%. It hovers around 1.5 to 2% among households making $50,000 to $75,000. For those earning less than $15,000, will the unbanked rate eventually stabilize at 7.5%? 10%?

So while America's overall banked rate will continue to improve from 94.4%, there may be a good chance that it peaks-out at some permanent plateau significantly below 100%. In Canada the banked rate lies somewhere between 99% and 100%. I'd guess that the US peaks below that, say at 97% or 98%. Canadians like a good conspiracy theory, but we are much less conspiracy theory-prone than Americans. If a culture of anti-bank mythologizing draws from the same source as conspiracy theorizing, we can assume that Americans are more likely to be prone to bank skepticism than Canadians.      

What does all this have to say about policy surrounding the unbanked? 

Postal banking vs Walmart cards vs FedAccounts

The plight of the unbanked has been used to justify all sorts of government fixes: a Federal Reserve-issued digital currency, FedAccounts, postal banking, a USPS prepaid card, and a public Venmo. At the core of all these projects is the idea that unbanked Americans are unbanked because of excessive fees and high minimum account balance requirements. And that theory may be right, to a degree.

But none of these projects tries to account for people who may be unbanked for the same reason they don't want to be vaccinated, or because they believe in QAnon. One of the motivating ideas behind FedAccounts, for instance, is to have the Federal Reserve provide a public option for the unbanked. But it could be that folks who are philosophically opposed to banks will also be intolerant of an account at the FED. God know the U.S. is rife with central banking conspiracy theories.

This may be one reason why places like Walmart are the best option for reaching the unbanked. Walmart isn't a bank, so it can attract bank skeptics. And it has the financial heft to offer those on a low income a set of well-priced banking products via its Walmart MoneyCenters (which offer check cashing, bill pay, and money orders) and its prepaid debit card, the MoneyCard. Many of the 5.4% of the population that FDIC categorizes as unbanked are happily getting financial services at Walmart. They aren't really unbanked; they are differently banked.

If not the Fed, perhaps the United States Postal Office is the right institution for reaching the philosophically unbanked. The USPS is not a bank. And according to Morning Consult, the post office is the most trusted brand in America. When asked how much do you trust each brand to do what is right? 42% of Americans responded that they trusted the USPS "a lot." And so people who bristle at the idea of keeping a Chase debit card in their wallet may very well be proud owners of a USPS card.

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P.S.: In a recent article for AIER Sound Money Project, I wrote about postal banking. But rather than advocating branch banking I suggested a USPS prepaid debit card/mobile app. Branch banking is in long-term decline. Below is a chart showing how branch visits have fallen across all demographics from 2017 to 2019:

Americans still visit bank branches fairly often, but less so in 2019.

Also, note the differences between demographics. Older people, whites, and those without a high school diploma visit more often than the rich, blacks, and young folks. But everyone is visiting less. pic.twitter.com/P7dyVSvINl

— John Paul Koning (@jp_koning) October 30, 2020

Much of this decline in branch visits is due to the huge popularity of mobile banking. Keep in mind, however, that low income people are more likely to rely on branch visits for their primary method of accessing bank services than high income people, as the chart below illustrates:

Even so, I question the wisdom of investing billions of dollars to convert 30,000+ USPS branches into full service banks when a single digital bank with an app & debit card will do. Yes, USPS branch banks would have been useful in 2017 or 2019, especially for low-income people and the elderly. But branch banking is a long-term investment, one with a payback period measured in decades. And I suspect that by 2025 or 2027 it will be uncommon for people of all income groups to visit their branch for teller services.

The ECB's digital euro: anonymous or not?

 

The European Central Bank (ECB) recently published a report that explores the idea of introducing a digital euro for use by the general public. This project is known as a central bank digital currency, or CBDC, and many other countries are exploring the same idea. John Kiff has a useful database here showing how far these projects have progressed.

Will the ECB's new euros-for-all be relatively open and anonymous like cash? Or will they require ID and permission like a bank account?

In short, the report says that anonymity may have to be "ruled out." It says that regulations do not allow anonymity in electronic payments, and the ECB must comply with regulations. I quote the passage below:

"While [anonymity] is currently the case for banknotes and coins, regulations do not allow anonymity in electronic payments and the digital euro must in principle comply with such regulations (Requirement 10)."

But I'm pretty sure the report is wrong on this. EU regulations do allow for anonymity in electronic payments. The Fifth EU Anti-Money Laundering Directive (AML5) exempts issuers of e-money/prepaid cards from collecting customer information as long as long as fixed monetary thresholds aren't exceeded. Yes, these exemptions are very small:

Source: Paytechlaw

So if the ECB believes that it must comply with existing regulation for electronic payments then surely a digital euro falls under e-money law, and thus it can have some anonymity. (Jerry Brito has pushed back on the first assumption, asking why a CBDC can't just occupy the same legal framework that has already been created for banknotes.)

By the way, the U.S. and Canada also provide such exemptions. That's why people can walk into a pharmacy and get a $200 Vanilla prepaid debit card without showing any ID and, say, buy food online for delivery. Or to make an anonymous donation.

Putting aside for the moment the ECB's views about payment anonymity, an interesting question is why democracies allow for small amounts of payments anonymity in the first place. 

On Twitter, we talk a lot about the civil liberties case for anonymity i.e. the right to stay anonymous. But that's not why regulatory exemptions to all-pervasive know your customer obligations exist. They exist because of political appeals to financial inclusion. Disadvantaged people often lack ID. To ensure that these people aren't locked out of the digital payment system, electronic money & prepaid card issuers are allowed to avoid collecting information when the amounts held are small.

So let's bring the conversation back to the ECB's report on a digital euro. Yes, the report did wrongly state that it can't legally provide anonymity. And yes, we can chide the ECB from a civil liberties perspective for not wanting to activate a feature for which it has legal right.

But given my earlier point about financial inclusion, a better critique is this:

The EU has chosen to build an anonymity exemption into payments law in order to ensure that all Europeans, including those without ID, can make digital payments. Why is the ECB choosing to avoid exploiting this exemption? In the very same report, after all, the ECB states that the decline in cash could "exacerbate financial exclusion for the 'unbanked' and for vulnerable groups in society, forcing the central bank to intervene." Isn't the ECB contradicting itself by saying that it wants to help the vulnerable while simultaneously refusing to activate a feature—anonymity—that might help reach this demographic?

Central banks such as the ECB are sailing into dicey political territory by choosing to pursue a new retail payment product. Who are they trying to serve, and why? More controversially, who are they choosing to not serve? Anonymity (or its lack) will be one of the most contentious design elements of a potential digital euro. Let's hope the ECB does a better job discussing this particular issue in the future. In this recent attempt it could be construed to be ducking behind non-exist laws rather than directly engaging with a tricky topic.

By the way, I understand why the ECB might not want to provide anonymity. The exemptions that AML5 permits are tiny. Is it even worth if for the ECB to exploit them? And let's face it, anonymity can attract bad actors. Due to their relative anonymity, iTunes and Steam gift cards are being repurposed by IRS and Social Security scammers as a safe way to extort payments from their victims. And ransomware operators have converged on bitcoin as a safe way to extort ransoms.

Ransomware developer Sodinokibi deposits $1 million in bitcoins on a Russian-speaking hacker forum. The idea is to attract affiliates by proving that they mean business: https://t.co/ZlxGsPkc6G pic.twitter.com/LSz6uM9MCk

— John Paul Koning (@jp_koning) October 3, 2020

Balanced against the dangers of anonymity are peoples' very legitimate concerns about civil liberties and financial inclusion. It's a tough issue. I don't envy the ECB.