Kraken v Kraken, or how to protect the public from crypto exchange failures

It's been a full year since FTX International and FTX-US collapsed, and the shocking thing is – there is still no regulated crypto venue in the U.S.! You'd think some lessons would have been learnt.

To best protect the public from the Sam Bankman-Frieds of the world, what the U.S. requires is securities-level oversight of crypto exchanges. Exchanges like Coinbase and Kraken are offering the sorts of investment services to the public that the U.S.'s main securities regulator, the SEC, is ideally positioned to regulate, such as trading, margin, custody, and market making. But one year after FTX's collapse, there doesn't appear to be a single SEC-regulated exchange.

The exchanges blame this on the SEC's lack of clarity. The SEC blames this on exchanges refusing to come in and register. God knows who's telling the truth.

Whatever the case, this intransigence only increases the odds that there'll be another U.S. crypto exchange collapse in the next few years, one that appropriate regulation could have otherwise prevented, or at least sheltered investors from the fallout.

What sort of protections am I talking about? After Canada suffered through the collapse of QuadrigaCX a few years back, and a bunch of Canadians like myself lost money, crypto exchanges were brought under the auspices of our existing securities regulatory framework, with a few nips and tucks to the rules to make them fit. This has led to a lot of changes that make Canadian crypto customers safer. I'm going to share the best example in this blog post.

Kraken is a well-known crypto exchange that serves both American and Canadian customers. However, if you're an American customers who uses Kraken, you possess a very different sort of asset than Canadian customers do.

Let's look at the fine print of the U.S. platform:

Source: Kraken's terms of service for U.S. customers

So in the U.S., asset are held "by us for you." That is, Kraken itself is doing the holding, safekeeping, or providing custody of crypto for its customers.

A key observation I want to make here is how fundamentally different this is from how standard regulated marketplaces function like the NASDAQ or the Toronto Stock Exchange. Traditional marketplaces offer a venue to trade assets, but they don't offer custody. If they tried to introduce this, their regulator would very quickly say no. I'll explain why below.

But first, let's head over to Kraken Canada. Once again, here's the fine-print:

Source: Kraken's terms of service for Canadian customers

What the underlined wording says is that if you're a Canadian, Kraken does not hold your crypto for you. That's very different from the U.S. Instead, Kraken says that customer crypto is deemed to be "custodial assets" and delegates your crypto to a "designated trust account at a Crypto Custodian." Bingo. There's the separation of trading from custody that I was talking about earlier, which aligns with standard practices for marketplaces.

Scan further through the fine print and you learn who that crypto custodian is: Anchorage Digital Bank:

Source: Kraken's terms of service for Canadian customers

Who is Anchorage? Anchorage is a federally-charted trust that is overseen by the Office of the Comptroller of the Currency, one of the key U.S. federal banking regulators. So if you hold some coins on Kraken, and you are an American, you own what is essentially a Kraken IOU, and you have to trust Kraken, but if you are a Canadian, you're effectively putting most of your trust in a federally charted financial institution. That's pretty stern stuff. 

Canadian securities regulators require all crypto exchanges operating in Canada to delegate at least 80% of customer crypto to a third-party custodian. (The other 20% can be held in a hot wallet for liquidity purposes.) Kraken doesn't appear to be doing this for its American customers, and that's because there's no U.S. regulator prompting it to do so. On top of requiring this separation, Canadian regulators stipulate that third-party custodians must be qualified. That is, they can't just walk in off the street. The custodian has to meet the regulator's standards, which requires having a Systems and Organization Controls (SOC) designation, and a bunch of other stuff too.

You can probably see by now that if you're a customer of Kraken, it's better to be Canadian than American, for the following reasons:

• Anchorage is a federally-regulated financial institution and subject to strict oversight. Kraken U.S. is for the most part unregulated. No one is peering over its shoulder to check whether it is doing a good job safekeeping your coins.
• Kraken has its fingers in a lot of different businesses, but Anchorage specializes on custody, and so it's probably better at the task.
• Anchorage is independent from Kraken. This separation mitigates the risk of loss, theft, or misuse of assets by Kraken management. This is particularly salient in Kraken's case because it engages in many other business activities, such as trading or market-making, and these pose potential conflicts of interest.

In the future, one hopes that Kraken's U.S. exchange provides the same level of customer protection as Kraken's Canadian platform. But that's only go to happen if and when the SEC dictates a fundamental separation of crypto trading from custody, and whether U.S. crypto exchanges actually listen to the SEC.

Addendum (Nov 21): Talk about good timing. The SEC just announced that it is suing Kraken's U.S. entity for, among many other things, failing to segregate customer crypto assets and dollar balances. Segregation is different than third party custody. It basically means that customer property is kept separate from corporate property. This helps to prevent double-dipping. An exchange can make use of a third party custodian, for instance, but not segregate those funds into corporate and customer buckets. The combination of segregation and third-party custody is optimal.

By contrast, Canadian securities law clearly specifies that Kraken and any other Canadian exchange must already be segregating customers crypto and funds from corporate funds. In the regulators' own words, exchanges must keep customer property "separate and apart from its own property." This is in addition to the requirement that they use a third party custodian to store customer crypto and fiat. We can verify by reading Kraken's undertaking with Canadian regulators, in which it promises that it will be keeping customer crypto "separate and apart from its own assets."

Segregation is just one other low-hanging bit of customer protection that U.S. crypto exchanges should already have implemented, but probably won't until prodded by the government.

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The next section is for pedants only, of which I'm embarrassed to be, which is why I'm putting this in very small print:

Kraken owns a U.S. bank. How does this fit into the story? Here are the details: In the U.S., the Kraken crypto exchange is really just the trade name for Payward Ventures. Payward Ventures is in turn a subsidiary of Payward, Inc. Payward, Inc has another subsidiary, Payward Financial, Inc, that owns a state-charted bank -- Kraken Bank. Notably, when you sign up as a customer of the Kraken crypto exchange, you are entering into a relationship with Payward Ventures, not Payward Financial. There is no indication in the exchange's terms of service that Kraken Bank is in any way involved in custody. Which seems... odd? Why wouldn't Kraken use its bank for custody?

When Kraken first applied to do business in Canada earlier this year, it said it wanted to use Kraken Bank as its custodian. Given that Kraken is in fact using Anchorage Bank as we speak, I suspect that Canadian regulators told Kraken: "Hey, guys. Kraken Bank is not sufficiently independent, you're going to have to use a third-party." And I suspect they were right about this.

Meanwhile, what about Canada's most popular exchange, Coinbase? Coinbase's Canadian terms of service doesn't indicate that it is using a qualified custodian. Customer assets are "held by the Coinbase Group for your benefit." Yeah, that's not going to fly with the regulators. I suspect that within a few months you're going to see it using a third-party like Anchorage, or its just going to leave Canada.

In praise of anti-money laundering thresholds

Two seemingly separate stories, a crypto and a banking story, have a common thread in anti-money laundering thresholds.

In the first story, the New York Times shows how regular folks are increasingly losing their bank accounts because their bank perceives them to be engaging in risky behaviour. In the second, the U.S. government has proposed an expansive new rule that would require financial institutions to report all customers who use cryptocurrency mixers to the government.

Anti-money laundering thresholds underpin what I'll call the Pragmatic Compromise between the government and citizens, albeit a tenuous compromise, for reasons I'll explain.

The U.S. government and its various law enforcement agencies have the ability to get full access to bank records for the purposes of fighting crime. They can do so directly, that is, without having to proceed through the standard process of convincing a judge to approve a warrant. This is an incredible amount of power to have. To counterbalance this, a compromise of sorts has been agreed to that limits the government's access to bank records. A number of key financial thresholds have been established, below which transactions are protected from surveillance.

The most well-known method the government has for accessing your personal financial information is the requirement that banks submit currency transaction reports, or CTRs (see below), every time someone withdraws or deposits paper money. Banks don't submit a report for all cash transactions. The threshold for submitting is set at $10,000. So if you withdraw $9,999, your name and address won't be reported to the government. If you withdraw $10,001, you'll lose the threshold's protection and will be reported.

The modern U.S. currency transaction report [source]

 

The U.S. has a long history of providing direct government access to banking records. The practice began in 1945 when Treasury Secretary Henry Morgenthau Jr, invoking war-time powers, issued an executive order (see below) instructing banks to begin reporting currency deposits and withdrawals made by the public. Known as TCR-1 forms, these reports were to be forwarded every month to the government with information about the cash amounts involved and the identification of the individual making the transaction.

Morgenthau's reporting requirement was motivated by the desire to stamp out black marketeering, writes Paul Camacho, which had emerged as a way to evade war-time rationing programs. But even though the war soon ended and rationing ceased, the practice of cash reporting continued through the 1950s and 1960s, albeit on what must have been legally dubious grounds now that it was peacetime.

Henry Morgenthau's 1945 executive order on currency reporting [source]

In 1970, the necessary legal formalization to justify the reporting of bank information was provided when Congress passed the Bank Secrecy Act, which encoded directly into law the requirement that banks record and report cash transactions, as well as legislating a set of extra recordkeeping and reporting requirements. Over the years, additional recordkeeping and reporting standards were added by Congress to the Bank Secrecy Act, including the 1994 requirement that banks screen for "suspicious" transactions and report them to the government by submitting a suspicious activity report, or SAR (see below).

While there's certainly a law & order case to be made for providing governments with direct (i.e. warrantless) access to financial records, there's a pretty clear set of reasons why society should want to limit this power. Allow too much access and banks will inevitably get bogged down in the expensive bureaucracy of filing reports, which can lead to accessibility problems as the accounts of customers deemed to be a compliance nuissance are terminated—especially the ones who tend to make riskier but legal transactions. There's also the crucial question of the public's right not to be be snooped on, especially without a warrant and probable cause.

Suspicious Activity Report form, introduced in 1995

The first legal challenges to the government's direct access to bank records only came in the mid 1970s. But after hearing these cases (California Bankers Association v. Shultz and United States v. Miller), the Supreme Court allowed the entire data collection apparatus to remain intact. The majority ruled that there was no expectation of privacy in bank records, and that the recordkeeping and reporting requirements imposed by the Bank Secrecy Act do not violate bank customers' constitutional rights.

With the public having no constitutional protections against direct government access to bank records, the lone remaining counterbalance is the various anti-money laundering thresholds.

Which gets us back to the New York Times article (we'll touch on the cryptocurrency further down). The reasons for the growing debanking problem that the Times article highlights is complicated, but I'd suggest that one driver is a steady deterioration of two key reporting thresholds at the heart of the Pragmatic Compromise.

The original $10,000 cash reporting threshold was set back in 1945 by Henry Morgenthau, a level that was ratified in 1972 after the passage of the Bank Secrecy Act. This level has never been adjusted. (Morgenthau also set a second and lower $1,000 threshohold, but this only applied when banknotes in denominations of $50 or higher were involved).

Alas, inflation has been steadily eating into each thresholds' real value. When the Bank Secrecy Act was passed, $10,000 was worth $75,000 in today's dollars. In Morgenthau's time it was equal to $173,000. Either way, when the data collection apparatus was first established and the Pragmatic Compromise reached, most people's day-to-day cash withdrawals and deposits would have been sheltered from reported requirements. With the passage of time and inflation, a much wider swathe of civilian cash transactions have lost the protection offered by Morgenthau's $10,000 threshold. That means more snooping. It also means more debanking. Rather than absorbing the growing compliance costs of having "risky" cash-reliant customers, banks are closing accounts.  

As for suspicious activity reports, when they were first legislated in 1994 the government subjected them to a $5,000 threshold, which is equal to around $10,000 today. With inflation having effectively destroyed half of the value of the threshold, more and more regular transactions are falling under suspicion. As the Times points out, suspicious customers don't make for good customers: "Multiple SARs often — though not always — lead to a customer’s eviction."

The Pragmatic Compromise that society came to decades ago is being poorly administered. To restore it, what is needed is a reasonably-sized one-time "catching up" of the various thresholds to account for at least part of the inflation that has occurred over the years, and then periodic adjustments to these levels each year to account for subsequent inflation. Maybe that'll solve some of the problems brought to light by the Times.

Now let's turn to the crypto story. In addition to the two classic anti-money laundering reporting requirements, CTRs and SARs, the U.S. government is now proposing a third reporting requirement: one for crypto mixing.

Last month, the government announced that it deems mixing of cryptocurrency to be of primary money laundering concern. Any U.S. financial institution that knows, suspects, or has reason to suspect that a customer's incoming or outgoing crypto transaction involves the use of a mixer will have to flag it and send a report to the government. That report must include information like the customer's name, date of birth, address, and tax ID.

The US Treasury's proposed rule for treating crypto mixing as a primary money laundering concern [link]

Notably, there are no thresholds to this proposed reporting requirement. Any customer crypto transfer with even just a whiff of mixing must be reported by financial institutions to the government.

In its proposal (it isn't final, yet) the government grants that there are "legitimate purposes" for mixing. What are they? I think the popular view of crypto is that it is anonymous, but this isn't quite right. Every bitcoin or ether transaction gets recorded on transparent databases. This makes them trackable by anyone. In some respects, crypto may be the least privacy-friendly financial medium ever created. Mixing your coins in a jumble along with other's coins is one of the ways to free oneself from this all-seeing eye, both for criminals who have stolen coins and regular folks who don't want their financial lives displayed for all to see.

Given that there can be licit reasons for mixing, and putting this in the context of the decades-old Pragmatic Compromise, precedent would seem to suggest that the government should include a reasonably-sized threshold for reporting crypto mixing. If this was set at, say, $10,000 (and then adjusted yearly for inflation), then a customer could in theory mix $8,000 worth of bitcoins and then deposit them at an exchange, and that exchange would not need to report the transaction and the person who made it. Go above $10,000, and the customer will end up in a government computer.

Without a reasonable threshold, the same phenomenon that the Times documents with respect to bank customers will happen to crypto users. A wave of deplatforming will hit as financial institutions close the accounts of any customer that betrays even a hint of risky activity, much of which might only appear to be mixing when it isn't.

The government has the capacity for changing its initial stance on thresholds. If you go back to the early 1970s when the Bank Secrecy Act's thresholds were set by executive order, the government initially proposed a $5,000 threshold. After the public provided comments and grievances were aired, the final rule compromised and pushed it up to $10,000.

Bank Secrecy Act fact of the day. The Act's reporting threshold for currency transactions was originally set at $5,000. After comments were received from the public, the government's final rule upped this to $10,000, which exists to this day. pic.twitter.com/AAPgxmESmp

— John Paul Koning (@jp_koning) November 14, 2023

Likewise for SARs.

The government's original 1995 proposed rulemaking for suspicious activity reporting included no thresholds. So even a $10 or $20 suspicious payment would have been reported to the government. In response to public push-back, the government admitted that its first version of the rule would impose a "burden of reporting," and in its final version it introduced a $5,000 threshold for filing a SAR, which the U.S. has to this day.

The government also granted in its 1995 SAR decision that the adoption of a threshold was intended to "conform the treatment of money laundering and related transactions to that of other situations in which reporting is required." This seems to me to be a pretty clear admission of the Pragmatic Compromise; that reasonably sized dollar thresholds are a standard element of any anti-money laundering reporting requirement. I don't see any reason why the government's 1995 olive branch for suspicious activity reporting should not be extended to crypto mixing.

How would a cash-only central bank conduct monetary policy?

What role do changes in the supply of banknotes play in contributing to a central bank's ability to carry out monetary policy? Put differently, to what degree does "printing," or creating new physical currency and issuing it into the economy, contribute to generating a central bank's desired inflation rate of 2-3%?

In a recent blog post at Econlog, Scott Sumner suggests that printing physical cash and "forcing" or "injecting" it into the economy has been an important part of central banks hitting their inflation targets, albeit less so now than in times past. I'm not so sure.

Having imbibed Scott's blog posts for more than a decade, I think I'm 99% on the same page as he is when it comes to thinking about monetary policy. We both agree that a central bank must either reduce the interest rate that it pays on the monetary base, or inject more monetary base into the economy, in order to push up prices. Using either of these two methods, the central bank sets off a hot potato effect in which a long chain of market participants do their best to unload their excess money balances, a process that only comes to an end when all prices have risen to a new and higher equilibrium such that no one feels any additional urge to spend away their extra money. Scott once described the hot potato effect as the the "sine qua non of monetary economics."

The monetary base is comprised of two central bank financial instruments: physical banknotes (a.k.a. cash) and digital clearing balances, sometimes known as reserves, a type of money used by banks.

Reading through Scott's post, I think the one spot where we may disagree is on the relative role played by the two types of base money in the hot potato process.

For my part, I don't think that cash has ever had much of a primary role to play in setting off a hot potato effect. All of the initial uumph necessary for driving prices towards target has typically been provided by reserves, either via a change in the interest rate on reserves or a change in their quantity. Once that initial uumph has been delivered, a whole host of other money types – physical currency, bank deposits, checks, money market funds, and PayPal balances – helps convey the forces originally unleashed by reserves to all corners of the economy.

An example of the hot potato effect in action may help illustrate.

Let's start with a central bank that needs to push inflation up to target. It reduces the interest rates on reserves. The first reaction to lower rates is a flight out of reserves into other assets, say shares.

As a result, share prices quickly rise. Those existing shareholders who realized their gains by selling at the new and higher price now find themselves with a hot potato on their hands; they have too many monetary balances in their possession and not enough non-monetary things.

Some of these ex-shareholders may choose to spend their excess deposits to go on, say, a vacation. As a result, airline ticket prices rise. Others transfer their extra money to their PayPal account in order to send it to friends and family, who may in turn make purchases, pushing up the prices of whatever they buy. Another group of ex-shareholders decides to buy used cars. They withdraw banknotes, their banks in turn asking the Fed to print new banknotes and ship them over. Used car prices rise.

The point is, the initial uumph is delivered by the change in reserves, and this gets conveyed to all prices by a daisy-chain of spenders offloading an array of different types of excess money.

In this story, note that cash isn't being actively "injected" into the economy by central banks, nor by commercial banks. Rather, people are choosing to draw cash out as their preferred method for getting rid of unwanted money, in response to a set of forces initiated by reserves. Reserves are the central bank's lever for change; cash is merely responsive.

Consider too that in a world where cash no longer exists, and has been replaced by digital payments options, monetary policy is still effective. In this world, the response to a reduction in the interest rate on reserves gets conducted to all the economy's nooks and crannies via non-cash types of monies, like fintech balances and bank deposits. (I'd be curious to hear if Scott is of the same opinion about monetary policy in a world without cash.)

Here's an interesting thought experiment. Would it be possible to redesign cash and reserves in such a way that cash takes over the initiatory role in monetary policy from reserves? That is, can we turn cash into the active part of the monetary base, the one that drives changes in monetary policy, and relegate reserves to the passive role?  

One step we could take is to pay interest on cash. This may sound odd, but it's possible to do so by setting up a serial note lottery to pay, say, 3% per year to holders of cash. (I wrote about this idea here and here.) Simultaneously, reserves would be rendered less important by no longer paying interest on them.

Now when a central bank needs to raise consumer prices in order to hit its targets, it reduces the interest rate on cash from 3% to 2%. This ignites the hot potato process as the entire economy suddenly tries to offload its unwanted $20 and $100 bills, which at 2% just aren't as lucrative as before.

Another change we could enact would be to modify the mechanism by which central banks inject base money into the economy. As it stands now, central banks inject base money by purchasing assets with new reserves. Since reserves are digital, they are a lot more convenient for making billion dollar asset purchases than physical money. These extra reserves become hot potatoes in the hands of asset sellers, which sets off the process of price adjustments described in previous paragraphs. If central banks were to buy assets with cash rather than reserves, that would put cash in the driver's seat, albeit at the expense of convenience.

It's an interesting thought experiment, but in the end I don't think it's very helpful to get bogged down over which type of base money has more monetary significance. As Scott says, the key point is that the central bank controls the price level via its control over base money in general. They can raise prices by either adding to the supply of base money, or by reducing the demand for base money with a cut in the interest rate paid on reserves. "It's basic supply and demand, nothing more." 

Crypto adoption in America

Source: America Loves Crypto

You may have recently come across the America Loves Crypto marketing campaign, sponsored by Coinbase, the U.S.'s largest crypto exchange. In an attempt to promote the voting power of crypto owners, the website makes the claim that 52 million American adults currently hold crypto, which constitutes 20% of the U.S. adult population. If true, that's a massive voting block.

As the source for its 20% statistic, Coinbase cites an online survey of 2,202 adults that it commissioned from Morning Consult last February, which among other questions queried respondents for how much crypto they currently hold.

If you've been following other sources for cryptocurrency adoption data, Coinbase's 20% statistic seems... questionable?

To see why, let's dig into U.S. crypto adoption data. What follows is a quick rundown of what the best surveys have had to say about Americans crypto ownership. Later on in the article I'll get into who they are, how much they own, and why they hold it.

1) The granddaddy of all U.S. payments surveys is the Federal Reserve's Survey and Diary of Consumer Payment Choice, or SDCPC. The SDCPC is a long-running data collection effort that tries to paint a comprehensive picture of U.S. consumers' payment preferences and behavior. It fortuitously began to incorporate crypto-related questions way back in 2014, although crypto is just a tiny portion of the incredible amount of data collected by the SDCPC.

The Fed's SDCPC is run through the University of Southern California's Understanding America Study panel. In its 2022 iteration the SDCPC polled more than 4,761 participants. Notably, the SDCPC includes both a survey and a 3-day diary portion. Diaries are more labor intensive to administer than surveys, but provide better information since they minimize recall bias.

The SDCPC found that 9.6% of American adults owned cryptocurrency in 2022, up from 9.1% in 2021, and far higher than the 0.6% it polled back in 2015. However, that's far less than Coinbase's 20% claim. Only one of these numbers can be right. Which one is it?

The SDCPC's historical findings are in the table below.

U.S. cryptocurrency adoptions rates. Source: Federal Reserve's 2022 Survey & Diary of Consumer Payment Choice

2) The Federal Reserve publishes another survey that also sheds light on U.S. crypto adoption. The Fed's annual Survey of Household Economics and Decisionmaking (SHED) examines the financial lives of American adults and their families, and is therefore more general than the Fed's SDCPC, which is focused exclusively on payments.

The Fed's SHED is administered by Ipsos using Ipsos's KnowlegePanel panel. In 2022, 11,667 participants completed the SHED.

The SHED only began to include questions about crypto in 2021. It finds that 10% of Americans used cryptocurrency during 2022, where "using" is defined as buying, holding, or making a payment or transfer with crypto. This amount was down from 12% in 2021 (see table below). The number of Americans who held cryptocurrency as an investment, a narrower definition than "using", fell to 8% in 2022 from 10%.

Source: Federal Reserve's 2022 SHED

The SHED's 8-10% number neatly confirms the SDCPC's 9.6% finding while disaffirming Coinbase's 20% statistic.

3) The next decent source for crypto adoption data is tabulated by a group of four economics and finance researchers using quarterly surveys of the Nielsen Homescan panel, comprised of 80,000 households. With response rates of 20-25% per survey, that represents data from 15,000 to 25,000 respondents.

Weber, Candia, Coibion, and Gorodnichenko (Weber et al) found that at the end of 2022, the fraction of all households owning crypto had risen to 12%. The black dotted line in the chart below shows how ownership rates have changed over time.

Source: Weber et al (2023) using Nielsen Homescan Panel data

 

4) The fourth in our survey of crypto surveys was conducted by the Pew Research Center using its American Trends Panel. In a March 2023 survey of 10,701 panelists, Pew found that 17% of American adults have "ever invested in, traded, or used" a cryptocurrency. This is a very broad category, and would presumably include someone who casually bought $25 worth of bitcoin back in 2015 and sold it three days later, and has never touched it again.

Drilling in further, of the 17% who have ever owned or used crypto, 69% report that they currently hold some, which works out to a 2023 ownership rate of 11-12% among American adults. That's not too far off the two Fed surveys and Weber et al, but significantly different from the Coinbase result.

5) A fifth source of data comes from Canada, which serves as a decent cross-check against U.S. data given that both countries are quite similar in terms of culture and geography. Of the two key Canadian surveys, the first is the Bank of Canada's long-running Bitcoin Omnibus Survey (BTCOS), administered by Ipsos, which amalgamates participants from three different panels.

The 2022 BTCOS polled 1,997 Canadians and found an ownership rate of 10%, down from 13% the year before (see chart below). This constitutes a lower bound to ownership rates since it only includes bitcoin owners. The 2022 BTCOS also finds that 3.5% of Canadians own dogecoin and 4% own ether. However, it's not possible to add these amounts to the 10% bitcoin ownership number since many respondents own multiple types of crypto. 

Source: Bank of Canada 2022 Bitcoin Omnibus Survey

The second Canadian survey of note was carried out by the Ontario Securities Commission in 2022 to explore Canadian attitudes towards crypto assets. Conducted with Ipsos, the survey polled 2,360 Canadians in early 2022. It found that 13% of Canadians currently own any type of cryptocurrency, including crypto ETFs, which are legal in Canada but illegal in the US.

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So there you have it. The two Federal Reserve surveys put crypto ownership at 9.6% and 8-10% respectively in 2022, while Weber et al peg it at 12% using Nielsen Homescan data. Pew has American crypto ownership at 11-12% by early 2023. And in Canada, the Bank of Canada calculates bitcoin ownership to be at 10% by the end of 2022, while the Ontario Securities Commission pegs total crypto ownership at 13% in early 2022, before much of crypto imploded.

Given this range of data, the 20% adoption rate that Coinbase's Morning Consult survey trots out is a glaring outlier and probably deserves to be thrown out. The American crypto owner is a potentially sizeable voting group, but not as big as Coinbase would like us to believe.

For what it's worth, I've found a few other odd things with Coinbase's Morning Consult survey that further adds to my skepticism. Morning Consult reports that 8% of respondents currently own a cryptocurrency called USDC, down from 10% the quarter before (see here for more). The survey also says that 5% currently own Tether. USDC and Tether are stablecoins. To anyone who follows crypto closely, the idea that 1 in 10 Americans own any particular stablecoin is absurd. Given that Morning Consult has surely got this wrong, perhaps through a sampling error, that makes you wonder about the quality of their overall work.

However, even if we ignore Coinbase's Morning Consult survey, the 9.6% adoption rate found in the bellwether SDCPC is still breathtakingly high. In just fifteen years, crypto has gone from a strange niche product to something that is being held by tens of millions of Americans.

What additional facts do we know about America's crypto owners?

Size of holdings

Going through the SDCPC data, the majority of Americans who own crypto only have a little bit of the stuff. Out of all U.S. crypto owners surveyed, 45% owned just $0-200 worth of crypto in 2022. This is illustrated in the chart below. The median quantity of crypto held was $312. Given such small amounts, I doubt that these crypto owners qualify as durable crypto adopters, as opposed to folks who've jumped on the bandwagon when they saw a Superbowl ad from Coinbase, bought some dogecoin, and have since stopped paying any attention.

The SDCPC data suggests that 1 in 4 crypto owners are what I call crypto fundamentalists, holding more than $2,000 worth of crypto. Given that 90% of Americans don't hold any crypto at all, two in every 100 Americans qualifies as a crypto fundamentalist.

This skewed distribution of crypto ownership is confirmed by survey results from Weber et al and the Nielsen Homescan panel. An outlier group of hard-core owners, representing around 8% of all crypto owners, allocates their entire portfolio to crypto (see chart below). By far the largest group of crypto owners is comprised of small dabblers who put just 0-5% of their portfolios into crypto.

Source: Weber et al (2023) using Nielsen Homescan Panel data

Reasons for ownership

Why do Americans own cryptocurrency? Despite being labelled as "currencies," cryptocurrencies are not generally used as a medium for making payments. Price appreciation is the dominant motivation for owning them.

When the SDCPC survey queried participants in 2022 for their "primary reason for owning virtual currency," the most popular answer (at 67%) was investment (see chart below, orange rows). The second most popular reason (21%) was "I am interested in new technologies." It was rare for respondents to list any sort of payments-related use case as their primary reason for ownership. As for lack of trust in banks, the government, or the dollar – all of which are common cryptocurrency themes – these were rarely mentioned in 2022 as a primary reason for ownership.

Interestingly, Americans crypto owners were not always so obsessed with price appreciation. In 2014, the SDCPC found that American crypto currency owners tended to offer a much broader set of motivations for owning crypto, including lack of trust, cross-border payments, and to make purchases of goods and services (see chart above, blue rows).

The dominance of investment as the motivating reason for owning crypto is echoed in Weber et al's analysis of Nielsen Homescan survey data. Respondents were allowed to give multiple reasons for owning cryptocurrency, the most popular reason (see chart below) being to take advantage of "expected increase in value." The desire to use cryptocurrencies for international transfers was almost nonexistent, as was the desire to be "independent of banks."

Crypto owners don't care about making international transfers, private purchases, or being "independent of banks," as the chart shows.

What they want is "increase in value."

This is a fairly reliable data source: 80,000 households participating in the Nielsen Homescan Panel. pic.twitter.com/0oBfATgFoY

— John Paul Koning (@jp_koning) June 22, 2023

The Fed's SHED survey isolates the same pattern as the other two surveys (see table below). Of the 10% of Americans who report using cryptocurrency in 2022, most do so as an investment. One small difference is that the SHED reports that around 2% of all survey participants used crypto to send money to friends of family in 2022. This suggests the transactional motive, while not primary, may be somewhat more prevalent than the previous two surveys suggest.

Source: Federal Reserve's 2022 SHED

Types of cryptocurrency held

What sorts of crypto were popular with Americans? Using Nielsen Homescan data, Weber et al found that of the 11% of survey respondents who are crypto owners, 70% held bitcoin while just over 40% held ether and dogecoin respectively.

Around 11% of American households owned crypto in 2021, according to a Nielsen Homescan survey of 80,000 households.

Of this 11%, 4 out of 10 households held Dogecoin.

So around 6 million US households owned Dogecoin in 2021, which is just nuts. pic.twitter.com/31FjTbfqBE

— John Paul Koning (@jp_koning) July 4, 2023

This distribution is echoed in the Fed's 2022 SDCPC. Almost 65% of all crypto owners surveyed held bitcoin (the data is here), making it the most popular type of cryptocurrency. Meanwhile, 44.8% held ether and 38% held dogecoin, a coin that was originally created as a joke in 2013. That works out to around 4-5% of all Americans who are in on the joke.

Crypto bros

There's a reason that people throw around the term "crypto bro." Without exception, all of the U.S. surveys find that cryptocurrency owners tend to be young, male, and have a high income. 

The same goes for Canada, where in 2022 there were three male bitcoin owners for every female. The Bank of Canada has also regularly tested bitcoin owners for their degree of financial literacy using the Big Three questions method, and finds that they tend to have lower financial literacy than non-bitcoin owners.

The prototypical Canadian bitcoin owner in 2022 was a young university-educated male, employed at a high-income job, and lacking financial literacy. pic.twitter.com/N3hQX4AWes

— John Paul Koning (@jp_koning) September 28, 2023

Interestingly, in addition to isolating the crypto bro pattern – the tendency for crypto owners to be young, male, and wealthy – both the Pew survey and the Fed's SHED (see table below) find that U.S. crypto owners are more likely to be Asian, followed by Black and Hispanic, and least likely to be White.

The Fed's SHED survey dug deeper into usage by demographics, and found that while "investment" remains the driving case for owning crypto, and that the rich use the stuff proportionally more than the poor, certain demographic groups tend to rely on it more than others for making transactions. Specifically, the SHED finds that among low income families, 5% report an investment motivation for holding crypto while 4% report a transactional motivation.

Source: Federal Reserve's 2022 SHED

All of this data suggests to me the existence of three American crypto archetypes. 

The most dominant crypto archetype is the young wealthy male crypto dabbler, most likely non-white, who holds a few hundred bucks worth of doge or some other coin in order to gamble on prices going up. Coinbase's America Loves Crypto campaign makes the claim that "the crypto owner is a critical voter," but I suspect this doesn't hold for the dominant dabbler archetype, who probably doesn't have much attachment to their casual $50 bet on doge or litecoin or bitcoin, and thus can't be assembled into a voting block for crypto-related cause.

Another archetype is the much rarer crypto fundamentalist, a young male who has committed most of his savings to crypto. I suspect these are the types I encounter on Twitter, who evangelize and debate crypto to anyone who'll listen. This may be a small group, but they are also the most likely to vote for crypto-related causes.

Lastly, there seems to be a very small group of low-income people who are using crypto for actual transactions, the original use-case that Satoshi Nakamoto intended when he introduced the first cryptocurrency back in 2008.

Inflation as a tax

Last week I explored how Henry VIII resorted to coin debasement as a way to raise revenues in order to fight his wars. This provided Henry with the financial firepower to annex the city of Boulogne from the French in 1544, albeit at the price of England experiencing one of its greatest inflations ever.

Zoom forward five hundred years and Rishi Sunak, the Prime Minister of the UK, has ignited a controversy by referring to inflation as a tax, and further suggesting that the "best tax cut I can deliver for the British people is to halve inflation." His BBC interviewer disputed the claim, saying that inflation isn't a tax, a stance that the BBC upholds on its fact checking page.

Rishi Sunak, "The best taxt cut that I can deliver for the British people is to halve inflation."

Laura Kuenssberg, "Inflation is not a tax"

Rishi Sunak, "Inflation is a tax" pic.twitter.com/6LgMbeaprY

— Farrukh (@implausibleblog) October 1, 2023

If you recall, my previous article showed how Henry VIII's debasement functioned very much like a tax, say a new customs duty on wine or a beard tax. It did so by incentivizing people to flock to English mints to have their precious metals turned into coinage, Henry extracting a small fee on each coin. But the 21st century monetary system is very different from that of the middle ages. Is Rishi Sunak right to characterize inflation as a tax?

First, we need to better define our terms.

What do the BBC interviewer and Sunak mean by inflation? In the western world, prices have been rising at a regular pace of 2-3% each year for decades as result of central bank policy, which targets a low and steady inflation rate. Is this the definition they are using? Alternatively, Sunak and his interviewer may be referring to inflation as a *change in the change* in price. Since 2022 or so, that 2-3% rate has leapt to 8-9% all over the western world. Is it this jump that Sunak and his interviewer are talking about?

For the sake of this article, we'll assume that the conversation between Sunak and the BBC refers to the latter, a spike in the rate of inflation.

Secondly, what is meant by the word tax? Sometimes when we say that something is a tax we mean that it causes suffering. That is, inflation is taxing: it makes people's lives harder by increasing the cost of living, with salaries failing to keep up. It creates unfair changes in winners and losers.

Fair enough. But the more precise view I want to broach in this article is that inflation is actually a tax, where we define a tax as a formal charge or levy, set by the political process, that leads to cash flowing from the population to the government.

What does the data show?

Interestingly, a surprise jump in inflation leads to the very same effects as a new tax. All things staying the same, a new tax leads to an increase in government revenues. This improves the government's fiscal balance, or the difference between its revenues and expenses. A recent IMF paper by Daniel Garcia-Macia using data from 1962 to 2019 shows how an inflation shock typically achieves this exact same end result, boosting government revenues and improving its fiscal balance. This effect lasts for a few quarters, even up to two or three years, then recedes.

The IMF's chart below breaks down exactly how an inflation shock tends to improve government finances using quarterly data going back to 1999:

Charts source: IMF

Total tax revenue (the first panel) immediately begins to rise after the inflation shock at about the same rate as inflation.That's because most taxes are set by reference to values or prices, say like the prices of goods and services, or the price of labor, or the value of corporate profits. Since inflation pushes these amounts higher, this gets quickly reflected in tax revenues.

Income taxes and profits taxes (the second panel) rise particularly fast. Inflation is presumably pushing tax payers into higher income tax brackets, a process known as "bracket crreep," and so the government very quickly starts to collect a proportionally-larger amount of income tax.

Meanwhile, the government's total expenditures, the third panel, typically stay flat or only marginally rises in the quarters after the inflation shock hits. Notably, the amount of wages that are paid to government employees and social benefits (panels 4 & 8) tend to fall.

The net effect is an improvement in the government's fiscal balance. More specifically, for a 1% increase in inflation, the government's overall balance tends to improve by about 0.5% of GDP. And so an inflationary shock ends up at the same endpoint as a new tax: higher revenues and a better budget. That doesn't necessarily mean that inflation is itself a tax. Taxes have a degree of intentionality. They get implemented through a political process that has a certain set of goals in mind. By contrast, the extra revenue that an inflation shock raises is often (though not always) accidental, the result of external forces rather than political decision making.

So while it may not fall under the dictionary definition of a tax, the tax implications of a modern inflation shock resemble that of a new tax.

Everything I've written above applies to an inflation shock, say a rise from a 2-3% to 8-9%. Next I want to show that even constant 2-3% inflation can have the same revenue implication as a tax. Here's how.

Banknotes and seigniorage

Governments usually have a monopoly over the issuance of two key financial instruments: banknotes and settlement balances (also known as reserves). We all know what banknotes are, but what are settlement balances? Commercial banks find it useful to keep a stock of settlement balances on hand to make crucial large-value payments to other banks. The central bank, which the government controls, is the monopoly provider of these balances. (Sometimes banks are required by law to keep a a fixed number of settlement balances on hand, often above and beyond their day-to-day needs, a policy referred to as required reserves.)

Historically, interest rate on both types of central bank-issued money have been set at 0%. At the same time, the rates on short-term credit instruments (Treasury bills, commercial paper, bankers acceptances, etc) are determined by the market, typically hovering at a positive rate ranging between 0.25% to 5% over the last thirty years. These yields are priced to compensate investors for inflation.
 
The interest rate gap this gives rise to allows central banks to earn a steady stream of revenues, borrowing at an artificially cheap rate of 0% from both the banknote-using public and banks, and reinvesting at, say, 3%. Most of the revenues that the central bank collects from this interest margin flows back to the government. Economists usually refer to these revenue stream as seigniorage.

So seigniorage performs the same function as a consumption tax or an income tax: it takes resources from the public and gives it to the state. Likewise, a reduction in seigniorage would be very much like a tax cut.

If politicians wanted to, they could do away entirely with this form of raising government revenues. They have two ways of going about this. One way would be to have the central bank reduce price inflation to zero. By doing so, the interest rate on short-term credit instruments like Treasury bills would also fall to 0%, or thereabouts, since these instruments no longer need to compensate investors for inflation. And so the gap between the 0% rate at which central bank fund themselves and the rate at which they reinvest would cease to exist, seigniorage effectively shrinking to zero.

Over the last few decades, governments have taken a second route to removing seigniorage: they have begun to pay a market-linked yield on settlement balances. Canada, for instance, adopted this policy in 1999, and the Bank of England did so in 2006. By paying a market-based return, central banks no longer extract seigniorage from banks by forcing them to hold 0% assets. 

However, that still leaves banknotes as a significant source of seigniorage. We can calculate how much the UK government roughly earns from banknote seigniorage. With £95 billion in banknotes outstanding in October, and interest rates at 5.1%, the Bank of England's banknote-related seigniorage comes out to around £5 billion per year, much of which flows back to the government. That sounds like a lot, but it's only a small chunk of the £790 billion in taxes the UK government collected last year.

Banknote seigniorage isn't set in stone. It's a policy choice. If governments wanted to, they could reduce this form of seigniorage by paying interest on banknotes. One way to go about this would be to introduce a banknote serial number lottery. This lottery would offer around £5 billion in cash prizes to holders of winning banknote serial numbers, equating to a 5% interest rate on banknotes. Doing so would be akin to enacting a tax cut on British citizens.

To sum up, the fact that both an inflation shock and steady 2-3% inflation have implications for government revenues suggests that while inflation may not quite qualify as a tax, it is certainly tax-like.

Top 13 blog posts

I've been writing on this blog for a while now – over ten years. Many of those posts are now forgotten (by myself included), but some were pretty popular at the time, and a few still get a steady stream of readers. Someone recently asked me for a list of my top ranked posts according to traffic volume, in order to (presumably) get a better taste for my writing.

Well, here they are. Enjoy!

1. Starbucks, monetary superpower (2019)

Starbucks has a gift card program that provides it with fantastic amounts of 0% interest funding. This is by far the most popular thing I've ever written.

2. Bitcoin, 11-years in (2019)

Bitcoin isn't a commodity or a currency, it's a game.

3. Bringing back the Somali shilling (2017)

If the Somali government wants to bring back the official Somali shilling, it'll have to buy back all the counterfeit shillings issued by warlords.

4. One country, two monetary systems (2020)

How the Yemeni rial split into two different rials when war tore the country apart.

5. There are now two types of PayPal dollars, and one is better than the other (2023)

A spotlight on PayPal's new stablecoin and how it reveals America's monetary fragmentation.

6. Ripple, or Bills of Exchange 2.0 (2013)

An analysis of Ripple, back when it was still cool.

7. The gold trick (2017)

The very strange fiscal effects of changing the US's official gold price from $42.22. If you google around you'll see I've written about this in a few other venues. Always popular with the gold bugs.

8. Fedcoin (2014)

First thoughts on a Fed-issued blockchain-based dollar.

9. What happens when a 96 bitcoin ransom payment ends up on Bitfinex (2020)

Shopkeepers get to keep stolen cash. Does the same apply to stolen bitcoins?

10. Kyle Bass's big nickel bet (2019)

In which I try to calculate the storage costs of hoarding 5-cent coins... 44 million of them!

11. Dictionary money (2017)

A very wonky monetary system in which the unit-of-account and medium-of-exchange are separated from each other.

12. Bitcoin is more like ham radio than the early internet (2020)

Searching for a better analogy for bitcoin, landing on ham radio.

13. The siren call of T+0, or real-time settlement (2017)

Instant securities settlement is no panacea, folks.

How to debase the coinage in order to pay for wars

Henry VIII, after Hans Holbein the Younger

It's fun to imagine traveling back in time and engaging with the then-prevailing technologies. Would you be able to ride a boneshaker or use a counting board? It's probably harder than you think: kids today can't even use a 1980s rotary phone. In this post I'm going to write about one specific techno-institution, the mint, and a particular function that it sometimes played many centuries ago; funding wars.

If you had to go back to 16th century Europe, and you were asked to operate the mints in a way such that they raised enough revenues so that your patron, the king, could wage war against a neighbouring country, how would you go about that?

I think the general sense that most of us have is that you'd need to somehow "debase" the coinage. The majority of coins back then were made of precious metals. If you could sneakily remove some of the silver and gold from each coin, and replace it with cheaper copper, then you'd be able to amass a hoard for the king (albeit at the expense of the public), and he could use that to hire an army.  

Now, if you went back in time with the above hazy notion of debasement, you wouldn't have much luck, and might even get your head chopped off. There's a grain of truth to it, but much of it won't work.

So before you head off in a time machine, here's what you need to know about the business of minting.

The first thing you need to know is that the King (or Queen) owns the royal mints, which they rent out to private parties to operate. Another important fact is that the public brings their own personal supply of precious metal – raw silver, silver cutlery and dishes, old coins, etc – to the mint, and then after waiting a week or two for the order to be processed, walks out with the final product; newly-minted coins.

But the mint's customers don't leave with as much silver (or gold) as they arrived. For each ounce of precious metals that gets minted into coin, the King collects a fee, known as "seigniorage", usually around 5% in the case of silver. The private individual who runs the mints gets a much smaller cut too, called brassage.  

If you're scrambling for a modern analogy, I suppose you could think of the medieval business of minting as very much like a modern laundromat, where customers bring their clothes, have them processed, and leave with their clothes, paying a small fee to the laundromat owner, who in turn pays a big chunk of this to the franchisor.

Like a laundromat owner, the monarch would have earned a fairly steady stream of revenues from their mints. Coins were more useful and liquid than raw silver, so there was an ever-present demand to convert raw silver into coin for transactional purposes. But remember, the challenge you face isn't just to generate regular profit. The king wants a massive surge in revenue. He's got a war to wage. How are you going to repurpose the mints to provide this gusher?

Your first attempt to raise money for the king might be to boost the minting fee from the low single digits to 20-25%. That might work. And you wouldn't be the first to go this route. For centuries, the English seigniorage rate on silver typically hovered around 5%, as illustrated in the chart below from a paper entitled The Debasement Puzzle, by Rolnick, Velde, and Weber. For gold, the minting fee was typically at 0.5% to 2%. To help fund his war against the Scots and the French, Henry VIII raised the seigniorage on silver to a remarkable 50-60% in the 1540s. Gold fees skyrocketed to 15%.

Source: Rolnick, Velde and Weber [pdf]

Mind you, fee hikes alone aren't going to work. Dissuaded by sky-high costs, many people will stop bringing their silver and gold to the mint to be coined, and the King's seigniorage revenues will dry up. A bothersome coin shortage will probably develop, too. Off with your head! says the King.

After thinking about it some more, you realize that, like a modern laundromat owner keen to make more revenue, you need to dramatically increase the amount of material going through the mint. How to do so?

You've got a few levers to increase throughput. One option is to introduce new products. If you offer new denominations of coins, for instance, people may bring more silver to the mint because those denominations are useful to them.

There's certainly precedent for that. To help pay his armies, Henry VIII brought back the testoon, a coin worth 12 pennies (or a shilling) in the hope that there would be significant demand for them, and that this would boost throughput and thus mint revenues. Testoons complemented Henry's silver halfpennies, pennies, groats (4 penny pieces), and sixpence (six pennies), in addition to a range of high denomination gold coins.

Below is an example of one of Henry's testoons, first minted in 1542. Because they had so much copper in them (more on that later), many of the testoons that exist today have a greenish tinge (due to copper oxidation). In the 1540s, Henry VIII's silver coins still hadn't turned green, but had a reddish tinge, which tended to reveal itself on his nose. Which is why Henry's nickname was Old Coppernose.

English groat (4 pence) issued 1547-49. Source: The British Museum

But introducing new denominations probably isn't going to generate a huge rush to the mints, since a new denomination will to some extent cannibalize existing demand for other denominations. Anyone who orders more testoons is likely to order fewer groats, for example. You'll have to do more.

In addition to introducing new coins, another strategy you might try is to cancel old ones. By having the King demonetize a popular coin, or declare it to be "no longer current," those coins will cease being legal tender or acceptable for taxes. The public will be forced to bring their demonetized coins to the mint to be converted into legal coins, the rush to do so creating a revenue windfall for the King.

And indeed, Henry VIII's successor Edward VI (who continued his father's wars) did this exact same move in 1548, declaring the testoons his father had reintroduced just four years before to be no longer current, as recounted in a paper by C.E. Challis (1967). I've clipped the relevant part below:

The demonetization of testoons is announced. Source: C.E. Challis

But we still haven't broached the main method: debasement. This is where the gusher begins.

Together with the King, you announce to the public that anyone who brings precious metals to the mint will now get more coins than before, for the same weight of precious metal. So for example, if someone used to be able to bring, say, 10 grams of pure silver to the mint and got 100 pennies minted, now they can bring 10 grams and get, say, 200 pennies. Same amount of silver, more coins.

As the operator of the mint, you could enact this change by cutting the weight of each penny by half, or, if you wanted to be more clever, maintain the same weight but reduce its fineness by 50%, by introducing more cheap copper to the mix. Either way, you've just debased the currency.

But how exactly does this raise revenues for the King?

Let's think about this change from a merchant's perspective. Say that our merchant owes a supplier 1 pound (a pound is 240 pennies). He's about to pay his debt off with everything he has, 240 pennies, when the debasement is announced. He can now bring his 240 pennies to the mint and have them recoined into 480 pennies. That allows him to pay off his debt, which is still denominated at 1 pound, and still have 240 pennies for himself. What a great opportunity! The merchant heads off to the mint with his silver.

Or imagine our merchant need to buy some property that's priced at 10 pounds, or 2,400 pennies. If he has only 1,200 pennies on hand, he can't afford it. But with the debasement having just been announced, the merchant can now convert those 1,200 pennies into 2,400 pennies and make the purchase.

Congratulations, you've created a revenue gusher! What you've effectively done is offer a short-term arbitrage opportunity to those who are paying attention, most likely the rich and well-connected, at the expense of the not-so-aware. To take advantage of a profitable situation, these enterprising individuals will immediately bring all their silver and gold to the mint. And you'll collect a toll on all that metal as it passes through.

But that arbitrage opportunity won't last forever. Debts will be recalibrated to account for the 50% decline in the penny's silver content. Prices of things like property will eventually double to reflect the new true value of the penny. At that point it will no longer be advantageous to bring one's silver to the mint to be recoined, and the revenue gusher you've created will subside.

You might try announcing debasements every few years or so, thus milking your mint's throughput on a continual basis. Too many debasements, though, and this trick will stop working, since that portion of the population that is the victim of the arbitrage you've created – the less aware – eventually wises up and protects itself by quickly increasing prices whenever a debasement occurs.

A constant series of debasements is exactly what Henry VIII and his son Edward enacted between 1542 and 1551 to keep paying their soldiers. Using data from a paper by John Munro, The Coinages and Monetary Policies of Henry VIII, I've charted out (above) how the penny's silver content changed over that time period. Going into the 1500s, an English penny contained 0.72 grams of pure silver. At the end of the Great Debasement, (the term used for Henry VIII's operations on the coinage) the penny contained just 0.11 grams of silver, constituting an 85% reduction in silver content.

We can further split out how Henry VIII's debasements were distributed between changes in fineness and changes in weight. Going into 1542, the English penny was 92.5% fine. Nine years later its purity stood at just 25% silver, the other 75% being base metal such as copper. As for weight, a penny weighed 0.79 grams in the early 1500s, but only 0.43 grams by 1551. 

These changes are illustrated in the chart below.

Thus it was diminutions in purity, not weight, that drove the biggest chunk of the penny's debasement, although weight did have a role to play.

How successful were these policies in creating a financial gusher for Henry and his son?

The charts below from Rolnick, Velde, and Weber (which I've clipped from  a second paper authored by the trio) show how the combination of mintage policies enacted in the 1540s – debasement, new testoons, and a demonetization of the testoon – led to a large influx of silver and gold to the English mints.

Source: Rolnick et al

According to Challis, the combination of these inducements, along with a big boost in fees, resulted in minting profits of £1.3 million for the two kings from 1542 to 1551. This would have paid for a big chunk of the £3.5 million in military expenditures over that same period, much more than actual taxation, which only yielded £976,000.

Of course, the final result of all this was a significant number of deaths, and what one account describes as "an episode of sixteenth-century ethnic cleansing which in its aims and implementation was not dissimilar from ...the former Yugoslavia in the 1990s or, most recently, with the Myanmar government’s actions against the Rohingya." It also caused one of the worst episodes of price inflation that England had ever seen. According to Munro, the English consumer price level rose by 123% between 1541 and 1555.

So there you have it. If you had a time machine, you now know how to go back to medieval Europe and operate the royal mints in order to fund big ticket items like wars. (Whether you should actually do so is another question.)