Category Archives: DLT

Frosties Rug Pull Demonstrates Community is Key to NFT Projects

On January 9, 2022, creators of the Frosties NFT Collection abandoned their project after investors spent over $1.2 million buying the entire inventory of digital “cartoon ice cream” characters. The money received by the creators was transferred the same day.

Relying on the Chinese lucky number 8 four times over, the collection of 8,888 Frosties was described as “Cool, Delectable, and Unique” and quickly sold out based on claims made by the creators.  Their project website – which has since been taken down, promises the following:

Frostie NFTs are made up of over a hundred exciting traits of backgrounds, body, clothing, eyes, mouths, eyewear, hats, toppings, and items. Each Frostie is a unique, non-fungible token (NFT) on the Ethereum blockchain.

Frosties will have staking, metaverse, breeding functions, and so much more!

Holding a Frostie allows you to become eligible for holder rewards such as giveaways, airdrops, early access to the metaverse game, and exclusive mint passes to the upcoming seasons.

The Frosties presale will take place on January 7th and the main sale will take place on January 8th.

Join the Frosties community on Twitter and Discord!

After the January 8, 2022 public drop of Frosties at a floor of 0.04 ETH, the project’s Twitter and Discord server accounts were taken down and in a “rug pull” the floor price was removed.  It was also a cash grab given the NFTs stayed with their new owners whereas the creators stopped all further efforts to build or benefit the community.

What happened next is instructive.  First, the value of the underlying NFTs have been selling both low and very high.  In other words, the market is now dictating the pricing and life goes on with how these assets are going to be priced.

As for moving forward with the project, the Frosties Rug Pull demonstrates that projects can go forward with or without the original creators.  The key is to have a passionate community and at least a few folks who can help lead the charge from a technical perspective. 

In the case of Frosties, someone named EsahcHslaw took charge and posted on reddit:  “We are wrapping Frosties under a new contract for those who want to continue to hold while the project kicks off again. Old dev won’t gain royalties this way. The community will own the funds. Community ran, doxxed multisig, roadmap, website, new Twitter. DM for DC server invite.” 

By removing the possibility of creators obtaining future royalties, Frosties owners effectively removed the creators from the project going forward.  And, if the Frosties community continues growing organically – with new social media channels and active community involvement, the Frosties Rug Pull will demonstrate that an active community is the primary engine for driving NFT value.

Defi Security Growing Pains Continue with BitMart Breach

On December 6, 2021, crypto exchange BitMart – which bills itself as “The Most Trusted Crypto Trading Platform”, announced a security breach “mainly caused by a stolen private key that had two of our hot wallets compromised.”   A tweet from security analysis firm PeckShield first called attention to this hack days earlier.  According to Peckshield, the loss is around $196 million.  Interestingly, BitMart at first denied there was any hack – claiming it was “fake news”.

According to the BitMart Twitter release:  “At this moment we are temporarily suspending withdrawals until further notice.”  A Telegram “ask me anything” is scheduled for 8:00 p.m. est this evening.

Similar to what was done by other centralized crypto exchanges after a security incident, BitMart will use its own funds to compensate users impacted by the theft.   

The BitMart theft comes on the heels of a report by London-based consulting firm Elliptic revealing billions of dollars stolen from DeFi platforms.  According to Elliptic’s recently released report, the overall losses caused by DeFi exploits total $12 billion and of that amount, fraud and theft accounted for $10.5 billion, seven times the amount from last year.

Thefts hitting crypto exchanges such as BitMart and DeFi protocols such as Poly Network shine a light on the fact DeFi is largely driven by startups lacking cybersecurity maturity.   In contrast, the financial institutions that literally spend billions on cybersecurity want no part in helping DeFi projects; and more likely, welcome cyber incidents that tarnish DeFi’s reputation.  Until they reach a higher level of security and such incidents become less commonplace, DeFi projects will continue making platform users whole after a security incident – or risk a total collapse in the market for non-money laundering usage. 

Depending on their popularity, open-source products can be highly secure and DeFi should be no different. At some point in time – after decentralized protocols are adequately security tested and implemented and DeFi projects become fully independent and organic and not reliant on any centralized cloud solution or centralized servers, breaches such as the one that hit BitMart will be rare.  In other words, as the market and business opportunities for DeFi increase in scale and scope DeFi’s security profile will naturally evolve.

DeFi May Overtake Traditional Finance If Crypto Changes to 26 U.S.C. § 6050I Becomes Law

The day after the world’s largest NFT event concluded – a truly spectacular event, a bill criminalizing unreported digital asset transactions over $10,000 was sent for presidential signature.  Prior to passage, one blogger warned:  “The amendment to section 6050I is an affront to the rule of law and to the norms of democratic lawmaking. It was slipped quietly into a 2,700 page spending bill, allegedly as a tax measure to defray the bill’s trillion-dollar price tag even though section 6050I is in fact a costly criminal enforcement provision.”

While US bankers and financial institutions thought this provision would level the playing field or even knock DeFi out from the playing field, it may eventually have the exact opposite impact.  By way of background, the 1980’s era 26 U.S.C. § 6050I requires persons who engage in “a trade or business” and receive “more than $10,000 in cash in 1 transaction (or 2 or more related transactions)” to file a Form 8300 report containing the “name, address, and TIN of the person from whom the cash was received, the amount of cash received, [and] the date and nature of the transaction”. 

In the proposed amendment to this law, however, there is a new additional definition of “cash”, namely “any digital asset (as defined in section 6045(g)(3)(D))”.  The definition of “digital asset” is broadly defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.”.  Not surprisingly, existing exemptions for “cash received by financial institutions” and reporting organizations or for those transactions “occurring outside the United States” all remain intact.

If this law is signed “as is” – which is apparently likely, it will push a knife deep into the virtual heart of DeFi, NFTs and any other burgeoning alternative investment solutions targeting US customers.  The KYC and reporting requirements would presumably create insurmountable disadvantages.

Some bitcoin whales rejoiced given that hodlers don’t really care much about DeFi or NFTs – they just want to buy more bitcoin and anything that gives rise to anti-governmental sentiment is bullish for hodlers.  In fact, BTC rose to new heights on the news.

While in the short term DeFi and NFT platforms may have significant new hurdles if this bill is signed into law, in the long term it may have the opposite impact intended by the bankers who likely pushed for this financial reporting provision in an “Infrastructure Bill”. 

For one thing, no one country can kill something that is truly decentralized – whether it is China, India or the United States.  The whole point of decentralization is that it is not tethered to any country.  Mandating governmental centralized reporting is no different than pushing a child into a pool – the reality quickly becomes “sink or swim”.  If this bill gets signed, platforms may very well expedite their decentralization plans and US banks will be flanked by truly decentralized platforms they cannot control or influence and participants who would rather take more control over their financial future.  After a decade or two, traditional financial institutions may very well go the way of Sears.

UPDATE: November 16, 2021

On November 15, 2021, the Infrastructure Bill was signed into law. None of the major news outlets discussed the change to 26 U.S.C. § 6050I – with only a few discussing the changes impacting digital asset broker disclosures. One senator, however, introduced on November 16, 2021 a bill to repeal all of the Section 80603 digital asset provisions – including that one involving 6050I. With any luck, it will quickly be enacted into law. And, if not, there is still the potential that down the road this change will forever alter the financial institution landscape by accelerating implementation of DeFi.

$600 Million Loss Shines a Light on DeFi Security

On August 10, 2021, Chinese cross-chain DeFi platform, Poly Network, was apparently hit with the exploit of a smart contract vulnerability in its “EthCrossChainManager” contract impacting three separate chains, including two leading DeFi blockchains – Ethereum and Binance Smart Chain, and numerous cryptocurrencies.   This latest exploit is part of a major trend in security incidents involving DeFi platforms.

Poly Network developers quickly asked for help on Telegram to block transfer of the stolen assets:   “We call on miners of affected blockchain and crypto exchanges to blacklist tokens coming from the above addresses.”  

In another August 10, 2021 post on Telegram, Poly Network also posted:  “If you are experiencing any difficulty due to the hack that just happened theres [sic] a compensation plan , connect your wallet and get your refund in minutes , our dev only lose but this did not affect any of our users.”  

It is not clear how this protocol platform would make all users whole.  

As a start, the ESL Poly Network team also posted the following open letter asking for the return of the stolen assets:

Not surprisingly, this plea was immediately derided:  “Imagine successfully stealing over $600m and have the people you stole from think there’s a chance you might be willing to return it with what amounts to a passive-aggressive post-it note on the fridge.”  

Notwithstanding the obvious desperation found in its letter, the Poly Network team may be on to something given this was apparently never really a “hack” – it was likely yet another person who exploited a vulnerability in a deployed smart contract.  As of August 11, 2021, $119 million in Binance pegged BUSD was returned by the hacker’s associated address to those 947,598 owners impacted by the exploit.  BUSD is a stablecoin used to trade crypto assets on the Binance chain.  And, another $134 million was also soon thereafter returned to other impacted owners.  According to Chainalysis, at total of $261 million in cryptocurrencies have been returned to date.

A review of the micro transactions found on Etherscan and BscScan indicates that the “hacker” has been testing literally thousands of ways to move the stolen assets.  In other words, the exploiter does not know what to do with the stolen booty.  A few posts back that up – including one where the “hacker” is allegedly asking for someone to instruct on how to circumvent miner scrutiny.

The “hacker” purportedly also posted:  “WHAT IF I MAKE A NEW TOKEN AND LET THE DAO DECIDE WHERE THE TOKENS GO.”  

As things continued going downhill, the claimed sole perpetrator of the exploit – again claiming such identity solely by virtue of using the perpetrator’s wallet address, allegedly came out as an innocent interloper:

Information posted in the form of a Q&A on an ETH transaction Private Note section goes into further detail:

It’s looking like these posts are all from the same exploiter.  A spreadsheet tracking the exploit – including related communications, can be found on Google docs.  Even if these posts are not genuine, chances are still high the exploit was performed by one or more persons who decided to offload some coin and ultimately decided to give back – as apparently already done to the tune of $261 million, whatever could not safely be absconded with using his/her/their current knowledge.  There were certainly many out there willing to provide the necessary crypto laundering assistance, but apparently the advice was not taken – the clearest signal this was committed by an “ethical” hacker.

Poly Network is at its essence an interoperability protocol used by and integrated with many DeFi projects so this exploit will have direct ripple effects well beyond the Poly Network.  The more indirect impact of this exploit is the slight chance it might be replicated elsewhere by others having the necessary domain knowledge to move stolen assets.  

The best way for investors to minimize the likelihood such failings will not impact them in the future is to seek out and only use DeFi platforms that rely on a holistic “security by design” architecture – something not easily found in a decentralized world. Not surprisingly, in a recent survey nearly 75% of institutional investors and wealth managers state that the security of virtual currencies is a “significant” hurdle stopping many individuals from entering the crypto asset space – let alone the more exotic DeFi domain where software vulnerabilities can still cause the exfiltration of $600 million in digital assets.  Beaches will always have little appeal to swimmers when there are known sharks in the water.

UPDATE: August 12, 2021

Except for $33 million in Tether stablecoins previously frozen by Tether, the entire amount taken was apparently returned. Reuters is reporting that this was done in return for an after-the-fact $500,000 “bug bounty”.

The DeFi End Game

A skilled chess player will tell you the best way to study chess at a high level is to first study endgames and truly learn the power of each piece.  Memorizing book openings generally comes last.  If one wants to learn about the insurance industry, first take a job in the claims department.  In a similar way, students of disruptive technologies benefit from first learning their “end game”.  

Blockchain is one disruptive technology that still has not fully discovered its business sea legs.  The purported proxy for blockchain – Bitcoin, recently hit all-time highs so naturally on January 3, 2021 a forecaster placed a ten-year target of $1 million on this speculative asset.   Every good bubble requires inflating and the very speculative Bitcoin bubble currently being massively inflated by hedge fund money is no different.   

Bitcoin’s bubble ascension does not mean, however, the seismic blockchain and distributed ledger technology (DLT) shifts taking place over the past five years in the financial industry have been illusory or should be ignored.  As previously recognized, “acceptance of blockchain technology by the financial industry will be indelible proof those mistakes of 1995 made by retail sales and marketing companies will not be repeated by the financial industry.” 

Over the past several years, financial titans have reluctantly come out swinging in favor of convertible virtual currency (CVC) transactions.  For example, most US PayPal customers now have the ability to buy, sell and hold four different cryptocurrencies – BTC, ETH, LTC, and BCH, and use them as a funding source with the company’s 26 million merchants.  Presently, PayPal’s maximum dollar amount for weekly CVC purchases is $20,000 but even that relatively high consumer amount will likely change upwards as Paypal moves up the financial transaction food chain – with Paypal’s Venmo next in line.

The largest bank in the United States – J.P. Morgan Chase, launched its JPM Coin in 2019, and in October 2020 set up an entirely new business, Onyx, as an umbrella for its blockchain and CVC initiatives – including JPM Coin.  According to Jamie Dimon, Chairman and CEO of J.P. Morgan:  “Onyx is at the forefront of a major shift in the financial services industry. This new business unit reflects J.P. Morgan’s commitment to innovation as we continue to build cutting-edge technology that delivers a better, faster and more inclusive financial system.” On December 10, 2020, J.P. Morgan announced it completed a live, blockchain-based intraday repo transaction using JPM Coin.  And, Visa has filed a patent application for what may seem perfunctory, namely recording digital currencies on a blockchain.

Apart from these blockchain-based efforts, there is a whole category of blockchain initiatives that will forever fundamentally alter the broader financial sector – to the likely chagrin of PayPal, J.P. Morgan, and Visa. The banner name for these new blockchain and DLT initiatives is “DeFi”, or decentralized finance.

In December 2019, the entire Total Value Locked (TVL) in the DeFi market was worth less than $700 million, by the end of December 2020 it grew to $14 billion, and as of January 5, 2021 the total TVL in DeFi was at over $19 billion and growing – representing a staggering growth trajectory.  The TVL in the DeFi market represents all DeFi projects but is largely driven by the lending platform MakerDAO – a decentralized credit platform supporting Dai, a stablecoin pegged to the US dollar.  Decentralized exchanges (DEXes) such as Uniswap largely make up the remaining bulk of projects.  DEXes enforce trading rules and execute trades without charging the high fees normally associated with alternative investment trades.   

A commitment of $19 billion to DeFi initiatives may seem miniscule compared to, for example, the over $6 trillion in foreign exchange trades conducted each day.   On the other hand, each DeFi transaction potentially empowers individuals while at the same time weakening the grip over the monetary system currently held by central banks and finance intermediaries – a true game changer by any measure.

Generally relying on the public Ethereum blockchain platform, most DeFi projects deploy smart contracts to automate what previously required human intervention – obviating the need for central authorities such as banks or intermediaries.  DeFi Pulse nicely showcases the benefits of DeFi by describing it as “money Legos” and giving the following example:

Compound is a money market or, in other words, a lending service on Ethereum. When you supply DAI to Compound, you receive cDAI tokens which represent both your DAI in Compound and any interest you’ve earned from lending. Since cDAI is a token, you can send, receive, or even use cDAI in other smart contracts. Money Legos in action: ETH into MakerDAO to mint DAI tokens, DAI being supplied to Compound, cDAI tokens can be used in other DApps.  For example, you can swap ETH for cDAI on a DEX and instantly start earning interest for just holding cDAI. And because you choose how you interact with smart contracts on the blockchain, you can use a DEX aggregator like DEX.AG to compare and trade at the best prices across all the popular DEXes, all within seconds.

In 2021, crowdfunding will help fund some of the DeFi startups looking to eventually disintermediate the more traditional financial firms these startups would otherwise approach for financing.   As of November 2020, online platforms can raise up to $5 million in seed capital in a State-preempted manner – with previous platforms raising hundreds of millions of dollars using the prior SEC Regulation Crowdfunding cap of $1.07 million.  Even though a typical crowdfunding online platform itself breaks away from traditional centralized banking platforms its success is not relevant for purposes of the DeFi initiatives potentially opened up by Regulation Crowdfunding.  What may be more relevant are the new ideas coming to market without the latent influence of legacy financing.  

Before widespread adoption of any DeFi product is even feasible, however, regulatory scrutiny will be needed to protect consumers onboarding these new DeFi applications.   Given that a CVC wallet is the exit ramp for many DeFi initiatives, it is no surprise that has been an area of regulatory interest.  For example, the US Treasury’s Financial Crimes Enforcement Network (‘‘FinCEN’’) recently proposed a rule that would require banks and money service businesses to file a report with FinCEN containing information related to a customer, their CVC transaction, and counterparty (including name and physical address) “if a counterparty to the transaction is using an unhosted or otherwise covered wallet and the transaction is greater than $10,000.” FinCEN is issuing regulations on transactions using digital currency wallets because the growth of individual CVC transactions will continue unabated.  

While providing a suggested Token Safe Harbor Proposal, SEC Commissioner Hester M. Peirce offered an excellent analysis of the “regulatory Catch 22” faced by decentralized networks looking to comport with SEC regulatory law. In addition to Commissioner Peirce’s forward thinking, the SEC also recently set free its FinHub as a separate office to assist blockchain and DLT innovators.  

Despite these technology-forward initiatives, the SEC continues placing an exclamation point on its regulatory reach. For example, the SEC last month shook the Ripple world by claiming in a lawsuit Ripple’s XRP token –  used by financial institutions around the globe, was an unregistered security.  It also ended the year by filing a Cease and Desist Order against ShipChain on similar grounds. These sort of efforts convey US regulators still corralling the blockchain stallion – albeit primarily through the Howey door. Disruptive DeFi initiatives should remain undeterred.

More urgent concerns for the DeFi community are coding bugs, double-spend exploits, traditional hacks, and any number of faulty implemented software functions caused when smart contracts fail to undergo adequate audits.  Despite only losing $50 million in 2020, malicious actors will certainly begin seeing a larger target over DeFi’s head as its growth continues.  Moreover, given most DeFi projects run on Ethereum, there are future threats not even widely discussed – such as those potentially arising from miners who map out transactions on a blockchain for a fee and who are no longer satisfied with just receiving their fees.

All of these potential risks – whether regulatory, technological, malicious, or competitive, however, remain dwarfed by the potential upside found in a successful, widely-adopted DeFi application or protocol.  One likely key to success is to replicate what companies such as PayPal chose to do – take a widely used existing tool and deploy into it a profitable new way that allows for flexibility with actual autonomy and consumer self-determination.  DeFi will ultimately go nowhere if it only brings into the fold insiders stuck in Moore’s early adopter phase.  

Moreover, no open-source project can ascend until a large enough market believes the tradeoffs between ease of use, financial benefits, and utility ring strongly in its favor.  For example, despite having a strong web server market position, a Linux desktop will never really threaten Microsoft’s foothold until the relevant commercial and consumer markets believe a Linux desktop truly meets all of their needs. 

Similarly, DeFi will never gain a foothold reaching above the “PayPalJPMVisa” mountain peak until at least one DeFi application checks all the relevant boxes for a sizable enough market.  It may be a decade before a DeFi project reaches that vantage point – with the classic Amazon vs. Sears endgame likely being studied along the way. 

Microsoft Occupies Throne on Data Privacy Day

As Data Privacy Day is celebrated today, BigTech companies continue shoving each other for the data privacy throne.  Apple would have you believe it is the one true leader of the data privacy rights movement.  Even though Amazon has recently been moving in the right direction, when it comes to “Data Privacy Day”, only Microsoft makes it a daily event. 

Obviously, all companies benefit by moving towards a better data privacy regime.  As recognized by Mastercard’s Chief Privacy Officer:   “Privacy and accountability are central to our data-driven innovation, and have become key differentiators for our brand. This research reinforces the fact that privacy is a critical investment for forward-looking companies.”

In one of the first studies to estimate privacy returns for companies on a global scale, Cisco’s 2020 Data Privacy Benchmark Study assessed the benefits companies see in areas such as “operational efficiency, fewer and less costly data breaches, reduced sales delays, [and] improved customer loyalty and trust”.   More than 70% of those surveyed indicated they saw  “significant” or “very significant” benefits in each of these areas based on their investments in data privacy initiatives.  As for the actual quantification of these benefits, for every $1 of investment, the average company purportedly received $2.70 of benefit. For Microsoft, this monetary lift does not appear to drive its privacy epiphany.

Seeking to erase years of insecure Windows development contributing to countless data incidents, Microsoft’s newfound focus on data privacy the past five years originates from the very top. It’s privacy head recently testified before Congress exactly because she is a longstanding privacy steward now seeking Congressional help for consumers.  Microsoft CEO Satya Nadella went one step further at the 2020 World Economic Forum in Davos by suggesting that consumers obtain compensation for their data:  “Data that you contribute to the world has utility for you, utility for the business that may be giving you a service in return — and the world at large.  How do we account for that surplus being created around data? And who is in control around giving those rights?”  He recognized:  “What if the consumer benefited from their data as well as advertisers? More work needs to be done around data dignity – and new business models in the 2020s.”

This is not to say Microsoft is now rushing to compensate consumers for the use of private data.  Recently, it was uncovered that Microsoft built cancer algorithms using patient data obtained from Providence Health & Services in Renton, Washington.  No report exists of Microsoft compensating patients for this use of their data.  Nevertheless, when it comes to building the brightest path for data privacy there remains no other BigTech company suggesting that consumers be compensated for their data or promotes the use of a decentralized identity for consumers – the likely precursor to any viable “right of compensation” statutory scheme. When it comes time to finally do the right thing, Microsoft will apparently be leading the way to ensure it gets correctly done.

UPDATE: March 5, 2020

According to the Verge Tech Survey 2020: “Microsoft leads big tech companies in the number of Americans who say they trust it, at 75 percent of survey respondents. Amazon is close behind, at 73 percent. Pulling up the rear is Facebook: just 41 percent of Americans say they trust the company to safeguard their personal information.”

Is 2020 The Year Big Business goes all in on Blockchain and DLT?

In December 2017, it was recognized that in “the same way that the World Wide Web was never defined solely by Pets.com, the benefits of blockchain technology should never be defined solely by the latest price of Bitcoin.”  Now that the mid-2018 crypto bloodbath is well in everyone’s rearview window, it is clear that blockchain and DLT technologies have firmly taken corporate root and may actually someday bear some real fruit. 

No one can deny 2019 has seen great strides in the implementation and corporate adoption of enterprise DLT solutions as well as proactive growth in the regulatory oversight of blockchain technologies:

As exemplified by current projects emanating from the likes of J.P. Morgan and Fidelity Digital Assets, financial institutions will continue in 2020 taking calculated risks deploying blockchain and DLT technologies. 

Even though it may still may be another year or two before any consumer products hatched from these new technologies ever reach mass markets, 2020 may eventually be known as the year blockchain and DLT went mainstream in corporate America. 

Chinese President Xi Jinping lavishes praise on blockchain Technology

On October 24, 2019, Chinese President Xi Jinping was reported to lavish praise on the promise of blockchain technology arguing that it is imperative for China to accelerate its development. According to a local Chinese news agency, he said: “We must take the blockchain as an important breakthrough for independent innovation of core technologies, clarify the main direction, increase investment, focus on a number of key core technologies, and accelerate the development of blockchain technology and industrial innovation.” He also emphasized “the role of blockchain in promoting data sharing.”

A day earlier Facebook’s Mark Zuckerberg was grilled by politicians on his Libra project and he tried his best to argue if Libra failed China would simply launch its own competitive initiative. Ohio Congressman Anthony Gonzalez did not buy Zuckerberg’s argument: “What I don’t think is the right frame is, ‘If Mark Zuckerberg and Facebook don’t do it, Xi Jinping will do it.’ This isn’t Mark Zuckerberg versus Xi Jinping. I think that’s totally different. Framing that way, in my opinion, is somewhat misleading to me.”

Despite the obvious self-serving nature of his China references and likely disdain for China given Facebook has been banned in China for over a decade, Zuckerberg is correct in recognizing a potential long-term threat from China. Tied to its clear lead in 5G – by way of Huawei, achievements in AI computing, and long-ago implemented digital payment ecosystem, China is developing a real-time tracking system for all of its citizens – with the potential of exporting such capabilities to other countries and even deploying them outside of China to non-citizens. Setting up its own national digital currency may actually be beside the point.

Indeed, blockchain technology may not even be needed by President Xi Jinping to create a permanent record of all citizen interactions. China may possibly use blockchain technology or distributed ledger technology for grandiose tracking plans, or it may ultimately not bother given possible security and scalability challenges with such nascent technologies.

Whatever the direction ultimately taken by China, the takeaway from President Xi Jinping’s recent comments is clear – China will invest nationally in new technologies such as blockchain whereas the United States will largely stay on the sidelines and rely on private companies to innovate and deploy new technologies – which is actually Zuckerberg’s argument for allowing Libra to proceed.

Senate Banking Committee Focuses on Libra Privacy Issues

On July 16, 2019, a Senate Panel lobbed missives across the Libra bow when questioning David Marcus, the head of Facebook’s Calibra subsidiary.   As suggested by the title of the hearing – “Examining Facebook’s Proposed Digital Currency and Data Privacy Considerations”, today’s hearing was really all about Facebook and not about digital currencies or blockchain technologies in any broader context.

Using a tone that permeated for much of the hearing, Sen. John Kennedy ignored Facebook’s participation in a Swiss Association that purportedly leaves Facebook with little control over Libra and instead mocked: “Facebook wants to control the monetary supply. What could possibly go wrong?” Sen. Sherrod Brown (D-OH) reinforced this lack of trust when he said that Facebook was dangerous because it did not “respect the power of the technologies they are playing with, like a toddler who has gotten his hands on a book of matches, Facebook has burned down the house over and over, and called every arson a ‘learning experience.'”

Sen. Brian Schatz summed up the mood nicely when he recognized: “You’re making an argument for cryptocurrencies generally. The question is not, ‘Should the U.S. lead in this?’ Why in the world, of all companies, given the last couple of years, should [Facebook] do this?” 

On a more substantive side, the hearing was driven by a concern for privacy rights. As reported in The Wall Street Journal,  Mr. Marcus suggested that Facebook would not monetize users’ data related to Libra because no financial or account data from the Libra network would be shared with Facebook:  “We’ve heard loud and clear from people, they don’t want those two types of data streams connected.”

Even though it did not garner much public analysis, Chairman Crapo’s Statement provides an important privacy perspective that may also set the table for future legislative action: “Individuals are the rightful owners of their data. They should be granted a certain set of privacy rights, and the ability to protect those rights through informed consent, including full disclosure of the data that is being gathered and how it is being used.”

And, despite all of his protestations to the contrary, in his own prepared testimony, Mr. Marcus actually provides a rough roadmap detailing how the financial and transactional data obtained by Calibra could directly bolster Facebook’s data surveillance revenue.

Specifically, Mr. Marcus states: “The Calibra wallet will let users send Libra to almost anyone with a smartphone, similar to how they might send a text message, and at low-to-no cost.  We expect that the Calibra wallet will ultimately be one of many services, and one of many digital wallets, available to consumers on the Libra network.   We do not expect Calibra to make money at the outset, and Calibra customers’ account and financial information will not be shared with Facebook, Inc., and as a result cannot be used for ad targeting. Our first goal is to create utility and adoption, enabling people around the world— especially the unbanked and underbanked—to take part in the financial ecosystem.  But we expect that the Calibra wallet will be immediately beneficial to Facebook more broadly because it will allow many of the 90 million small- and medium-sized businesses that use the Facebook platform to transact more directly with Facebook’s many users, which we hope will result in consumers and businesses using Facebook more. That increased usage is likely to yield greater advertising revenue for Facebook.

To suggest that the mere ancillary use of Facebook’s platforms by Calibra users will alone cause an increase in advertising revenue makes little sense.  The only way Calibra will yield greater “advertising revenue” to Facebook is directly related to the well-understood increase in value user data would have after alignment takes place between transaction data and the other data obtained from Facebook’s platforms and services.  Indeed, advertisers have long recognized that personalization data is not nearly as useful as relevance data.

A long-term goal of Facebook’s Libra project, namely combining user data with associated financial and transactional data, should not be considered well-hidden. Mr. Marcus’ written testimony all but confirms Facebook will eventually harvest transactional and KYC data:  “Calibra will not share customers’ account information or financial data with Facebook unless people agree to permit such sharing.”  Indeed, Sen. Pat Toomey specifically asked Mr. Marcus whether Facebook intended to seek user consent to monetize Calibra-derived financial data and Mr. Marcus incredibly responded: “I can’t think of any reason right now for us to do this.” Really?

Facebook likely only has to ask and it will get whatever user permissions necessary to satisfy existing regulatory and statutory requirements.  Depending on the ultimate success of Amazon’s recent $10 offer for tracking data, Facebook may not even need to give much in return for such consent. In other words, once this particular genie is let out of the bottle there will likely be no turning back and any unencumbered launch of Libra might very well be the death knell for data privacy as we know it.

UPDATE: July 18, 2019

House Financial Services Committee Hearing of July 17, 2019

One major difference between the Senate hearing conducted on July 16, 2019 and the House Financial Services Committee hearing of July 17, 2019 was the sort of testimony provided by industry experts.  Even though the Senate smartly sought testimony from Wall Street and blockchain industry expert Caitlin Long, unlike with the House, there were no one educating the Senate on Calibra’s privacy issues.

For example, MIT Professor Gary Gensler’s prepared House testimony lays out a number of questions regarding privacy that Facebook should answer at some point:  “We know that many of the most intrusive privacy practices of concern to privacy regulators have actually been subject to some form of consumer consent. So, it will be essential to conduct a more thorough analysis of what uses of Libra data should be allowed and which uses should be prohibited. How would such restrictions be monitored and enforced? What are the limited exceptions and might Calibra broadly seek customer consent in the form of standard user agreements? It would be likely that Calibra would want to commercialize this data. At a minimum, without sharing the raw transaction data from customers’ Calibra Wallets, it would still likely analyze such data to earn money either through advertisements or by offering targeted services to wallet holders.”  

As well, in the prepared written testimony of Robert Weissman, President of Public Citizen, there is a long discussion explaining why Facebook is a “Corporate Surveillance Leviathan” that cannot be trusted with the proposed Calibra wallet.

The House Hearing also raised the issue of whether Facebook would be able to pick and choose users of the Calibra wallet – potentially forcing persons to conform their behavior to Facebook standards. In one highlight of the House Hearing, Congressman Sean Duffy waved a twenty-dollar bill in the air while making the point that anyone, including persons who say horrible things, can use a twenty-dollar bill but: “Who can use Calibra?”  In response, Mr. Marcus pointed out anyone who could satisfy Calibra KYC requirements – which then begged the loaded follow-up question from Congressman Duffy:  “Could Milo Yiannopoulos and Louis Farrakhan use Calibra [given they are both banned from Facebook]?”  In response, Mr. Marcus said that an applicable policy hasn’t yet been written but that it was “an important question that [Facebook] needed to be thoughtful about.”  

Given Facebook’s poor track record – indeed, former Facebook executives readily acknowledge Facebook holds too much market power and should not be trusted going forward, these and other “important questions” must be answered as soon as possible.

Will Libra Coin Kill Off Privacy For Good?

In January 2018, Facebook publicly announced it was going to take a deep dive into cryptocurrencies.   That same month, Facebook removed all ads from its platform that promote “initial coin offerings or cryptocurrency”.   Facebook’s policy was “intentionally broad” and banned “all ads related to cryptocurrencies — not just those directly trying to sell cryptocurrencies or cryptographic tokens.”  One example of a banned ad was provided by Facebook:  “Click here to learn more about our no-risk cryptocurrency that enables payments to anyone in the world”. 

In other words, Facebook’s “Libra Coin” – described as a “low-volatility cryptocurrency” for global payments in the sort of White Paper written for every ICO ever launched, began percolating at the very exact time Facebook banned ads about ICOs and cryptocurrency.  

Facebook’s crypto advertising ban and duopolistic reach pretty much sums up why potential users should be careful before jumping on the Libra bandwagon.  In what can only be considered ironic, the “Libra Coin” is not even a true cryptocurrency or even built on a blockchain – it is apparently the token for a permissioned payment network that is partially decentralized while requiring the disclosure of sensitive authentication data as well as use of the Calibra wallet owned and operated by Facebook itself.  Most importantly, as a node on the network Facebook will also have access to all consumer transaction data flowing on the network.  Like icing on a global cake, by being part owner of a de facto bank, Facebook will also get to share in any float interest.

Those premier venture firms and companies who have anted up to align with Facebook’s project may believe in the collective end game but to align now with Facebook simply because of its tremendous reach will likely be a mistake for them as well as the consuming public.

UPDATE: October 13, 2019

On October 4, 2019, PayPal withdrew its participation in the Libra Association. And, on October 11, 2019, Visa, Mastercard, eBay, and Stripe joined with Paypal in also withdrawing their participation in the Libra Association. Some have suggested these major payment industry defections spell the death knell for Facebook’s Libra project. In response, Facebook publicly stated the defections were “liberating” and understands why these companies chose not to continue taking the regulatory pressure. Given the significant regulatory hurdles that stand in the way of Libra’s successful launch, Facebook’s proposed privacy-killing “new global currency” will thankfully never see the light of day in its current form.