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How MtGox Failed the Five Parties Governance Test

Financial Cryptography - Wed, 02/26/2014 - 13:56
This was a draft of an article now published in Bitcoin Magazine. That latter is somewhat larger, updated and has some additional imagery. MtGox, the Bitcoin exchange, is in the news again, this time for collapsing. One leaked report maintains that MtGox may only have 2,000 Bitcoins in reserve over against 744,408 BTC in liabilities - which indicates a reserve of less than 1%. MtGox originally claimed that their troubles stem from a long-term exploit of the evil malleability bug, which was exploited by means of repeated double spending through an algorithm. However a loss of 99.7% of their reserves cannot be attributed to some mere market timing bug. It is clear that the failure of MtGox is a failure of governance. Trust Shall Not Live by Tech Alone One of the temptations for applied cryptographers is to think that we can solve all problems with clever mathematics and inspired code. Thus there has been much discussion over the past two decades about using cryptography to build trust models that work for untrusted parties over the Internet. This hope in cryptography is misplaced, and often dangerously so. In the first generation of the Internet, SSL was promoted to solve the trust and security problem. However, it failed to do that. Although it secured the line of communications, it left the end-points open to attack, and failed to solve the problem of knowing who the person at an end-point really is. As history shows, and MtGox confirms, the end-point security question is by far the dominating one, and thus we saw the rise of phishing attacks, “man in the browser” attacks, and server breaches throughout the 2000’s. Yet, SSL remains synonymous with Internet e-commerce security, and its very domination is a blindness that attackers benefit from. Bitcoin can be broadly described as an attempt to solve the problem of governance of a centralised issuer of currency through technology. By using a common protocol to manage a public blockchain, we can make sure everyone follows the rules and make it technically impossible to issue more Bitcoins than the protocol has decreed shall ever exist. However, like SSL, Bitcoin’s solution to the issuance problem has left open the weaker parts of the system to continued attack. In order to provide useful Bitcoin services, businesses must hold the users’ Bitcoins and/or their cash in trust. These businesses, such as exchanges, brokerages, online wallets, retail, etc, are at risk from insider theft, external hacking and loss through poor accounting. Bitcoin’s brilliant design for issuance governance may have obscured a complete lack of protection for end-point governance. How can a user trust a person to protect his or her value? This is not a new problem for finance. It is called the “agency problem” in reference to the fact that an agent acts for the user as a trusted intermediary. Institutions in the finance space have been dealing with the issue of trusted intermediaries for millennia. This field is broadly called “governance” and has many well known methods for achieving accountability and reliability for fiduciary institutions. Drawing from “Financial Cryptography in Seven Layers,” Governance includes the following techniques: Escrow of value with trusted third parties. For example, funds underlying a dollar currency would be placed in a bank account. Separation of powers: routine management from value creation, authentication from accounting, systems from marketing. Dispute resolution procedures such as mediation, arbitration, ombudsman, judiciary, and force. Use of third parties for some part of the protocol, such as creation of value within a closed system. Auditing techniques that permit external monitoring of performance and assets. Reports generation to keep information flowing to interested parties. For example, user-driven display of the reserved funds against which a currency is backed. As technologists, we strive to make the protocols that we build as secure and self-sustaining as possible; our art is expressed in pushing problem resolution into the lower layers. This is an ideal, however, to which we can only aspire; there will always be some value somewhere that must be protected by non-protocol means. Our task is made easier if we recognise the existence of this gap in the technological armoury, and seek to fill it with the tools of Governance. The design of a system is often ultimately expressed in a compromise between Governance and the lower layers: what we can do in the lower layers, we do; and what we cannot is cleaned up in Governance. The question then is how to bring those practices into a digital accounting and payment system. To address this weakness of customer escrowed funds, back in the late 1990’s we developed a governance technique for digital currency that we called the “Five Parties Governance Model.” (This model was built into the digital currency platform that we designed for exchange, called “Ricardo”.) The five parties model shares the responsibility and roles for protection of value amongst five distinct parties involved in the transactions. Although originally designed to protect an entire digital issuance, a problem that Bitcoin addressed with its public blockchain and its absence of an asset redemption contract, this technique can be broadly applied to many problems such as that which has brought MtGox down. The Five Parties Model (5PM) In terms of a cryptocurrency issuance with a single issuer (Ricardo model), the Five Parties Model looks like this (Figure 1). Figure 1. Simple Five Parties Model Issuer. The Issuer is the institution guaranteeing the contract with the User. This is the person or entity ultimately responsible for the assets and whether the governance succeeds or fails. In the present case, MtGox is the contractual party that is guaranteeing to deliver an exchange of value, and in the mean time keep those values secure. In Ricardo the Issuer is the party who defines and offers the contract for a particular issuance, which contract creates the rules that govern the five parties. As can be seen from the following screen capture taken from the Internet Archive, MtGox did in fact have a contract with the users to fully reserve their internal Bitcoin and currency accounts: Figure 2. Mt. Gox Terms & Conditions However, as an Issuer, MtGox appears to have failed to implement internal controls to put the other four parties into place. Trustee. In a digital value scenario, there is always a Trustee role that controls creation or release of long-term funds. For MtGox, this Trustee might be the person who signs off on outgoing wires and outgoing Bitcoin payments, or it might be the person who creates or deletes the derivative monetary units (BTC,LTC,EUR,USD,etc) inside the exchange’s books. For a cryptocurrency that contracts to an underlying asset, the Trustee’s account, sometimes known as the Mint account, is the only one that has the ability to create or destroy digital units of value, as that underlying asset pool increases or decreases. For a cryptocurrency without a contractual underlying, the protocol itself can stand in the person’s stead by employing an algorithm such as Bitcoin’s mining rewards program. Manager. The manager is the person or entity, usually an employee of the Issuer, who asks the Trustee to perform the big controlled operations: create or destroy digital assets, or deposit or withdraw physical ones, in order to reflect the overall pattern of trading activities. The Manager typically works on a daily trading basis. As funds come in and go out, some of these request match each other. For a perfect balance, nothing needs to be done, but normally there is an overall flow in one direction or another. As trading balances build up or draw down, the Manager asks the Trustee to authorise the conversion of daily trading assets against the long-term reserves. In the MtGox context, when BTC is flowing out and cash is flowing in, the Manager would ask the Trustee to release the BTC from the cold wallets, and would deliver cash into the long-term sweep accounts held at bank under the Trustee’s control. The Trustee would control that action by looking at the single transfer into the sweep account to confirm the transaction is backed by assets. In the context of an issuance of digital gold, the Manager might receive an inflow of a 1kg physical bar. The Manager must bail the physical gold into the vault, and present the receipt to the Trustee. With that receipt in hand, and any other checks desired, the Trustee can now release 1kg of freshly-minted digital gold to the Manager’s Account. The Manager is in this way guarded by the Trustee, but it works the other way as well. In a well-governed system, the Trustee can only direct value to be sent to the Manager. In this way, the Trustee cannot steal the value under trust, without conspiring with the Manager; a well-run business will keep these two parties at a distance and bound to govern each other by various techniques such as professional conduct codes. For example, Ricardo has an ability to lock the Mint’s account together with the Manager’s account in this fashion. Bitcoin lacks account-control features, but there is no reason that MtGox could not have implemented account-control for their internal Bitcoin accounts. Operator / Escrow / Vault. For a cryptocurrency, the operator is the part of the business ensuring that the servers and the software are running and properly doing their job. By outsourcing this to a third party, we add another degree of separation of powers to the governance model. In the case of Ricardo and similar contractually-controlled issuances, there is generally a single server cluster that maintains the accounts. The sysadmin for this server controls the accounts and ensures that no phantom accounts or transactions are let in; software designs assist by including techniques such as triple entry accounting, which guarantees that only original users can create signed instructions to transfer value with their private keys. For the physical side of a digital issuance such as gold, a vault fills the operator role. In the case of GoldMoney.com the vault operator is ViaMat. They don’t do anything with the client’s gold unless they receive a signed instruction from the Trustee. They just keep thieves from physically stealing it. Bitcoin is very different in this respect in that it creates the public blockchain as the accounting mechanism. In this case, the operator role is not outsourced to one party, rather it is spread across the miners, the software and the development team, presenting a very strong governance equation over operator malfeasance. For a business such as MtGox, the operators or escrows are two-fold. On the one part is the bank providing accounts, and especially the primary account holding long term cash reserves. On the other part, as an exchange provider, is the set of cold wallets holding long term BTC. The Fifth Party - The Public as Auditor. The final and most important element of the Five Parties Model is the role of the Public as auditor. Typically, the role of audit is to examine the books to validate that the other parties are indeed doing their job. As is covered elsewhere (Audit), paid auditors have a long-term conflict of interest, which has been at the root of several notable disasters in the last decade - the failure of Enron, the wholesale bankruptcy of banking in 2007 financial crisis, the collapse of AIG, none of which auditors rang the bell for. Auditors, as well as being conflicted, are also expensive, which leads to the search for alternates. Once we have mined the cryptographic techniques available to us, we are still left with a set of things we cannot control so easily. What then? Introducing you, the user, or the Public. You do not have a conflict of interest, in that it is your value at risk, and you have a strong interest in seeing that the other four parties are doing their job properly. Which then begs the question of how you, the public, can audit anything, when audit almost by definition means seeing that which cannot be seen? The answer is to make that which was previously unseen, seen. Some examples of digital currencies that have supported audit by you the Public include: e-gold.com published a real time balance sheet of their digital issuance. Goldmoney.com publishes their physical gold as held by their vault operators, and auditors publish the monthly report. Bitcoin publishes the blockchain. Ricardo publishes the balances of the Trustee and Manager accounts. Two-Sided Variation on the Five Parties Model The Five Parties Model is just and exactly that - a model. Which means there are variations and limitations, and a business must modify it to suit. For example, many businesses in the space have not one but two bases of value to control: an underlying asset and a digital issuance. Bitcoin Exchanges fall into this category, for example. When an Issuer is backing the digital currency with a reserve asset, both of these assets need to be protected. To do this, we utilise two instances of the Five Parties Model in a mirrored pair. In each, the Issuer and the Public act as parties on both sides, whereas the Trustee, the Operator and the Manager may be duplicated (or not). Figure 3 shows an arrangement where a single Manager works with mirrored Operators and Trustees. Figure 3. Two-Sided or Mirrored Variation of the 5 Parties Model An exchange such as MtGox would have had an even more complicated regime. For every one of their assets - BTC, Altcoins, USD, EUR, JPY, etc, they would have needed to delegate operators, trustees and managers. We as users expect they did that, which then leaves us with a question -- what went wrong? MtGox Failed Because Nobody Was Watching Them We can now measure MtGox against the governance picture drawn above. Although originally developed for an issuance, the model applies wherever there is an important asset to protect. As a business, the role of Issuer is relatively easy to identify - the company MtGox itself. Their terms and conditions constituted a clear contract between themselves and the users, where MtGox would hold the user’s Bitcoin assets in reserve. Likewise, the Operator for cash is clear: the banks holding the long-term value are presumably identifiable via incoming and outgoing wires. MtGox had transactions going in and out for some time, so Managers are in evidence. The Operator for the long-term BTC cold wallets is the Bitcoin network itself. What about Trustees? Although MtGox has repeatedly placed blame on their in-house operations team for various hacks and bugs, it is rather more likely that they fell short on the appointment and management of Trustees. Somehow, the Management created for themselves 744,408 BTC on their internal books against an underlying reserve of only 2,000 actual Bitcoins, which should have been an obvious disaster to all. If this is the case, this suggests that no Trustees were appointed at all, and Managers were essentially uncontrolled. Finally, the Public as auditor is not in evidence. MtGox on their website did not show the balances of any of their major asset classes, nor provide any easy way to ensure that their parties are doing their job. Ideally, MtGox would have displayed a balance sheet with references to cold wallets on one side, and their internal Bitcoin/Altcoin balances on the other side. The former is checkable via the blockchain, the latter could be made available by the operator, and periodically audited to ensure the code providing the balance query was accurate. With this information, you the Public as individuals or as media or other observers can verify that things are as they should be, and if not, sound the alarm! That’s what Twitter is for, that’s what sites such as DGCMagazine.com, CoinDesk.com and BitcoinMagazine are for. Under such circumstances failure might be expected and indeed may be inevitable. As MtGox did not have a sufficient governance model in place, we might have been disconcerted to learn that more than $300 million worth of Bitcoin managed to disappear, but we should also be aware that we may ultimately blame our own failure to insist on good governance. What other players in the Bitcoin world will fall for the same lack of care? You, the fifth party, the auditing Public would be well advised to review all of your Bitcoin partners to see what forms of governance they use, and to choose wisely. It is your value at risk, and demanding quality governance such as is outlined above is your right....

Presenting the #1 financial haven for dictators and criminals

Sovereign Man - Wed, 02/26/2014 - 05:55

February 26, 2014
Medellin, Colombia

Pop quiz: When really nasty criminals and dictators want to hide their illicit gains, which country do they go to?

I’ll make this easy for you– multiple choice:

a) Switzerland
b) British Virgin Islands
c) Hong Kong

With all the drama, history, and stigma surrounding Switzerland, most people would choose (A).

Yet over the last few years, Switzerland has worked hard to shed this reputation, even going so far as to propose laws making it easier for them to freeze dictators’ funds.

But in reality, the correct answer to the question is (D), none of the above. It’s the United States of America.

Despite being at the forefront for every other country in the world to eradicate banking privacy, the US government has hardly done a thing about the huge cracks in its own banking system… at least when it comes to foreigners.

Many states ranging from Delaware to New Mexico boast corporate entities that can be completely private, especially for foreign shareholders.

Not to mention, attorney-client privilege laws in the US mean that a lawyer can be inserted between a foreigner and their Delaware bank account, making the funds virtually untraceable back to the original shareholder overseas.

Last– the US banking system is so large with hundreds of billions of dollars of inflows and outflows, it’s quite easy for several hundred million to slip right past the radar.

So if you’re a villainous dictator who has plundered your citizens’ wealth, you’d be a fool to stash that cash away in Switzerland. Wall Street banks are waiting with open arms, and Saul Goodman is just a phone call away.

None of this, by the way, is any wild conspiracy theory. It’s all fact… validated by the US government itself.

You see, the Financial Crimes Enforcement Network (FinCEN), an agency of the US Treasury Department, sent out a rather frantic email blast to banks across the United States yesterday about former Ukrainian President Viktor Yanukovych.

Mr. Yanukovych recently fled his home country and is on the run from mass murder charges. And as you can imagine, he has spent years plundering the wealth of Ukraine.

FinCEN recognizes that Yanukovych has substantial assets stashed away in the Land of the Free… and they’re keen to avoid yet another embarrasing public scandal in which the US banking system is caught financing a fugitive dictator.

So their email yesterday was a not-so-subtle suggestion to banks across the country that they should sound the alarm bells with respect to “suspicious movements of assets related to Viktor Yanukovych. . . and other senior officials resigning from their positions or departing Kyiv.”

It certainly begs the question– why would FinCEN send out such an admonishment to US banks?

Simple. Because while ordinary citizens are treated like dairy cows and medieval serfs, FinCEN knows that the United States is the #1 financial safe haven in the world for foreign criminals and dictators.

Unbelievable. 55-year old widow fights against the North Korean government

Sovereign Man - Tue, 02/25/2014 - 07:12

February 25, 2014
En route to Colombia

Li Mi-Yung just wanted to be free.

This 55-year old widow in North Korea had spent the last 18-months building up an off-grid residential homestead. She was, for the most part, fully independent.

She collected rain as a source of water. She had her own waste disposal. She generated her own electricity from the sun.

Sounds pretty admirable, right? Especially in a place where so few people are independent.

Unfortunately, upon finding out about Ms. Li’s living situation, the local authorities in North Korea dispatched entire teams of government workers to Ms. Li’s home, attempting to evict her and haul her in front of a tribunal.

Truly despicable. You’d think that the North Korean government would be eager to learn from her so that everyone else’s lives could be improved.

But alas, what else can one expect from the government of North Korea…?

There’s just two minor corrections I need to make to this story before I go on, though.

Li Mi-Yung is really Ms. Robin Speronis. And she does not live in North Korea. She lives in Cape Coral, Florida… in the Land of the Free. Everything else is true.

Yes, rather than try to learn from Mr. Speronis in an effort to improve the city’s public services, she was apparently branded as some kind of criminal mastermind who must be stopped at all costs.

When they heard last November that she was living off-grid, the city posted a notice of eviction, citing numerous code violations. They concluded that her dwelling (which she had been living in since January) was “unfit for human habitation.”

Furthermore, she was told that continuing to live at (or even ENTERING) the property would constitute misdemeanor trespassing and subject her to arrest.

Days ago, the case was heard in front of a special magistrate. City officials read off a seemingly endless list of code violations, and expert witnesseses were paraded into the court to confirm her nefarious deeds.

Naturally. Someone who unplugs from the system can only be trouble.

At the end of the hearing, the judge waived his hand, finding her guilty of some violations, not guilty of other violations, and then ordered her to at least partially plug back in to the grid.

I wish I could use a word like “amazing”, “unbelievable”, or “incredible” here. But I can’t. Because this is now par for the course in the Land of the Free.

Collecting rainwater now constitutes a crime. Being free and independent gets you threatened with eviction and hauled into court.

In the Land of the Free, you are unfit to decide for yourself how you want to live. And the government has all the power in the world to forcibly bend you to its will, even if it means terrorizing citizens into using public utilities.

It’s quickly getting to the point where anyone who wants to take back any personal freedom is going to have to seriously consider heading overseas to places where governments leave you the hell alone to live your life in peace.

Yes, it’s a radical thought. But so many great civilizations before were founded by intrepid free men and women who left their home countries in search of liberty and opportunity.

Why not now?

World governments agree to automatic information sharing

Sovereign Man - Mon, 02/24/2014 - 08:03

February 24, 2014
Sovereign Valley Farm, Chile

It’s like 34 drunken sailors holding each other up. That’s the best way I can think of to describe the latest product from the good idea factory that is the OECD.

Over the weekend in yet another cushy five-star hotel, representatives from this unelected supranational bureaucracy announced plans for world governments to exchange all their citizens’ tax and financial data with one another.

The 34 members states of the OECD are enthusiastically supporting this measure. And it constitutes the end of whatever remains of financial privacy.

The premise behind the OECD’s destructive pipedream is, as usual, to stamp out ‘tax evasion’. But this is a misnomer to being with.

Just about every multinational company out there employs strategies to reduce their current tax liabilities that are perfectly legitimate based on existing tax laws.

This is why companies like Google and Apple famously earn billions in profits but pay almost no tax. They’re vilified. But it’s legal.

These companies have shareholders from all over the world. And their solemn responsibility is to maximize shareholder value… not maximize the amount of funds that politicians in a single jurisdiction get to blow on wars and welfare.

There are also isolated individuals who are sitting on undeclared income stashed away in an overseas bank somewhere. But the aggregate amount is tiny compared to the $60+ billion that Microsoft alone has stashed away overseas, untaxed.

You’d think they’d get at the root cause of the problem and try becoming more competitive… lowering tax rates and streamlining government operations (shocker!)

But no. Instead they resort to even more Draconian tactics to lord over private citizens’ financial records and unilaterally set aside long-standing international treaties.

It’s a pathetic display of exactly the sort of tactics that governments embrace when they go broke. And most of these OECD countries ARE broke– Italy, Japan, the US, Spain, Greece, etc.

So what we have now are a bunch of bankrupt member states who think that they are helping the other bankrupt member states raise revenue by terrorizing citizens (rather than actually fixing the problem).

It’s genius. But what else can one expect from the OECD?

This is the same organization which said, in the same meeting over the weekend, that Germany should accept higher inflation so that the rest of Europe wouldn’t suffer from deflation.

The arrogance is astounding.

This is the same logic as borrowing your way out of debt and spending your way out of recession… brought to you by the same guys who completely missed all the warning signs of the Global Financial Crisis. Along with the IMF. The Federal Reserve (and every other central bank in the world). And every government out there.

Yet these are the rocket scientists who pull the levers that control the system.

It behooves anyone who can see the big picture to distance yourself as much as possible from this system.

This means, for example, keeping a portion of your savings in real assets that they cannot control, as opposed to paper assets that they conjure and manipulate.

Most importantly, it means not having all of your eggs in one basket. Bankrupt governments will resort to any measure they feel is necessary to maintain the status quo.

And if you live, work, invest, bank, run a business, own real estate, etc. all in one of these bankrupt countries, you are really taking on tremendous risk.

Smoking cigars by a mountain of napalm

Sovereign Man - Fri, 02/21/2014 - 11:10

February 21, 2014
Sovereign Valley Farm, Chile

I need to caveat this missive and highlight that I am not a pessimistic person. I’ve traveled to so many places over the years– well over 100 countries. And I typically visit 30-40 each year.

So I’ve seen first hand the tremendous opportunity that exists in the world, and the incredible way that human beings innovate to overcome challenges.

But the reality is that the world is on fire right now. In some places, like Ukraine or Thailand, quite literally.

In many others (like Japan, China, and much of southern Europe), there are heaps of smoldering embers beneath a continent-wide funeral pyre.

And in the Land of the Free, it’s as if politicians and central bankers are smoking their back-room cigars at the foot of a mountain of napalm and thermite that grows ever-higher by the day.

If you step back and look at the big picture, there is cause for concern.

For one, the tiniest elite has achieved record wealth thanks to the endless money printing of central bankers. The richest 300 people in the world alone addded $524 billion to their fortunes in 2013, while billions of other people across the planet pay higher prices for food and fuel.

This gap between rich and poor has grown to its widest since the Great Depression… and I would argue in many ways since the feudal system.

Obviously this isn’t a tirade against wealth, but rather the massively disproportionate benefits realized by a tiny elite at the expense of everyone else. And it exists because there is no separation between Bank and State. As Henry Ford said,

“It is well enough that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

Well, it’s happening. People might not fully understand how central banking works. But they know there is something very rotten in the system.

And they’re starting to realize that it doesn’t have anything to do with a single party, or an individual. Even in the Land of the Free, more voters than ever are disgusted by both parties and identify with neither.

This is fundamentally what’s happening in Ukraine. People understand the system is rotten to its core– that a band of criminals has taken control, and that ‘elections’ will only serve to put a new band of criminals in control.

It is precisely what will likely play out in southern Europe, where unemployment among the youth (i.e. those of revolutionary age) is astoundingly high. And potentially even in the Land of the Free.

It’s an uncomfortable and contentious notion, I know. But this rotten system is fundamentally the same in the developed west. The only difference is there is even more debt underpinning it.

Every living creature has a breaking point. It is in our instincts to rise up when threatened.

And rather than watching these kinds of events unfold on TV thinking, “That could never happen here,” I would suggest looking at the situation rationally, and historically. Many great civilizations before arrogantly assumed the same thing.

So the question to ask is, “Am I prepared if this kind of turmoil ever comes to my doorstep?”

The one investment you want to avoid at all costs

Sovereign Man - Thu, 02/20/2014 - 07:18

February 20, 2014
Sovereign Valley Farm, Chile


I read it twice to make sure my brain had processed the number correctly. Yep, 4.1%.

This was the annual yield promised on a new 5-year bond investment that a private banker colleague had sent to me. I couldn’t believe it.

The bond issuance was by a state-owned company in India. And despite the Indian government having a -very- recent history of capital controls, price fixing, and asset confiscation, and despite the company being rated near JUNK status, the bond only carried a yield of 4.1%.

This is really amazing when you think about it. Central bankers have destroyed money and interest rates to the point that near-bankrupt companies in shaky jurisdictions can borrow money for practically nothing.

It’s an utter farce. The rate of inflation is -at least- 3% in many developed countries. Central bankers will even say they are targeting 3% inflation.

This means that if investors simply want to generate enough income so that their after-tax yield keeps pace with inflation, they have to assume a ridiculous amount of risk.

This is a really important point to understand given that the global bond market is so massive– roughly $100 trillion, with nearly $1 trillion traded each day in the US alone.

This is almost twice the size of the global stock market. And even if people never invest in a bond themselves, they’re directly connected to the bond market.

Your pension fund owns bonds. The bank that is holding on to your money owns bonds. The companies listed on the stock market that you invest in own bonds.

Yet bonds are some of the worst investments out there right now. And that’s saying a lot given how overvalued stock markets are.

Here’s the bottom line: adjusting for both taxes and inflation, bondholders are losing money, even on risky issuances.

Think about it– if you make a 4% return and pay 25% in taxes, your net yield is 3%. If inflation is 3%, your entire gain is wiped out… so you have taken that risk for nothing.

If inflation rises just a bit then you are in negative territory.

There are those who suggest that deflation is a much greater risk right now than inflation… and that bonds are great investments to own in the event of deflation.

But here’s the thing– even if deflation takes hold and prices fall, anyone who is deeply in debt is going to feel LOTS of pain. Instead of their debt burden inflating away, now they’ll be scrambling to make interest payments.

So while bonds are a sensible deflationary investment in theory, in practice deflation will only increase the likelihood of default. This puts many bond investments at serious risk.

Last, if interest rates rise from these all-time lows, a bond’s value in the marketplace will plummet. So not only will you have made zero income, you would be looking at a steep loss if you try to sell.

Longer term, fixed rate bonds in weak currencies are almost guaranteed losers and should be avoided at all costs. You would be much better off setting your cash ablaze in a bonfire. It’s at least a better story to tell and will save you years of anguish watching your position erode.

Premium members: watch out for an alert this afternoon in which Jim Rickards (author of the acclaimed Currency Wars and one of the smartest guys in finance) gives some really great investment advice and thoughts on how to structure one’s portfolio amid all of this insanity.

“No, sire, it is a revolution…”

Sovereign Man - Wed, 02/19/2014 - 08:15

February 19, 2014
Sovereign Valley Farm, Chile

It’s pretty ironic that I have two visitors right now in my home– one from Ukraine and the other from Thailand.

Both of their countries are in the midst of chaotic turmoil right now, characterized by riots and violent clashes between protestors and police.

It reminds me of the old quote from Louis XVI upon being informed in 1789 that the French people had stormed the Bastille. The King asked, “Is it a revolt?”

“No, sire,” the duke replied, “It is a revolution.”

People in both of these countries have reached their breaking points. In Ukraine especially, economic conditions have deteriorated in almost spectacular form.

History is packed with examples of how people rise up in the streets whenever economic conditions deteriorate.

The French Revolution in 1789 is one famous example; the French people finally reached their breaking points after nearly starving to death.

The 2011 Egyptian Revolution and entire Arab Spring movement is a similar example.

In fact, a 2011 study from the New England Complex Systems Institute showed a clear statistical correlation between social unrest and (specifically) food prices. The higher food prices get, the greater the chances of riots and revolution.

This is not a condition exclusive to the developing world; it is a fundamental human trait to provide for one’s family.

And while human beings will take a lot of crap from their governments– stupid regulations, higher taxes, erosion of freedom, and even inflation– the moment that a man is no longer able to put food on the table for his family, revolution foments.

Europe and the US are not immune to this. And with deteriorating wealth gaps, 50%+ youth unemployment, unchecked government power, and a system that disproportionately favors the elite, the conditions are ripe.

The main difference is that Westerners have been brainwashed into believing that the civilized people voice their grievances in a voting booth rather than doing battle in the streets.

It’s a false premise. Unfortunately, so is violent revolution.

As my dictionary so perfectly defines, “revolution” has two meanings.

First, it can denote an overthrow of a sitting government, whether violent or ‘bloodless’.

But in celestial terms, ‘revolution’ denotes a complete orbit around a fixed axis. In other words, after one revolution, you end up right back where you started.

So whether violent or non-violent, or whether in a voting booth or on the streets, revolutions put a country right back where it started.

In the French revolution, people traded an absolute monarch in Louis the XVI for a genocidal dictator in Robespierre for a military dictator in Napoleon.

In 1917, the Russians traded Tsarist autocracy for Communist autocracy.

In 2011, Egyptians traded Hosni Mubarak for Mohamad Hussein Tantawi (who subsequently suspended the Constitution), for Mohamed Morsi (who as President awarded himself unlimited powers), for yet another coup d’etat.

All of this is because of a knee-jerk reaction– ‘if our country is having major problems, we should throw the bums out and let the man on the white horse take over.’

This creates a never-ending cycle in which the fundamental problems perpetuate.

It’s not about any single person or group of people. It is the system itself that needs changing.

In our system we award a tiny elite with the power to kill, steal, wage war, educate our children, and conjure unlimited quantities of paper money out of thin air.

This is just plain silly. And antiquated. We’re not living in the Middle Ages anymore where we need kings to tell us what to do, knights to keep the peace, and serfs to do all the work (and enrich the nobles).

Yet this is not too far from the system we have today.

The real answer is within ourselves. As Ron Paul told our audience in Santiago last year, become less dependent on the government and more self-reliant:

This idea is beginning to resonate with more and more people who are increasingly disgusted with the system… and all parties.

With our modern technology, transportation, and access to information, we have all the tools available to do this.

IMF report: ‘Debt is good’. What are these people smoking?

Sovereign Man - Tue, 02/18/2014 - 09:40

February 18, 2014
Sovereign Valley Farm, Chile

Probably every kid in the world has at some point dreamed of having a time machine and being able to travel back to the past… usually to see dinosaurs or something like that.

Time travel is an almost universal fantasy. And if I could snap my fingers and turn the pages of time, I’d be seriously curious to check out the thousand-year period between the decline of the Western Roman Empire and the rise of the Renaissance.

They used to refer to this period as ‘the Dark Ages’ (though historians have since given up that moniker), a time when the entire European continent was practically at an intellectual standstill.

The Church became THE authority on everything– Science. Technology. Medicine. Education. And they kept the most vital information out of the hands of the people… instead simply telling everyone what to believe.

People living in that time had to trust that the high priests were smart guys and knew what they were talking about.

Interpreting facts and observations for yourself was heresy, and anyone who formed original thought and challenged the authority of church and state was burned at the stake.

Granted, human civilization has come a long way since then. But the basic building blocks are not terribly different than before.

Anyone who challenges the state is still burned at the stake. And our entire monetary system requires that we all trust the high priests of central banking and economics. Those that stray from the state’s message and spread economic heresy are cast down and vilified.

You may recall the case of Harvard professors Ken Rogoff and Carmen Reinhart who wrote the seminal work: “This Time is Different: Eight Centuries of Financial Folly”.

The book highlighted dozens of shocking historical patterns where once powerful nations accumulated too much debt and entered into terminal decline.

Spain, for example, defaulted on its debt six times between 1500 and 1800, then another seven times in the 19th century alone.

France defaulted on its debt EIGHT times between 1500 and 1800, including on the eve of the French Revolution in 1788. And Greece has defaulted five times since 1800.

The premise of their book was very simple: debt is bad. And when nations rack up too much of it, they get into serious trouble.

This message was not terribly convenient for governments that have racked up unprecedented levels of debt. So critics found some calculation errors in their Excel formulas, and the two professors were very publicly discredited.

Afterwards, it was as if the entire idea of debt being bad simply vanished.

Not to worry, though, the IMF has now stepped up with a work of its own to fill the void.

And surprise, surprise, their new paper “[does] not identify any clear debt threshold above which medium-term growth prospects are dramatically compromised.”

Translation: Keep racking up that debt, boys and girls, it’s nothing but smooth sailing ahead.

But that’s not all. They go much further, suggesting that once a nation reaches VERY HIGH levels of debt, there is even LESS of a correlation between debt and growth.

Clearly this is the problem for Europe and the US: $17 trillion? Pish posh. The economy will really be on fire once the debt hits $20 trillion.

There’s just one minor caveat. The IMF admits that they had to invent a completely different method to arrive to their conclusions, and that “caution should be used in the interpretation of our empirical results.”

But such details are not important.

What is important is that the economic high priests have proven once and for all that there are absolutely no consequences for countries who are deeply in debt.

And rather than pontificate what these people are smoking, we should all fall in line with unquestionable belief and devotion to their supreme wisdom.

Why Dispute Resolution is hard -- but not so elusive as to escape solutions

Financial Cryptography - Tue, 02/18/2014 - 02:41
Steven J. Murdoch and Ross Anderson have released a paper entitled "Security Protocols and Evidence: Where Many Payment Systems Fail," to be presented in a few weeks in Financial Cryptography Conference, in Barbados. It is very welcome to point people in the direction of dispute resolution, because it is indeed a make or break area for payment systems. The paper itself is a light read, with some discussion of failures, and some suggestions of what to do about it. Where it gets interesting is that the paper tries to espouse some Principles, a technique I often use to get my thoughts in order. Let's look at them: Principle 1: Retention and disclosure. Protocols designed for evidence should allow all protocol data and the keys needed to authenticate them to be publicly disclosed, together with full documentation and a chain of custody. Principle 2: Test and debug evidential functionality. When a protocol is designed for use in evidence, the designers should also specify, test and debug the procedures to be followed by police officers, defence lawyers and expert witnesses. Principle 3: Open description of TCB. Systems designed to produce evidence must have an open specification, including a concept of operations, a threat model, a security policy, a reference implementation and protection profiles for the evaluation of other implementations. Principle 4: Failure-evidentness. Transaction systems designed to produce evidence must be failure-evident. Thus they must not be designed so that any defeat of the system entails the defeat of the evidence mechanism. Principle 5: Governance of forensic procedures. The forensic procedures for investigating disputed payments must be repeatable and be reviewed regularly by independent experts appointed by the regulator. They must have access to all security breach notifications and vulnerability disclosures. I have done these things in the past, in varying degrees and fashions, so they are pointing in the right direction, but I feel /as principles/, they fall short. Let's work through them. With P1, public disclosure immediately strikes an issue. This is similar to the Bitcoin mentality that the blockchain should be public, something which has become so tantalising that regulators are even thinking about mandating it. But we live in a world of crooks. Does this mean that a new attack is now about to become popular -- using the courts to force the publication of ones victim's secrets? The reason for financial privacy is to stop scumbags knowing where the loot is, and that is a good reason. As we enter a more transparent world for crooks, because of such innovations as Internet data tracking, economic intelligence harvesting, drugs-ML, AML, sharing of seized value by government agencies, monolithic banks incentivised to cross-sell and compete, etc, the need for financial privacy goes up not down. If you look at M&A's paper, the frustration in the courts that they faced was that the banks argued they couldn't disclose the secrets. Yet, courts readily deal with this already. Lawyers know how to keep secrets, it's their job. So we're really facing a different problem, which is that the banks snowed the judge with bluff and bluster, and the judge didn't blink. As Stephen Mason writes in "Debit Cards, ATMs and the negligence of the bank and customer," in Butterworths Journal of International Banking and Financial Law, March 2012: "The only reason the weaknesses have been revealed in some instances, as discussed in this article, is because the banks were required to cooperate with the investigating authorities and explain and provide evidence of such weaknesses before the criminal courts. In civil actions, the banks have no incentive to reveal such weaknesses. The banks will deny that their systems suffer from any weaknesses, placing the blame squarely on the customer." The real problem here is that banks do not want to provide the evidence; for them, suppression of the evidence is part of their business process, a feature not a bug. Hence, Principle 1 above is not sufficient, and it could be written more simply: P1. Payment protocols should be designed for evidence. which rules out the Banks' claims. But even that doesn't quite work. Now, I'm unsure how to make this point in words, so I'll simply slam it out: P1. Payment protocols should be designed to support dispute resolution. Which is a more subtle, yet comprehensive principle. To a casual outside observer it might appear the same, because people typically see dispute resolution as the presentation of evidence, and to our inner techie, they see our role as the creation of that evidence. But, dispute resolution is far more important that that. How are you filing a dispute? Who is the judge? Where are you and what is your law? Who holds the burden of proof? What is the boundary between testimony and digital evidence? In the forum you have chose, what are the rules of procedure? How do they affect your case? These are seriously messy questions. Take the recent British cases of Shojibur Rahman v Barclays Bank PLC as reported (judgement, appeal) in Digital Evidence and Electronic Signature Law Review, 10 (2013). In this case, a fraudster apparently tricked the victim into handing over a card and also the PIN. This encouraged Barclays to claim no liability for the frauds that followed. Notwithstanding this claim, the bank is required to show that it authenticated the transactions. In both of the two major transactions conducted by the fraudster, the bank failed to show that they had authenticated the transactions correctly. In the first, Barclays presented no evidence one way or another, and the card was not in use for that transaction, so the bank simply failed to meet its burden of proof, as well as its own standards of authentication as it was it undisputed that the fraudster initiated the transaction. In the second, secret questions were asked by the bank as the transaction was suitably huge, /and wrong answers were accepted/. Yet, in district court and on appeal the judges held that because the victim had failed in his obligation to keep the card secure, defendant Barclays was relieved of its duty to authenticate the transactions. This is an outstanding blunder of justice -- if the victim makes even one mistake then the banks can rest easy. Knowing that the banks can refuse to provide evidence, knowing that the systems are so complex that mistakes are inevitable, knowing that the fraudsters conduct sophisticated and elegant social attacks, and knowing that the banks prepared the systems in the first place, this leaves the banks in a pretty position. They are obviously encouraged to hold back from supporting their customer as much as possible. What is really happening here is a species of deception, and/or fraud, sometimes known as liability shifting or dumping. The banks are actually making a play to control and corral the dispute resolution into the worst place possible for you, and the best place for them -- their local courts. Meanwhile, they are telling you the innocent victim, that they've got it all under control, and your rights are protected. In terms of P1 above, they are actually designing their system to make dispute resolution tilted in their favour, not yours. They should not. Then, let's take Principle 2, testing the evidence functionality. The problem with this is that, in software production, testing is always the little lost runt of the litter. Everyone says they will look after her, and promise to do their best, but when it matters, she's just the little squealing nuisance underfoot. Testing always gets left behind, locked in the back room with the aunt that nobody wants to speak to. But we can take a more systemic view. What us financial cryptographers do for this situation is to flip it around. Instead of repeating the marketing blather of promises of more testing, we make the test part of the protocol. In other words, the only useful test is one that is done automatically as part of the normal routine. P2. Evidence is part of the protocol. You can see this with backups. Most backup problems occur because they were never actually used at the time they were created. So good backups open up their product and compare it back to what was saved. That is, part of the cycle is the test. But we can go further. When we start presenting this evidence to the fraternity of dispute resolution we immediately run into another problem highlighted by the above words: "the designers should also specify, test and debug the procedures to be followed by police officers, defence lawyers and expert witnesses." M&A were aware of cases such as the one discussed above, and seek to make the evidence stronger. But, the flaw in their proposal is that the process so promoted is *expensive* and it therefore falls into the trap of raising the costs of dispute resolution. Which make them commensurately less effective and less available, which breaches P1. And to segway, Principle 3 above also fails to the same economic test. If you do provide all that good open TCB stuff, you now need to pull in expert witnesses to attest to the model. And one thing we've learnt over the years is that TCBs are fertile ground for two opposing expert witnesses to disagree entirely, both be right, and both be exceedingly expensive. As before, this approach increases the cost, and therefore reduces the availability of dispute resolution, and thus breaches P1. And, it should be noted that a developing popular theme is that standards and TCBs and audits and other big-costing complicated solutions are used as much to clobber the user as they are to achieve some protection. The TCB is always prepared in advance by the bank, so no prizes for guessing where that goes; the presence of the institution-designed TCB is as much antithetical to the principles of protection of the user, so it can have no place in principles. Now, combining these points, it should be clear that we want to get the costs down. I can now introduce a third principle: P3: The evidence is self-evident. That is, the evidence must be self-proving, and it must be easily self-proving to the judge, who is no technical wizard. This standard is met if the judge can look at it and know instantly what it is, and, likewise, so can a jury. This also covers Principle 5. For an example of P3, look at the Ricardian Contract, which has met this test before judges. Principle 4 is likewise problematic. It assumes so much! Being able to evidence a fraud, but not stop it is a sort of two-edged sword. Indeed, it assumes so much of an understanding of how the system is attacked that we can also say that if we know that much about the fraud, we should be able to eliminate it anyway. Why bother to be evidence-protected when we can stop it? So I would prefer something like: P4: The system is designed to reduce the attack surface areas, and where an attack cannot be eliminated, it should be addressed with a strong evidence trail. In other words, let's put the horse before the cart. Finally, another point I would like to bring out which might now be evident from the foregoing, is this: P5: The system should be designed to reduce the costs to both parties, including the costs and benefits of dispute resolution. It's a principle because that is precisely what the banks are not doing; without taking this attitude, they will also then go onto breach P1. As correctly pointed out in the paper, banks fight these cases for their own profit motive, not for their customers' costs motives. Regulation is not the answer, as raising the regulatory barriers plays into their hands and allows them to raise prices, but we are well out of scope here, so I'll drift no more into competition. As an example of how this has been done, see this comparison between the systems designed by CAcert and by Second Life. And, Steve Bellovin's "Why the US Doesn't have Chip-and-PIN Credit Cards Yet," might be seen as a case study of P5. In conclusion, it is very encouraging that the good work that has been done in dispute resolution for payment systems now has a chance of being recognised. But it might be too early for the principles as outlined, and as can be seen above, my efforts scratched out over a day are somewhat different. What is going to be interesting is to see how the Bitcoin space evolves to deal with the question, as it already has mounted some notable experiments in dispute resolution, such as Silk Road. Good timing for the paper then, and I look forward to reports of lively debate at FC in Barbados, where it is presumably to be presented....

It ripped me up inside to see this kid in jail

Sovereign Man - Mon, 02/17/2014 - 07:49

February 17, 2014
En route from Buenos Aires, Argentina

On the tail end of my Army career over a decade ago when I was still living in the Land of the Free, I used to be a volunteer for the Big Brothers / Big Sisters program.

If you’ve never heard of it, BBBS is a non-profit that temporarily matches up at-risk youth with responsible mentors in an effort to provide kids with positive role models.

When I first enrolled, the administrators linked me up with a kid from the inner city just hitting his ‘tween’ years. I’ll call him “DJ”.

DJ was great. Despite living in one of the most violent, crime-infested areas of Dallas, he had managed to keep a positive attitude on life. He was always smiling, and polite.

And unlike a lot of kids from his area who aspired to be either drug dealers or professional basketball players, DJ wanted to be in real estate sales.

(I used to encourage this by driving him around on the weekends looking at open houses and property listings, trying to teach him the valuation methods that I had picked up over the years.)

Eventually, life got in the way. My business interests and personal philosophy had always been pulling me overseas. And my father (the primary reason I had been living there to begin with) had passed away after a terrible bout with cancer.

DJ and I saw less and less of each other. And in our periodic phone calls, it became clear that he was changing. For the worse.

By the end of high school, DJ had hooked up with the wrong crowd. The constant influence of other youth had a powerful effect on him. And with a father in prison and his mother barely at home, he quickly got pulled into a darker world.

His entire personality was changing. It was as if he had become a completely different person. Gone was the happy kid with solid, realistic aspirations and a drive to succeed. DJ had become a thug, respecting only violence, ignorance, and wanton cruelty to other human beings.

Right after his 18th birthday he was arrested for a whole slew of felonies– and was just old enough to be tried, convicted, and sentenced as an adult.

The last time I saw him I barely recognized him. It was sad… really ripped me up inside.

This story is far too common; I’m sure many of our readers have been in similar situations, watching people they once cared about descend into a chaotic downward spiral.

I’ve been thinking about this over the past few days during my time in Argentina. Because nations, like people, can enter a downward spiral from which they become completely unrecognizeable.

The Economist recently did a great spread on Argentina, explaining how this country– this city– used to be one of the greatest in the world.

In its heydey, Buenos Aires was considered among the wealthiest, most opulent places in the western hemisphere.

A century ago in 1914, GDP per capita in Argentina was higher than in most of Europe, and its economic growth outpacing even the flourishing United States.

And while the rest of the world blew itself to smithereens in the Great War, Argentina very smartly remained neutral.

By 1918, Argentina was one of the only prosperous, debt-free nations left. And the consequent surge in exports to support all the reconstruction in Europe resulted in a heady economic boom.

But that was then. Today is a different story.

Decades of utterly destructive corruption, debt, and absurd economic centralization have taken an irreversible toll on the country and its economy.

Despite its massive potential, abundant resources, huge population, and culturally-ingrained business prowess, Argentina has become a pitiful shell that continually vaccilates into the the 3rd world.

And people here have had their liberties and livelihoods ravaged by a government that has imposed price controls, capital controls, media controls, and people controls.

They have nationalized private pensions, confiscated private assets, jailed opposition, spawned a currency crisis, and corrupted public institutions.

All of this has devastated a once rich culture. Theft, deceit, and coercion are all now unfortunately pervasive. Crime and malfeasance have become the means of survival for a substantial portion of the population.

Like DJ, this place is hardly recognizable when compared to its former greatness– the result of a long, steady decline punctuated by a sudden collapse.

Regrettably there are a number of ‘rich’ Western nations in this cycle as well. And a great many people are waking up each day with this realization thinking “This is NOT the country that I grew up in…”

But this IS what happens after decades of poor choices: Too much debt. Too much war. Too much money printing. Too much regulation.

Just as people in decline enter a vicious cycle where the consequences of their actions begin to feed on each other, nations too reach a point of no return– a bifurcation point where the decay becomes exponential.

And once they reach this point, the trend becomes a one-way decline where they must first hit rock bottom before being able to climb out.

If you’re not willing to be pulled into that spiral, I’d encourage you to consider your own situation.

If you live, work, bank, invest, own real estate, structure a business, etc. all in the same country… and that country is on an obvious decline that you can feel in your gut, then you are taking serious, serious risks with your livelihood.

The oppressive controls employed by the Argentine government provide the perfect case study of what happens to people who ignore their instincts and trust their politicians.

If you only read one thing this weekend, read about the Vampire Squid

Financial Cryptography - Sat, 02/15/2014 - 03:56
If you read only one thing this weekend, read this. This is why the 2007 crisis was not resolved. This is why we now socialize their losses, but leave them their profits. This is why it is impossible to fix, and the only game in town is predicting which economy is toast, this weekend, and which investment bank is making monopoly profits while being technically bankrupt. It is likely impossible to roll back the USA's lifting of the Glass-Steagall barrier, which is in other places known as sound banking. How one deals with a world in which banking is morphing into industrial combines with infinite and free capital is beyond my small brain; we need something like bitcoin, but much stronger. Hack on, your code may save society as we know it....

This is why I am so optimistic about the future

Sovereign Man - Fri, 02/14/2014 - 10:33

February 14, 2014
Buenos Aires, Argentina

It’s clear that in today’s world, young people are constantly getting the shaft. Everyone is, really. But in many ways, young people have it the worst.

Youth unemployment rates in ‘rich’ countries are shocking. Abysmal. Young people are the last to be hired and the first to be fired.

It’s young people who will inherit the mountains of debt that their governments have accumulated. And if they’re lucky enough to even find work, young people will spend their entire lives paying progressively higher taxes so that the politicians can make the interest payments.

They’ll also spend their lives supporting reverse demographic pyramids in pension systems around the world. But decades from now when it’s their turn to collect, those pension programs will have run dry.

It’s young people who are expected to go fight, and die if necessary, every time bloodthirsty politicians decide to go to war to protect the bankers’ interests.

It’s an unfortunate position to be in these days: more costs, fewer benefits, and almost no opportunities. The old tried and true method for success– study hard, get a good job, work your way up the ladder– simply no longer applies.

That’s why it’s more important than ever for young people to break free from this system and set their own path. And to do that, it’s imperative to be armed with valuable skills and a network of like-minded colleagues.

Long-time readers know that I sponsor and host an intensive workshop every summer in Lithuania for aspiring young entrepreneurs and freedom-seekers. And this is precisely our aim– to provide young people with valuable skills and a strong network of like-minded people from around the world.

To do this, I bring in some of the most talented and successful entrepreneurs I know. And together, the instructors imbue some of the most valuable business skills we’ve all accumulated through years of making mistakes and grinding it out in the world.

It’s the sort of stuff they just don’t teach in university or business school.

Not to mention, the network has become something truly extraordinary. Each summer we generally have upwards of 30 countries represented, places like the Philippines, Zimbabwe, Colombia, Bulgaria, and more.

For the students, this means forging strong relationships with people from all over the world. This alone is tremendously valuable.

It’s ironic that we’re discussing this today as I have just landed in Argentina– easily one of the most economically distressed places on the planet. As I’ll describe more on Monday, this country is a clear sign of things to come in the developed West.

But despite the overwhelming economic hazards created by politicians and central bankers, I remain unabashedly optimistic about the future. And it is these camps– the opportunity to spend time with so many brilliant young people– that renews my optimism each year.

This liberty and entrepreneurship camp is free to attend. Our charitable organization foots the bill for the whole thing. Students are only expected to get themselves there, and we even occasionally award travel scholarships.

There is a very competitive application process, though. Each year, the initial interest is often in the thousands. Yet we are only able to select about 60 students.

But if you are a motivated young person, or know someone who fits the description, I’d encourage you to check out this page. Learn more about what we do, and sign up to receive instructions on how to apply.

Totalitarian government at work

Sovereign Man - Fri, 02/14/2014 - 09:35

February 13, 2014
Santiago, Chile

The IRS scandal caused a massive uproar last year when it was revealed that the agency was deliberately targeting non-profit political groups solely based on their names or political themes.

One of those groups was called True the Vote, a grassroots, non-partisan organization that recruits and trains volunteers to monitor elections.

The founder and president of True the Vote, Catherine Engelbrecht, recently gave testimony to the House Oversight & Government Reform Subcommittee on Regulatory Affairs in which she revealed how the US government used mafia tactics to go after her, her organization, family, and her private business.

As she explained, before founding her non-profit organization a few years ago, her life was ordinary.

Since founding it, though, she has been subjected to more than 15 instances of audit or inquiry by federal agencies ranging from the IRS, FBI, the Bureau of Tobacco, Alcohol, Firearms and Explosives, etc.

In 2012, her business was subjected to inspection by the Occupational Safety and Health Administration (OSHA). And even though the agency said it found no significant irregularities, it still issued a fine of $20,000.

The FBI even investigated her non-profit organization on SIX separate occasions in conjunction with domestic terrorism cases.

This is sickening. While her only ‘crime’ was to try to make the government more transparent, the government went out of its way to ruin her.

She tells her story in a quick seven-minute account. It’s a chilling reminder of what happens when you challenge the state.

I encourage you to watch Catherine Engelbrbecht’s brief testimony here.

This chart will make you want to sell your stocks

Sovereign Man - Wed, 02/12/2014 - 09:13

February 12, 2014
Santiago, Chile

Three million percent.

That’s the investment return that Andy Bechtolsheim has made on his Google investment.

If you had parked $100,000 in Google stock when it IPO’d ten years ago, your investment would be worth $1.4 million today. Not bad.

But Andy was one of the first major investors in Google before it went public. He wrote Larry and Sergey a $100,000 check back in 1998 for an investment in Google that is worth $3 billion today.

Granted, this is the exception and not the rule. But in the world of private investments, the potential for outsized returns is very real.

Most investors stick to the mind-numbing mantra of stocks and bonds; the size of the global bond market alone is estimated to be well north of $100 trillion (roughly 140% of world GDP).

And owing to this sheer size and liquidity, big institutional investors have no choice but to own stocks and bonds.

But as we have pointed out before, world stock and bond markets are heavily manipulated, if not rigged, by central bankers who control the money supply.

Fundamentals no longer matter. If one single person (now Fed Chair Janet Yellen) says she will print, stocks go up. If she says she will taper, stocks go down.

This isn’t investing. It’s gambling. Financial analysis has been replaced by soothsaying and tasseography (reading the tea leaves), hoping to detect some hint in the direction that central bankers are leaning.

This is the chief reason why I seldom participate in public markets anymore; it seems ludicrous to pile on a giant tidal wave of paper currency and entrust central bankers with my investment returns.

Not to mention, it’s uncertain how long they can keep this party going as the following (rather scary) chart shows. There’s an eerie parallel between the market’s performance today and the runup to the crash of 1929.

It certainly begs the question, though: if you don’t have the appetite to play this rigged game, where can you invest?

This is where the little guy has a HUGE advantage. Because while institutions are chained to the bond market, individual investors literally have a world of options… like investing in private businesses.

Think about it– nearly every successful company out there, like Google, first started out as a private venture looking to raise money from investors.

And now that the rules for crowdfunding have become much less strict, there’s an inspiring amount of opportunity out there, even for small investors.

I come across these sorts of deals all the time. And there are a number of places in the world that are completely overlooked.

Everyone knows about Silicon Valley. There’s no shortage of deals to invest in there, but the region is crawling with angel investors and VC funds.

Chile presents an intriguing opportunity in this sense.

Santiago is becoming a thriving hub of entrepreneurship and has actually been named among the top 20 global startup ecosystems.

The Start-Up Chile incubator program has proved incredibly successful since its launch in 2010, and numerous energetic entrepreneurs are flocking here from all over the world to take part.

Yet Santiago’s startup scene has one major shortcoming: it lacks any significant funding outlet for entrepreneurs that want to scale their businesses.

As the Startup Ecosystem Report says: “There is an overall funding gap in Santiago. In total, Santiago startups raise 97% less capital in stage 2, 94% less in stage 3, and 90% less in stage 4 than [Silicon Valley] startups.”

For such a promising and rapidly developing startup scene, this is a major anomaly… and a big opportunity.

If you’re like me and invest in private businesses, this place is an investment paradise: plenty of great deals, and very little competition from other investors.

These convicted felons are more resilient than the average Joe

Sovereign Man - Tue, 02/11/2014 - 07:05

February 11, 2014
Sovereign Valley Farm, Chile

I’ve recently read about a program in California whereby inmates at San Quentin state prison plant organic gardens within the prison’s walls:

It’s an incredible irony that, in doing so, these convicted felons are achieving a level of resilience and security that many ‘free’ people on the outside have never realized.

Right now most people are totally reliant on the big system for basic necessities. Just ask any child where our food comes from– the grocery store, of course.

Little thought is given to the often thousand mile journey from field to fork. We simply show up and expect shelves fully stocked with food (or more appropriately, ‘food-like substances’).

We fuel our vehicles by going to the gas station. Again, very little thought is given to the rigor involved in extracting oil off the coast of some tinpot dictatorship, shipping it to a faraway refinery, and ultimately bringing it to the gas pump.

We flip the switch and the lights come on without regard for the complexities of power generation and transmission that start with pulling coal or uranium out of the ground.

We don’t give much thought to any of this because the system has been carefully refined over the decades. And for the most part it works.

Because of this success, we’ve grown to completely depend on it. Few people even know how to change their oil anymore.

On one hand, this is a remarkable achievement. Freed from the burden of growing our own food and fetching our own water, we have more time to specialize in what we do best.

On the other hand, there are serious vulnerabilities in this giant, complex system. We see this every time there is a natural disaster, weather anomaly, or spike in oil prices.

We can also see the cracks forming with the surge in pesticide-resistant ‘superbugs’, instances of major food contamination, and infrastructure failures (anyone remember last year’s Superbowl?)

But perhaps the greatest vulnerability is that this entire system– food, energy, the money supply, etc.– is ultimately controlled by a handful of people. As George Carlin said, “It’s a big club. And you ain’t in it… You and I are NOT in the big club.”

They decide everything– the quality and composition of the food we put in our bodies; the value of paper money; what chemicals go in the water supply… everything.

This effectively makes most people serfs, dependent and beholden to those who control the necessities.

It doesn’t have to be this way. And declaring your independence, or at least reducing your dependence on this system is one of the easiest things to do. You don’t have to be rich. You don’t need to be a rocket scientist. You don’t need a fancy degree.

You can make huge strides with something as simple as a tabletop garden… even just a handful of dirt in a styrofoam cup.

You don’t even need to spend money on seeds. Nearly every vegetable you’ve likely ever eaten already had seeds inside. You probably have a few hundred right now.

More advanced readers may want to consider purchasing a small plot of land and developing their resilience there. In parts of the world (like here in Chile), this can be done on the cheap.

In an inflationary environment where the central bankers who control the money supply are printing with reckless abandon, trading some of their paper currency for land makes a world of sense.

Americans who abandoned citizenship jumped 1,402% last quarter

Sovereign Man - Mon, 02/10/2014 - 11:04

February 10, 2014
Sovereign Valley Farm, Chile

631 people renounced their US citizenship in the 4th quarter of 2013.

This is an entire order of magnitude higher than the 45 people who renounced in 4Q/2012. And in total, 3,000 Americans renounced their citizenship in 2013– another record high.

The previous record (1,777) was set in 2011, which shattered the previous record before that (1,534) which was set in 2010, which was more than twice the number (742) that renounced in 2009.

You can see the trend here. And it’s not hard to figure out why it’s happening.

As the United States Taxpayer Advocate Nina Olsen recently told Congress in her scathing report about US tax policy:

“[T]ax requirements have become so confusing and the compliance burden so great that taxpayers are giving up their U.S. citizenship in record numbers.”

In her report, Ms. Olsen specifically points to the Foreign Account Tax Compliance Act (FATCA), which was passed by Congress four years ago. She states that FATCA “has the potential to be burdensome, overly broad, and detrimental to taxpayer rights.”

That’s putting it politely.

I have written several times before that FATCA is one of the most destructive, insidious pieces of legislation ever passed. And the worst effects are only now -starting- to be felt.

Among other things, the law requires new disclosures for US citizens with foreign accounts. And just to make sure it’s absolutely clear how the US government views its tax serfs, they put this little ditty in the instructions:

“The fact that a foreign jurisdiction would impose a civil or criminal penalty on you if you disclose the required information is not reasonable cause [to NOT file this form].”

Basically they’re saying, ‘Even if disclosing this information would cause you to go to jail in a foreign country due to their confidentiality laws, we don’t give a damn. We still expect you to file this form. Otherwise we will throw you in jail in the US.’

(yes, there are potential criminal penalties for not filing this form…)

This isn’t exactly how a free society treats its citizens. It’s a constant threat of force with these people. Even the most mundane, bureaucratic tasks are cause for intimidation.

As I have pointed out so many times before, you can’t even apply for a passport (i.e. permission to leave the country) in the Land of the Free without being threatened with fines and imprisonment.

All of this has come at tremendous cost. Aside from permanent damaging the US government’s reputation and its role in the global banking system, the human cost is nearly incalculable.

Think about it– it’s not the Obamaphone recipients who are renouncing their citizenship and leaving the country. These are smart, talented, energetic people who could have actually contributed something.

And as this productive class gets out of dodge, they leave behind more people who want something for nothing… and fewer people to pay the bill.

It’s the same situation the Romans were in back in the 5th century.

Undoubtedly there are folks out there who would call the thousands of people who have renounced ‘cowards’ and ‘traitors’ (though they are in respected company given that the British considered George Washington a traitor).

But lest we judge ‘renunciants’ poorly, we should first ask– is it more honorable to lay down and let yourself be plundered by a bunch of blundering, bungling, deceitful politicians…?

Doubtful. Besides, divorcing yourself from your bankrupt, insolvent government is not the same as divorcing yourself from your culture or values.

You are who you are no matter what color your passport is.

Bitcoin Verification Latency -- MtGox hit by market timing attack, squeezed between the water of impatience and the rock of transactional atomicity

Financial Cryptography - Mon, 02/10/2014 - 04:36
Fresh on the heels of our release of "Bitcoin Verification Latency -- The Achilles Heel for Time Sensitive Transactions" it seems that Mt.Gox has been hit by exactly that - a market timing attack based on latency. In their own words: Non-technical Explanation: A bug in the bitcoin software makes it possible for someone to use the Bitcoin network to alter transaction details to make it seem like a sending of bitcoins to a bitcoin wallet did not occur when in fact it did occur. Since the transaction appears as if it has not proceeded correctly, the bitcoins may be resent. MtGox is working with the Bitcoin core development team and others to mitigate this issue. Technical Explanation: Bitcoin transactions are subject to a design issue that has been largely ignored, while known to at least a part of the Bitcoin core developers and mentioned on the BitcoinTalk forums. This defect, known as "transaction malleability" makes it possible for a third party to alter the hash of any freshly issued transaction without invalidating the signature, hence resulting in a similar transaction under a different hash. Of course only one of the two transactions can be validated. However, if the party who altered the transaction is fast enough, for example with a direct connection to different mining pools, or has even a small amount of mining power, it can easily cause the transaction hash alteration to be committed to the blockchain. The bitcoin api "sendtoaddress" broadly used to send bitcoins to a given bitcoin address will return a transaction hash as a way to track the transaction's insertion in the blockchain. Most wallet and exchange services will keep a record of this said hash in order to be able to respond to users should they inquire about their transaction. It is likely that these services will assume the transaction was not sent if it doesn't appear in the blockchain with the original hash and have currently no means to recognize the alternative transactions as theirs in an efficient way. This means that an individual could request bitcoins from an exchange or wallet service, alter the resulting transaction's hash before inclusion in the blockchain, then contact the issuing service while claiming the transaction did not proceed. If the alteration fails, the user can simply send the bitcoins back and try again until successful. Which all means what? Well, it seems that while waiting on a transaction to pop out of the block chain, one can rely on a token to track it. And so can ones counterparty. Except, this token was not exactly constructed on a security basis, and the initiator of the transaction can break it, leading to two naive views of the transaction. Which leads to some game-playing. Let's be very clear here. There are three components to this break: Latency, impatience, and a bad token. Latency is the underlying physical problem, also known as the coordination problem or the two-generals problem. At a deeper level, as latency on a network is a physical certainty limited by the speed of light, there is always an open window of opportunity for trouble when two parties are trying to agree on anything. In fast payment systems, that window isn't a problem for humans (as opposed to algos), as good payment systems clear in less than a second, sometimes known as real time. But not so in Bitcoin; where the latency is from 5 minutes and up to 120 depending on your assumptions, which leaves an unacceptable gap between the completion of the transaction and the users' expectations. Hence the second component: impatience. The 'solution' to the settlement-impatience problem then is the hash token that substitutes as a final (triple entry) evidentiary receipt until the block-chain settles. This hash or token used in Bitcoin is broken, in that it is not cryptographically reliable as a token identifying the eventual settled payment. Obviously, the immediate solution is to fix the hash, which is what Mt.Gox is asking Bitcoin dev team to do. But this assumes that the solution is in fact a solution. It is not. It's a hack, and a dangerous one. Let's go back to the definition of payments, again assuming the latency of coordination. A payment is initiated by the controller of an account. That payment is like a cheque (or check) that is sent out. It is then intermediated by the system. Which produces the transaction. But as we all know with cheques, a controller can produce multiple cheques. So a cheque is more like a promise that can be broken. And as we all know with people, relying on the cheque alone isn't reliable enough by and of itself, so the system must resolve the abuses. That fundamental understanding in place, here's what Bitcoin Foundation's Gavin Andresen said about Mt.Gox: The issues that Mt. Gox has been experiencing are due to an unfortunate interaction between Mt. Gox’s implementation of their highly customized wallet software, their customer support procedures, and their unpreparedness for transaction malleability, a technical detail that allows changes to the way transactions are identified. Transaction malleability has been known about since 2011. In simplest of terms, it is a small window where transaction ID’s can be “renamed” before being confirmed in the blockchain. This is something that cannot be corrected overnight. Therefore, any company dealing with Bitcoin transactions and have coded their own wallet software should responsibly prepare for this possibility and include in their software a way to validate transaction ID’s. Otherwise, it can result in Bitcoin loss and headache for everyone involved. Ah. Oops. So it is a known problem. So one could make a case that Mt.Gox should have dealt with it, as a known bug. But note the language above... Transaction malleability? That is a contradiction in terms. A transaction isn't malleable, the very definition of a transaction is that it is atomic, it is or it isn't. ACID for those who recall the CS classes: Atomic, consistent, independent, durable. Very simply put, that which is put into the beginning of the block chain calculation cycle /is not a transaction/ whereas that which comes out, is, assuming a handwavy number of 10m cycles such as 6. Therefore, the identifier to which they speak cannot be a transaction identifier, by definition. It must be an identifier to ... something else! What's happening here then is more likely a case of cognitive dissonance, leading to a regrettable and unintended deception. Read Mt.Gox's description above, again, and the reliance on the word becomes clearer. Users have known to demand transactions because we techies taught them that transactions are reliable, by definition; Bitcoin provides the word but not the act. So the first part of the fix is to change the words back to ones with reliable meanings. You can't simply undefine a term that has been known for 40 years, and expect the user community to follow. (To be clear, I'm not suggesting what the terms should be. In my work, I simply call what goes in a 'Payment', and what comes out a 'Receipt'. The latter Receipt is equated to the transaction, and in my lesson on triple entry, I often end with a flourish: The Receipt is the Transaction. Which has more poetry if you've experienced transactional pain before, and you've read the whole thing. We all have our dreams :) We are still leaves the impatience problem. Note that this will also affect any other crypto-currency using the same transaction scheme as Bitcoin. Conclusion To put things in perspective, it's important to remember that Bitcoin is a very new technology and still very much in its early stages. What MtGox and the Bitcoin community have experienced in the past year has been an incredible and exciting challenge, and there is still much to do to further improve. When we did our early work in this, we recognised that the market timing attack comes from the implicit misunderstanding of how latency interferes with transactions, and how impatience interferes with both of them. So in our protocols, there is no 'token' that is available to track a pending transaction. This was a deliberate, early design decision, and indeed the servers still just dump and ignore anything they don't understand in order to force the clients away from leaning on unreliable crutches. It's also the flip side of the triple-entry receipt -- its existence is the full evidence, hence, the receipt is the transaction. Once you have the receipt, you're golden, if not, you're in the mud. But Bitcoin had a rather extraordinary problem -- the distribution of its consensus on the transaction amongst any large group of nodes that wanted to play. Which inherently made transactional mechanics and latency issues blow out. This is a high price to pay, and only history is going to tell us whether the price is too high or affordable....

Digital Evidence journal is now open source!

Financial Cryptography - Sat, 02/08/2014 - 23:47
Stephen Mason, the world's foremost expert on the topic, writes (edited for style): The entire Digital Evidence and Electronic Signature Law Review is now available as open source for free here: Current Issue         Archives All of the articles are also available via university library electronic subscription services which require accounts: EBSCO Host         vLex">HeinOnline         v|lex (has abstracts) If you know of anybody that might have the knowledge to consider submitting an article to the journal, please feel free to let them know of the journal. This is significant news for the professional financial cryptographer! For those who are interested in what all this means, this is the real stuff. Let me explain. Back in the 1980s and 1990s, there was a little thing called the electronic signature, and its RSA cousin, the digital signature. Businesses, politicians, spooks and suppliers dreamed that they could inspire a world-wide culture of digitally signing your everything with a hand wave, with the added joy of non-repudiation. They failed, and we thank our lucky stars for it. People do not want to sign away their life every time some little plastic card gets too close to a scammer, and thankfully humanity had the good sense to reject the massively complicated infrastructure that was built to enslave them. However, a suitably huge legacy of that folly was the legislation around the world to regulate the use of electronic signatures -- something that Stephen Mason has catalogued here. In contrast to the nuisance level of electronic signatures, in parallel, a separate development transpired which is far more significant. This was the increasing use of digital techniques to create trails of activity, which led to the rise of digital evidence, and its eventual domination in legal affairs. Digital discovery is now the main act, and the implications have been huge if little understated outside legal circles, perhaps because of the persistent myth in technology circles that without digital signatures, evidence was worth less. Every financial cryptographer needs to understand the implications of digital evidence, because without this wisdom, your designs are likely crap. They will fail when faced with real-world trials, in both senses of the word. I can't write the short primer on digital evidence for you -- I'm not the world's expert, Stephen is! -- but I can /now/ point you to where to read.That's just one huge issue, hitherto locked away behind a hugely dominating paywall. Browse away at all 10 issues!...

US State Department rolled, as NSA slides further off-mission. Shoulda used a BlackPhone :D

Financial Cryptography - Sat, 02/08/2014 - 12:36
In what is either belly laugh-level hilarity, or a serious wakeup call for the American taxpayer, Reuters reports on the recent "Fuck the EU" leaks of phone calls. (h/t to zerohedge.) It turns out the recordings may have been (gasp) lifted off the airwaves: Some U.S. officials blamed Moscow for leaking the call, noting that the recording, posted anonymously, was first highlighted in a tweet from a Russian official. In Washington, U.S. officials said Nuland and Pyatt apparently used unencrypted cellphones, which are easy to monitor. The officials said smart phones issued to State Department officials had data encryption *but not voice encryption*. Wtf? Where the hell are you, oh, NSA's security division aka Central Security Service? The Information Assurance mission confronts the formidable challenge of preventing foreign adversaries from gaining access to sensitive or classified national security information. How is it that officials of the State Department have zero, zip, nada, nuttin security while blathering on about international negotiations involving an entire strategic country, a major pipeline, and the number one PR circle-jerk for the nation-states? I had thought that all these things were in the killing zone for the NSA. Ukraine, energy, the Olympic Games, check check check! But apparently not. The evidence on mission drift is somewhat damning, and becoming deafening. They have dropped the baby in many ways. They recently downgraded their irrational fear of terrorism, by prioritising the insider threat as a 'national security threat'. Without apparently understanding the bleeding obvious, that insiders such as Snowden and Manning are a threat to them, not to the people who pay their salaries: “[Snowden and the insider threat] certainly puts us at risk of missing something that we are trying to see, which could lead to [an attack],” said Matthew Olsen, the director of the National Counterterrorism Center. Spoken without any cynicism or humility! If they got back to work, and crafted their mission to deliver return on investment to the taxpayer, instead of stealing from other countries' taxpayers, they wouldn't have time to worry about schoolboy plots like terrorism and rogue sysadms. Message to the American taxpayer: demand your money back. Buy a blackphone instead....

The financial rot just keeps getting worse -- FX is FuXed, the Old Lady's in on the FiX, and the fight against the devil volatility goes on?

Financial Cryptography - Fri, 02/07/2014 - 12:22
FT comes out with this tantalising flash of the gauntlet, at 4pm Friday: The BoE representatives have on several occasions asked whether a particular currency fix can be manipulated, one member of the committee has told the Financial Times previously. Bloomberg, being American and less subtle, loads up both barrels and lets fire, also at 4pm Friday: Bank of England officials told currency traders it wasn’t improper to share impending customer orders with counterparts at other firms, a practice at the heart of a widening probe into alleged market manipulation, according to a person who has seen notes turned over to regulators. A senior trader gave his notes from a private April 2012 meeting of currency dealers and two central bank staff members to the Financial Conduct Authority about six weeks ago because of mounting media coverage of the investigation, said the person, who asked not to be named while probes are under way. Traders representing some of the world’s biggest banks told officials at the meeting that they shared information about aggregate orders before currency benchmarks were set, three people with knowledge of the discussion said. The officials said there wasn’t a policy on such communications and that banks should make their own rules, according to the people. ... During a 15-minute conversation on currency benchmarks, traders said they used chat rooms to match buyers and sellers ahead of the fix to avoid trading at one of the most volatile periods of the day, the people said. That required them to share aggregate positions. They instigated the discussion because they were concerned that similar practices were under scrutiny at the time in the Libor investigations, the people said. The Bank of England officials said they viewed the practices as positive to reduce market volatility and wouldn’t take the matter to the standing committee, according to the people with knowledge of the meeting. That body included a representative from the Financial Services Authority, the FCA’s predecessor, according to central bank records. (My humble emphasis.) As a flat-out claim of a go-ahead for insider trading, it doesn't get any damning. Expect heads to roll. Names were named: Dealers at the April 2012 meeting with Martin Mallett, the Bank of England’s chief currency dealer, and James O’Connor, who works in its foreign-exchange division, were told not to record the discussion or take notes, one of the people said. One trader wrote down what was said soon after leaving because of concerns spawned by investigations of attempted manipulation of the London interbank offered rate, or Libor, the person said. And boom! I'm not sure what they call willfully avoiding the trail of evidence is, but that's close enough to establishing intent as makes no difference. Messrs Mallet and O'Connor are unavailable for comment (4-m, Friday) because they're trying to drag their lawyers out of some Threadneedle Street pub, one hopes. It's enough to turn the crisis-weary public to Bitcoin. How on earth can regulators snub the nose at the blockchain when $5.8 billion of fines have been slapped on the Libor scandal, just ONE of the corruptions in the banking world?...