Long Take: The principle behind Mastercard's CipherTrace acquisition, L1 growth, and IRS getting your bank data

Hi Fintech futurists — this week, we cover the following:

  • Thesis: Paying attention is the path to seeing and doing. Mastercard has bought CipherTrace to see blockchain-based finance, to launch new businesses, and to plug in more networks into its nexus. The crypto networks proliferate at every layer, creating more computation on Ethereum, Polygon, Arbitrum, Optimism, Fantom, and Solana. The US executive seeks to see more too, asking the banks for their records of financial transactions to enforce taxation compliance.

  • Topics: Payments, regulation, politics, crypto, blockchain, computation, exchange

  • Tags: Mastercard, Visa, CipherTrace, Chainalysis, IRS, Plaid, Finicity, Ethereum, Polygon, Arbitrum, Optimism, Fantom, Solana

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Long Take

Attention

Before you can do, you must learn to see.

Before you can see, you must learn to pay attention. Attention is the currency of consciousness.

When attention is elsewhere, there is no illumination, no knowledge of what is happening before you. When attention is frayed, nothing can be done, and all we do is gaze in recursive motion at the universe. Doomscrolling. But when attention is honed and sharpened, then we stab at the heart and are victorious.

Attention is directed by our individual minds, to direct our individual utility functions. And for larger things still — like corporations and sovereign nations — attention takes the shape of the cultural zeitgeist. The stories we tweet, sing, and meme put a spotlight on phenomena. Once lit, we can start paying attention and *seeing* what is happening. We can make mental maps. We can make models and blueprints. And then of course, we can act.

Mastercard and CipherTrace

What a strange parable to lead us into a card network acquiring a compliance startup. But there we are.

MasterCard has acquired blockchain forensics company CipherTrace, outflanking Visa’s recent purchase of the top NFT status object, a CryptoPunk. This follows the MasterCard acquisition of Finicity, which had put the company into the embedded finance warzone with Visa. It is a battle for the status of “network of networks”.

While the deal value for CipherTrace was not announced, it follows on from a $27 million funding by Third Point ventures in June, which would imply a $100 million to $500 million valuation (our guesstimate). For comparison, competitor Chainalysis raised $100 million at a $4 billion valuation, led by Coatue, around the same time period.

The reason that such hedge funds have started cutting checks into crypto is fairly straightforward. The forensics firms are integrated into institutional custodians like Fireblocks and Anchorage — and thus are visible to institutional traders, empowering proprietary trading business and therefore becoming a permission slip for funds touching crypto for the first time.

In this way, it’s interesting and profound that CipherTrace was acquired by a payments company. Meditate on this for a moment though. Does CipherTrace derisk trading? Or money movement? Payments? Or crypto assets? Or securities? The answer is meaningful: *Yes* to all of the above, and there is no difference between the payment and trading industries any longer.

The card networks have a dilemma. They have no choice but to participate in global financial value networks, or risk being disintermediated by frontier technology. Such technology has raced from PSD2 and open banking, to DeFi and open source finance. At the same time, they are closely regulated across every global jurisdiction. Remember for example the withdrawal of Visa and Mastercard from the Facebook Libra project back in 2019, when it became clear that the project had a Congressional target on its proverbial head.

This tension requires negotiation. See below for Mastercard’s stated principles for interacting with blockchain-based value. Safety, privacy, security, and compliance are high on the list.

CipherTrace's mission in the world overlaps pretty closely with these requirements. Funded by the US Department of Homeland Security among others, the startup seeks to “Protect financial institutions from virtual asset laundering risks and crypto-related threats” and “Grow the blockchain economy by making it safe for users and trusted by government”.

These words are of course anathema to much of crypto community, who seek decentralization of sovereignty and economic power, data control through pseudonymity, and resent the idea that cybercrime is more prevalent in crypto assets than in traditional finance (not obviously true).

And yet, we should all agree that getting a few more billion people into digital money through whatever gates may be is a worthwhile thing to achieve.

So what can we deduce as a signal? First, Mastercard will have a better path to integrating blockchains into its own ecosystem. Plugging in Bitcoin, Ethereum, and others becomes easier if there is a compliance gate that rigorously screens the flows of funds. The crypto river waters are cleansed as they join the global money ocean.

Second, Mastercard will get deeper into bank efforts related to crypto assets, thereby deepening its ties to deposit capital. The OCC has positioned American federal banks to be crypto custodians. They have relationships with merchants, payment processors, and other commercial intermediaries. They also, of course, plug into Mastercard and Visa for issuance. With CipherTrace, the Mastercard can derisk bank activity in crypto and be the partner of choice for risk-seeking depository institutions.

And third, Mastercard gets to *pay attention* by buying a meaningful company, and then its get to *learn to see* by scanning the massive nodes and data faucets of the thousands of blockchain assets. The super-organism of the card network is aware of these new creatures, it senses them with new appendages, and it is learning their language. Perhaps to eat them raw.

More Layers Coming

As quickly as the powers learn to see, new places for economic activity evolve. These nooks and crannies are the places where pioneers go, to trade their Magic cards and whisper stories of yield farming and NFT looting.

The crypto markets have had a volatile summer, with a sentiment-driven downward trend after the all time highs in the Spring, flipped into bullish territory by incredible organic growth of the NFT industry — going from one fashion to another. One emerging story, which we normally don’t focus on but should at least highlight, is the competition between computational blockchains for who gets to run software.

This is pretty important, because whoever gets to run software gets to run the financial industry powering global commerce. Our view is that Ethereum is a pretty well-settled champion of “layer 1”, meaning the base layer on which everything else sits. A number of other attempts at direct competition from 2017 have failed out, and are better left unnamed so as not to give them any search engine optimization credit. But 2021 has seen the rise of either competitor layer 1s, or adjacent projects called layer 2s or sidechains, which attach to Ethereum.

It is in this way that Solana has generated $40 to $80 billion of market capitalization, to name the most popular upcoming protocol (we give the range to show the difference between current float and fully diluted numbers). Solana is backed by the $20 billion FTX crypto exchange, which in turn is banked by a recent crypto billionaire fortune. It is optimized for institutional traders, and early enthusiasm from Silicon Valley seems loud. Capital seems to be parking there as well, though how organic the numbers are we do not know.

Some other examples of the growing world of Web3 includes Polygon ($8-12B marketcap), Fantom ($4B), Mina ($1-4B). Projects like Arbitrum and Optimism, which are roll-up approaches for Ethereum, are also gaining a ton of attention. Here’s a thread for the technically inclined.

We can also ignore financial value, and just focus on transaction count. Transactions are the clockwork of blockchains, measuring the beating of machine hearts.

You can see Ethereum at 1.2 million transactions, Polygon at 6 million, and Fantom pushing to 2 million. Their value and purpose is different but the core takeaway is this — the demand for trusted computation far outstrips supply. When additional capacity is added to the blockchain economy, it is soon filled with activity.

We talk about layer 1s and layer 2s to make you conscious of what matters here, to give you the tools to see and explore, to build the mental maps and models used by pioneers. If Mastercard is willing to buy CipherTrace to give itself new sight, you too should want to see.

The Taxgods Want In

President Biden’s administration is paying attention too.

It sees a funding gap for the infrastructure spending the government wants to do, and is pointing at tax under-reporting as a place to raise more revenue. Apparently, 15% of taxes due is not collected, in large part from higher-net-worth individuals using more sophisticated approaches to earnings (e.g., partnerships, offshore accounts). For this, the government recommends an $80 billion investment in the IRS technology budget to build systems to collect an additional $320 billion of revenue.

Additionally, the IRS wants to pull financial transaction data from existing banks in order to generate $460 billion of revenue over the next decade. The banking industry is at arms — the American Bankers Association, the Bank Policy Institute, and the Consumer Bankers Association have previously written a sternly worded letter that suggested the proposal is not practicable.

In Europe, PSD2 has long forced banks to open up their data in a standard API format. In the US, banks have fought data aggregation tooth and nail. Plaid and others have crowbarred the information out for the benefits of fintechs, as permissioned by their users. But now that the IRS is coming for this data, things feel a bit … icky. It is not the data owner that is allowing data transfer, but rather the government taking the data by force for its own design.

Should the IRS just be able to get an injunction to Plaid and get their entire database to enforce tax compliance? Is this an unreasonable search and seizure of private consumer data by the government? And once banks begin to provide data to the IRS, which other government agencies will choose to drink the financial nectar? Spoiler alert: literally every single one, and always and forever.

The sovereign has become ready to talk in the language of data feeds, to pay attention to our modern language. It sees where the money is, and understands how value flows around its outdated modes and systems. It sees too PayPal, and Square, and the card networks. And it sees you Bitcoin, and you Ethereum, and even you Solana. There it will get in time.


More information isn’t enough for a competitive edge. What we need is better judgment to separate signal from noise. Get clarity with a Blueprint subscription.