June 21, 2017 | Written by: Tracey Lindeman
Categorized: Finance | New Thinking | Technology
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Legal cannabis is a $7-billion business in the U.S.—and it’s almost all done in cash. That’s in the process of changing.
The mental picture of people stuffing piles of $20 bills into their mattresses isn’t far off from the truth for some cannabis business owners. The drug may be legal in some states, but it’s still classified as an illegal Schedule I drug alongside methamphetamines and heroin at the federal level—and that classification makes handling the proceeds of its sale a federal crime. That, in turn, makes getting bank accounts extremely difficult.
Shaun Gindi, CEO and co-owner of Colorado dispensary Ajoya, is one of the lucky ones who has a business bank account, but getting it required a lot of hassle and red tape. He first entered the then-newly legalized medical cannabis business in 2009. He then spent years securing bank accounts only to lose them when the bank found what his company sold. Gindi estimates he’s been kicked out of a half-dozen banks.
“You write the wrong check, and boom,” he says. He finally secured a bank account with Safe Harbor Private Banking, which was created by the Safe Harbor Credit Union to deal with the cannabis market.
The cash-intensive nature of the business makes it ripe for criminal activity. Paying an electrician or plumber, for instance, with money obtained from the sale of cannabis is technically money laundering, according to the Desert Sun newspaper (although the IRS still happily collects taxes from these businesses). That can make it hard to discern actual laundering from just paying a bill. It also turns dispensaries into sitting ducks; Gindi hires armored trucks to pick up cash from his businesses daily to help reduce the risk of robberies. He’s got a bank for the trucks to deliver the cash to, but many of his peers don’t.
Where conventional banking has failed, technology has provided a unique opportunity that is beyond ripe for the picking. The blockchain, which makes up an online ledger where transactions made in digital currencies like bitcoin are recorded and processed, has become a particular point of fixation as a solution to the cannabis industry’s banking woes.
Bringing blockchain to a cash-only business
Blockchain’s ability to serve the legal cannabis industry is built upon its history of serving not-so-legal markets. “Silk Road and the dark market proves that this model works in terms of you can use bitcoin in terms of buying illicit drugs as well,” says Jeremy Clark, a scholar in applied cryptography at Montreal’s Concordia University with a particular interest in bitcoin and other cryptocurrencies. “Now, because blockchain is so popular, everyone wants to be a blockchain solution,” he continues. The cannabis industry is no exception.
In today’s legal-weed regulatory landscape, blockchain technology has the opportunity to step out from the shadows and lend a sorely needed method of banking to an industry battling for legitimacy. A number of companies are taking up the task. One such company is Tokken, founded in 2016 by Lamine Zarrad.
Since arriving in the U.S. as a young refugee from Azerbaijan, Zarrad has taken turns as a Marine, a Wall Streeter and most recently, as a self-described “bank cop” for the U.S. Treasury’s Office of the Comptroller of the Currency. He quit that last job to start Tokken after coming to understand the impact that being unbanked has on cannabis entrepreneurs.
In addition to another bit of obvious wordplay, Tokken is a play on the word “token,” which in the realm of cryptocurrencies can be best described as a digital IOU—or, as a simple analogy, it’s like a drink ticket that can be redeemed at a bar. The ticket is assigned a value by the issuer, and the recipient agrees to use it for that intended value. The bartender exchanges the ticket for a drink. At the end of the night, the issuer pays the bar in actual (fiat) money for the number of drinks served via the ticket system.
As Zarrad explains, the tokens are used as an accounting measure on Tokken’s backend, but transactions are processed in U.S. currency end-to-end. “We piggyback off the ledger system,” he says. In terms of how it works, the short answer is that it uses unique and indelible digital signatures to log each transaction onto the digital ledger.
Meanwhile, Tokken CTO Cory Flanigan has a longer, more complicated answer: “Because we only use blockchains as a distributed ledger, and not cryptocurrency for settlement, there is no conversion. Instead, for each transaction, we generate a cryptographic signature of the metadata surrounding the transaction. The business, location and other relevant factors are concatenated [or, linked] and hashed into a unique string of characters. This cryptographic string cannot be reverse-engineered to obtain any data. It is a one-way process from transaction data into signature,” he wrote in an email. “In this way, we’re able to use a public blockchain as a distributed database for these cryptographic signatures to prove the integrity of our internal systems and transactions, while protecting the privacy and security of our businesses and consumers.”
So far, the blockchain has proven more secure than the cash-only alternative. As CTO Flanigan notes, the size of the public-blockchain network and the way consensus on it works makes it difficult to hide or alter data that’s been registered on the ledger.
Tokken, which is backed by chartered financial institutions, makes a smartphone app and web-based vendor UX that overlays this technology. Dispensary customers download the app and input their names and phone numbers for authentication purposes, as well as upload their debit or credit card info; in that, it works similarly to a digital wallet, like Apple Pay or PayPal. The smartphone app is geo-fenced, meaning it can only be used to pay for weed inside of stores that are customers of Tokken’s. And, like a credit-card company, Tokken takes a percentage of the sale as its cut.
The two Ajoya shops are beta testers of Tokken’s technology, and CEO Gindi is happy to report that so far it’s been a success. “It’s as simple as going into our account and transferring with any other bank account,” he says. Handling sales digitally offers a layer of security that helps protect his business and his employees. “It takes the cash off the table,” says Gindi.
Blockchain use beyond payment processing
Digital payment processing is a major hurdle to overcome in the current regulatory framework surrounding the legal-cannabis industry. But looking forward, it’s low-hanging fruit compared to some of the other financial and legal obstacles that make the weed biz so difficult to harness.
A Reagan-era tax-code rule known as 280E, for instance, prohibits businesses like Gindi’s from writing off normal business expenses. He can’t deduct his employees’ wages, the electricity bills from his growing facility or his armored-truck contract, meaning he pays income taxes on his gross revenues, rather than net income. “I’ve had years where I’ve had to pay six-digit tax bills,” says Gindi. And people like him pay those tax bills in—what else?—cash. Regulations like these could serve to keep cannabis a cash-only business as some of the more unscrupulous entrepreneurs look for ways to under-report revenues.
Blockchain can’t help with the regulatory environment, but the technology may be able to help with the other major issue: Lending. Cannabis businesses can’t typically access bank loans, credit cards and in some cases even outside investment, but new models of blockchain-based lending are beginning to take shape. As Forbes explained earlier this year, companies like Colorado’s SALT (Secured Automated Lending Technology) are exploring how to sidestep conventional banking and lending institutions and capitalize on the growing marijuana market. Tokken, too, says blockchain lending is “within the realm of possibility” considering its success so far with payments.
Eight years ago, the blockchain was in its most nascent form. The absence of capital led some to take out predatory loans. Gindi recalls the lending environment at the start of Colorado’s move toward legalization: “Those shotgun marriages—it was crazy to watch what was going on.” A colleague lost a million-dollar-selling business over what was originally a $50,000 loan, he continues.
Blockchain technology can be useful here, but it does have some limitations too. Cryptography expert Clark says the biggest issue in lending of any stripe is the risk that the loan recipient runs off with the cash. “Blockchain will not solve that problem for you,” he says. “It can help by adding transparency, so you might know a reputation or have some insurance on the side or that type of thing.”
Although some are optimistic, as Bloomberg reported, that banks will sort out their risk-assessment models and a regulatory framework for lending to these businesses in the near future, blockchain has the opportunity to thrive now—along with the legal-weed businesses it supports. In Gindi’s case, he says that if he had access to loans and investment at the outset, his business would look a lot different than it does today. “I would probably have a dozen stores instead of two.”