Cryptocurrency As A Tool for Money Laundering: Lessons and Outlook

News, Opinion | March 5, 2019 By:

A recent report from cryptocurrency forensics firm CipherTrace suggests that, at today’s prices, $1.3 billion USD worth of bitcoin was received directly by major cryptocurrency exchanges for criminal activities between January 2009 and September 2018.

To put these numbers into perspective, the United Nations Office on Drugs and Crime estimates that approximately $800 billion – $2 trillion USD is laundered globally every year. The usage of bitcoin and other cryptocurrencies as tools for money laundering has likely been overstated by many mainstream media outlets, as traditional techniques still appear to be far more popular for concealing financial proceeds from governments.

Contrary to popular opinion, it is quite difficult to launder money using bitcoin as opposed to regular fiat due to the transparent nature of blockchain transactions and the semi-anonymous nature of addresses. For example, anyone with a web browser can easily view any bitcoin transaction ever made, establish the amount transferred, the user address behind each transaction, and the entire transaction history of that address.

The bitcoin network is composed of a number of wallet addresses. Each of these nodes are used to send and receive the currency. Each time a coin is sent from one wallet to another, a transaction is recorded in the network. The nodes are connected by directed edges, from sender to receiver, representing their involvement in a transaction. In addition, wallets can conduct multiple transactions with each other over time. These properties make the bitcoin network a directed multigraph.

Network analysis, a method used to analyze, control and monitor a business process and workflows, has been used as evidence in high profile prosecutions. For instance, in the Trendon Shavers Bitcoins Ponzi scheme case, the SEC got involved based on the nature of bitcoin transactions, leading to the conviction of Czech fraudster Tomáš Jiříkovský (creator of the Sheep darknet marketplace), who directly stole a user’s bitcoins. Shavers, who enticed investors with promises of high return on investments, eventually raised at least 764,000 bitcoins from 48 investors and misappropriated the funds, and eventually was sentenced to 18 months in prison.

The fact that bitcoin transactions are forever discoverable has been the focus of the Robert Mueller led Special Counsel investigation too. In its indictment of 12 Russian intelligence operatives last year, US authorities were able to track the use of bitcoin by Russian agents to pay for a range of incriminating online purchases.

While the addresses and transaction records are permanent and easily tracked, what is considerably more challenging is identifying the individuals behind the strings of numbers and letters. To this end, exchanges have an important role to play.

The Ciphertrace report found that 97% of the criminal bitcoin activities occurred on exchanges operating in countries with “weak AML regulation.” Broadly, this equated to little or no legal requirement on exchanges to report suspicious transactions to financial authorities and low bar KYC requirements meaning exchange accounts could be established without rigorous identity-checking.  

Before the government mandated shutdown of crypto exchanges in China in late 2017, the Chinese bitcoin market was one of the most regulated in the world and the strict oversight of the Chinese government proved to be an effective disincentive to money launderers.

Chinese crypto exchanges, for example, had direct relationships with the government-controlled People’s Bank of China and exchange users had daily withdrawal limits that could only be carried out in Yuan. Chinese capital control laws mandate that individuals are not allowed to purchase more than US$50,000 of foreign currency per annum and businesses can only exchange the Chinese Yuan for other currencies with approval from authorities.

Coupled with the transparent nature of the blockchain, it became clear to most that non-crypto, non-digital, traditional money laundering techniques – such as moving money abroad through art, property, and insurance, to name but a few – were better avenues for concealing off-shore money movement than crypto.

The challenges facing regulators to modernize and apply legal frameworks to emerging technologies that function and are governed by software code is a daunting thought. Balancing a pro-innovation policy that acknowledges the value of cryptographic assets as operational instruments that can improve the efficiency of legacy financial and business systems, while also keeping a check on potential use to conduct illegal activity, will be an ongoing challenge for international regulators. China’s response was to first make initial coin offerings illegal, followed by the ban of crypto exchanges — effectively crippling crypto’s potential as an economic stimulant for the economy and driving successful entrepreneurs, like the Binance exchange, offshore.   

Digital assets have a wide spectrum of users; ranging from developers, traders, long term investors looking for gold substitutes, tech evangelists, and black markets agents seeking alternative methods to obfusticate illegal activity. As the mainstream audience gains more understanding in the wider crypto industry today and the alternative digital currencies, users dealing with bitcoin for illicit purposes are starting to make up a lesser portion of active crypto participants.

Due to the libertarian roots of crypto that feeds into the DNA of digital asset users and infrastructure operators, friction between crypto and regulatory bodies is likely to be an ongoing narrative for some time. Even if exchanges and crypto custody providers want to avoid drug or terrorism-related transaction activity on their platforms, the thought of freely handing over all private user data to authorities is likely to remain a difficult pill to swallow.

A ‘good faith’ agreement between crypto users and regulators, is likely needed in the short to medium term as markets mature and monitoring infrastructure in the space expands and develops. This so-called ‘good faith’ would be to acknowledge that the majority of crypto users are not accessing the ecosystem as a route to disguise illegal financial activity, and therefore blanket laws that force all users to hand over sensitive personal data are unnecessary.    

The challenge of cryptocurrency being used for money laundering activities is still an ongoing issue. However, improved information and regulatory understanding have both quelled criminal interest to use assets like bitcoin to conceal illegal activity, improving the understanding of the legitimate reasons to participate in the ecosystem.