Criminal Kryptonite: How Blockchain Can Help in the Fight Against Organized Crime

  • Data suggests that the use of cryptocurrencies for criminal purposes is limited and diminishing.
  • The risk of criminal activity in the crypto ecosystem is often used to justify more regulation.
  • Looking at the data, in context, could be used to better calibrate regulatory efforts.
  • Blockchain technology may be a blessing for law enforcement.

Narrative

International efforts to regulate cryptocurrency are proceeding as blockchain technology increasingly enters the mainstream. A careful balance needs to be struck between fostering innovation and providing an adequate regulatory framework. Supporters of blockchain should welcome measures to rid the space of criminal elements while being wary of ever-expanding regulation.

Cryptocurrencies do not operate in a regulatory vacuum. Measures already exist to crack down on criminal behaviour. The EU’s fifth and sixth anti-money laundering directives have made cryptocurrency exchanges subject to the EU’s money laundering measures. These exchanges must now carry out compliance checks on their clients and flag suspicious activity. In the US, FinCEN requires cryptocurrency exchanges to register with them and maintain anti-money laundering compliance programs. BitMEX was recently fined $100m for failing to comply. These measures are significant, as 99% of all cryptocurrency transactions occur on centralised exchanges.

To justify more regulations, public officials and commentators frequently mention the presence of criminal activity in the cryptocurrency space. The activities of these bad actors are often amplified in order to create a sense of urgency.

Here are just a few recent examples. In August, the Chair of the SEC, Gary Gensler called the industry “rife with fraud, scams and abuse” and equated it to the “wild west”. The Financial Action Task Force, the intergovernmental organisation set up to fight money laundering and the financing of terrorism, also refers to cryptocurrencies as the “wild west” of finance on their website. They argue that cryptocurrencies could become the “safe haven” of terrorists and criminals.

At a roundtable in February, Janet Yellen warned that the use of cryptocurrencies to traffic drugs and organise terrorist activity was growing. In January, Christine Lagarde was equally somber regarding cryptocurrencies. In calling for more worldwide regulations, she stated that Bitcoin had been used for “totally reprehensible money laundering activity”. Paul Krugman, who wrote a 2013 op-ed entitled “Bitcoin is Evil”, also recently tweeted that “Tax evasion and illegal transactions are still the only serious uses of cryptocurrency.”

Fact

It is necessary to separate fact from narrative in order to assess the extent to which criminality makes use of blockchain technology. The United Nations Office on Drugs and Crime (UNODC) estimates that the amount of money laundered each year is equal to 2 to 5% of global GDP. In US dollar terms, that would be $800bn to $2tn a year.

The most reliable data regarding the use of cryptocurrencies in illicit activities seems to come from a number of specialised blockchain analytics firms. One of these is Chainalysis, which provides research and tools to uncover criminal networks operating with cryptocurrencies. Their research has been referred to by the European Commission in their impact assessment report for the most recent anti-money laundering measures. They have also collaborated with the US Department of Justice in uncovering terrorist networks.

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According to their 2021 Crypto Crime Report, the share of cryptocurrency transactions involved in criminal activity decreased dramatically in 2020. The majority of criminal acts were scams, which fell 71%, year over year, followed by transactions on darknet markets. Darknet transactions were overwhelmingly dominated by one single platform that operates in Russian-speaking countries. The fastest growing component was ransomware, which the report suggests may have surged because more people are working from home as a result of the pandemic.

Chainalysis estimates that 0.34% of all worldwide cryptocurrency transactions were involved in criminal activities. This translates to $10bn worth of transactions. Taking UNDOC’s low estimate, this would make cryptocurrencies responsible for 1.25% of the world’s money laundering activity. Taking their high estimate, it would equate to 0.5%. They come to three conclusions based on these observations: Criminal activity carried out through cryptocurrencies is declining, remains relatively small and is comparatively smaller to the illegal activities carried out in other, more traditional methods of money laundering.

Another leading crypto analytics firm funded by the US Department of Homeland Security, Ciphertrace, reports an even lower incidence of criminal activity in blockchain. They estimate crypto crime in 2020 was $1.9bn, down 57% from 2019.

It is important to point out the potential limitations of this data. Firstly, the 2020 numbers may rise if new crimes are uncovered after the reports were published. Secondly, the reports mostly cover crime native to cryptocurrency. While this may be a subset of the illegal funds in cryptocurrencies, it makes sense to focus on this data. Dirty money, like all money, does not magically appear on the blockchain. Money generated from offline crime will have needed some form of on-ramp to be converted into cryptocurrency and an off-ramp to be converted back into fiat. In all probability, this involves traditional financial institutions failing in their compliance obligations. Finally, the notorious “unknown unknowns” are not quantifiable but the same is true when looking at criminal activity involving cash or banks.

Opportunity

In addition to encouraging data, there are practical reasons why crime is not suited to blockchain technology and cryptocurrencies may actually be a godsend for law enforcement. The transparency and traceability of blockchain facilitates and accelerates law enforcement operations. If one element of a criminal organisation is uncovered, the entire network can be mapped out rapidly. Law enforcement has had numerous notable successes leveraging this technology, including the take down of darknet markets, terrorist networks, scam artists and others.

These observations are supported by a report written by the former director of the CIA, Michael Morell. For his report, Morell interviewed public officials, as well as finance and intelligence professionals. During his research, an official at the Commodity Futures Trading Commission confirmed that it was easier to trace criminal activity with cryptocurrency than it was using traditional banking or cash. A former senior official at the US Treasury, Sigal Mandelker, concurred, and stated that this opinion was widely shared by people working in law enforcement.

Other anonymous experts shared this opinion and one even argued that criminal financial activity could be entirely eradicated if it all shifted onto blockchain! Morell himself concludes that “if there was one financial ecosystem for bad actors to use that would maximize law enforcement’s chances of identifying them and their illicit activities, it would be blockchain.”

Morell comes to two overarching conclusions in his report. The first is that the perception regarding criminal activity on Bitcoin is overblown and the second is that blockchain technology has the potential of being a powerful tool in law enforcement.

The unique opportunity which blockchain provides law enforcement is shared by others as well. In a public testimony regarding national security in February, the former Assistant Secretary of the Treasury for Terrorist Financing and Financial Crimes, Daniel Glaser, stated that blockchain technology provides “enhanced opportunities” for law enforcement to trace the activities of criminal networks. These sentiments are also expressed in an article published in the US Justice Department’s Journal of Federal Law and Practice. This article, authored by the Assistant United States Attorneys of the Western District of Washington and the District of Oregon, argues that cryptocurrencies provide “law enforcement with an exceptional tracing tool” as the blockchain “provides investigators with ample information about how, when, and how much cryptocurrency is being transferred. Moreover, this information is publicly available; no subpoenas or warrants are required to obtain it.”

Blockchain technology could also be implemented to prevent certain types of crime. As an example, an article on the Brookings Institution blog points out how blockchain may be used to fight and eradicate corruption. Bribes in the public sector are estimated at $1.5tn to $2tn a year. Managing the financing of public projects through a transparent and traceable blockchain could go a long way to eliminating the mishandling of public funds. This, in turn, could have an immensely positive impact on development efforts in the world’s poorest countries.

Conclusion
Data shows that the use of cryptocurrencies in criminal activity is diminishing and less prevalent than the public narrative implies. Blockchain technology may be a unique blessing for global law enforcement. The focus should be on leveraging the technology to fight and prevent crime rather than on imposing regulations that may achieve little and penalise the industry.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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