Speculative bubble or no, perhaps the greatest challenge facing Bitcoin, cryptocurrencies in general, and the broader world of blockchain is the fact that all of these efforts in some way support criminal endeavors.
I’ve written about how criminal enterprise is largely responsible for the value of Bitcoin, and to be sure, it drives the demand for many alternative cybercurrencies as well.
However, regardless of whether you believe cryptocurrency is all about facilitating crime vs. crime being but a small, unfortunate side effect of the rise of crypto coinage, there’s no arguing with the fact that global law enforcement recognizes that cryptocurrency is the criminal’s playground.
In fact, four primary areas of criminal activity lend themselves to cryptocurrency: tax evasion, money laundering, contraband transactions, and extortion – not to mention the theft of cryptocurrency itself, which is all too easy with Bitcoin.
Cryptocurrencies have actually led to a massive cat and mouse game with law enforcement, as agencies get better at identifying criminal behavior, while criminals come up with new evasion techniques and increasingly anonymous cybercurrencies in order to defeat the efforts of law enforcement.
While much of this innovation in the greater cybercurrency/blockchain arena aligns with the interests of criminals, there is another side to this story: the increasing recognition that law enforcement requires its own technological innovation in order to keep up.
Steve Garfield, Jørn Eriksson, and Jason Bloomberg
Cryptocurrency: Criminal vs. Law Enforcement Cat-and-Mouse Game
The Challenge of Anonymity
Anonymity, of course, is one of the most important tools in the criminal’s toolbox. For money laundering in particular, the entire purpose of the criminal activity is to separate the perpetrator’s identity from financial transactions.
Anti-Money Laundering (AML) efforts, therefore, are understandably concerned about cryptocurrency. Complicating this story for the money launderers is the fact that Bitcoin itself is not truly anonymous. “While Bitcoin has a reputation for anonymity, the entire history of Bitcoin transactions is visible to all users,” explains Helene Rosenberg, Director of Cash Management, Global Transaction Banking for Barclays US, in a recent white paper. “Therefore, the blockchain technology/ledger, combined with a monitoring tool, actually allows for increased visibility into potential clients’ activity – more so than would traditionally be available for MSBs [money service bureaus].”
On the one hand, therefore, Bitcoin transaction monitoring technology is a viable market niche for supporting law enforcement efforts. On the other hand, criminals realize that Bitcoin isn’t sufficiently anonymous and as a result, they’re driving increasingly anonymous cryptocurrency variants known as ‘altcoins.’
One approach to creating anonymous altcoins is ‘zero-proof technology.’ “Zero-proof technology removes any identifying information (sender, recipient, and amount of a transaction) from a blockchain’s ledger, essentially eliminating one of blockchain technology’s most celebrated features when it comes to AML—the ability to trace transactions,” explains Joseph Mari, Senior Manager of Major Investigations in the Anti-Money Laundering Financial Intelligence Unit at Bank of Montreal . “The first cryptocurrency to implement this technology is referred to as Zcash.”
Zcash, however, is but one of many altcoin efforts that seek to bring the anonymity that Bitcoin lacks. “Monero and Dash are the names of just two of many cryptocurrencies that offer ‘anonymous transactions.’” Mari continues. “Neither utilizes zero-proof technology.”
Another approach to anonymity favored by criminals: The Onion Router (Tor), which anonymizes the IP address of the user. Tor is thus particularly useful for contraband transactions on the Dark Web. “Anonymous Bitcoin users utilizing Tor pose one of the biggest challenges for potential Bitcoin regulation and enforcement,” writes Kavid Singh, Assistant Attorney General at the Texas Office of the Attorney General. “Workable anti-money-laundering laws for Bitcoin, therefore, must either bypass or eliminate anonymity in the network.”
The innovation supporting criminal enterprise appears to have an edge on advancements in law enforcement, however. “Blockchain technology will evolve very quickly to become untraceable,” says Albert Mavashev, CTO at Nastel Technologies. “New developments are being implemented in Zcash, Dash and other up-and-coming Bitcoin variants such as Verge and Nav Coin, which will make digital transactions virtually untraceable. Currently I don’t see what law enforcement can do to stop this.”
Law Enforcement Fights Back
Regardless of the level of technical anonymity in the cybercurrency itself, one fact gives law enforcement a break: criminals must eventually exchange their cryptocoin of choice for fiat currency (aka ‘real money’) at some point.
Sufficient observation of such transactions can therefore lead to the ‘deanonymization’ of bad actors by discerning patterns which give law enforcement something to go on. “At a high level, two approaches to detecting suspicious activity are possible: deanonymization and anomaly detection,” explains Juan Llanos, Financial and Regulatory Technology Lead at ConsenSys. “Some of these techniques are already widely used in traditional financial services, especially those that focus on volume, frequency and velocity.”
Anomaly detection is a common law enforcement tactic, as fraudulent or otherwise criminal behavior doesn’t follow the same patterns as legal activity. “Not all anomalies are indicative of illicit activity, however,” Llanos warns. “The goal is to detect transactions that are both anomalous and suspicious, and therefore reportable.”
Such detection boils down to transaction monitoring – a mature technical capability across enterprise IT shops well before cryptocurrency hit the scene. “Tracking and monitoring liquidity movement within and across blockchains could be used for law enforcement by monitoring a set of addresses and where money is going,” Mavashev explains. “Law enforcement can use Nastel transaction analytics tooling to perform forensics as well as to see patterns in seemingly unrelated on and off chain transactions.”
In fact, one of the more innovative approaches to monitoring cybercurrency transactions potentially uses blockchain itself. “Blockchain technology, by its very nature, lends itself to integrated decentralized monitoring efforts of financial transactions,” explains Floyd DCosta, Management Consultant and Cofounder at Blockchain Worx. “A Blockchain-based platform will give regulators, auditors, and other stakeholders an effective and powerful set of tools to monitor complex transactions and immutably record the audit trail of suspicious transactions across the system.”
Such an approach is not without its hurdles, as multiple banks would all have to participate. “Each financial institution which would be part of this system would serve as a node within the private permissioned blockchain network,” DCosta continues. “Since relevant information would be stored in the blockchain and be made available to each node, suspicious activity can be detected and highlighted to all related participants.”
Whether the financial community will come to a consensus about using blockchain to monitor cryptocurrency transactions or not, there is widespread agreement that traditional approaches to law enforcement are insufficient. “Blockchain and cryptocurrencies present AML professionals with several new challenges that require an evolved approach,” says Bank of Montreal’s Mari. “Furthermore, it would be prudent to take this concept one step further and visualize what it would take to effectively monitor existing banking products on a blockchain that utilizes zero-proof technology.”
There are few calls, however, for shutting down Bitcoin or other cryptocurrencies, as there is general agreement that such a move would impede legal uses of the technology while allowing illegal uses to flourish.
Perhaps the best advice comes from Texas Assistant Attorney General Singh. “Regulators should pursue a balanced approach: one that fosters Bitcoin’s benefits and deters money laundering,” Singh opines, “Understanding that at a certain point regulation will be ineffective against anonymous users.”
Regulation alone, of course, never suffices to deter crime. If the criminals choose to leverage innovative technology to facilitate their activities, then law enforcement must do the same.