Cryptocurrencies: New avenues for an age-old problem

It is estimated that 3% of money laundering is now attributable to cryptocurrencies, and with the total market value increasing by a staggering 34 times in 2017 – from $18bn to $610bn – this is only set to rise.  The question is: what are regulators doing about it? 

The most well-known cryptocurrency, Bitcoin, started a trend for digital currency or ‘cash’, which can be used to pay for goods and services or stashed away as an investment.  Bitcoin’s revolutionary blockchain technology, a distributed public ledger which replaces the need for a trusted third party to validate transactions and maintain balances, has paved the way for other digital currencies to enter the market through initial coin offerings (ICOs).  ICOs are a method of raising capital, whereby a new cryptocurrency is issued to investors in exchange for other widely accepted cryptocurrencies such as Bitcoin or Ethereum, or fiat currencies.  Thanks to an increase in demand for cryptocurrencies and ICOs, start-ups have raised billions of dollars through ICOs, and there are now almost 1,500 cryptocurrencies on the market. 

In theory, anyone with an internet connection and a digital wallet can buy or sell cryptocurrencies.  Traditional anti-money laundering framework requires companies to do due diligence in areas such as knowing the customer including, validation of their identity, tracking sources of wealth and sanction checks – investing in cryptocurrencies makes it a lot easier to ignore these obligations. 

Whilst cryptocurrencies such as Bitcoin have a publicly viewable ledger, an increasing number of cryptocurrencies make it impossible for investigators to track transactions or identify the parties involved by design (e.g. Monero).  Based on the CryptoNote protocol with significant levels of obfuscation built into the blockchain, Monero protects the identity of senders as well as the recipients.  This makes it easier for criminals to engage in the financing of illicit activities with protection from even the most powerful investigatory techniques. 

Cryptocurrencies are really just new avenues for an age-old problem.  According to Vitalik Buterin, founder of Ethereum, “regulators will always try to come up with new ways to control and analyse transactions, and people will always try to think how to hide these transactions.” 

What we do know is that governments and authorities hate a lack of control and visibility; if history tells us anything, it is that any attempt to get around regulation is soon met by improved regulation.  It is clear that regulators have every intention to crackdown and regulate cryptocurrencies – recent actions taken provide insight as to what the future might hold. 

In July last year, the US Securities Exchange Commission (SEC) said that tokens issued in 2016 by the Decentralized Autonomous Organisation, one of the first ICOs, constituted securities – the first sign of the SEC having jurisdiction over these issues.  A statement issued by the SEC Chairman, Jay Clayton, in December 2017 said that “the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.”  Clayton also mentioned that the SEC’s Division of Enforcement will continue to police this area and “recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws.” 

Also in the US, the Northern District of California indicted a Russian national, Alexander Vinnik, and an organization he allegedly operated, BTC-e, for laundering at least $4bn of criminal funds through Bitcoin.  According to the indictment, BTC-e was used to facilitate computer hacking, fraud, identity theft and drug trafficking.  The US Attorney’s Office has said that it will continue to prosecute money launders and cyber-criminals wherever and however they use the internet to commit their crimes. 

The UK and other EU governments are planning to crackdown on online platforms where cryptocurrencies are traded, requiring them to carry out due diligence on customers and report suspicious transactions.  The Treasury said: “We are working to address concerns about the use of cryptocurrencies by negotiating to bring virtual currency exchange platforms and some wallet providers within anti-money laundering and counter-terrorist financing regulation.”  Further, the UK government is negotiating amendments to the anti-money-laundering directive to ensure firms’ activities are overseen by national authorities.  The rules are expected to come into effect in the next few months. 

Taking more dramatic measures, the People’s Bank of China ruled ICOs illegal in September last year.  This announcement was shortly followed by three of China’s main Bitcoin exchanges deciding to cease trading in China.  In less than a two week period, the price of Bitcoin fell by over 30%.  The impact of this ruling illustrates the volatile nature of cryptocurrencies and the potential for further falls in value if there were to be increased regulation. 

Actions already taken by authorities show that increasing enforcement is inevitable, and that cryptocurrencies are stuck between a rock and a hard place.  Their unregulated nature might make them attractive now, but in the future the only way they will be able to survive is by embracing regulation, which is counterintuitive to them and might make their bubble burst.