Throughout history, people have concealed their wealth to evade taxes or avoid confiscation by the government.[1] More recently, organized criminal gangs, drug lords and various terrorist groups have all needed to conceal their illicit gains and move money around the world without the knowledge of the authorities.[2] Enter money laundering—broadly defined as an attempt to obfuscate or “launder” illegally sourced funds, effectively concealing the true source of the money by portraying it as the result of a legitimate business enterprise.[3] With the rise of bitcoin and other cryptocurrencies, many have worried that their seemingly anonymous and decentralized nature would result in a dramatic increase in money laundering and tax evasion.[4] Contrary to popular belief however, cryptocurrencies are not ideal for money laundering, and the key to drastically limiting the scope of money laundering may lie in the blockchain technology powering bitcoin.
Numerous methods and tactics are used by criminal entities and other nefarious actors seeking to conceal and smuggle illicit funds,[5] but classic money laundering is usually carried out through three different stages: placement, layering and integration.[6] First, the money is secretly placed into the financial system. Funds are then moved around to create confusion and lengthen the paper trail, creating new layers of records. Finally, the clean money is integrated into the legitimate financial system. While not strictly money laundering in the traditional sense, anti-money laundering laws have increasingly targeted the financiers of terror groups and nation-states seeking to evade international sanctions.[7]
Although no reliable figures can be given for the magnitude of money laundering, estimates have ranged from two to five percent of the global economy,[8] creating significant policy concerns for regulatory and law enforcement bodies. To combat money laundering, the U.S. government has passed a string of laws and regulations,[9] collectively known as Anti-Money Laundering (“AML”) and Know Your Customer (“KYC”) laws.[10] These acts and regulations force banks and financial institutions to report any suspicious transactions, set up effective compliance and risk control programs, and verify a customer’s identity.[11]
As bitcoin and other cryptocurrencies have gained increased recognition and importance, policy makers have worried that an increase in money laundering and the attendant facilitation of illegal activity is an inevitable side effect of its popularity.[12] Silk Road, the now defunct online drug bazaar, exclusively accepted bitcoin as a payment mechanism.[13] Recent international hacking attacks,[14] particularly those using the “ransomware” method, in which compromised computers are frozen until payment is rendered,[15] demanded payments be made in bitcoin.[16] The arrest of a man accused of running a multibillion-dollar money laundering scheme involving bitcoin has only highlighted the potential for misuse of cryptocurrencies.[17]
Nonetheless, solid evidence of large scale money laundering using cryptocurrencies has thus far not materialized,[18] as certain features of cryptocurrencies prevent them from becoming the ideal money laundering instrument. On the surface, bitcoin, the original and most popular cryptocurrency, has all the ingredients for successful money laundering: it’s portable, transferable between borders, has relatively low transaction fees, secure, reasonably safe from confiscation, and seemingly anonymous.[19] Yet bitcoin is not truly anonymous, as the blockchain records every transaction on an immutable ledger, providing a complete transaction history.[20] Thus, while the public address of bitcoin wallets does not contain identifying information as a bank account would, every transaction can be tracked and monitored.[21] The weak link for aspiring money launderers is now fiat conversion, or exchanging their bitcoins for dollars and euros, which is normally done on centralized exchanges, such as Coinbase or Gemini.[22] Law enforcement can track a bitcoin address implicated in illegal activity, and if the suspected bitcoins are transferred to an exchange, force the exchange to hand over that customer’s information.[23]
Furthermore, new blockchain based technologies can potentially curtail money laundering. Chainalysis, a blockchain focused startup recently retained by the IRS, has developed technologies for tracking transactions done through cryptocurrencies.[24] Numerous other startups are experimenting with blockchain technology to streamline KYC compliance in the financial system and thereby reduce money laundering. Companies such as IBM, Synechron, ConsenSys, KYC-Chain, and Tradle’s are all developing blockchain based applications to help financial companies reduce the expense and time of KYC compliance.[25] Deloitte recently noted that blockchain can help in identifying customers who attempt to create a fraudulent transaction history, by spotting irregularities and inconsistencies in financial data.[26]
While increased adoption of blockchain technology has the potential to reduce money laundering and other financial crimes, multiple obstacles remain. The development and increasing popularity of new privacy focused coins such as Zcash, Monero and Dash, all of which aim to obscure or otherwise anonymize the transaction data normally available in bitcoin transactions,[27] may facilitate an increase in money laundering and tax evasion. The eternal tug of war between regulators and criminals seems set to play out via a new battlefront, in the land of cryptocurrencies. Hopefully, blockchain technology will usher in an era of increased transparency and grant regulators the tools they need to reduce financial crimes.
[1] See Wikipedia, Money Laundering, https://en.wikipedia.org/wiki/ Money_laundering#cite_ref-11 (last visited Nov. 26, 2017).
[2] See JX Low, Money Laundering, Aml-Cft (Sept. 6, 2017), https://aml-cft.net/library/money-laundering/.
[3] Fincen, History Of Anti-Money Laundering Laws, https://www.fincen.gov/history-anti-money-laundering-laws.
[4] See Christian Brenig Et Al, Economic Analysis Of Cryptocurrency Backed Money Laundering (2015), https://pdfs.semanticscholar.org/cccb/f96b3efa46cdb 74233f1e5b13209ffab8c9e.pdf.
[5] See supra note 1.
[6] See supra note 3.
[7] Primarily through the U.S.A. Patriot Act, which amended the Bank Secrecy Act. See 12 U.S.C. § 1953 (2016).
[8] FATF, How Much Money Is Laundered Per Year? http://www.fatf-gafi.org/faq/moneylaundering/.
[9] Such as the Bank Secrecy Act, Money Laundering Control Act, Anti-Drug Abuse Act, and the U.S.A. Patriot Act. See supra note 3.
[10] The impetus is placed on banks and other financial institutions to help curtail money laundering by identifying and monitoring suspicious transactions and verifying their customer’s identity, hence the term “Know Your Customer.” See United States Securities And Exchange Commission, Anti-Money Laundering (AML) Source Tool For Broker-Dealers, https://www.sec.gov/about/offices/ocie/amlsourcetool.htm#1.
[11] Id.
[12] See supra note 4.
[13] Joon Ian Wong, Dark Markets Grow Bigger and Bolder in Year Since Silk Road Bust, Coindesk (Oct. 6, 2014), https://www.coindesk.com/dark-markets-grow-bigger-bolder-year-since-silk-road-bust/.
[14] The hacking of hundreds of thousands of computers worldwide in May 2017 in what was known as the “Wannacry” ransomware attack. See Nicole Perlroth, More Evidence Points to North Korea in Ransomware Attack, N. Y. Times (May 22, 2017), https://www.nytimes.com/2017/05/22/technology/north-korea-ransomware-attack.html.
[15] Id.
[16] Id.
[17] Stab Higgins, $4 Billion: Russian Man Arrested for Alleged Bitcoin Money Laundering Scheme, Coindesk (July 26, 2017), https://www.coindesk.com/4-billion-russian-man-arrested-alleged-bitcoin-money-laundering-scheme/.
[18] See supra note 4.
[19] Id.
[20] Essentially, the path of any given bitcoin can be traced from user to user, or wallet to wallet. See Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, https://bitcoin.org/bitcoin.pdf.
[21] In a very simplistic explanation, bitcoin wallets consist of a public address or key, which can only be unlocked by a private key. Creating a wallet is free and easy to do, and does not require the user to input in any identifying information. However, transactions to and from that wallet are recorded on the blockchain; a decentralized, publicly available, distributed ledger which records every bitcoin transaction. Thus, bitcoin transactions are only pseudonymous and not truly anonymous, in that if the owner of a wallet is identified, his transaction history is publicly available for law enforcement use. See Id.
[22] Roy Keidar & Yigal Arnon, How blockchain could end, instead of enable, money laundering, VentureBeat (Oct. 8, 2017), https://venturebeat.com/2017/10/08/how-blockchain-could-end-instead-of-enable-money-laundering/.
[23] Id.
[24] Joseph Cox, IRS Now Has a Tool to Unmask Bitcoin Tax Cheats, The Daily Beast (Aug. 22, 2017), https://www.thedailybeast.com/irs-now-has-a-tool-to-unmask-bitcoin-tax-cheats.
[25] Prableen Bajpai, How Blockchain Can Help Reduce Money Laundering, Nasdaq (Nov. 21, 2016), http://www.nasdaq.com/article/how-blockchain-can-help-reduce-money-laundering-cm712251.
[26] Deloitte, Blockchain applications in banking, https://www2.deloitte.com/content/dam/Deloitte/uk/Documents/Innovation/deloitte-uk-blockchain-app-in-banking.pdf.
[27] See Nathan Reiff, The Rise of ‘Private’ Cryptocurrencies, Investopedia (Sept. 15, 2017), https://www.investopedia.com/news/rise-private-cryptocurrencies/.
