By Eray Arda Akartuna
AML/CFT & futures analyst
In the world of new and disruptive technologies, trends that are set in motion can be hard to stop. The Bitcoin frenzy, which has revolutionised not only payments but also entire industries, is just one of many examples. Presenting a secure transparent network, the underlying Blockchain technology has the power to automate, increase the speed and reduce the costs of transferring funds, goods and services while removing middlemen and central authorities from the equation. Yet the flurry of interest surrounding cryptocurrencies like Bitcoin has also attracted criminals and terrorists, whose existing operations have been disrupted by the pandemic.
Cryptocurrencies have three core features that, although facilitate innovation, are inherently criminogenic. They are semi-anonymous, globally transferrable and decentralised, meaning that, overall, they are more elusive than traditional financial assets. Between 2017 and 2018, Australia reported a 190% increase in reported cryptocurrency fraud cases,[i] while the UK warned in 2019 that cryptocurrency fraud had tripled.[ii]
The disruption of illicit cash flows and other traditional crimes due to Covid-19 has caused cryptocurrency-related crime to accelerate. Beyond fraud, both the FBI and the Financial Action Task Force (FATF) have issued pandemic warnings for rising cryptocurrency-induced money laundering and terrorist financing.[iii] [iv] The Mexican financial intelligence unit, raising concerns about regional trends among drug, sex and human trafficking groups, has noted “a transition to committing crimes in cyberspace, like acquiring cryptocurrencies to launder money,” which it says is being accelerating by Covid-19.[v]
Understanding these risks and devising effective prevention measures is therefore a priority. Between May-August 2020, a study currently pending publication conducted at University College London (UCL) gauged the opinion of global experts from law enforcement, academia, fintech and compliance, regarding cryptocurrency-related money laundering and terrorist financing risks and potential preventative measures. Their findings, explained below, highlight the pressing need for stakeholders to act now to ensure that Blockchain develops through responsible innovation with minimised financial crime risks.
- The possibilities for using crypto-tokens as illicit alternative mediums are growing
Typical Blockchain-based money laundering involves converting illicit cash into cryptocurrencies and transferring them between criminal-owned wallets. However, Blockchain-powered alternative mediums are becoming more varied as the underlying technology develops. Projects such as the Ethereum Blockchain have facilitated the creation of ‘decentralised applications’ (dApps), which allow the peer-to-peer trading of services, such as computing power.[vi] New crypto-tokens, meanwhile, can hold ownership information that allows real-world asset trading across the Blockchain, such as securities or shares in assets such as gold or fine art. While highly innovative and capable of transforming the world of finance as we know it, such developments are nevertheless straying further away from regulation.
This raises the concerning possibility that high-value assets, possibly acquired illegally, are now tradeable via associated crypto-tokens with a fraction of the legal oversight required in the regulated financial system. As the diagram below shows, this risk extends to a number of different crypto-tokens, each rated by experts as posing medium-to-high risks.
Some tokens were deemed lower risk due to the regulated nature of their issuers, particularly entities issuing digital securities. Others, such as stablecoins, are essentially normalising the concept of ‘privately-owned currency’ that can rival the world’s central banks, creating intense debate over their regulation. An example is Facebook’s Libra project, which, under intense scrutiny for its possible money laundering risks, has been abandoned by many investors.[vii]
Unsurprisingly, terrorists have also started taking advantage of these opportunities. In August 2020, US authorities seized 300 cryptocurrency accounts and millions of dollars related to social media financing campaigns by the al-Qassam Brigades (Hamas’s military wing), al-Qaeda and Islamic State.[viii] While UCL study participants described terrorist financing methods as comparatively ‘old school’ to money laundering, the pandemic is leaving financiers with little alternative to embracing technological advances.
- Concealment measures unique to blockchain technology are cause for concern
Beyond crypto-tokens and peer-to-peer trading platforms, the Blockchain ecosystem additionally hosts many unique measures designed to conceal transactions and identities, some of which, shown below, have been deemed high risk by experts.
The exploitation of some of these methods (such as privacy coins, mixers/tumblers and ICOs) have been observed in the past.[ix] Others were based on speculation of what the future could hold. One such potential future risk was the possible terrorist exploitation of highly sophisticated smart contracts. These protocols can allow the pooling of funds across multiple users through decentralised autonomous organisations (DAOs), which are then collectively sent by sympathisers to terrorist entities.[x] In effect, these can act as elusive ‘digital charities’ that can substitute for traditional fundraising methods disrupted by the pandemic, such as charity fraud or extortion.
- Existing regulations are inadequate, but new regulations must not stifle innovation
Recent EU and US regulations require virtual asset service providers, such as custodial wallet providers and crypto-exchanges, to detect and report suspicious transactions. However, the inherent criminogenic features of the Blockchain and its unique concealment measures arguably make these regulations ‘young but already outdated’.[xi] Instead, UCL study participants suggested a four-point approach, tackling the problem from different perspectives.
Despite these suggested measures, experts were quick to emphasise the fine balance between regulation and innovation. Traditional regulations have faced sharp criticism for being ineffective and expensive, with a 2009 UNODC study finding that they only captured 0.2% of illicit transactions worldwide.[xii] Entire institutions have undergone ‘de-risking’, withdrawing services from crime-prone areas such as the US-Mexican border, fearing that compliance costs would outweigh the financial benefits of entering such markets.[xiii] This has left perhaps millions of people with reduced financial sector access, a factor itself incentivising cryptocurrency use. When devising new solutions for Blockchain-related risks, such regulatory failures should be avoided.
As even the most traditional-minded criminals realise the advantages of cryptocurrencies, it is unlikely they will abandon them when the pandemic subsides. Covid-19 should serve as a renewed call for international action, across all relevant industries, to stay ahead of the latest threats, so that Blockchain technology can develop sustainably and securely. It is, most of all, imperative that fintech start-ups are not burdened by ineffective regulations that can damage their vastly beneficial potential for global innovation.
Note: For more about the study featured in this article, please contact firstname.lastname@example.org.
[i] Justin Hendry, ‘Aussies Lost $6.1m to Cryptocurrency Scams Last Year’, iTnews, 29 April 2019, https://www.itnews.com.au/news/aussies-lost-61m-to-cryptocurrency-scams-last-year-524382.
[ii] ‘Cryptoasset Investment Scams’, Financial Conduct Authority (FCA), 27 June 2018, https://www.fca.org.uk/scamsmart/cryptoasset-investment-scams.
[iii] ‘FBI Expects a Rise in Scams Involving Cryptocurrency Related to the COVID-19 Pandemic — FBI’, Press Release, Federal Bureau of Investigation (FBI), accessed 5 January 2021, https://www.fbi.gov/news/pressrel/press-releases/fbi-expects-a-rise-in-scams-involving-cryptocurrency-related-to-the-covid-19-pandemic.
[iv] FATF, ‘COVID-19-Related Money Laundering and Terrorist Financing: Risks and Policy Responses’ (Financial Action Task Force, May 2020).
[v] Diego Oré, ‘Latin American Cartels Turn to Cryptocurrencies for Money Laundering’, BusinessLIVE, 8 December 2020, https://www.businesslive.co.za/bd/world/americas/2020-12-08-latin-american-cartels-turn-to-cryptocurrencies-for-money-laundering/.
[vi] R. A. Canessane et al., ‘Decentralised Applications Using Ethereum Blockchain’, in 2019 Fifth International Conference on Science Technology Engineering and Mathematics (ICONSTEM), vol. 1, 2019, 75–79, https://doi.org/10.1109/ICONSTEM.2019.8918887.
[vii] Kari Paul, ‘Payment Firms Back out in Painful Blow to Facebook’s Cryptocurrency Libra’, The Guardian, 11 October 2019, sec. Technology, https://www.theguardian.com/technology/2019/oct/11/payment-firms-back-out-in-painful-blow-to-facebooks-cryptocurrency-libra.
[viii] ‘Global Disruption of Three Terror Finance Cyber-Enabled Campaigns’, United States Department of Justice, 12 August 2020, https://www.justice.gov/opa/pr/global-disruption-three-terror-finance-cyber-enabled-campaigns.
[ix] CipherTrace, ‘Cryptocurrency Anti-Money Laundering Report, 2018 Q4’ (CipherTrade Cryptocurrency Intelligence, January 2019), https://ciphertrace.com/wp-content/uploads/2019/01/crypto_aml_report_2018q4.pdf.
[x] Jerry Brito, ‘Some Facts about Digital Currency and Terrorist Financing’, Medium, 19 November 2015, https://medium.com/@jerrybrito/some-facts-about-digital-currency-and-terrorist-financing-ffe5e6962c66.
[xi] Valentina Covolo, ‘The EU Response to Criminal Misuse of Cryptocurrencies: The Young, Already Outdated 5th Anti-Money Laundering Directive’, SSRN Scholarly Paper (Rochester, NY: Social Science Research Network, 13 December 2019), https://doi.org/10.2139/ssrn.3503535.
[xii] UNODC, ‘Estimating Illicit Financial Flows Resulting from Drug Trafficking and Other Transnational Organized Crimes’ (United Nations Office on Drugs and Crime, Studies and Threat Analysis Section (STAS), Division for Policy Analysis and Public Affairs (DPA), October 2011), https://www.unodc.org/documents/data-and-analysis/Studies/Illicit_financial_flows_2011_web.pdf.
[xiii] Dominic Suszek, ‘De-Risking Sparks Controversy At U.S.-Mexico Border’, Global Radar, 4 March 2018, https://www.globalradar.com/de-risking-sparks-controversy-at-u-s-mexico-border/.