Telecoms & IT

Crypto Crime

Tackling Unlawful Cryptocurrency Use

The rapidity and anonymity of crypto-transactions make them attractive not only to risk-prone investors, but also to criminals. Finding an efficient solution that does not completely undermine or overturn the nature of digital currencies is proving to be extremely hard.

Cryptocurrencies are a relatively new addition to the exclusive club of alternative investments, and rarely has an asset class caused so much division. Experienced managers remain skeptical of cryptos’ high degree of volatility, while others, with younger and riskier profiles, are viewing the 1-2% allocation in Bitcoin or Ethereum as a guarantee of further portfolio diversification. Certainly, the degree of market knowledge required by such an investment is highly questionable—some would go as far as considering it pure gambling. Nonetheless, cryptocurrencies have gained broad popularity, for one major reason: speed.

Cryptocurrencies go up and down in value with startling and notorious rapidity. But this swiftness also extends to the way in which they move from one location to another. This feature makes them very attractive for funding purposes, especially for venture capital, and we are seeing start-ups increasingly using initial coin offerings (ICOs) to gain quick capital that is relatively low risk given the irreversible nature of these transactions.

As virtual currencies become more widely accepted and play an ever-expanding role in commerce, governments have increasingly come to recognize that they are an emerging and potentially enduring reality, both in the legal world as in the illegal one.Unfortunately, yet predictably, the fast pace with which crypto-transactions are executed has drawn the attention of a growing number of terrorists and criminal organizations, which see in decentralized digital currencies the potential for a great deal of fundraising and money laundering.

Islamic fundamentalists fighting in Syria and separatists in eastern Ukraine are using bitcoin addresses for payments, probably encouraged by the rise in alternative fiat-exchange accounts that surpass the hurdle of cashing out funds in sovereign currencies. Transaction anonymity, irreversibility of payments, and global reach make for a perfect shield for cybercrimes totally hidden from the authorities. Moreover, since the values of virtual currency change rapidly and unpredictably, holding virtual currencies in e-wallets poses an unnecessary risk that leads to a multiplier effect on transactions, making it harder for web authorities to track illegal activities.
As the number of businesses accepting digital currency payments grows, governments are presented with a dilemma: on the one hand, they are under pressure to embrace a comprehensive, flexible, and super-swift solution; on the other, they put their financial segments at greater risk of uncontainable and undetectable fraud. In the US, policymakers have made targeting cryptocurrency-fueled terrorism and the illicit use of digital coins for any purpose a top priority, presenting the Financial Technology Innovation and Defense Act and the Homeland Security Assessment of Terrorists Use of Virtual Currencies Act before Congress.

In Australia, a new law gives the Australian Transaction Reports and Analysis Center (AUSTRAC) the power to police digital currency exchanges (DCEs) trading in a variety of crypto currencies including Bitcoin, Ethereum, and Ripple. In the UK, efforts are at play to bring digital currency exchange firms and custodian wallet providers into Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) regulation as part of the EU Fifth Money Laundering Directive (5MLD). This is in line with the risk-based approach taken by the Financial Action Task Force on Money Laundering (FATF). An equally notable effort made by the UK authorities is the plan to further expand the Joint Money Laundering Intelligence Taskforce (JMLIT), which facilitates information sharing between the financial sector and law enforcement.

While necessary and commendable, these efforts seem to fail to take into account the constraints of the current legal framework, as well as wider technological and operational challenges faced by banks regarding incorporating these laws due to older legacy systems. This is not to say that regulation efforts are ineffective. It simply implies that rather than increasing regulatory oversight and law enforcement scrutiny, more effective prevention lies in finding reliable vehicles to implement these regulations. Indeed, it is not too far-fetched to suggest that a technology-related issue can be properly solved only by an equally technological countermeasure. It is in this context that regtech comes into play.

A sub-set of fintech, regtech focuses on specific technologies that may facilitate the delivery of regulatory requirements more efficiently and effectively than existing capabilities. Probably the most famous of the technologies promoted by regtech is public blockchain, a decentralized ledger that allows for any transfer to be visible to anyone, including authorities, thanks to a series of mathematical formulas that record transaction data, tracking sender, receiver, and order.

In addition to being decentralized, public blockchain is also a peer-to-peer network in which each participant maintains their own replica of shared append-only information kept in sync using protocol referred to as consensus. In addition, public blockchain provides certain guarantees on the immutability of the ledger, even when some participants are faulty or malicious. Contrary to the private version, the public blockchain network is completely open, allowing anyone to join and participate in the network, something that implies little to no privacy for transactions. However, while parties must agree to total transparency when registering an account on a public blockchain network as a “matter of security,” the overall process is still not as convincing in terms of security as might be hoped by a number of concerned authorities.

Talks around enforcing blockchain structure are just in their primary phase, and it is still unclear how the companies and individuals behind every unique account will take to this. And how to implement this remains a different kettle of fish.

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