The underlying technology that facilitates Bitcoin allows people from anywhere in the world to transact without supplying their real-world identity. Instead, transactions are identified through a unique set of alpha-numeric characters – known as a public address. In this sense, cryptocurrency transactions are ‘pseudonymous’, as opposed to ‘anonymous’.
As a result, certain high-profile commentator’s argue that the characteristics of the blockchain protocol are an ideal conduit for money laundering activity. Such viewpoints include Bill Gates – who claims that “cryptocurrencies are used for buying fentanyl and other drugs”, UK Prime Minister Theresa May – who states that cryptocurrencies require enhanced scrutiny “because of the way they can be used, particularly by criminals” and then Bill Harris - former CEO of PayPal, who pontificates that cryptocurrencies are "best suited for one use criminal activity".
Those who concur with the above viewpoints often refer to the infamous case of Silk Road – an open marketplace that facilitates the buying and selling of illicit goods and services such as narcotics and stolen credit cards. In this sense, cryptocurrencies afford criminals with an added layer of privacy, insofar that they can trade prohibited products and receive payment in an asset that is not tied to their personal identity.
Prior to the website being shut down by the FBI in 2013, Silk Road had generated sales in excess of $1.2 billion. The result of the crack-down? Bitcoin lost close to a quarter of its value over night. However, the overall cryptocurrency markets have come a long way since the days of Ross Ulbricht and his illicit marketplace.
Anti-money laundering regulation – the current state of play
Although anti-money laundering (AML) regulation is still in its infancy, there are already measures in place to prevent illicit actors from attempting to use cryptocurrencies to conceal their proceeds of crime. In Japan – the world’s first nation to recognise Bitcoin as a currency, blockchain assets are regulated in the very same way as their domestic financial services sector. What this means is that those operating in the industry must install stringent AML controls to detect and prevent financial crime.
Then over in the U.S., in 2013 national legislators concluded that third party cryptocurrency exchanges that deal with fiat currency must employ the same AML monitoring and reporting requirements as stipulated under both the Money Laundering Act and the Bank Secrecy Act.
The results of such regulatory actions dictate that any individual that attempts to engage in a cryptocurrency purchase (or sale) in exchange for real-world currencies such as the U.S. dollar must first go through a customer due diligence (CDD) process. At an absolute minimum, the individual will be required to supply a range of personal information (such as their full name, address and country of residence), along with some supporting documents like a passport or driving license.
Furthermore, when trading volumes reach a certain level (dependent on both the jurisdiction and the exchange in question), then enhanced CDD measures will be applied. This could include a number of controls such as a proof of address statement, the provision of a social security number or even a demand to prove the individual’s source of funds.
Bitcoin and money laundering is not an easy feat
Ultimately, any cryptocurrency exchange that has a relationship with a financial institution will not allow any individual to transact with real-world money unless they first go through a CDD process. Otherwise, they not only risk losing their ability to accept fiat currency from customers, but they would also face financial and/or criminal sanctions.
In a nutshell, this removes the opportunity for a criminal to conceal their illicit income anonymously, thus eliminating the motivation to use cryptocurrencies as a money laundering avenue.
To further amplify these viewpoints, a recent academic study by Fanusie and Robinson - Bitcoin Laundering: An Analysis of Illicit Flows into Digital Currency Services – concluded that of all Bitcoin transactional activity between 2013 and 2017, less than 1% was a result of money laundering activity. Moreover, the same study also explained that the illicit activity they analysed peaked in 2013 - which coincides with the closure of Silk Road.
In reality, these figures are minute, especially when one considers that according to the International Monetary Fund – it is estimated that between 2-5% of global GDP is attributable to money laundering. Interestingly, this figure was published prior to the launch of Bitcoin.
So where does this leave us? It would be naive to suggest that the blockchain eco-system is immune to money laundering threats, however it is argued that using cryptocurrencies to conceal illicit wealth is not an easy feat to achieve.
There are a plethora of ‘privacy coins’ such as Monero, Zcash and Dash that - due to their underlying technology, allow anonymous transactions – at least in the sense that they cloak the ability to link a movement of funds to a particular wallet address. However, here remains the fundamental point – how do they inject real-world money into the markets without first identifying themselves?
Nevertheless, the installation of the aforementioned regulations that force third-party fiat-to-crypto exchanges to implement stringent CDD processes is certainly a step in the right direction. We at SURGE Technologies believe that an AML framework is not the only regulatory safeguard that the industry will soon adopt in its entirety, as the Wild West of initial coin offerings (ICOs) are becoming ever-more securitized by national regulators.
Financial crime and ICO’s
The ICO space – which in 2017 raised the cryptocurrency equivalent of more than $5 billion, is rife with unsavoury projects whose objective is to raise as much money as possible from unsuspecting investors. In fact, a recent study by Statis Group - an ICO advisory organization, claimed that more than 80% of all ICO's that concluded in 2017 were nothing more than a scam.
Let’s not forget – the Financial Action Task Force, who are the global standard setters when it comes to money laundering and terrorist financing recommendations, make it clear that any crime that is committed with the view of making a financial gain is in fact a money laundering offence.
The key driving force behind this upsurge in ICO fraud is because of the loose regulatory status that tokens represent. Practically every ICO to date market their token as a utility, rather than a security. What this means is that investors are afforded no rights or protections, nor do they hold any tangible stake in the project. This allows ICO’s to bypass all regulatory oversights that we are used to seeing in the real-world financial markets.
However – the future of ICO’s is actually in good position, with more and more crypto-startups now looking to market their token as a security.
A new and exciting safeguard – tokenized securities
In doing so, they must go through a stringent due diligence process with their respective national regulator before they can even think about engaging in an ICO. Moreover, the project will be at the helm of regulators on an ongoing basis, to ensure that the operation remains compliant.
This provides cryptocurrency investors with a new lifeline, as they are afforded with the very same rights as they would expect when investing in a real-world company or asset. Recognizing this desire for a regulated space, we at SURGE Technologies will be keeping a close eye on the tokenized security space while we continue to develop our fully-fledged algorithmic bots to profit from the hugely lucrative cryptocurrency markets.