In continuation of the previous post on the topic “Introduction and Regulation of Cryptocurrency”, this half of the article discusses the illegal uses of cryptocurrency and the need for a regulatory framework for the same.
Even though the cryptocurrency provides certain benefits and comes along with certain drawbacks, there is a malignant side to it as well. Cryptocurrencies are being used for nefarious purposes like hacking, money laundering, obtaining illegal goods and services and fraudulent activities. The paper covers the various illicit activities that are carried out with the help of cryptocurrency and induces one to ponder over the need for regulation of this digital currency. Some of these illicit activities include the following:
Money laundering is a process through which money acquired from undertaking illegitimate activities like drug trafficking and terrorist activities are disguised as money received from legitimate sources. Every day, millions of dollars are laundered worldwide through financial systems, corrupt officials and businesses trying to hide their illegal money. According to the Financial Action Task Force, an intergovernmental organization, which includes 36 countries, around two percent of the global annual gross domestic product, amounts to money laundering.1 As the use of digital or virtual currency is exploding, so is its misuse, to facilitate the illegal activity of money laundering. This was pretty evident in the case of Liberty Reserve, a company indulged in transfer and payment processing of currency. This was based in Costa Rica that was accused by the U.S. Department of Justice (DOJ) on May 28, 2013 for laundering $6 billion for cyber-criminals, drug trackers, child pornographers and other deleterious actors. It was one of the biggest money laundering cases in the U.S.2 Silk Road, a bitcoin based online market was seized and its owner and operator, Ross William Ulbricht was arrested on October 1, 2013 for money laundering. Silk Road was introduced in 2011 and worked as an online market that exclusively provided illegal goods and services like drugs, and murder for hire in exchange for bitcoins. The website comprised of over 13,000 listings for drugs, listings for spiteful software programs, fake passports, pirated media content and computer hacking facilities.3
Face-to-face trading of bitcoins called Satoshi Squares has also taken shape in some cities like Bangkok, Bratislava, London, Helsinki, Berlin, Tel Aviv and Toronto. Individuals participating in this type of setting meet at marketplaces to purchase bitcoins in exchange of cash. These face-to-face transactions are a matter of concern as they are becoming a platform to launder money. The issue with these transactions is that people can either purchase bitcoins or exchange them for something else. “As a result, one could easily sell illegal services or products strictly for Bitcoins, or purchase large amounts of digital currency with regular currency, then transit the digital currency offshore and either exchange it for more illegal products and services or convert it to another nation’s currency then deposit it into a bank.”4
Unethical hackers are getting access into various elements of bitcoin like exchanges, marketplaces, wallets and mining activities. They attack these elements to find the weaknesses in coding. This has affected sellers, purchasers, miners and businesses. As the number of users and transactions are increasing, the hackers are getting into the personal wallets or even to the entire transaction. Most of the users exchange bitcoins online or face-to-face. UK-based bitcoin exchange ‘Bitcoinica’ was hacked in March 2012, and 18,547 BTC were stolen from users’ accounts.5 In February 2014, U.S. based Poloniex exchange lost approximately 12 percent of its reserves due to a coding error that a hacker was able to misuse.6 Unfortunately, there is no central regulation authority that stores passwords or issues replacement keys. One area where bitcoin has not been able to match the security standards that of a bank as when we deposit money in the bank against loss or theft, unlike bitcoins which are not immune to attacks by hackers. Another element that can be hacked is the bitcoin wallets. There are two parts to the wallets that are at risk – the wallet and private key. Many wallet customers keep up to 80 percent of their bitcoins offline for protection against hackers.7 Wallet holders can access these wallets using a private key. The private key can be stored digitally either online or offline through means that don’t include using the Internet. Unfortunately, there is no central regulation authority that stores passwords or issues replacement keys. One area where bitcoin hasn’t been able to match the security standards is that of a bank, as when we store money in bank, it has to be insured by the bank against loss or theft, unlike bitcoins. Hackers can target wallets as well as wallet providers. In June 2011, Allinvain, BitcoinTalk forum member, became one of the first victims to lose bitcoins due to hacking. His computer was hacked due to which he suffered a loss of around 25,000 bitcoins.8 Consumer Finance Protection Bureau’s news on virtual currencies warned the bitcoin consumers that if a hacker gets access to their private key and is able to access the wallet, a huge loss of virtual currency could occur9
As bitcoins are gaining popularity among users, fraudsters are finding new ways to deceive consumers and loot them. Some of those techniques are Ponzi schemes, imitation websites and phishing emails.
- Ponzi Schemes
A Ponzi scheme is a fraudulent investing scam, which promises high returns to investors with low risks. Returns to existing investors are paid through the funds contributed by the new investors. In Ponzi schemes, the operator places attention on attracting new investors to make “promised payments to earlier investors as well as divert some of the invested funds for personal use.”10 Bitcoin has been accused of being a Ponzi scheme. Economist Nouriel Roubini posted “So Bitcoin isn’t a currency, it is [by the way] a Ponzi game and a conduit for criminal/illegal activities. And it isn’t safe given hacking of it.”11 The Securities and Exchange Commission issued a warning in 2014 to customers raising a concern about fraudsters trying to coax investors into Ponzi and other schemes in which the virtual currencies are used to enable, or just fabricate investments.12
Phishing is a fraudulent practice of mailing people by disguising oneself as a reputed and trusted entity to obtain personal and confidential information like security number, password, or credit card details. These emails generally come from sites and businesses where the user does not have an account. They contain a malicious link that addresses the user to a site, set up to trick them into revealing sensitive information. Bitcoin holders can be targeted by phishing emails in numerous ways. One of the predominant ways includes a person sending their wallet file and private key to a user and requesting them to forward the bitcoin to another address.13 The bait for the user is that they will be tempted to retain the bitcoin sent to them and not forward it.14 If they get greedy and end up accepting the wallet, it releases a file that drains all their bitcoins.
One of the major criticisms against cryptocurrency is that it can be used to finance terrorist activities, but it remains highly speculative. Since cryptocurrency is borderless, it can be really attractive for terrorist finances as they can transfer funds across countries in a cheap way. They can avoid legal barriers, which makes it really beneficial for them. The Department of Defense’s Combating Terrorism Support Office stated that there is a risk related with bitcoins and stated that the rise in virtual currency can spread threat finance by increasing anonymity, transnational velocity and efficiency of terrorist attacks.15 Terrorists can hide their financial activities under the garb of anonymity or pseudonymity. Even though the real currency is way better as a medium to finance terrorist activities because it is very difficult to trace the transaction back to the person, certain characteristics of cryptocurrency like speed, cost, security make it a lucrative source to finance such activities.
The anonymity of cryptocurrency has made way for cybercriminals to hold victims’ hard drives hostage to extort payment from them in terms of bitcoins. Even though encrypting someone’s data and holding it hostage for ransom is not a new crime, its payment in digital currency is. These extortion schemes cost the hackers some pennies but their results can be huge due to which this has become a prevalent crime in the digital world. In June 2014, a well-known security blogger posted that it was a “year extortion went mainstream” due to the arrival of cryptocurrency.16 An example of crypto extortion was in June 2014, when various letters of extortion were mailed to some small business enterprises and retailers in California, New Hampshire and Michigan threatening them with everything ranging from negative online reviews on sites like Yelp to anonymous allegations of terrorist activity if they didn’t pay in bitcoins before a stipulated date.17
Exploitation of Women and Children
It is generally agreed upon that cryptocurrency is being used to fund child pornography, sexual exploitation, and human trafficking. Even though credit card companies have blocked the criminals indulging in these crimes, they are pushed to use bitcoins for these transactions because of its anonymity.18 Usually, the children and women who are exploited are from deprived countries around the world and are forced into such crimes. Bitcoins allow human traffickers to buy and sell girls for sex without the fear of legal consequences.19 Child sex trafficking is becoming wide spreading as traffickers believe that they can work anonymously using bitcoins.20
Taking into account all these illegal activities that are solicited through virtual currency owing to the absence of a central regulatory authority, it is imperative to have a body in place that regulates the transactions involving cryptocurrency.
Framework for Regulation
Now that it has been established that there is a need to have a regulatory authority to check the use of cryptocurrency, it calls for a discussion on a regulatory framework that could be put in place to limit the illegitimate uses of digital currency. This section proposes some regulations which are intended to disrupt the use of cryptocurrency for criminal activities but does not impair the potential of the currency. A person who would not engage in criminal activities using normal currency could do so with the help of cryptocurrency due to its feature of anonymity and low cost. Governments could tackle this issue by introducing price regulations imposing costs on dealings in cryptocurrency. For instance, a sales tax could be imposed on some cryptocurrency transactions. The regulatory cost should be conditioned on anonymity. For example, businessmen should be allowed to accept cryptocurrencies by other parties who reveal their identities by signing receipts of the transaction or by using a private identification number. Any cryptocurrency that has not been disclosed should be prohibited.21 This would not increase the cost of using cryptocurrency vis-a-vis normal fiat currency. The framework should also require users who choose to avoid the regulatory cost to provide information just like they would be required to do for other financial accounts.22 The information can be given directly to the businessman or to a third party entity approving transactions for the businessman. This would provide twin benefits as it would deter criminals from using the cryptocurrency platform for carrying out criminal activities, as they would have to be mindful of the regulatory costs and their identity being disclosed.23 The cost-benefit that earlier existed in engaging in illegitimate activities would disappear. Further, if law-abiding users are incentivized to disclose their identities, the entire virtual currency system will become more transparent.
This article discussed the advent of cryptocurrency along with its various benefits and shortcomings. We have seen how it is being ill-used for carrying out criminal activities due to its very features that make it attractive. While there is no doubt about the fact that it is a great innovation and its users who abide by the law are benefitting from it, it is critical to note that the gloomy side has raised more concerns. Therefore, it is essential to have a regulatory authority that can restrict the misuse of cryptocurrency without affecting its potential to be an efficient medium of exchange.
List of citations and references
- International Monetary Fund, Financial System Abuse, Financial Crime and Money Laundering- Background Paper (February 12, 2001), 10.
- Beyond the Silk Road: Potential Risks, Threats and Promises of Virtual Currencies: Hearing before the Senate Committee on Homeland Security and Governmental Affairs (November 18, 2013)
- United States Government Accountability Office, Virtual Currencies: Emerging Regulatory, Law Enforcement, and Consumer Protection Challenges, 30
- What is the Threat of Money Laundering Associated with Bitcoin?”.
- Alex Hern, “A history of bitcoin hacks,” The Guardian, March 18, 2014.
- “Theft forces Bitcoin firm offline,” BBC News, September 5, 2012.
- Richard Boase, “Hackers steal $1.2 Million of bitcoins from Inputs.io, a supposedly secure wallet service,” CoinDesk, November 17, 2013.
- Hern, “A history of bitcoin hacks.”
- Consumer Financial Protection Bureau Consumer Advisory, Risks to consumers posed by virtual currencies, 2-5.
- “Investor Alert: Ponzi Schemes Using Virtual Currencies” U.S. Securities and Exchange Commission (7 May 2014).
- Nermin Hajdarbegovic, “World Bank Report: Bitcoin is a ‘naturally occurring’ Ponzi,” CoinDesk, July 17 2014.
- Supra note 10.
- Kadhim Shubber, “Hook, line, and sinker: how to avoid bitcoin phishing scams,” CoinDesk, June 14, 2014.
- PJ Delaney, “Will Bitcoin Be Used to Fund Terrorism?” Crypto Coins News, August 13, 2014.
- Brian Krebs, “2014: The Year Extortion Went Mainstream,” Krebs on Security, June 26, 2014.
- “Businesses Fear – ‘Bitcoin Extortion,’ but BBB ratings are safe from the new threat,” Council of Better Business Bureaus, July 2, 2014.
- Ernie Allen (President and CEO, International Centre for Missing & Exploited Children), interview with the authors, August 26, 2014.
- Michelle Lillie, “Bitcoin fuels the human trafficking market,” HumanTraffickingSearch.net, April 22, 2014.
- Kevin Grasha, “Sex trafficking of minors a ‘growing problem,’ Lansing State Journal, 3 Oct 2014.
- Omri Marian, A Conceptual Framework for the Regulation of Cryptocurrencies
- Supra note 21
The Author, Mitali Arora, is a law student in O.P. Jindal Global University
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