Report: An Analysis of Bitcoin’s Use in Illicit Finance

The Cipher Brief is publishing the full report, with permission.

As I saw firsthand in my 33-year career at the Central Intelligence Agency, the process our government uses to get this balance right can often be frustratingly slow, but it has ultimately and typically met the challenge.

One example is how our government has adjusted to technological advances in financial and payment networks while simultaneously safeguarding vital systems.  Online banking was introduced in 1994, but it was not until 1999, with passage of the Uniform Electronic Transfers Act , that standards were put in place to establish the legality of electronic documents and signatures.

Having devoted my career to protecting and advancing the national security interests of the United States, I recognize the importance of ensuring that technological advancements related to critical industries are accompanied by smart, informed, and timely adjustments to regulatory frameworks, policies, and laws.

It is against this backdrop that I, and two of my colleagues from Beacon Global Strategies, conducted an analysis regarding the degree of illicit activity associated with cryptocurrencies in general and Bitcoin in particular.

Large banks are providing Bitcoin related services, with Morgan Stanley saying it will soon offer access to three Bitcoin funds for its wealth management clients.

AlphaBay, formed in 2014 and widely viewed as an heir to Silk Road, was shuttered by international authorities in 2017 after building a customer base of over 400,000, with transactions conducted largely in Bitcoin.

The conventional wisdom on this issue has been reinforced by public statements from senior government officials on both sides of the Atlantic who have suggested that Bitcoin is used primarily for illicit activities.

In undertaking our analysis, we consulted a diverse group of experts in the fields of cryptocurrency technology and investment, financial services, payment systems, global intelligence and security, financial regulation, and law enforcement.

And I assumed that those officials who have raised concerns about the use of Bitcoin in illicit activity—with the objective of ensuring regulatory vigilance—must be among the best-informed experts on this issue.

But digging deeper, their statements center on two assertions: First, that Bitcoin is used “frequently” or “primarily” for illicit financial transactions, and second, that the use of Bitcoin in such transactions is growing.

According to a recent study by blockchain analytics firm Chainalysis, illicit activity among all cryptocurrencies as a percent of total cryptocurrency activity from 2017 to 2020 was less than 1 percent.

Meanwhile, estimates of illicit activity in the economy as a whole, overwhelmingly conducted through traditional financial intermediaries and with traditional fiat currencies, are on the order of 2 to 4 percent of global GDP.

A former CIA analyst added credence to the above estimates, telling us that, due in part to the difference in overall volume, most illicit activity still takes place in the traditional banking system and not via cryptocurrency.

However, the firms we spoke with believe the unseen illicit activity is relatively small.

According to the Chainalysis study, the two most significant types of illicit activity are those related to “simple” scams and purchases on the dark web.

On the key issue of terrorist financing, the former CIA terrorism expert believes that the hype is much greater than the reality and that cryptocurrency is not yet an important platform for terrorist organizations.

However, two major cryptocurrency analytics firms have concluded that this is due to Bitcoin’s dominance in the market and, therefore, its accessibility, not because it has attributes that make it more attractive to illicit users.

And while Bitcoin is the cryptocurrency most used in illicit activity, other cryptocurrencies are used far more often for illicit purposes as a share of their total transactions.

There is also mounting evidence that illicit activity is flowing away from Bitcoin and toward AECs.

Blockchain technology is a powerful but underutilized forensic tool for governments to identify illicit activity and bring criminals to justice.

In a February 2021 testimony before the House Subcommittee on National Security, International Development and Monetary Policy, former Assistant Secretary of the Treasury for Terrorist Financing and Financial Crimes Daniel Glaser stated that, when it comes to transparency in the international financial system and the domestic financial system, “cryptocurrencies provide enhanced opportunities in certain ways for law enforcement agencies to be able to trace transactions”.

Another went so far as to say that “if all criminals used blockchain, we could wipe out illicit financial activity.”  In fact, its transparent nature led one blockchain analytics expert to compare transactions on blockchain to having the “whole world” be a witness to paying someone $2,000 in a dark alley.

When viewed together with other data derived from the analysis of blockchain analytics as well as traditional law enforcement tools like subpoenas, blockchain technology can allow for the identification of both illicit activity and the identities of end users.

Broader enforcement of Know Your Customer still have “weak or porous KYC processes”.

Although DEXs are responsible for only a small portion of overall cryptocurrency transaction volume, their decentralized, mostly open-source nature adds an additional layer of anonymity and thus offers increased opportunities for moving illicit funds.

Like other illicit activities, such as the use of performance enhancing drugs in athletics, authorities are constantly working to catch up to new masking techniques used by illicit actors.

Finally, in December 2020, cryptocurrency forensics software was even able to reliably trace stolen Bitcoin that had been passed through several coin mixers.

First, it can be used as an investigative tool in existing cases; law enforcement can use the blockchain to uncover the illicit activity of the target of an investigation .

While there is a growing cadre of government officials who have successfully used blockchain analytic tools to prosecute bad actors and seize illicit proceeds, relatively few current government employees have the skills to use this technology to its full potential.

One expert went even further, saying that the biggest threat involving cryptocurrencies is not illicit finance but rather that governments do not yet fully understand the power of blockchain as a tool for law enforcement and intelligence agencies.

This gradual recognition helps explain the number of significant legal cases that have been broken through the use of blockchain analysis.

In the July 2020 breach of Twitter’s network, when over 100 high-profile accounts were hacked to promote a scam asking followers for Bitcoin, it took only two weeks for investigators to identify the perpetrators and make arrests.

Finally, in late 2020, the law firm Kobre & Kim was able to use blockchain analysis to trace and retrieve $32 million in cryptocurrency that had been passed through coin mixers.

And as more seizures and arrests are made, we believe illicit actors—who are technology-agnostic—will continue to move away from using Bitcoin for money laundering purposes to other avenues that make it easier for them to hide their activities.

In light of the conclusions we have reached, why do we see such alarmist statements and articles about the threat posed by Bitcoin?  There are several reasons.

We need to reevaluate these sorts of stories by recognizing that it was the transparent nature of the blockchain that allowed law enforcement to so quickly identify the trail of illicit payments, whereas such payments made through the traditional financial system might have proven more difficult to trace.

The same could have been said for electronic banking and e-signatures 20 years ago, which stirred up significant debate regarding consumer protection and integrity of the financial system.

My hope with this paper is not that it will be the final word on the issue of Bitcoin and illicit finance but rather, as I noted in the introduction, that it will lead to a more fact-based discussion of the issue.

…Read the full story