“This study aimed to identify where individuals turn in order to cash out or transmit bitcoins (BTC) acquired from illicit entities and to discover typologies for criminals ‘laundering’ bitcoins,” the report says.
The study
describes bitcoin laundering as a special type of money laundering that exists within the Bitcoin network where a user moves some bitcoins to a new address in a manner that obscures the original source of funds. The conversion of bitcoins into fiat currency on exchanges that lack adequate anti-money laundering (AML) and know-your-customer (KYC) policies can also fall under the category of bitcoin laundering.
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In addition to describing the common mechanisms for bitcoin laundering and explaining that this sort of activity is a small percentage of all transactions sent to exchanges and other conversion services, the study also offers some recommendations for law enforcement in terms of preventing the masking of illicit funds on the Bitcoin network.
It should go without saying that any study related to the dark web or illicit use of the Bitcoin network needs to be taken with a grain of salt because avoiding detection is the whole reason for a criminal to use these sorts of platforms in the first place.
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Much of the study, which is titled “Bitcoin Laundering: An Analysis of Illicit Flows Into Digital Currency Services,” revolves around the use of “conversion services.” Conversion services are basically platforms where users convert bitcoins to fiat currency (a Bitcoin exchange) or another cryptocurrency (a cryptoexchange), or move the bitcoins to another Bitcoin address accessible to the user. This results in a flow of funds that cannot be viewed or traced directly on the public blockchain
< script> (adsbygoogle = window.adsbygoogle || []).push({}); According to the study, darknet markets are the main source of funds that are sent to conversion services in bitcoin laundering attempts.
Additionally, the number of illicit services that could be the source of “dirty bitcoins” sent to a conversion service increased fivefold from 2013 to 2016. Having said that, the study finds that the sources of illicit funds entering conversion services are quite centralized.
“Only a small number of entities account for the majority of illicit activity in our sample,” the study says. “Nine of the 102 illicit entities were the source of more than 95 percent of all laundered bitcoins in our study. All nine were darknet marketplaces.”
While exchanges are the most commonly used type of conversion service, bitcoin mixers and gambling sites have much more illicit funds coming into their platforms as a percentage of their overall transactions. As potential conduits for bitcoin laundering, these two types of conversion services benefit from concealing their country of operations and avoiding enforcement of AML regulations.
“Fewer than 10 percent of all transactions overall passed through unknown jurisdictions ... while 52 percent of illicit laundering went through them,” the study says.
Much like the sources of illicit funds, the conversion services where these funds are sent are also highly centralized, the study finds. The data indicates that 97 percent of illicit transaction volume at mixers and gambling sites goes through three different entities. Additionally, two platforms in Europe account for half of all illicit transfers that go into exchanges.
Not Much Bitcoin Laundering Activity Overall, and It’s on the Decline
Another notable aspect of the study is that the data indicates a low level of bitcoin laundering as a percentage of all payments sent to conversion services.
“The amount of observed Bitcoin laundering was small (less than one percent of all transactions entering conversion services),” notes the study.
The report clarifies that the actual volume of illicit Bitcoin transactions sent to conversion services is “almost surely to be significantly larger” than what the data in the study shows because intermediate transactions are not counted. In other words, the report only covers transactions made directly from an illicit source, such as a darknet market, to a conversion service.
The study also indicates a decrease in illicit Bitcoin transaction volume going to conversion services over time.
“It is likely that illicit bitcoins fell as a percentage of total volume entering conversion services due to the cryptocurrency’s increasing popularity as a speculative investment as well as new laundering techniques,” the study says. “The drop may also reflect better AML/CFT compliance by conversion services, including the use of blockchain analysis services to determine customers’ source of funds.”
The study later adds, “Our study, the first of its kind, indicates that while most types of conversion services have received some bitcoins from illicit activity, the vast majority of the funds they receive do not appear to be illicit.”
Recommendations for Law Enforcement That Will Likely Fall Short
The report offers recommendations for law enforcement in terms of what they can do to combat the effectiveness of bitcoin laundering.
First, the study says proper KYC and AML policies need to be enforced on the bitcoin mixers and gambling sites that allow for anonymous usage. It notes that the three conversion services that account for 97 percent of bitcoin laundering on these types of platforms should be targeted by financial authorities.
“The fact that most mixers and gambling sites hide their location of operations indicates they probably seek to evade the basic regulations in place to uphold transparency and financial integrity standards in most jurisdictions,” adds the study.
Of course, it should be noted that targeting these sorts of services will become nearly impossible as they become more decentralized over time. Decentralized platforms like JoinMarket, TumbleBit and ZeroLinkremove the ability for authorities to clamp down on bitcoin mixing in an effective manner, as these solutions act more as software than services.
Second, the report also calls for increased AML and KYC compliance at European exchanges.
“Many large European Bitcoin exchanges do implement robust AML policies,” says the study. “However, this is out of choice rather than obligation, and there are some who choose not to, possibly to attract business from criminals.”
The study adds that the European Union is already moving in the right direction via an update of their 2015 Anti-Money Laundering Directive to include fiat-to-cryptocurrency exchanges, but in the view of the authors of the paper, crypto-to-crypto exchanges must also be regulated in this manner.
Again, it needs to be pointed out that more problematic technology — at least from law enforcement’s point of view — is on the horizon in the form of decentralized cryptoexchanges. Through the use of cross-chain atomic swaps via the lightning network, users will be able to instantly trade between different cryptoassets without the need for a trusted third party.
Third, the study calls for a sort of propaganda campaign against the use of darknet markets by criminals and the general public at large.
“Law enforcement should increase customer skepticism about [darknet market] sites’ integrity and reduce the perceived security of such platforms by exposing their vulnerabilities publicly,” says the study.
The report adds that law enforcement should make it well known that they’re lurking on these darknet markets to further shake confidence in them.
Darknet markets are another area of the Bitcoin ecosystem that are becoming more decentralized through platforms such as OpenBazaar. While illicit activity on the OpenBazaarnetwork appears to be limited at this time, it could potentially explode in popularity as a reaction to law enforcement’s hypothetical campaigns against the centralized darknet markets.
Fourth, the report praises the decision by financial authorities in the United States to regulate exchanges as Money Service Businesses. The authors of the paper would like to see this sort of policy rolled out worldwide.
Last, the study notes the need to prevent the illicit use of bitcoin and other cryptocurrencies to get around economic sanctions imposed by the United States or other nations.
“In addition to mitigating illicit finance risks like criminal money laundering, there will likely be a need to develop strategies to counter state actors aiming to use cryptocurrencies to circumvent U.S., EU, and UN sanctions.”
Recently, there have been reports of North Korea, Russia and Venezuela all looking into separate mechanisms for avoiding economic sanctions through the use of cryptocurrencies.
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