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BLOG: Cryptocurrency in Financial Crime

19/02/2020

Tom Edwards examines the rise of cryptocurrency and its impact on the criminal justice system, including the regulation of cryptocurrency and the implications for practitioners in criminal cases.


Bitcoin is something that now almost everyone will have heard of. Other cryptocurrencies are on the rise and increasingly commonplace both in the news and now, in practice. We have all heard stories of the vast profits that supposedly be made from trading them, and of individuals becoming “Bitcoin Millionaires”.

Leaving aside obvious frauds such as the OneCoin saga, recently there has been a global trend towards the use of cryptocurrencies in the criminal fraternity. Turning their backs on cash, there are obvious advantages to criminals in using cryptocurrencies as opposed to cash or fiat currencies.

This article looks at the rise of the cryptocurrency, some of its major uses and highlights possible implications for those practising in criminal law. It also considers the impact of the Fifth European Anti-Money Laundering Directive and its introduction into English law.

What is a cryptocurrency?

Crypto means hidden or secret. We all know what a currency means. Cryptocurrencies come in many different “brands” with Bitcoin probably the most well-known. This year was set to be the year we would see the Libra implemented, the brainchild of Mark Zuckerberg. This was prior to his acceptance that Facebook may not be the best vehicle through which to launch the new online currency. Many of the main parties involved in the launch project (including Visa, Mastercard and Paypal) subsequently pulled out. In funding and sponsoring terrorist activities Al-Qaeda favoured the use of Z-cash. Silk Road, the infamous dark web drug supply website, accepted cryptocurrencies as payment in order to provide their customers with greater anonymity than were available from other payment services such as Visa or Paypal.

Increasingly, criminals are turning to cryptocurrencies as their choice of currency. In August last year three men were found guilty of drugs supply charges at Aylesbury Crown Court. Drugs had been sold across the world, including as far afield as Australia. Police were initially tipped off by the FBI. Much of the money used to pay for the drugs was transacted in Bitcoin. With more young people looking online to buy drugs, accepting cryptocurrencies as payment meets their needs in a more digitised age. The anonymity provided and ease of transfer, as compared with the difficulties involved in laundering large amounts of cash, make it easy to see why it is an attractive option to criminals.

In addition, up until recently, cryptocurrencies were completely unregulated. Unlike cash they are not underwritten by a government or secured against a reserve. There is no regulation associated with their creation, making them easily accessible to all. They are also incredibly secure. The complexity involved in their creation, relying on highly sophisticated algorithms, blockchains (a complex system of creation), servers (or nodes) and users means that they are extremely difficult to replicate.

Whilst all the above may sound good (particularly to a would-be criminal) there are down sides. The currency is highly volatile. Within the last ten years the pound dipped by seven per cent on its worst day (the pound’s crash being the day after the Brexit referendum), oil by 10 per cent. By contrast Bitcoin’s worst day saw it fall by twenty-five per cent. Other cryptocurrencies are even more volatile.

Some are the Emperor’s new clothes. Karatbars, launched in 2011 was ordered last year to be wound up. Heavily promoted by famous footballers, the currency’s stability was guaranteed by a goldmine in Madagascar, listed in the company’s assets. Unfortunately the mine was reported not to contain any gold.   Another scheme in Canada, Quadriga CX, lost $190m when the scheme’s founder died, he being the only person with the passwords to unlock the digital wallets where the money was held. The firm operating the scheme have since gone bankrupt. In total last year saw a 150% rise in fraud associated with cryptocurrencies.

Its other major drawback is its lack of liquidity. A transaction carried out via a crypto-currency can take days to convert or exchange. That is compared to seconds with a fiat currency. Converting a cryptocurrency into something that the average person can spend is therefore less than easy. (They are not accepted at the supermarket.) It takes great effort to change a currency such as Bitcoin into pounds sterling. Banks and other organisations have strict rules on how much they can accept and convert.  

Why are they problematic?

There is nothing inherently wrong or illegal in many of these cryptocurrencies but, their increased use poses problems. In addition to the significant rise in losses reported last year, it is estimated that many lower value frauds would have gone unreported. Bitcoin is the favoured currency on the dark web, where criminal activity is rife.  The forms in which it can be used in criminal activity are many: “laundering dirty money, scamming victims out of funds, defrauding investors, monetizing ransomware software or buying illicit goods” are all cited as uses to which the money is put by online criminals. Martin Lewis (of Money Saving Expert.com) had his face used unlawfully to fraudulently advertise the sale of cryptocurrency online.

They are also relatively easy to launder. Cash is bulky, requires physical transport has huge associated risks if the launderer is found in possession of the money. Money in bank accounts can easily be traced and has long been subject to anti-money laundering regulation. By contrast it is relatively easy to launder cryptocurrency to those in the know. Tumbling (a complex process involving transferring through Tor and dark web wallets to complete a process called “hopping”) and simply laundering through unregulated exchanges can clean the money with minimal intervention or means of being traced.

It is estimated that countries without anti-money laundering procedures (AMLPs) receive thirty-six times more Bitcoin than those with AMLPs. That’s almost 97% of bitcoin going through unregulated countries as opposed to regulated ones. Karatbars was registered in Belize.

As a result cryptocurrencies do pose a threat to governments and currency stability due to their frequent use in criminal activities. A recent study published for the European Parliament estimated a cost of 7 billion euros worldwide. Attempts are being made to address this. The biggest threat identified is the anonymity provided by their use. Instructional videos are freely available on YouTube. Tax evasion is all the easier if an asset’s ownership cannot be identified. Even if in some cases an asset can be identified, the cost of ascertaining that information is often prohibitive. Jurisdiction is yet a further hurdle faced by the authorities. It also makes enforcement (for example of a confiscation order) nigh on impossible. As so often, it seems that the criminals are one step ahead of the game.

What has the government done about them?

As a result of the above, the EU has issued a new directive 2018/843 on the prevention of money laundering and terrorist financing (“5AMLD” for short). This makes specific reference to the increased use of cryptocurrencies in terrorist funding which, at the time of drafting, were not caught by anti money laundering provisions. Its stated aim was both prevention and detection. The UK has now enacted the directive in The Money Laundering and Terrorist Finance Regulations 2019. By regulation 13 a crypto-asset is defined as “a cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically”.

The regulations make it compulsory for any provider of exchanges for crypto-currencies to apply the usual due diligence procedures, applying to people, companies, trusts and other organisations so that the true beneficial ownership of such crypto-currencies can be identified. Enhanced due diligence will apply when dealing with high-risk customers as well as an obligation to report suspicious activity. Digital wallet providers and exchanges will now also be subject to registration for the purposes of compliance. That said, compliance across small to medium sized companies is not expected to be widespread for some years yet due to extent of the obligations that will need to be met.

Implications for practitioners

With cases involving cryptocurrencies already coming before the court and with the dramatic rise in crime associated with them, they can’t be far from becoming a more regular feature of our day-to-day practices. Costs to the public purse may be the only block on seeing them becoming even more of a feature. I have barely outlined the complex process of the creation and issuing of money in a given cryptocurrency but, if there is an issue in a case as to their ownership or value, practitioners will need to have a good understanding of the currencies. Experts will need to be almost routinely engaged.

One area where there will be clear implications will be in POCA proceedings. Cryptocurrencies will fall to be declared as assets which can and should form part of any confiscation order. In this instance the value of those assets may be critical to a defendant. Given the comparative volatility and flux of all cryptocurrencies, the value of them will need to be assessed regularly, even on the day of any hearing itself. What may seem to a financial investigator to be a silk purse may in fact be a sow’s ear and vice-versa.

Only time will tell as to what, if any further regulation is imposed on the use of cryptocurrencies. Whilst it cannot be in doubt that their use by the criminal underworld is increasing, it may be that the costs of detection and investigation are significant factors deterring investigators from prosecution. How their use is dealt with inside of the courtroom remains to be seen.

19/02/2020

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