The Dark Side of Crypto

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29 Dec 2023

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Despite the revolutionary potential of cryptocurrencies, the technology is sadly being leveraged by some malicious, criminal, and fraudulent entities. There is a dark side, where despite the natural transparency of the blockchain, money laundering is prevalent and perilous.
We’ll explore how anonymity and decentralization provide fertile ground for illicit financial activity, whilst also showing how this issue is far more complicated to solve than may appear on the surface.

How Cryptocurrencies Can Be Used for Money Laundering

Money laundering with crypto is the process of taking illegally obtained money, turning it into digital currencies, obscuring the origin, and then sending the coins on a digital journey that is hard to trace, before withdrawing it as clean and legitimate funds.
Here’s an example of how the process could look*:

Illegal funds go on-chain, either through cash purchases of crypto, the use of peer-to-peer exchanges to buy coins, or exploiting security vulnerabilities to onboard with centralized crypto exchanges
Transactions begin with the intention of distancing the funds from the original source, which can be achieved through complex movements via certain wallets or exchange services, or by utilizing coin mixing services to hide the trail. Some criminals may even purchase privacy coins such as Monero to hide their on-chain activities
After being moved, hidden, and “washed”, the clean funds re-enter the traditional financial system in the form of fiat currency or other assets. If the laundering process was done efficiently, law enforcement would find it challenging or impossible to track the origins of the funds

*Of course, this is not financial advice and you should never launder money
Mixing services, privacy coins, and decentralized exchanges are often pointed at as perfect hideouts for cybercriminals, however, it’s important to remember that plenty of legitimate people use their services too. Rather than outright banning these services and trying to wipe them out of existence (which would only create multiple new alternatives in their place), crypto regulators and analytics companies are instead attempting to advance their own tech capabilities. This will help to identify the bad guys and counteract their illicit activities.

Challenges Tracking Illicit Transactions on the Blockchain

If transactions are all tracked on the blockchain, why is it so hard to trace who is making them and source them back to their origin?
Here’s why:

Anonymity: Rather than using your name and other personal identifiers, cryptocurrency moves between cryptographic alphanumeric wallet addresses that allow their users to remain anonymous
Mixing Services: Mixers allow users to deposit and pool their crypto funds, which are then fragmented, shuffled, and redistributed in a “clean” way. They’re no longer the same funds that were deposited, and the connection between the original depositor and the destination is severed
Decentralization: The design of decentralized finance and the ideals that it was built on, which stop any single entity from having absolute oversight or control, make tracking and identifying criminals inherently difficult. Consider also how complex decentralized data is, and how advanced your knowledge and tools must be to sift through tonnes of cryptographic data to uncover any useful or incriminating information
24/7, 365, Borderless: Crypto is hard at work everywhere, all the time, and without restriction. The scale of crypto and its global nature makes it very difficult for law enforcement agencies not only to trace illicit funds back to criminals but to enforce regulations or collaborate with international law enforcement agencies. Consider also the difference in laws and regulations and this issue is only amplified
Criminal Adaptation: Every time regulations and analytics companies improve their tech, the criminals do too, doing their best to keep several steps ahead. This is because some cryptographers and blockchain developers sadly chose to join the dark side…

The job of those tracking illegal transactions appears much more difficult than those making them.

Regulatory Efforts to Combat Money Laundering

Anti-money laundering (AML) regulations are the main tool used by cryptocurrency exchanges and services to combat criminal activity. What can be agreed by almost all investors, traders, enthusiasts, and probably criminals too, is that AML is woefully inadequate in tackling crypto-crime.
In 2024, expect to see governments around the world doing more to tackle coin mixing services, which have been identified as the single biggest aid to money launderers washing their cryptocurrencies. US-based Tornado Cash is the most high-profile platform to already be banned, with Blender.io also being banned after being used extensively by North Korean hackers.

Blockchain Forensics and Investigative Tools

Here are some of the most popular forensics and investigative tools for tracing transactions and taking down money launderers:

Case Studies and Notable Alleged Money Laundering Incidents

Here are some of the biggest and most audacious alleged money laundering incidents in crypto.

Plus Token Ponzi Scheme

Back in 2019, Plus Token, a fraudulent cryptocurrency investment program disguised as a high-return scheme, collapsed, leaving executives to run away with around $3 billion in crypto. The scam significantly impacted Bitcoin's value and this huge amount constituted 64% of all crypto crime volume at that time.

Good news: Fortunately, investigators caught the ringleaders and in December 2020 they were sentenced to 11 years in prison. More than 100 people were arrested in the enormous investigations that followed this huge hack
Bad News: Almost none of the funds were ever recovered or returned to the millions of scammed investors

KuCoin Hacking

In 2020, more than $275m worth of crypto was hacked from KuCoin, with Bitcoin, Ethereum, and several ERC-20 tokens being stolen from hot wallets. The blame was placed on KuCoin’s weak security and storage strategies.

Good news: 84% of the funds were recovered and redistributed
Bad news: The remaining 16% were laundered and remain untraced

OneCoin Scandal

The OneCoin scandal was one of the most infamous cryptocurrency scams in history, with around $4bn being stolen. Founded by Ruja Ignatova in 2014, OneCoin marketed itself as a revolutionary cryptocurrency investment opportunity but was, in reality, a multi-level marketing scheme (Ponzi) that offered imaginary high returns and easy wealth to investors. Once the jig was up, the higher-level execs did their best to disappear under new identities.

Bad news: Ruja Ignatova was never found and has become known notoriously as “The Missing Crypto Queen” and the subject of documentaries and podcasts. Less than 10% of the stolen $4 billion has been recovered
Good news: Co-Founder Sebastian Greenwood was caught and jailed

Silk Road Scandal

The Silk Road was a notorious dark web marketplace operated by Ross Ulbricht. The site facilitated extensive illegal drug and weapons trade, human trafficking, and assassinations, all while using cryptocurrency to complete transactions and launder funds. When Ulbricht was arrested in 2013, he had amassed hundreds of millions of dollars in illicit funds.

Bad News: More than $200m was laundered through the Silk Road
Good News: Ulbricht was sentenced to double life imprisonment plus 40 years, without the possibility of parole, as well as having to pay $183 million in restitution, based on the total sales of illegal drugs and counterfeit IDs

Do you enjoy reading these stories? Here are a few more worth looking into:

BitConnect
Bitclub Network
Terra / LUNA (Do Kwon’s Serbian adventures are very interesting)
FTX / Alameda (We opted not to cover this as it’s still very much ongoing)
Axie Infinity
Thodex
Pincoin
SushiSwap

The Future of Combating Crypto Money Laundering

Every year the cryptocurrency industry changes in unforeseen ways. The technology jumps two steps forward. Hackers, scammers, and rug-pullers drag us one step back. Each time cryptocurrency receives some mainstream adoption and institutional or governmental support, some major disaster comes along to provide frustration and friction (FTX, Celsius, BlockFi…).
The future is a mystery that will demand a concerted effort from legitimate entities to drive decentralized technology and analytics forward, to improve regulations and frameworks, to improve collaboration between international law enforcement agencies, and to develop better preventative measures and education.
Cohesion is key to taking down the bad guys and ending money laundering - if such an outcome is ever possible.

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