The criminal and political risks of digital currencies
- One of the most prominent technologies in the past year has been the digital currency market and its accompanying technology known as blockchain.
- Its exponential growth has attracted global attention, from government regulators and major businesses to organised criminal syndicates and lone hackers.
- While its high investment risks are well-documented, this report seeks to analyse the political and criminal risks that lurk within this new system of digital transactions.
Bitcoin, the first decentralised cryptocurrency, began operating in January 2009 and remains the dominant and largest cryptocurrency in terms of market capitalisation. Apart from Bitcoin, more than a thousand other cryptocurrencies have emerged, such as Ethereum and LiteCoin. At the heart of these cryptocurrencies is blockchain, a type of public distributed ledger that allows participants in a specific network to transfer digital files and verify the integrity of the database without relying on a central authority. Each participant can independently audit the database at a specific moment. Proponents of blockchain extol its benefits as a crime-fighting tool. Its key innovation is the creation of a transparent, auditable log of transaction records. Several benefits associated with this include the elimination of unauthorised transfers and fraudulent activities as participants can immediately identify and reject data irregularities. Though the users of blockchain are anonymous, all transactions are traceable, thanks to their unique digital footprint. Any updates to the database must receive consensus approval from participants. This can improve transparency and accountability in supply chains to streamline business processes. New developments have largely separated the currency from the technology. In the art and diamonds markets, blockchain is already being used to secure provenance. This has reduced the trade in conflict diamonds and created a process to track the transfer of ownership of artworks. U.S. retail corporate Wal-Mart Stores and U.S. financial services company Visa are testing blockchain to streamline their supply chains, speed up payments and store records. U.S. technology firm IBM was one of the first big companies to move into the sector, seeing opportunities for supply chain security in sectors from shipping to food safety. Meanwhile, cryptocurrency is experiencing huge volatility in exchanges, where they are bought, sold and traded. However, digital currencies are also being used for a number of illegal activities, both by nation states and criminal groups. This carries political and reputational risks for legitimate entities seeking to harness the new technology and payment methods.
Money-launderingWhile governments recognise the potential positive applications of blockchain technology, national regulators tend to view the combination of using blockchain with digital currencies with suspicion. This is because the anonymity given by the blockchain could allow money-launderers to hide their transactions or to access cash. However, the European Commission found that the threat of money-laundering through virtual currencies is currently overstated: to launder money in this way requires a high level of technological expertise. It appears that criminal groups within the E.U. still lack the ability to master the technology. Nonetheless, this will not remain the case, as organised criminal groups are generally highly innovative; a recent police operation revealed that a family within the Italian Ndràngheta had been encrypting spoken and written communications. Encrypting transactions is a likely evolution.
Illicit goodsDigital currencies can be used for simpler criminal means. Australia blames virtual currencies for a rise in organised crime, claiming that criminal syndicates use Bitcoin and its rivals as tender for illicit goods. Silk Road, the worlds first darknet market, ran on Bitcoin. This is currently the key crime risk associated with using cryptocurrency. Businesses could face mounting reputational risk merely through their association with virtual currencies that are being used to purchase illegal goods such as weapons and narcotics.
Pyramid schemesVirtual currencies have also become the focus of a number of Ponzi schemes targeting unsuspecting customers. Fraudulent cryptocurrency exchange platforms generate returns for older investors from the funds contributed by the newest investors. The U.S. Securities and Exchange Commission (SEC) issued an alert warning investors of unregulated trading platforms in which potential investors are promised high returns in a virtual currency after buying into the scheme with a conventional currency. In 2016, an American man was found guilty of running a USD4.5 million Ponzi scheme, in the first ever SEC cryptocurrency prosecution. Law enforcement agencies are particularly concerned by initial coin offerings (ICOs). An ICO typically involves selling units of a digital platform, rather than stakes in a company, to raise funds for a project. Though in itself an ICO is not a pyramid or Ponzi scheme, it is a highly unregulated process and carries with it a high financial and crime risk. Many unsuspecting would-be investors are vulnerable to investing in a cryptocurrency with a much lower value than the broker claims. To some, including the central bank governors of Russia and Kenya, virtual currencies themselves are pyramid schemes, due to their unregulated nature. This suspicious attitude is likely to prevail over the long term, and regulation will likely lag far behind the development and usage of cryptocurrencies.
Proponents of digital currencies commonly praise its anonymity, transparency and efficiency. Apart from using it as a payment mode, governments and individuals in politically isolated countries also recognise that they could capitalise on these benefits in other ways.