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Margaret Cullum

Money laundering is obviously a hot topic surrounding bitcoin and other digital currencies. With the conviction of Ross Ulbricht, we know that law enforcement has taken a major interest in the area.   Legitimate businesses need to be concerned with the possibility of money laundering, as it can present a major risk to the company, both civilly and criminally. A report was released by Europol this week citing digital currencies as an important component of their new model of organized crime.[1]

When most people think of money laundering, they imagine someone taking a suitcase full of cash to a shady, off-shore bank. What I will call “traditional” money laundering schemes are, in fact, usually much more complex. They involve many “layers,”[2] which help obfuscate the origin of the money. In some ways digital currency laundering functions in a similar way. However, I believe that digital currency money laundering is both easier to accomplish and more difficult to detect.

Much has been made of both the pseudo-anonymity of bitcoin and also the transparency of its transactions through the blockchain. However, as in traditional money laundering investigations, law enforcement will rely on traditional law enforcement tools, like subpoenas and search warrants, to obtain the identities of users.  What they actually get from those records will only be as helpful as the company wants them to be. By this, I simply mean that legitimate businesses, particularly if they are Money Services Businesses,[3] need to have strong anti-money laundering (AML) programs in place. If the FBI subpoenas the records of your users, they need to have actual identifying information. As we all know, you cannot just walk into a bank and open an account without any identification. Banks and other traditional financial institutions have “Know Your Customer” (KYC) programs as part of the overall AML program because of the risk that money laundering presents.

While the motive behind creating many of these digital currencies may be to promote privacy and keep currency decentralized, taking those ideals too far is dangerous for digital currency companies because they risk being drawn into a criminal investigation. If the FBI thinks your records are lacking or you are being uncooperative, red flags will go up. From there, you may become a target in the investigation. They may point to a concept called “willful blindness.” Basically, you knew something suspicious was going on, but instead of investigating the problem, you just ignored it. And while there may not be proof that you yourself actually laundered money, there will probably be enough evidence for you and other employees of the company to at least be indicted for conspiracy to launder money. As I pointed out in an earlier blog post,[4] conspiracy is a favorite among federal prosecutors because it carries large penalties but the underlying crime does not have to be proved.[5] Conspiracy to launder money carries a penalty of up to 20 years in prison and $500,000 fine. Furthermore, the economic and brand ramifications of even an indictment can be incredibly costly and irreversible. Upon receipt of a criminal subpoena, you should have a criminal attorney review it and advise you as to how you should respond. You will probably end up cooperating with the feds, but you need to make sure that you have protected yourself and your users from any other kind of liability. If the FBI shows up with a search warrant, that means you are most likely a target of an investigation, and you should call a criminal attorney immediately.

But even in situations where there are no records—there is just the blockchain with its ebb and flow of public transactions, law enforcement may be able to identify users. Computer scientists have used what’s called “clustering” analysis to identify users based solely on their addresses in the blockchain.[6] I will not try to explain their methods; I became a lawyer to avoid anything involving complex math. This may seem a bit too sophisticated (or expensive) for the feds, but, remember, they are also concerned about digital currencies being used for terrorist financing. Counterterrorism obviously gets an enormous amount of funding, and I could easily imagine the NSA doing this type of analysis.

But criminals being criminals, they have figured out ways to work around this problem. The most obvious way is to simply use a different digital currency, like darkcoin, and a dark wallet. But since we’re primarily concerned with bitcoin, criminals have come up with a new way to layer the transactions. Bitcoin laundries or tumblers are now available in which one uses an intermediary to conduct the transaction, similar to some of the layering that occurs in traditional money laundering. Let’s say that User A wants to buy a grenade launcher off of the (now defunct) Silk Road. The blockchain will show that User A has sent User B 0.5 BTC. User B, the tumbler or laundry, will then pool all of the bitcoin from all of its users into one account. User B then sends a different amount to the Silk Road, but obviously enough to cover the price of the grenade launcher. So essentially, there is no one-to-one transaction that can be traced. The origin and the destination are muddled by the intermediary, as with traditional money laundering. However, with digital currencies, the danger is that with the speed and sophistication of computers this type of layering won’t just occur a few times—it will occur thousands of times before the bitcoin reaches its ultimate destination. For example, what if a mining outfit were turned into a laundry?

Needless to say, I think the best advice I can give is to have a strong AML program, investigate suspicious activity, and not accept transactions involving bitcoin laundries or tumblers. I would also keep tabs on employees, as many money laundering schemes tend to involve a so-called “inside man.” I’m not sure what the solution will be to control the dangers of money laundering, but I know that the government’s response will be to create many more regulations.

 

This post is meant for informational purposes only; it should not be construed as specific legal advice. If you have a legal issue, please consult an attorney.

 

[1] “Exploring Tomorrow’s Organised Crime,” available at https://www.europol.europa.eu/newsletter/massive-changes-criminal-landscape

[2] “Layering” is a term of art meaning that multiple transactions are used to create levels that further distance the original transaction from its original insertion into the legitimate financial world.

[3] See my earlier post, “Potential Pitfalls and Current Trends in Federal Criminal Law,” Digital Currency Council blog post, dated December 9, 2014, available at http://www.digitalcurrencycouncil.com/legal/potential-pitfalls-current-trends-federal-criminal-law/

[4] Id.

[5] Most money laundering investigations will be conducted by the federal government. State district attorneys’ offices simply do not have the capability, sophistication, or man power. The major exception is the Manhattan District Attorney.

[6] “A Fistful of Bitcoins: Characterizing Payments Among Men with No Names.” Sarah Mieklejohn et al. 2013. Available at https://cseweb.ucsd.edu/~smeiklejohn/files/imc13.pdf. See also “Follow the Bitcoins: How We Got Busted Buying Drugs On Silk Road’s Black Market,” Forbes, Andy Greenberg, September 5, 2013, available at http://www.forbes.com/sites/andygreenberg/2013/09/05/follow-the-bitcoins-how-we-got-busted-buying-drugs-on-silk-roads-black-market/

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