By Anna Semler
Cryptocurrency has emerged as an exciting new medium of exchange with rapid changes in value. As brands like Bitcoin become household names, questions also arise around the different uses for cryptocurrency and growing calls for regulation.
The U.S. government must develop rules to protect against illicit cryptocurrency activity, especially as adversarial states like Russia begin to use digital currencies to avoid Western sanctions and other obstacles to illegal financial activity.
What is cryptocurrency?
A cryptocurrency is a digital currency with no physical form which relies on a technology known as blockchain to record transactions. The first cryptocurrency, Bitcoin, was created by Satoshi Nakamoto in 2008, but many others have now emerged including Ethereum, Litecoin, and DigitalNote.
Cryptocurrency is not controlled by a central authority but rather inherently decentralized, which mitigates threats posed by system issues or hackers. Without a central server, cryptocurrencies like Bitcoin rely on a public record where everyone has access to the history and activity behind each transaction. This online ledger tracks transactions by adding new ‘blocks’ of information to the existing record of transactions: hence, the ‘blockchain.’ The information in each block is permanent, unalterable, encrypted, and stored securely as such in the blockchain.
More Bitcoins can be added to the system through ‘mining,’ a process where users use high-powered computers to solve complicated cryptologic puzzles. If a miner succeeds in solving a puzzle, they can then create a new block for the blockchain by authenticating information and confirming a set amount of transactions. In return, they are paid in Bitcoin for their services. The Bitcoin reward is designed to decrease over time with the addition of each new block to the blockchain.
What are some issues around cryptocurrency?
Cryptocurrency offers new opportunities for investment and exchange, but it also creates new platforms for illicit activity like money laundering. The blockchain technology meant to keep track of cryptocurrency transactions publishes public records of all transactions through the blocks of data that are created for each person-to-person transaction. However, not all transmissions of funds create records to add to the blockchain.
Users can opt for other methods to hide their tracks, including cashing out digital coins into dollars or another type of fiat (paper) currency, converting the funds to another type of cryptocurrency, or using a ‘conversion service’ to transmit digital coins to other users in certain ways which make it hard for the currency to be traced to a single user or a single transaction in a blockchain. These services include “tumblers” or “mixers,” Bitcoin ATMs, and online gambling sites that accept cryptocurrency.
Strategies to further obfuscate user identity can lead to issues with money laundering. Money laundering with cryptocurrency, also referred to as ‘cleaning’ cryptocurrency, funnels the digital currency through different addresses or uses ‘conversion services’ to make it difficult to trace where the money came from. As illicit funds pass through different wallets, transactions, or investment opportunities, the coins are ‘cleaned,’ or mixed around, to make sure they are from different sources or are difficult to trace even with blockchain technology.
It is important to note that–as far as we know–the vast majority of Bitcoin transactions, the most popular cryptocurrency, are legal. However, geographic distribution shows that Europe displays a “disproportionate amount of illicit activity” compared to other regions of the world involved in cryptocurrency markets. Further, conversion services based in Europe receive the highest number of illicit bitcoins compared to those in other global regions.
Why is Russia interested in cryptocurrency?
While individuals may abuse cryptocurrency for illegal private gain, some countries–including Russia–are starting to see cryptocurrency as a possible component of their economic and political strategy. The Kremlin recently began warming up to the cryptocurrency industry, and products like Bitcoin or a new “crypto-ruble” will soon become legal in Russia. Whether supporting the Russian economy, President Putin’s political power, or new alliances, cryptocurrency is a promising new platform for the Kremlin.
Recent Russian interest in cryptocurrency is a drastic change from a few months ago, when Putin described cryptocurrencies as risky and possibly linked to crime. However, Russia’s parliamentary newspaper now reports that Russia is hoping to pass cryptocurrency legislation by July 1. The market will be “legitimized” by mid-summer, claims the official state publication, and two laws have already been drafted. First, the Central Bank has drafted legislation to establish a legal basis for the release of the cryptocurrency tokens in Russia, the “initial coin offering” or ICO, and to regulate the turnover and mining of the currency. The Ministry of Finance also released a draft of a law establishing that digital cryptocurrency can only be used to make transactions in exchange for other assets by the operator of the exchange. “This rule prohibits barter transactions between legal entities and individuals,” said Nina Efimova, Department of Legal Regulation of Economic activity at the Finance University of the Russian government.
Sergei Glazyev, Economic Advisor to Russian President Vladimir Putin, has stated that Russia has an “objective need” for cryptocurrencies due to the situation caused by American and European sanctions. These were imposed on Russia following the Russian annexation of Crimea and the subsequent violent conflict in Ukraine. The U.S. has also cited Russian interferencein the 2016 Presidential election as a motivation for recent, stronger sanctions against Moscow. The Kremlin hopes that cryptocurrencies could effectively allow it to circumvent these restrictions and provide a boost to Russia’s ailing economy.
Beyond the potential for economic benefits, however, cryptocurrency-enabled illicit networks may provide new pathways for Russian oligarchs to pass money through different countries, under different names, and to different cryptocurrency users without facing traditional obstacles to illicit financial activity. Cryptocurrency may become a sustaining force of Putin’s power as allied kleptocrats find it easier to avoid sanctions and investigators face an increasingly difficult task in “following the money.”
Intriguingly, cryptocurrency has also fostered a greater working relationship between Russia and Venezuela with the launch of the latter’s national “petro” currency in March 2018. With Russian involvement in the project half-heartedly hidden behind the scenes, the cryptocurrency is linked to the value from Venezuela’s oil reserves with the explicit aim of undercutting sanctions imposed by the United States. Time magazine reported that “senior advisors to the Kremlin have overseen the effort in Venezuela,” and Putin himself signed off on the project last year. Russian efforts with the “petro” can be viewed as an experiment to test the effectiveness of using cryptocurrency to outmaneuver American sanctions—before the Russians establish a crypto-ruble to help get around sanctions of their own.
What is America doing?
The United States has recognized the risks posed by cryptocurrencies. In January 2018, Treasury Secretary Steven Mnuchin stated: “My No. 1 focus on cryptocurrencies, whether that be digital currencies or bitcoin or other things, is that we want to make sure that they’re not used for illicit activities.” He went on to clarify that “in the U.S., our regulations [state that] if you’re a bitcoin wallet, you’re subject to the same regulations as a bank.” This is promising as cryptocurrencies like Bitcoin continue to increase in popularity.
However, the United States has become a haven for illicit financial activity because of legal loopholes which allow for the anonymous beneficial ownership of companies and trusts. More focus is needed on strengthening existing anti-kleptocracy measures if the United States is to have any hope of keeping up with cryptocurrency technology and other evolving platforms for illicit financial activity.
To combat illicit activity and prevent cryptocurrency from becoming a tool for undermining sanctions, U.S. policy makers should examine cryptocurrency policies introduced in South Korea and Japan. In January 2018, South Korea confirmed new measures which only allow cryptocurrency trading from “real-name bank accounts” with a new cryptocurrency identification system to prevent fraudulent activity. Japan has also taken measures to improve the legitimacy of the cryptocurrency industry, including the implementation of a self-regulatory body among licensed exchange operators and new rules which “require exchanges to keep customers’ and company assets separate.”
As cryptocurrencies continue to grow in popularity and use in the United States, regulatory action must keep pace in order to verify the identities of users and protect the integrity of the digital economy.