How to Crack Down on Cryptocurrencies

Bitcoin and other cryptocurrencies are electronic currencies that rely on a technological innovation called a “blockchain”—essentially, a complete transaction record, or “ledger,” stored across a network of computers rather than on a single site. Because of the transparency and alleged incorruptibility of the blockchain ledger, many anticorruption advocates have welcomed the possibility that blockchain technology might be an effective technology to combat corruption in a variety of ways, from ensuring transparency and accuracy in land records to helping to fight money laundering. Whether that optimism is justified remains to be seen. Unfortunately, the most popular application of blockchain to date—Bitcoin—is proving to be a major problem for the fight against corruption, money laundering, and a whole range of other black-market transactions.

Bitcoin is an unregulated currency and is fundamentally difficult to track. Bitcoin allows for the transmission of large amounts of money without the need to go through the traditional, and heavily regulated, financial service providers. Unlike cash, which is also difficult to trace, bitcoins are easy to hide, as the information necessary to stash hundreds of millions of dollars can be kept on a small USB thumb drive. And despite the vaunted transparency and incorruptibility of the Bitcoin “ledger,” which does indeed record all Bitcoin transactions, there is no easy way to establish the real-world identities of Bitcoin users. Nor is there any easy way to generate a record of individuals’ bitcoin holdings, which would have to be reconstructed from hundreds of thousands of transactions. Laundering money with bitcoins is further facilitated through the use “mixing” technologies that pool bitcoins and forward them onward to other accounts, thwarting the transparent blockchain.

Government efforts to address these problems have so far fallen short. China has begun to crack down on domestic Bitcoin exchanges, and some countries such as Bolivia have outright outlawed the use of Bitcoin. But these efforts have largely failed because the storage and exchange of bitcoins requires so little information; you can send bitcoins using protocols as simple as email or text message. Many governments have financial disclosure laws that require public officials to declare all their assets, including bitcoins. And sometimes officials do: three Ukrainian ministers recently disclosed, pursuant to Ukraine’s new asset declaration law, holdings of a combined US$45 million worth of bitcoins. But if corrupt government officials chose to violate the law by failing to disclose their Bitcoin holdings, it would be all too easy for them to do so without getting caught. Governments could also crack down on the services that make bitcoins easier to use—the digital exchanges and apps—but all this would likely do is cause the providers of those electronic services to shift their operations to other jurisdictions, as has happened with digital torrenting sites (which facilitate the pirating of digital content) after the US cracked down.

There is, however, an alternative regulatory strategy that holds more promise: 

While there are some vendors that directly accept bitcoins, most do not, and those that do accept bitcoins can be expected to eventually liquidate them for usable currency. Much of bitcoins’ value, then, comes from the fact that they can be easily converted to US dollars or Euros. This provides an avenue for meaningful regulation: governments can target the exchange of bitcoins into other currencies.

The US government has already implemented a set of policies to regulate traditional financial institutions in the fight against terror, including reporting requirements for cash withdrawals and large deposits, as well as mandated reporting of other suspicious activity. The US government could effectively blacklist cryptocurrency exchanges from linking to US banks or credit cards. With a concerted multinational effort, this could be feasible; few will want bitcoins if they can only be traded for Myanmar kyat.

It is unclear if the political will exists to crack down on bitcoin in this manner, especially since it would require buy-in from so many governments. If there exist even a few currencies for which bitcoin can be exchanged, then individuals can launder money through bitcoin, convert it to the currency of the nation which has not blacklisted it, and then further launder the money through formal currency exchanges into USD. Therefore, it would be best if every country were to crack down in a joint effort. Needless to say, this would prove politically difficult and require immense international cooperation.

Nevertheless, blacklisting bitcoin in just the US and EU would have ripple effects that might destabilize the currency and make it an unpopular choice for money laundering. A blacklist would cause some users to abandon the currency immediately, and the quick sale could tank the price and devalue the bitcoins held, legally or illegally, by all others. Once the currency is seen as unstable and that its long-term future is under threat of government intervention, risk-averse individuals and in particular those holding massive amounts of money would become reluctant to stash those funds in bitcoins.

Governments must address cryptocurrency issues in order to maintain effective control over money-laundering and corruption, as well as other problems like terrorism or North Korean sanctions that Bitcoin complicates. Bitcoin is astonishingly simple to store and transfer, making regulations that attempt to regulate Bitcoin holdings directly unlikely to succeed. By targeting the ability to transfer bitcoins to other currencies – even just to USD and Euros – governments can begin to clamp down on this unregulated currency and undercut efforts to use it for nefarious purposes.

2 thoughts on “How to Crack Down on Cryptocurrencies

  1. Pingback: How to Crack Down on Cryptocurrencies | Matthews' Blog

  2. You’re right that cryptocurrencies pose a unique challenge to governmental anti-corruption efforts, especially in their ironic lack of end-user transparency despite relying on a fully-public ledger of transactions. And I agree that the exchanges seem like the most promising target for government action/regulation. But I wonder if co-opting the exchanges and directing them to adopt further safeguards (as, you pointed out, governments already do for banks, etc.) might be better than blacklisting all exchanges in an attempt to shatter the currency.

    There’s clearly an appetite for electronic currencies, and it’s unlikely that all of it is due to its potential to aid in nefarious activity. Coordinated blacklisting, if possible, would destabilize bitcoin and harm its popularity, but it might just settle at a lower value after absorbing the initial hit. Likewise, you might only chase away the casual libertarians masking their online shopping activity rather than money launderers sophisticated enough to exchange for non-U.S. and EU currencies. After all, you underscored the incredible intergovernmental coordination required for blacklisting — and all it would take is one major currency to ignore such efforts and become the “Switzerland of cryptocurrencies.” Perhaps semi-legitimizing the exchanges that have sufficient safeguards, while blacklisting those that do not, may do more on the margins. Most all of the reputable U.S. exchanges already require identification to exchange bitcoin into USD, so targeting those that don’t could be a good start. Aside from that, there are increasingly effective ways to de-anonymize bitcoin ownership using publicly-available data, and even mixing technologies like CoinJoin aren’t impervious to sophisticated tracking. But it’s hard to know, because the tracking and masking technologies keep developing so fast.

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