Mon, Nov 23, 2015

Will Cryptocurrencies Become Tools for Fraud?

Virtual currencies—which are not legal tender in any country and are not issued or backed by any government—have become an important factor in international funds transfers. But features associated with these so- called “cryptocurrencies,” such as transaction anonymity and irreversibility of payments, have made them extremely attractive to cyber-criminals, drug dealers, money launderers and those involved in global fraud.

This article is based on a paper previously published in the Spring & Fall 2014 issue of Defense Against Terrorism Review (DATR), published by the NATO Centre of Excellence – Defense Against Terrorism (COE-DAT).

What Is Cryptocurrency and How Does It Work?

Cryptocurrency goes by many generic names. It is often referred to as virtual currency or as non-fiat currency.

Perhaps the simplest definition comes from FinCEN: “‘virtual’ currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.”

Bitcoins are a common example of a cryptocurrency. Bitcoins are not issued by a central bank or government, but rather may be purchased from a Bitcoin exchanger. Bitcoin exchangers accept conventional currencies and exchange them for Bitcoins based on a fluctuating exchange rate. Once acquired, the Bitcoins are stored in a digital wallet associated with “the user’s Bitcoin ‘address,’ analogous to a bank account number, which is designated by a complex string of letters and numbers.” A Bitcoin transaction, which takes the form of a transfer of value between Bitcoin wallets, is recorded in a public ledger called a “blockchain.” “To be confirmed, transactions must be packed in a block that fits very strict cryptographic rules that will be verified by the network.” The chart below provides a simple overview of a transaction using a virtual currency (a Bitcoin for purposes of this example).

Person A wants to pay Person B for some product or service. Person A may be able to go directly to a money exchanger (who will exchange a sovereign currency for Bitcoins) or may have to go through a money transmitter to get it to the exchanger. The Bitcoins go into Person A’s virtual currency wallet. Person A transfers them to Person B. Person B then can go through a money exchanger to get currency which can be deposited in a bank.

Virtual currencies represent a challenge for law enforcement and every national government.

Why Is Cryptocurrency Attractive to the Fraud, Money Laundering and Criminal Underground?

If you were a fraudster, a money launderer or a criminal who wished to use the Internet to move funds globally to support your drug dealing or human trafficking operations, what characteristics would you want in a value-transfer tool?

  • Anonymity – You would certainly want a system that did not require you to prove your identity and to have that validated identity tied to all of your transactions.
  • Global Reach – The system should permit money to be transferred from anywhere to anywhere, and in any amount. You also want the ability to carry out transactions through third countries with which you have little or no connection.
  • Speed – The system should carry out the transfers quickly, preferably within seconds. The faster the transaction, the less chance that it can be intercepted and blocked.
  • Non-Repudiation – Transactions should be immediately final. The person sending the money should not be able to “un-send” it or reverse the transfer.
  • Difficult for Authorities to Track Transactions – Obviously, you want a system that is not going to be an open book for the authorities to use to track your transactions or the actions of your group.

Cryptocurrency and Unlawful Transactions: the Current State of Affairs

The very characteristics of cryptocurrencies that make them attractive to fraudsters, terrorists, money launderers and criminals pose challenges for law enforcement and regulators. Two recent cases are Liberty Reserve and Silk Road.

The Case of Liberty Reserve

In what is described as possibly the largest online money laundering case ever brought by the U.S. government, in May 2013, federal prosecutors charged Liberty Reserve, a currency transfer and payment processing company based in Costa Rica, with allegedly laundering billions of dollars, having conducted 55 million transactions that involved millions of customers around the world. Liberty Reserve users were required to make any deposits or withdrawals through the use of third-party exchangers, “thus enabling Liberty Reserve to avoid collecting any information about its users through banking transactions or other activity that would leave a centralized financial paper trail.” Another key feature of Liberty Reserve transactions was that they could not be repudiated.

The Case of Bitcoin and Silk Road

For approximately two and a half years, an underground website known as Silk Road “was used by several thousand drug dealers and other unlawful vendors to distribute hundreds of kilograms of illegal drugs and other unlawful goods and services to well over a hundred thousand buyers, and to launder hundreds of millions of dollars derived from these unlawful transactions.” One of the two major ways that Silk Road sought to operate beyond the reach of law enforcement was by requiring “that all transactions on Silk Road be paid with Bitcoins, an electronic currency that is as anonymous as cash.” Silk Road operated from January 2011, when it was established, until October 2, 2013, when the website was seized by law enforcement. In all, Silk Road is alleged to have generated the Bitcoin equivalent of “approximately $1.2 billion in sales and approximately $80 million in commissions.” The alleged mastermind operator of Silk Road was ultimately convicted of multiple federal crimes.


Virtual currencies represent a challenge for law enforcement and every national government. Their promise to provide fast, safe and low-cost global funds transfers must be viewed relative to the risks associated with these currencies being used to facilitate and obfuscate transactions related to criminal activities, including money laundering, trading in illicit drugs and global fraud.

You can find the article in its entirety, including reference notes, in our Intelligence Center.
Learn more about fraud statistics and trends in Kroll’s annual Global Fraud Report.

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