There has been a lot of talk regarding virtual currencies, their anonymity, and their connection to crime. More talk will ensue, and it will never stop until solutions develop to embrace the current world we live in. Every problem has a solution. Sometimes it is simple, sometimes it is more complex. However, when it comes to solving problems that have to do with of human beings’ reifications and our society, they mostly tend to be simple. Virtual currencies were created as solutions to some problems. Naturally, they created other problems, sort of like this. That is why I’m writing this post, to talk about possible solutions to THAT problem: the anonymity problem of virtual currencies. The features that make them so efficient in facilitating crime, whether it is money-laundering, theft, payment for the provision of criminal services, or anything else.

Human interactions are based on common rules. When we communicate, we do so based on a set of rules: languages. When we play games, they always have rules. Even when we eat, we use rules. Rules help us facilitate our interactions, by providing expectations from a set of actions, thus increasing efficiency. Those rules, through time, have grown in scale. Instead of just two humans interacting based on their private established rules, now whole societies can interact based on a complex system of rules. When someone breaks a rule, we generally deem that as a wrongful act, and all developed societies in the world have penal codes that punish criminal acts: the acts that (we consider) break the most important rules.

Everyone expects to have some privacy in his or her life, even in transactions of value with other each other (i.e. what they buy and sell). The problem has forever been the balance of safety and security. To be able to have freedom, and control of your personal information, while at the same time, live in a functioning society that punishes criminals.

Virtual currencies and blockchains are turning out to be this generation’s defining creations. One of the main hindrances to their mass adoption is the anonymity aspect of them. Mass adoption, would mean their recognition and regulation by governments and regulatory authorities. Since we’re generalizing, it’s worth noting that they can also be designed to Not provide anonymity, it just happens that today, they mostly do. In addition to them providing anonymity by design, you can also decide to Not be anonymous when you use them.

It is effortless to facilitate crime when you are anonymous in a system where you transfer value. You can launder money, pay for drugs any other illegal substance, buy or sell any stolen thing or information, or buy and sell anything really. The way this to achieve this, is that most (if not all) virtual currencies are just databases that record transactions of usernames. There is no requirement to relate your real world identity to your username. All a professional killer has to do, is create a bitcoin (or any other virtual currency) username, and accept payment for her services. This is the reality, and there is no way to stop this system.

Lego Money Laundering
LEGO Money Laundering

This has always been the reality though! Criminals have never had to relate their identity to accept payment. That is how cash is used. Governments around the world, in an effort to provide utility and increase efficiency (in the system of storing and transferring value) have created physical representations of government-backed value systems: fiat currencies. These physical representations (i.e. cash) have those characteristics. You can use them to pay or receive for products or services and there is no requirement for identity records. The corner shop does not ask you for your ID when you by overpriced bubble gum. However, if you want to open a bank account, then you need ID & address verification, a phone number, and maybe other things. When talking about anonymity, cash is not the only one that provides it. There are more efficient methods to transfer value as well! You can even improve efficiency if you use other things people consider valuable in those endeavours, such as diamonds, gold, paintings, or even saffron (if you’re in the restaurant business)! The weight of $500,000 in cash is 5kg (11.02lbs) 1 and the approx. size of a football (not the yank kind). You could improve your efficiency and use a diamond instead.

Criminal systems around the world do not try to prevent crime by trying to stop it before it happens. Even Tom Cruise can’t do that. They try to deter crime so that people are discouraged to commit it. The same rationale is with the proceeds of crime. Governments have rules in place that make it really difficult for people to use value acquired from illicit gains. That is what money laundering is. Trying to make that illicit value seem as if it was earned legitimately. In their current form, virtual currencies do not provide governments with sufficient information about how people (who trade virtual currencies) have acquired that representation of value, because everything is anonymous.

Drying GBP
Literal Money Laundering

So, after that absurdly long introduction, we can get to the solution part. Instead of dismissing virtual currencies, governments can band together and create systems that deter users to become involved in criminal activity when using them. The question is: how would they attempt to do this?

The basic underlying concepts of virtual currencies can be used to provide leverage in the creation of something that automates forensics and discourages the store and transacting of ill-gotten gains. Virtual currencies are the most obvious manifestation of the now-famous distributed database system we know and love: the blockchain. The simplest explanation of Virtual Currencies is: a system to store and transfer value. However, in order for that system to work, every participant in the system must agree on the rules. Blockchains (virtual currencies) were mainly created for a simple purpose: to eliminate the intermediary. Databases have to exist somewhere and wherever they exist, users need to access them, and read and write data on them. The database holder is the intermediary (too much consolidated power). The solution to this problem was to have databases exist everywhere on every user’s possession, and synchronise changes between them by a predefined consensus agreement mechanism. In order for this idea to work, you need the distributed database to be open and readable by its users. Then the issue was to have control of personal information; this was achieved by anonymity. Anyone can create a username/address on a virtual currency blockchain, and the link between the identity of the person (physical or legal) is up to the creator of that username. Using bitcoin as an example, its usernames are visible its ledger user list. Virtual currency exchanges publicly communicate which address belongs to them (i.e. Bitfinex ’s wallet is: 3D2oetdNuZUqQHPJmcMDDHYoqkyNVsFk9r), because their business model requires them to make it public. Since each participant of a blockchain inherently has to have a copy of the database in order to participate in this system, that means that each participant has a copy of the ledger and can see every transaction ever done on that blockchain. From Bitcoin’s inception until the very last minute, you can trace the value of every bitcoin ever created and transferred. Imagine this as a system where a central bank prints a banknote, and you can follow that banknote wherever it goes. From the printing press, to the bank, the bank client, the cornershop owner, the grocery distributor, then back to the bank. It’s like that opening scene in the beginning of the movie Lord of War. That is actually possible with blockchains. Each participant user has the ledger and can look at it and trace everything. The issue with that is, you can see all the transactions all the blockchain users have done, but you do not know who those address owners are, unless they specifically tell you. The way that they can tell you, is to actually demonstrate that they have the private key to the address.

The manifestation of these concepts in technological form allows the creation of a system that bests even the most robust money laundering prevention mechanisms. Because it is possible to see every transaction, it is possible to create a system where every transaction can be checked beforehand whether it relates to any crime. Imagine a scenario where a shop owner can check whether the person buying a pack of gum is trying to pay for it with stolen money. Furthermore, with smart contracts, which are pre-programmed computer protocols that execute an action (in this case transfer of money) if conditions are met, you can create a system where this can be done automatically. Every law enforcement organ in the world has lists of criminals that they pursue. Some even have lists of virtual currency addresses that are connected to crimes. If some black hat hacker discovers a security hole and deploys ransomware, where they encrypt the hard drive and demand amounts of virtual currency to have the password to decrypt the hard drive, similar to what happened two years ago with Petya, the hacker’s virtual currency address can be added to the list. After putting it on the list, every transacting user afterwards can be implicated in the crime as well.

The basic legal premise concerning complicity in criminal acts is whether you know or not. If someone steals some money, and then comes to you and buys something with that stolen money, and you know that the money is stolen, then you are complicit in the crime 2. Currently, when someone steals some money, he goes around and buys stuff with it. You can’t expect supermarkets to know which money is stolen and which isn’t. If someone goes and buys a new Bugatti with cash in order for him to wake up in it , then that is pretty suspect, but still the burden is not completely on the Bugatti dealership to know whether the money is stolen or not. It is well within a person’s rights to ask the bank to provide him with $1.5M in cash, take that cash to the Bugatti dealership and have that experience. With Virtual Currencies, it is still the same premise, although it is possible to create a system where the ‘knowing’ can be automatic. Either this can be done regionally across different jurisdictions, or it can be done internationally as a joint project between various law enforcement agencies.

The premise is, to have a database (or better yet, a decentralised database) where law enforcement agencies can log virtual currency usernames involved in criminal activities. This database would be used similarly to how current systems work. People are investigated, their accounts are frozen, then they are charged, convicted, and their assets are confiscated. In terms of virtual currencies, the database of virtual currency users can be used to communicate which users were involved and are guilty of criminal activity: people that have acquired value unfairly. These databases allegedly already exist, and law enforcement agencies have them, but they are not open/public, and they are probably not cooperating with each other (because of bureaucracy).

After this database is established, then the legalisation and regulation of virtual currencies can occur. Virtual currency users will then have legal obligations regarding their activities in that sphere. Just like they do when they operate their bank accounts or use cash. However, because of their nature, the obligation is somewhat different. When law enforcement agencies freeze someone’s account or confiscate their cash, they are unable to use that value. When it comes to virtual currencies, they cannot stop them from being used, because anyone with a user’s/address’s private key can use the value of the username. Also, you cannot actually stop a virtual currency transaction from happening. If someone knows my username/address, they can send me money, that’s how donations work. Additionally, by design, the transaction is irrevocable.

Lego A1
A1 Lego Robot

This is where the database is necessary: if the sender was on the database, I could legally be required, to return the money to the sender. The technical details and specifications regarding this can be set by legal scholars regarding various legal requirements and already established concepts of various governments; however, the core concept would be that no one acquires value unfairly. If on the other hand, I do not return the money to the sender immediately (or as per the legal requirements), then I would be added to the database as well. This would have a deterrent effect. The process of returning money automatically can be built into wallets or online exchanges to improve it further. Transactions in (some) virtual currencies can be done by smart contracts whereby checks to the database are made beforehand so that no money is lost in transaction fees. This way, criminals are deterred, no one is involved in crime, and the only ones that benefit from this system are the miners (or some other entity designed by the relevant virtual currency creator) which facilitate transactions. This is reasonable, because they are the infrastructure of the whole system. Without them, it would not work.

What remains to be decided by the responsible people in charge, are the legal requirements regarding the implementation of this idea. Issues such as:

  • The timeframe in which the money should be transferred back to the sender on the database, because sometimes people don’t check their accounts all the time, or go on vacation, etc.;
  • The different types of databases and limitations of virtual currency users/addresses that are logged, because everyone is innocent until proven guilty;
  • The management of virtual currencies if law enforcement agencies have the private key;
  • The investigation procedure regarding criminal activities, will it be something like this, or some other form; and
  • Many other technical issues and international cooperation as well.

Having such a system would make legalisation easier, because it would create a possibility to have an enforcement mechanism where virtual currency users are discouraged from dealing with known or suspected criminals. Currently, real-world assets can be frozen or confiscated. With virtual currencies, the best you can hope to achieve is to ostracise them. Criminals work genuinely hard to acquire wealth that does not legally belong to them, almost just as hard as to acquire wealth legally. If the outcomes of criminal acts were representations of value that has no use, then the will to commit those acts would not exist. Pablo Escobar had a headache with his management of cash, but he could still use it, if nobody would have taken his money, then he probably would not even have been in that line of business.

The only limit of such a system is with virtual currencies that are designed to make de-anonymization of users and their transactions impossible. Virtual Currencies like Monero make it almost impossible to decipher who sent and who received what money. The only solution to that would be an outright ban. You cannot stop them from existing, but governments can make them illegal, thus no exchanges would deal with them. They would be relegated to the same position as cash. Just like blood diamonds and ivory is illegal, so can virtual currencies that make de-anonymization impossible be illegal.

Regarding the execution of this, I know some people that can help make it happen; if only he would stop creating too many great start-ups. The real problem in the execution is getting many governments cooperating. Just as you can’t censor the internet, you cannot confine virtual currencies to a country. Therefore, to have a database and enforce it, you have to have many of the world’s governments in agreement that this would be a good way forward. So currently we’re in a Field of Dreams situation. If someone creates this database, other governments will start using it, or at least copying it, and then cooperating with each other.

Show 2 footnotes
  1. Considering each $100 is 157 mm x 66 mm (W x H) and 0.10922 mm thick), that much money would be 5.66 L (1.28 gallons)
  2. This explanation is extremely simplistic, and don’t use my law degrees to shame me