High Crypto Crime Rates Threaten Privacy

One of the hottest conversations in the crypto community centers on the recently published security reports berating the use of cryptocurrency for illicit activities. According to Chainalysis’s 2020 crypto crime report, crypto transactions adjudged to stem from illicit activities rose to 0.08% of all the crypto transactions recorded in 2019. Although this stat shows that illicit activity still represents a negligible fraction of the crypto economy, the fact that 2019’s stats doubled 2018’s reported crypto crime data is, however, enough reason to worry for the future of the crypto industry.

In light of this, I have chosen to share more insight into the effect of crypto crime on the market, the plausible response of regulators, and the place of privacy in this conundrum.

Crypto Crime and Its Rippling Effect on The Digital Asset Market

I consider crypto crime an expanding terminology, as its scope covers a growing number of activities, including terrorism, crypto crime, money laundering, drug trafficking, tax evasion, and so on. Needless to say, the proliferation of crypto crime has had untold effects on the reputation of cryptocurrency. In the first nine months of 2019 alone, over $40 billion in crypto payments was reported to have emanated from the darknet. The verdict, as stated by experts, was that darknet markets are resilient to the recent clampdown from global regulators.

One might even argue that these entities are increasingly capitalizing on the perks of blockchain technology, especially the part that offers some degree of anonymity to participants. Chainalysis reiterated this assertion when it concluded that the influx of crypto payment options for illicit activities stems from the emergence of systems with similar functionalities to fully decentralized infrastructures like the Tor web browser and blockchain technology. The appeal of crypto technology to the underworld took an unexpected turn when Russia’s largest darknet marketplace announced its plan to launch a native token and distribute it to investors to expand its illicit operations.

While airing his view on the issue, Lory Kehoe, cofounder of Blockchain Ireland, stated:

“Darknets are bouncing back after aggressive take-downs in 2018, and as their revenue climbs, their crypto receipts would logically also be on the increase. I’m a huge advocate for regulation in this sector. Furthermore, existing rules do not fit digital currencies, and it is entirely incumbent on states to engage in constructive dialogue to ensure that crypto is treated legitimately and can be operated with robust oversight.”

In the same vein, Dr. Wulf Kaal, principal at Kaal.io, highlighted what he thinks might have caused the uptick in the use of crypto for illegal activities. Dr. Kaal argued:

“As it becomes easier to onboard or exit, small scale criminal activity, ransoms etc are increasing proportionally. I have not seen a correlation dataset but as the increases in ransom hacking attacks, for example, are associated with the cryptocurrencies.”

If you will recall, similar fundraising strategies had helped terrorist groups raise money. Crypto’s global remitting functionality is somewhat enabling a viable means to execute transactions hidden from regulatory infrastructures overseeing the global financial system.

Just recently, Insikt Group published a report highlighting the status of state-sponsored crypto crime while using North Korea as a case study. The report explained that North Korea, in an effort to relieve its economy from the adverse effects of US sanctions imposed on its economy, sponsors the mining of privacy-enabling coins and crypto-related cybercrimes.

So, how do all these disturbing developments affect cryptocurrency and its mainstream movement?

Crypto Crime Spurs More Regulatory Scrutiny and Market Volatility

As expected, the influx of crypto-enabled crimes has had a damaging effect on the reputation of the burgeoning technology. In what has become a recurring sentiment used as a yardstick to judge crypto’s viability, some nations have identified digitals assets’ appeal to the underworld as one of the reasons why they have moved to ban crypto activities within their border. To these economies, crypto provides an evasive means to launder money and participate in activities deemed illegal in such locations. And so, the disadvantages of enabling a crypto market outweigh the perks of crypto technology.

While this narrative has been held against crypto technology since it emerged in the global scene, its sentiment continues to ring true today even as illegal entities take a bolder stance on their affinity for cryptocurrency.

The second consequence of crypto crime on the digital asset market, as noted by Chainalysis, borders on the aftereffect of illegal activities on the prices of cryptocurrencies. In a report that revealed the possibility that the actions of fraudsters could cause the prices of cryptocurrencies to fall, Chainalysis noted that the sell-off of ill-gotten cryptocurrencies coincided with the sudden crash of Bitcoin last year.

According to the study, tracking the money trail of PlusToken, a Ponzi scheme that made off with $3 billion worth of cryptocurrency, revealed that the price of bitcoin dropped whenever batches of the fraudsters’ bitcoin stash were sold on Huobi crypto exchange.

According to the report, “the funds moved to the address of an OTC broker operating on Huobi to be liquidated — that’s how nearly all of the funds so far have been cashed out. For reference, OTC (Over The Counter) brokers facilitate trades between individual buyers and sellers who can’t or don’t want to transact on an open exchange. OTC brokers are typically associated with an exchange but operate independently. Traders often use OTC brokers if they want to liquidate a large amount of cryptocurrency for a set, negotiated price.”

Chainalysis discovered that the PlustToken “wallets sent a steady flow of Bitcoin starting in mid-April and spiking just before the arrests in late June. After that, we see no movement until a few spikes in August, before transfers spike again and remain high throughout September. Then, we see a few more spikes in October.”

Further investigation showed  ”spikes in on-chain flow to OTC brokers correlate with drops in Bitcoin’s price. There can be a lag, as Bitcoin that is moved on-chain to an exchange is not immediately traded. We see the best example on September 20th, when PlusToken scammers made large cash out of roughly $34 million worth of Bitcoin. Following that transfer, Bitcoin’s price drops steadily between September 24th and 26th, falling from just over $10,000 to about $8,000 and remaining there for roughly a month.”

In light of this revelation, it is clear that cashing out illegally gathered funds could have devastating consequences on price movements.

Regulators Keen on Eradicating Crypto Crime

Another impact of the surge of crypto crime has to do with the increase in initiatives looking to arrest the rise of crypto illicit activities. In other words, regulators are committed like never before to stifle the apparent ease of using crypto for illegal operations. As such, regulators are either creating crypto transaction tracking tools or enlisting the help of crypto analytics platforms who have the infrastructure to fish out illicit crypto transactions.

Also, we have begun to witness the emergence of crypto regulations targeted at containing the crypto crime scourge. Already, the SEC has doubled its effort to discourage the use of crypto fundraising schemes to generate money illegally. The clampdown of such activities has crippled the efficacy of ICOs and seen some culprits face the full wrath of the law. And from the looks of things, it is glaring that the regulatory scrutiny of 2019 is mere child’s play compared to what regulators have in store in 2020. This assertion holds as President Donald Trump is proposing the expansion of the Treasury Department’s oversight on matters relating to crypto crime.

As explained in a recent report, the Whitehouse included in its budget proposal for 2021 a section stating the intent to empower the US Secret Service as a means to “disrupt terrorist financing, hold rogue states and human rights abusers accountable, and detect and deter financial crimes.”

The document went further to explain why this initiative is imperative and might give regulators an edge in the fight against crypto crime. The document reads:

“Technological advancements in recent decades, such as cryptocurrencies and the increasing interconnectedness of the international financial marketplace, have resulted in more complex criminal organizations and revealed stronger links between financial and electronic crimes and the financing of terrorists and rogue state actors.”

Following the show of commitment, on the part of regulators, to put an end to crypto crime, crypto firms and investors have started to adopt measures that will establish the legality of their businesses. One of such measures is compliance with KYC and AML requirements. It has become a regulatory standard that crypto platforms must enable systems ensuring the verification of the identities of their users and ascertain the legality of their activities. In essence, these platforms are required to submit the logged personal data of their users whenever regulators request for them. With this practice becoming the standard in an industry that prides itself as the hub for censorship-resistant projects, there is an outcry that the privacy of crypto participants is under attack.

Dean Karakitsos, co-founder and CEO of Bloxy, in discussion with Cointelegraph, explained the threat that crypto surveillance, powere by the likes of Chainalysis, posed to ordinary people looking to adopt crypto for their everyday use, albeit with privacy-enabling systems. Karakitsos argued:

“The Crypto Crime Report does not determine an evident method on how it calculates the size of the darknet markets in terms of users. Assumptions support that darknet, in general, is a marketplace that all transactions in there are illegal and are happening between criminals using cryptocurrencies. A black box approach. That means any hidden network that runs Tor to protect users against censorship and participants transact in cryptocurrencies that market is part of darknet and participants are called criminals.”

In support of this view, John McAfee tweeted last year that regulators’ focus on anonymous transactions shows the intent of central authorities to eliminate all shreds of crypto privacy. McAfee tweeted:

“Bitcoin mixers are now being targeted. Anonymity itself is slowly being considered a crime. The word Privacy will soon mean Criminal Intent.”

What Are the Strategies Crypto Criminals Will Adapt to Evade Regulatory Oversight?

Knowing fully well that regulators have intensified their commitment to incorporate systems to track and apprehend crypto illegal activities, it is, therefore, certain that illicit crypto owners will search for new ways to cloak their operations. Some of the trends to expect in 2020 are:

Adoption of Non-Custodial Mixers

Mixers are tools that help participants boost the anonymity of non-private digital assets via coin shuffling. While this methodology has proved its efficacy, the shutdown of BextMixer in 2019 has, however, spurred illegal entities to adopt a more sophisticated variation of coin mixer. This improved method adopts CoinJoin functionality, which makes it even harder to track or confiscate illegal crypto funds.

Anonymous Coins

Perhaps the easiest way to circumvent regulatory scrutiny is by adopting privacy coins. These cryptocurrencies implement protocols providing anonymous transaction features absent in blockchains like Bitcoin and Ethereum. If the newly introduced regulatory initiatives in various regions of the world find a way of unraveling coin shuffling mechanisms, then the best bet is that the darknet will switch to privacy coins. However, some nations are aware of this threat and might move to ban all cryptocurrencies with anonymity protocols.

Chain Hopping to Obscure Crypto Trails

Another trend that might become prevalent is chain hopping. This practice involves the exchange of ill-gotten cryptos to other types of cryptocurrencies repeatedly until it is almost impossible to track the origin of the coins. For this to work, it is preferable to execute these trades on exchanges that are not too particular about KYC and AML requirements.

The Surge of Activities on P2P Crypto Exchange Networks

In a bid to evade surveillance at all costs, I expect anonymity-enabling P2P exchanges to experience a surge in activities. In other words, it is looking ever more likely that networks doing away with intermediary processes might become a breeding ground for illicit activities.

In light of the availability of multiple means to obfuscate illegal crypto transactions, I, for one, believe that regulators must acquire a better understanding of how these systems work. However, regardless of the types of enforcement mechanisms adopted for the sole purpose of eradicating crypto crimes, it is certain that participants’ privacy will be at the receiving end.