Bitcoin, money laundering, and the challenge that law faces in keeping up with technology
General ·I’m interested in the new organisational structures that blockchains, or other forms of distributed ledger, might enable, the problems they might solve and whether solving those problems can help make the world better. Bitcoin is enabled by one type of blockchain. As Jeni Tennison of the Open Data Institute explained:
Blockchains provide a way to store information so that many people can see it, keep a copy of it, and add to it. Once added, it is very difficult to remove information, which can reinforce trust in a blockchain’s content.
Bitcoins are a form of digital currency and blockchains were originally designed as a system to manage them. Within the Bitcoin system anyone can access and add information (such as what Bitcoins are used for, where they were spent and when) to the blockchain.
Someone (*) told me a theory about bitcoin the other week. I don’t know if the theory is right, or even close to right, but it reminded me of something I’ve come across before. A familiar, although slightly different, pattern. This kind of pattern matching is common in humans. It can help us grasp new concepts quickly. Sometimes it can also lead us astray. Given the pace of legal frameworks that can be a bad thing.
Money laundering
Money laundering is how a criminal makes it hard to discover that their money was gained illegally. There are many ways to do it. After money is laundered it appears to come from a legal source. It is ‘clean’. The criminal can enjoy the profits produced by their illegal activity with a reduced risk of punishment. Money laundering techniques evolve over time.
Let’s take an example:
Alice sells illegal drugs for cash. Alice has no other reason to have large amounts of cash hanging around. If the police find Alice with her cash then she will be in trouble.
Alice walks into a betting shop and puts the cash into a slot machine. Put a pound in. Press the button. Put a pound in. Press the button. It gets repetitive. But every so often there’s a big win. Alice ends up with £300 in cash in her pocket along with a receipt saying that she won it by putting in a single pound.
Slot machines have a built-in advantage for whoever runs them so Alice ends up with less money than she started with but it was worth it. If anyone asks then Alice now has a good reason to have the £300. She’s got clean money and is less likely to go to jail. Lucky Alice.
I know Alice’s story is true. It has become easier in the UK since the liberalisation of slot machines in 2001.
Here’s a more complex money laundering example. One made possible by newer technology and business models:
Roberto has a regular income in his country. He makes his money illegally: perhaps from drugs, perhaps from robbing people, who knows. Every week he gets some money coming in.
Roberto heard of M2M (machine-to-machine) and IoT (internet of things). M2M is when machines communicate with each other. IoT is when that happens across the internet. Communications cost money. At a basic level it is the machines and the cost of the network that connects the machines together but money might also be paid to intermediary organisations that pass on a message or that translate between the languages spoken by different machines.
Roberto spots an opportunity. He sets up some machines in both his home country and another country. He uses his illegal money to pay for the energy consumed by the machines and of wages of people to look after them. Roberto also sets up an intermediary organisation. His machines talk through the intermediary and pay a fee. The intermediary organisation helps turn the dirty money into clean money.
If Roberto sets up the intermediary in a third country he could produce the clean money in a different currency and legal jurisdiction. He could even pass the transactions through multiple intermediaries making it very hard for anyone to trace it back to him. Lucky Roberto.
I think Roberto’s story is true. Once upon a time I thought I saw some of the breadcrumbs left behind by his machines as they went from one intermediary to another.
A theory about bitcoin
And now for the bitcoin theory. It is not the usual story about money laundering by exchanging cash for bitcoins. It is a little more complex.
The blocks in the bitcoin blockchain store information. The information might say things like “Jerry transferred money to Jane”, “Brenda paid Mary” or any other message you like. Anyone can pass information to the bitcoin network for storage. Machines called ‘miners’ compete to create the next block by doing work to solve a complex computer problem. The miners are rewarded a number of newly created bitcoins for doing this work. This is called a proof of work system. It reduces the chance of two miners storing the same or conflicting information at the same time and helps the whole system to function.
Let’s imagine the tale of Francesca:
Francesca has money that she has received illegally and wants to launder. She has spoken to Roberto about his machines. Francesca has also heard about bitcoin but doesn’t trust anyone to change her money into bitcoins. She decides to combine the ideas.
Francesca builds a bitcoin mining farm. She hires people to run it. She buys specialised hardware to maximise her return. She pays the electricity bill. She stores information for people. (Even people like me who store silly messages about their football club on the bitcoin blockchain.) She receives bitcoins in return.
The bitcoins are controlled by whoever holds the key. Francesca can buy things with the bitcoins or other people that she trusts with the key can. Lucky Francesca.
Now I don’t know if the theory is true. I suspect it will not be a great money laundering scheme. After all bitcoin is more transparent than it is private. Perhaps Francesca’s aim is a more focussed one of transferring money from one country to another. To transfer it away from the control of a particular government to somewhere safer.
New technologies create new patterns of behaviour that are hard to predict
These patterns and the changes from Alice to Roberto to Francesca — one money laundering to avoid the local police, the next to avoid all authorities, the final one to, perhaps, avoid a single government — shows how hard it can be to predict how new technologies will be used.
Our governments want to stop money laundering whether it takes place through bitcoin, other cryptocurrencies or new technologies that follow. To do this governments will have to understand how both the bitcoin blockchain, and the many other types of distributed ledger, might be used for money laundering. They may think that we need to follow a pattern from old technologies and demand that we know people’s identity. If they do this then, as Joichi Icho points out, we risk more bad laws that could create adverse effects elsewhere. New technologies, and hence our societies, operate on a global scale with open standards that can be used and influenced by anyone. One country’s defence against money laundering or international terrorists might help another country’s moves to stop internal political opponents.
If we are to make the world a better place using new technologies then perhaps one of the biggest challenges we need to think about is the legal and political one. Our technologies and societies are becoming more global open, agile and dynamic. How do we create legal and political frameworks that aren’t rigid and take years to come into force but are instead adaptive and iterative enough to keep up with the changes in technology and society?
(*) I’m happy to add their name if they wish.