(https://twitter.com/realdonaldtrump/status/1149472282584072192) about Bitcoin and cryptocurrencies, stating that “Unregulated Crypto Assets can facilitate unlawful behavior, including drug trade and other illegal activity....” spooked the crypto market.
If I had a chance to sit down with POTUS today, I would take advantage of the opportunity to disprove the common misconception, as well as the Pavlovian conditioning that follows, that Bitcoin equals complete anonymity - equals drug money. In fact, I think that by the end of the conversation, the President would see that he is correct in that there are a few tweaks that need to be made to the cryptocurrency universe, but that overwhelmingly, Bitcoin can help make Make American Law Enforcement Great Again.
The most common misconception is that Bitcoin provides its users with full anonymity. In fact, the opposite is true. Bitcoin can only provide pseudo-anonymity in certain aspects and no anonymity whatsoever in others. While Bitcoin can, when used intelligently, help maintain a certain degree of privacy and serve as a tool of economic freedom, at the same time, for many law enforcement efforts, Bitcoin can actually be a brilliant tool for tracking bad guys’ financial actions.
First a few basics - all Bitcoin transactions consist of three key parameters: The sender’s address, the recipient’s address and the amount of Bitcoin transferred. Once the transaction is transmitted its (cryptographically stamped) time and date are also immutably written on the chain. Most importantly, the Bitcoin network is fully available to anyone with internet access. By “fully available” I mean its entire transaction history from day one. Furthermore, it’s immutable, thus it cannot be changed or erased, ever.
So if we look at the above parameters, it is clear to understand why the last two do not provide anonymity. For every transaction, the amount of Bitcoin transferred and exactly when it was transferred is recorded and immutable. No one can ever claim that this information was ever concealed, or meant to be concealed. And, this information will be traceable - forever.
Which leaves us with the claim that the addresses provide anonymity. This misconception probably stems from the lack of a standardized ledger that links addresses to their owners, like the ones that exist at every bank. However, this is extremely fragile, for a simple reason - humans interact with each other. Once this supposed anonymity breaks, and it always breaks, it collapses like a house of cards. Below is a simple example that demonstrates this. As it is only supposed to encapsulate the essence of Bitcoin’s pseudo-anonymity, I kept it as simple as possible. Naturally, certain aspects of the Bitcoin protocol are far more complicated, but are out of the scope of our discussion:
Because Bitcoin is fully accessible to everybody, combined with its immutability:
Just by making these three transactions, my neighbor and I, and the MAGA hat store have lost our Bitcoin anonymity to each other, forever. Imagine that in the “real” world buying a hat, using your credit card, will expose your entire purchase history (and future...) to the store from which you bought. Vice versa, you will have full access to the store’s history (and future) purchase history. Of course, in the case of Bitcoin, the history that is exposed is not the user’s entire history, as only the history linked to that specific wallet is revealed, and the same user may use multiple wallets that are not linked to each other. At the same time, the public nature of the bitcoin blockchain does reveal significantly more information about the flow of funds from one user to another than a typical bank transfer. Especially when combined with information from outside of the blockchain, this data can be very telling about the behavior of users and the networks between them.
To summarize: For every Bitcoin transaction, all of the transaction information and the past and future transaction information of the wallet addresses involved, are forever documented, unchangeable, linked and trackable among the users. For law enforcement, this information is a potential gold mine in order to curtail criminal activity.
Given that we successfully debunked Bitcoin’s “anonymity” myth, doing the same to the second misconception - that Bitcoin is a great tool for bad actors - is easier. Let’s assume that my neighbor and I were buying weapons from an illegal arms dealer (the “store”), and that I happen to be a law enforcement agent working undercover. I would now have access to valuable information, for instance:
Again, all this information is out in the open. No warrants required, no courts involved (at least not at this point), nothing. Law enforcement agencies in the past could only dream of having this kind of access to a network conducting illegal activity.
A real life example of this was the case of Silk Road, an online market mostly used for drug trading. It launched in February 2011 and operated until October 2013, when the FBI arrested the man allegedly behind it, Ross Ulbricht, a 29-year-old American. According to the complaint filed, “From February 6, 2011, to July 23, 2013, there were approximately 1,229,465 transactions completed on the site. The total revenue generated from these sales was 9,519,664 Bitcoins, and the total commissions collected by Silk Road from the sales amounted to 614,305 Bitcoins…”. Back then it was around $1.0 Billion of revenues and $61 Million in commission. Ulbricht was convicted and sentenced for life in prison without the possibility of parole. Just to make the point of Bitcoin’s faux-anonymity, it was chain analysis that led to convicting other suspects involved in Silk Road. Furthermore, only a few days ago, almost six years after Silk Road was shut down, a man was arrested in Ohio for trying to launder $19 Million allegedly earned selling drugs on Silk Road.
The irony is that Silk Road’s reliance on Bitcoin’s so-called unprecedented anonymity turned out to be one of the pitfalls that led its leaders straight to the hands of the FBI. There were, of course, other mistakes they made that allowed breakthrough in the investigation, but on a certain level it was similar to our simple example.
Once my initial point has been proved (that Bitcoin is not anonymous), it would only be fair to note that things have gotten more complicated in the past years when it comes to real anonymity using certain cryptocurrencies. In the eternal cat and mouse game of law enforcement, the bad guys are often the ones who come up with innovative ideas and technology to facilitate their illegal activity.
Since Bitcoin can not provide real anonymity to users, other types of cryptocurrencies, such as “Privacy coins”, have been introduced to try and tackle the challenge. As previously noted, it is falsely presumed that Bitcoin can hide users’ identity, though not the transaction metadata (amount and time). Privacy coins are trying to hide it all, using:
Just to be clear, I do not accuse anyone involved in the development of these cryptocurrencies of encouraging, supporting, or assisting illegal activity. Bitcoin and other cryptocurrencies were created in large part in order to provide more privacy and freedom in financial transactions. It is not surprising that newer blockchain protocols are being designed to provide higher levels of privacy than Bitcoin does. There are many legitimate reasons why people are looking for privacy, and there is a real concern that without additional development, cryptocurrency could be used by corporations or governments to engage in problematic surveillance. Privacy-enhancing protocols therefore are responding to real and valid concerns. Still, they do create challenges for law enforcement, unlike Bitcoin, as was announced by the FBI. One may assume that if a certain cryptocurrency can provide high-level anonymity, those involved in illegal activities (money laundering, terror, etc.) may use it for their financial operation.
There is no way around the simple truth that full anonymity, as proposed to be provided by certain privacy coins, is an immense challenge for law enforcement agencies. In recent decades, authorities have systematically increased their efforts in investigating the financial activities of suspects conducting large scale illegal activity. It seems that going after the money is an effective strategy in their war against crime. One of the main reasons is that financial activity over the “traditional” system, sophisticated as it may be, always leaves some kind of a trail. If a “modern” financial system which, theoretically, left no trail was introduced to the criminal world, the results could potentially be disastrous.
The bright side is that it’s still not too late. Authorities can still take a few measures in order to prevent potential financial chaos. The following are merely some suggestions to begin with:
Despite the bad rap given to Bitcoin in the President’s tweet, if bad guys want to use cryptocurrencies for illegal actions, it is probably best they use something other than Bitcoin. In this blog post I aimed to show quite clearly that if you want to be anonymous, Bitcoin is not the way to go. It is, however, generally agreed that unregulated cryptocurrencies can facilitate illegal activity. Still, it is safe to assume that cryptocurrencies, and privacy coins, are here to stay. Therefore, authorities cannot afford to ignore these instruments and would benefit from taking action sooner rather than later. Declaring them illegal might be the easiest, though not the wisest, solution and will probably not work. Therefore, intelligent regulation should be the answer. For starters, it may be achieved by providing the technological guidelines for features that these protocols should and should not allow.
The general underlying assumption is that most individuals are law abiding citizens who cherish their privacy. They would hate to have their financial history available to all, but would most probably be willing to cooperate with law enforcement agencies when they are asked to do so. As always, it is up to the authorities to find the delicate balance in regulating new technology and certain perils that it may withhold rather than prohibiting it, but it is best that the authorities also realize that there is huge added value in crypto, including assistance with crime fighting, and find a way to regulate but not suffocate.
Hexa Foundation is a non-profit organization focused on using blockchain to create social impact. Part of the Orbs Group, Israel's largest blockchain group, Hexa Foundation aims to use blockchain for social impact, harnessing the technology to help solve the region’s - and the world’s - most pressing humanitarian problems. Learn more at Hexa.org.