How can illegal Bitcoin transactions be detected?

How cryptocurrencies can be put into perspective

Cryptocurrencies have the potential to accelerate processes and reduce costs. However, theft, lack of security and crime can make them a risk.

Due to the rapid growth of the crypto markets, the call for tighter controls is growing all around Crypto assets continuiously louder. Many believe that the protection of blockchains is difficult to manipulate Distributed ledger-Technology (DLT) behind cryptocurrencies, also guarantees the security of the currency itself. However, crypto bills are regularly hacked: The most successful hacker attack of this kind to date cost Coincheck a total of 530 million US dollars in January 2018. The flood of ICOs (Initial Coin Offerings), which crypto firms use to raise capital outside of traditional banks and exchanges, opens the door to scammers. In addition, the anonymity behind cryptocurrencies facilitates various illegal transactions, from weapons to drugs to human trafficking. The technology behind it may be safe, but cryptocurrencies are not. And even if they were, they are so easy to use that criminal activity is difficult to rule out even then.

It will not be easy to introduce stricter controls. Many are of the opinion that crypto currencies are more of a commodity than currency due to the strong fluctuations in value - not an easy starting point for regulatory authorities.

The balancing act between security, transparency and innovation

Despite concerns that stricter rules reduce the innovation potential of Crypto assets Exciting developments can be observed: BitPesa, for example, a Bitcoin-based transfer service from a Kenyan start-up, ensures smooth and inexpensive transfers in Kenya's M-Pesa mobile money transfer system. In trade finance, thanks to DLT, you could attach accompanying documents to financial transactions behind cryptocurrencies and thus reduce the risk of human error or abuse.

In general, the risks of cryptocurrencies need to be identified and managed before they can reach their full potential. Many of these risks are based on anonymity. Although the path of cryptocurrencies in the open, decentralized network of the blockchain is transparent, the owner and purpose remain unknown.

This anonymity is incompatible with the current legal situation and global regulations, which increasingly demand transparency - to protect against money laundering, tax evasion and other criminal activities. If a government can't see a transaction, it can't tell if taxes are due. Even Switzerland had to relax its data protection laws in order to transfer money across its national borders.

Anonymity is also a problem for large financial institutions. New laws tightening liability rules for large corporations like banks and accounting firms could affect financial institutions' willingness to accept or transfer cryptocurrencies. The EU and UK Anti-Money Laundering Directives and laws like the Criminal Finances Act force financial institutions to avoid transactions that may be related to criminal activity. Just "not confirming" that taxes were paid on deposited crypto money could turn a bank into an accomplice. And whenever the owner of one Crypto assets remains anonymous, it is difficult for financial institutions to see whether sanctioned assets are being moved illegally or whether a transaction is the result of people and organizations that are subject to economic sanctions.

A question of perspective

Given these risks, it quickly becomes clear what disastrous consequences poorly regulated cryptocurrencies can have. In addition to the risk of fraud for customers, they can burden the state coffers and finance criminal activities such as terrorism or human trafficking.

So far there have been hardly any international votes and each country has its own rules. It is interesting that less democratic countries seem to feel more threatened by crypto money, especially with regard to the central control of their money supplies, and have issued corresponding regulations more quickly. China was once the country with the most active cryptocurrency market. Last year, however, the authorities banned all types of business and all platforms with corresponding services. In the face of excessive speculation, money laundering, tax evasion and fraud, Chinese regulators around the world have been at the forefront of tighter controls on cryptocurrencies.

Stricter laws are becoming more and more common. In the US, the SEC (Securities and Exchange Commission) conducted several researches and stated that many Coin Issuer along with their lawyers and advisors could have broken the rules. SEC Chairman Jay Clayton believes that most digital tokens are actually securities and should be subject to the relevant regulations. Clayton also admits that definitions in the industry are constantly evolving, that DLT has huge potential for the financial industry and that regulators need to remain flexible. The European Securities and Markets Authority, ESMA for short (European Securities and Markets Authority), emphasizes that ICOs are extremely risky, highly speculative investments outside the regulated area.

Meanwhile, in February the European Financial Supervisory Authorities (ESA, European Supervisory Authorities) for securities, banking, insurance, and retirement funds share common concerns about the growing number of people buying high-risk virtual currency without knowing the risks involved. Since virtual currencies and exchange are not regulated under EU law, control authorities warned that crypto investors are not protected against cyber attacks or trading institutions that are suddenly no longer available. Mark Carney, Governor of the Bank of England, stresses that Crypto assets not working like other currencies, but controlling them is essential.

In Spain, tax authorities have investigated cases of crypto-based tax evasion and money laundering and asked 60 companies to reveal the names and trading details of cryptocurrency buyers. South Korea has implemented measures to control speculation in the crypto industry and banned the use of anonymous bank accounts in trading cryptocurrencies. India's government has announced measures to "eliminate" cryptocurrencies in "illegal acts or as part of the payment system".

The call for a unified global solution

Since there is currently no international agreement on the control of cryptocurrencies, loopholes arise that create more and more opportunities to circumvent such controls. This has a negative effect on common reporting standardsForeign Account Tax Compliance Act and the intergovernmental exchange of data. A globally uniform solution approach for the legal regulation of crypto currencies is therefore required.

Said in March 2018Christine Lagarde, Executive Director of the International Monetary Fundthat the IMF would encourage countries to develop policies that would protect financial integrity and consumers in the crypto space as well as they would in the traditional financial sector. Lagarde also believes that the technology behind crypto assets can be used to “fight fire with fire”. For example, DLT could accelerate the exchange of information between market participants and regulatory authorities. This not only leads to a standardized collection of verified information from customers, but also helps to combat cross-border tax evasion. Another, albeit more radical, way to make cryptocurrencies more visible would be to create a national central bank digital currency (CBDC,Central Bank Digital Currency), essentially a digital version of today's currency. A CBDC would be alternative digital currencies (ADCs,Alternative digital currencies) far superior to Bitcoin. ADCs are not good investments: the prices fluctuate too much, the defense against hacker attacks is sketchy and as a currency they are completely unsecured. In contrast, central bank money is the ultimate asset. At the moment, ADCs have a major competitive advantage: DLT. Central banks can and will follow suit in this area. Research by EY and Cambridge University shows that 63 percent of central banks and 69 percent of other public sector institutions are experimenting with DLT protocols.

At the moment, however, the disadvantages of a CBDC still predominate. A freely available CBDC poses major challenges in the areas of technology, security, data protection and law. This creates a discrepancy between digital “fiat” and “non-fiat” currencies. Most customers would opt for the former, thereby pushing the latter even further into the experimental and potentially criminal fringes.

Cryptocurrencies (and the DLT behind them) have enormous potential to change the financial services industry in a positive way. You could accelerate business processes and reduce costs. However, adequate controls are needed to ensure that cryptocurrencies are not misused for criminal activities such as tax evasion. The basis for this is a joint solution approach by international authorities, individual states and the financial services industry.