New Bitcoin of the realm?

New Bitcoin of the realm?

March 4, 2013
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AML Challenges
March 2013 – May 2013

Bitcoin (BTC) is an emerging payments mechanism that many, if not most, readers of ACAMS Today are unfamiliar with. Yet, it is popular enough, and well-known enough, to not only have its own Wikipedia page1 and a wiki2, but there are also online3 and print versions of Bitcoin Magazine, as well as two conferences, one in California and one in Vienna, planned for 2013 covering topics of interest to the Bitcoin community. In addition, this year Bitcoin Central, a European Bitcoin exchange, became a registered payments system provider (PSP) in Europe.

So, what is Bitcoin and, as compliance professionals, does it create another viable channel through which financial crime can occur?

What’s a Bitcoin?

Bitcoin has been described variously as a digital currency, a virtual currency and a cryptocurrency, all of which are accurate. Bitcoins do exist primarily in the digital realm as transaction records denoting who has sent or received what amount of BTCs. As the only way to transact in BTC is through the network of computers with Bitcoin wallets, the currency is considered a virtual currency, similar in that regard to Linden dollars (available in the Second Life virtual world) and Ven (available in Hub Culture). The transactions denominated in Bitcoin are all encrypted, although the records are freely available in the block chain, which is the digital historical record of all transactions on each Bitcoin-enabled device.

What sets Bitcoin apart is the fact there is no central bank or regulatory authority. The Bitcoin network is a distributed peer-to-peer network where all devices have equal access to the network and the block chain that contains the information of which holders have access to how much currency. The network controls and the data architecture maintain the integrity of accounts. Transactions are considered final on completion and cannot be reversed.

The Bitcoin network prides itself on its anonymity features. The block chain records which addresses, (the Bitcoin equivalent of accounts), are involved in each transaction, but no personal identifying information is stored.

The other really notable difference between Bitcoin and other currencies is that the creation of additional currency is controlled by a strict algorithm rather than political or the socioeconomic needs of a nation-state or society. There is, in fact, a hard limit of just under 21 million Bitcoins that will be produced, through a process called mining, with the last expected to be minted in 2140. This limit is somewhat mitigated by the divisibility of each coin, which can be subdivided into 10 million satoshis, which were named after the pseudonym of the software’s creator. It is envisioned that, as time passes and the Bitcoin becomes more valuable, transactions will be denominated in smaller and smaller subdivisions of one BTC. The value of the currency is driven almost exclusively by supply and demand; in fact, some have claimed that it is hard to distinguish its value from that of a possible speculative bubble.

There are a number of exchange and payment processor services which will convert Bitcoins to traditional currencies and vice versa. The largest exchange, Mt. Gox, allows customers to exchange funds in U.S., Canadian and Australian Dollars, Euros, Swiss Francs, Japanese Yen, British Pounds Sterling, and Russian Rubles. The payment processor BitPay — which recently secured $510 thousand in an angel investment — also deals in Mexican New Pesos, which raises the specter of proceeds from narcotics trafficking being converted to BTC. And Coinabul4 permits the conversion of BTC to gold coins or bullion.

Bitcoins are used for both peer-to-peer payments and for purchase and sale of virtual and real-world goods and services. While the anonymity of the currency has proved to be fertile ground for sale of illegal items, such as the illicit drugs sold by the Silk Road black market, and proscribed services like online gambling sites, mainstream vendors, such as the WordPress blogging platform, accept payments in Bitcoin as well. There are even traditional brick-and-mortar venues, like the Just Sweet Dessert House in New York, that accept payment in Bitcoin.

While there have been wild swings in the value of a Bitcoin, it generally has appreciated over time. Over the past year, the value of the currency has more than doubled, rising from about US$6 to over US $15 at the current time.

Does Bitcoin pose a financial crime risk?

From a purely technical standpoint, Bitcoin is a compliance officer’s worst nightmare. Anonymous Bitcoin addresses are the perfect petri dish for both smurfing and the layering stage of money laundering. There is even a service called Bitcoin Fog5 that further anonymizes the currency by pooling deposited coins and processes withdrawals by creating multiple transactions of randomized size from the pool, breaking the chain between the coins received by the customer and the ones ultimately used for future transactions.

Scams denominated in Bitcoin are essentially consequence-free due to the irreversibility of transactions. In addition, there is evidence, documented in Max Raskin’s November 29, 2012 article in Bloomberg Businessweek6 that Iranian citizens are using the virtual currency to skirt the economic sanctions imposed on the country; they are both buying goods and services normally prohibited to them by the sanctions and are using Bitcoin to get their depreciating rials offshore and into safer, more stable currencies.

Consider this excerpt from the informational web site:

  • As anonymous as you want it to be. Just like with cash, transactions can be totally anonymous. Transactions are only identified by your Bitcoin address, and you can have as many Bitcoin addresses as you want. You create another new Bitcoin address with one click any time you want to. Bitcoin transactions can be made to be: anonymous***
  • Financial privacy. Gone are the days of “identity theft.” In the old days, credit cards required merchants to have proof positive of your identity in order to shop there. Because a Bitcoin address can only be used to receive money, and it cannot be used to extract money with Bitcoin, the merchant only needs to know two things: Did you pay? and, Where do you want your stuff sent to? Isn’t that the way it should be? Does your banker really need to know what you buy online?
  • Your account cannot be frozen. No one can freeze your account and keep your money (As long as you keep control of your Bitcoins yourself and don’t keep your Bitcoins in an online bank or wallet service. See the Security tab for recommendations).
  • No big brother. Third parties can’t prevent or control your transactions. Transfer money easily through the Internet, without having to trust middlemen; no central bank, nor central authority.
  • No censorship of who you’re allowed to send money to. No more blocking who you can make payments or donations to ­ just because someone doesn’t agree.

What prevents Bitcoin from being a viable money-laundering channel in any appreciable volume of hard currency is its scarcity. Approximately half of the eventual number of Bitcoins have been mined, each currently worth about US$15. In addition, according to Dan Goodin’s October 17, 2012 report in Ars Technica,7 about 78 percent of all Bitcoins are not being actively used, but are being held as investment vehicles. The rapid rise in the value of the currency further fuels that behavior. Therefore there are really only about US$33 million in the Bitcoin money supply.

While the value of each Bitcoin will undoubtedly continue to increase over time, until the total value of all BTC is in the trillions of dollars, euros or pounds sterling, attempts to place significant amounts of hard currency into the Bitcoin network will bump up against the harsh realities of supply and demand. Either the price of a Bitcoin will rise, due to the increased demand, or the money launderer will be unable to acquire sufficient BTC to cover the hard currency being laundered.

That being said, using Bitcoin as part of a larger money laundering scheme will allow money flows elsewhere to look less unusual and therefore be harder to detect. And smaller, pettier frauds, scams and schemes can find a safe haven in the Bitcoin network as they do in traditional economies.

Can the risk be mitigated?

Once money is denominated in Bitcoin, control over the asset flows within the network is lost irrevocably. The best way to control the risk is to make the network a walled city; while there may be safety within the walls, leaving town will leave the financial criminal on his or her own, without their cloak of invisibility. The radical way of doing this is to choke off Bitcoin’s oxygen by denying it access in the foreign exchange market. The equivalent of economic sanctions (e.g., the sanctions under Section 311 of the USA PATRIOT Act) that for the Bitcoin currency would force exchange houses underground and likely greatly devalue BTC. The downside of this scorched earth policy is that it hurts consumers who want easy, secure, cheap transactions for digital or real-world goods.

The kinder, gentler way of controlling the borders of the Bitcoin world is to ensure, through regulation, that exchange houses and all entities doing Bitcoin-denominated transactions have the same financial crime identification and reporting requirements as other entities. In this model, the casual user of BTC would have little or no impact on their use of the currency.

This being said, the need for such measures is very much determined by the value flowing through the system. With 10 million or so current Bitcoins valued around $150 million US, but only about $33 million in active circulation, the risks of significant financial crime is extremely low. Even when all 21 million Bitcoins have been mined, and if the hoarding factor drops significantly, the value of the BTC economy would have to rise by a significant amount in order for a large money laundering effort to use the Bitcoin without distorting the value of the currency in a significant way.

There is also the distinct possibility that the hoarders of Bitcoins may abandon the currency if the rise in its value is arrested, or even dips. If their investments leave the system in a significant way, the virtual currency’s value may drop significantly, further reducing its utility as a financial crime vehicle.

There is one caveat, however, while the Bitcoin network may never become a good vehicle for money laundering, the same is not true for people and companies trying to skirt economic sanctions, or trying to perform other illicit transactions. While regular transfer of large sums of BTC is probably not feasible for the same reasons that it is not a viable environment for money laundering, individual transactions of small to medium size will probably proliferate over time, until controls such as mentioned above are put in place at the gateways that do the currency conversions.

The U.S. Federal Bureau of Investigation (FBI) has reached similar conclusions in its April 24, 2012 unclassified intelligence assessment “Bitcoin Virtual Currency: Unique Features Present Distinct Challenges for Deterring Illicit Activity.”8

The bottom line

Bitcoin, at the current time, presents more problems for law enforcement involved in sales of controlled items than it does for large-scale fraud and AML professionals. It is already being used as a medium to bypass economic sanctions, however; for those reasons, it would behoove governments to formulate a regulatory response to limit the attractiveness of a currency custom-built to prevent the prying eyes of the law.

1 “Bitcoin,” Wikipedia, 31 January 2013, 31 January 2013

2 “Bitcoin,” Bitcoin wiki, 19 January 2013, 31 January 2013

3 “Bitcoin Magazine,” Bitcoin Magazine, n.d., 31 January 2013

4 “Coinabul,” Coinabul: Bitcoin to Gold Marketplace, n.d., 31 January 2013

5 “Bitcoin Fog,” Bitcoin Fog, n.d., 31 January 2013

6 Max Raskin, “Dollar-Less Iranians Discover Virtual Currency,” Bloomberg Businessweek, 29 November 2012, 31 January 2013

7 Dan Goodin, “78 percent of Bitcoin currency stashed under digital mattress, study finds,” Ars Technica, 17 October 2012, 31 January 2013

8 “Bitcoin Virtual Currency: Unique Features Present Distinct Challenges for Deterring Illicit Activity,” Wired, 24 April 2012, 31 January 2013,

Eric A. Sohn, CAMS, principal engagement manager, BankersAccuity, Skokie, IL, USA,


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