Russia, North Korea Eye Bitcoin for Money Laundering, Putting It on a Crash Course with Regulators

Bitcoin’s ever-rising valuations are helping to fuel sanctions cheating and money laundering, setting up a fight between governments and cryptocurrency powerhouses. 

Bitcoin’s rising value got a further boost last week with the debut of the first futures trading. But the digital currency has also attracted the attention the interest of U.S. adversaries. A report out this week says that Russia is eying the currency as a means to bypass harsh sanctions levied by the United States and European governments, while North Koreans are suspected of trying to steal Bitcoins from South Korean cryptocurrency exchanges. All this puts pressure on the U.S. government – and may ultimately hurt the cryptocurrency’s value.

In September, cyber security company FireEye reported that a state-sponsored hacker team — they suspect North Korea — had sent phishing emails to employees at South Korean exchanges, with at least one success. Researcher Luke McNamara noted that hackers target exchanges more than individual cryptocurrency accounts for the same reasons banks attracted interstate bank robbers during the 1930s: regulations varied from state to state, security varied from bank to bank, and, as gangster Willie Sutton observed, banks are where the money is.

Writes McNamara: “If actors compromise an exchange itself (as opposed to an individual account or wallet) they potentially can move cryptocurrencies out of online wallets, swapping them for other, more anonymous cryptocurrencies or send them directly to other wallets on different exchanges to withdraw them in fiat currencies such as South Korean won, US dollars, or Chinese renminbi. As the regulatory environment around cryptocurrencies is still emerging, some exchanges in different jurisdictions may have lax anti-money laundering controls easing this process and make the exchanges an attractive tactic for anyone seeking hard currency.”

But North Korea is not alone. On Tuesday, a Russian news site quoted Putin advisor Sergey Gazye as saying that the Russian government had an “objective need” for cryptocurrencies to circumvent sanctions. Wikileaks creator Julian Assange is also knee-deep in BitCoin, as are some prominent white nationalists and neo-Nazi groups.

Law enforcement agencies were already concerned that drug dealers, goods counterfeiters, and various shady groups were looking to launder money through Bitcoin. An October report from the Drug Enforcement Agency says that Chinese nationals eager to offshore money are—perhaps unintentionally—helping drug traffickers launder their profits through a shadowy web of less-than-well regulated Bitcoin exchanges that require fresh inflows of capital to fund high-risk trading activities.

Here’s how it works, according to the DEA: money brokers sell Bitcoin to drug traffickers, who pay in cash from U.S. and European drug sales. Chinese underground banking systems, or CUBS, sell Bitcoin to drug traffickers in exchange for drug money. according to the DEA. The CUBS then sell the drug cash to Chinese nationals in exchange Bitcoin, a popular product among Chinese looking to get their money out of China and circumvent local Chinese regulations. “The increasing use of OTC Bitcoin brokers, who are capable of transferring millions of dollars in Bitcoin across international borders, as part of a capital flight scheme is expected to continue to intertwine criminal money laundering networks with capital flight.”

The U.S. Department of Homeland Security has cracked down on cryptocurrency exchanges sporadically. In July, officers with the U.S. Secret Service, working with Homeland Security Investigations and Greek law enforcement authorities arrested Alexander Vinnik, a Russian national who founded BTC-e.com, the largest Bitcoin exchanger in Europe and one of the world’s top ten. They also shut down the exchange.

“It was also the exchanger of choice used by criminals,” former acting DHS secretary Elaine Duke told a Chamber of Commerce crowd in October. Duke said that about 91 percent of ransomware payments around the world went through BTC-e. “It was allegedly used to launder more than $3 billion for people involved in crimes from computer hacking to drug trafficking.” On Wednesday, a Greek court cleared Vinnik’s extradition to the United States.)

Defense One asked Duke at that event about the threshold for shutting down an exchange. “The threshold is determined by the cybercrimes, whether it violates a statute,” she said. “The recommendation [for investigation or enforcement] is based in the law enforcement sections of DHS and the federal government. There has to be some sort of criminal activity. It’s just like any other criminal investigation, whether they believe it violates, and whether evidence exists that the exchange violated [law].”

That implies that enforcement could be uneven. Several members of the Senate Judiciary Committee, including Chuck Grassley, R-Iowa, have sponsored a bill that could  force exchanges to operate much more like banks, subject to laws that guard against money laundering.

Currently, Bitcoin exchanges are largely unregulated. Some, such as Gemini, founded by the Winklevoss twins, voluntarily subject themselves to more regulation in the hopes of attracting business from more mainstream financial institutions. But that is more the exception than the rule, according to a industry expert who spoke to Defense One on background in order to avoid exposing an exchange she was affiliated with to selling pressure or legal action.

Legislation requiring exchanges to conform to the same rules as banks could increase transparency. It could also pushing billions in largely unregulated transactions toward emerging big boys that can afford to set up, well, banks.

That may be a good thing, but goes against the bottom-up ethos that is part of Bitcoin’s attraction. Also some industry interest groups, such as the Bitcoin Foundation, argue that the Senate bill could subject anybody looking to trade in the currency to the same rules that govern banks, or even national mints. That could chill the market, the Foundation argued in a letter to lawmakers, saying that the bill “would, in our view, effectively limit or even terminate development, at least in the United States, of this important technology because the burdens of compliance would be greater in many instances than the benefit of developing the technology in the United States.”

Llew Classen, the executive director of the Bitcoin Foundation, told Defense One in an email he anticipated that the legislation would pass but there was still lots of time and opportunity to fix the bits that the foundation objected to. “The legislation is not actually about removing the risk of money laundering using cryptocurrency, but rather updating existing statutes dealing with all forms. Cryptocurrency has been clumsily inserted into the statute by defining anyone issuing, redeeming or cashing cryptocurrency as a ‘financial institution’ - which brings with it the regulatory burden of that definition. We hope that the final bill will either remove cryptocurrency from s13 of the bill, or focus on large cryptocurrency exchanges dealing in fiat money to bear the regulatory burden.” He characterized responses from lawmakers as “positive.”

It’s clear that governments have to fix the gap  if those penalties are to have any meaning. But the legislation that’s so far been proposed, as well as law enforcement action that’s taken place, suggests that government actors still have a lot to learn about what Bitcoin is and how cryptocurrency markets function if they are to avoid disrupting legitimate trading and investment. In October, Defense One asked Duke whether DHS had some way to shut down exchanges without disrupting the market. She answered, “That’s a very technical question,” then got into a black Chevy Tahoe that quickly drove away.