The dark side of hyped bitcoin: This is why the crypto market threatens to become the next paradise for offshore accounts

  • With cryptocurrencies like bitcoin, the old familiar problem of tax havens and offshore accounts arises: How much good is regulation that isn’t implemented globally?
  • Experts interviewed by Business Insider are convinced that money laundering is a problem with cryptocurrencies, but it is becoming increasingly difficult for criminals in Germany.
  • Even if it is technically impossible to identify the owner of a wallet, the basic idea of bitcoin provides for certain transparency of transactions.
  • Visit the Business section of Insider for more stories.

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The largest known movement of crypto wealth to date took place in September 2019, when someone transferred bitcoins worth a total of $1 billion. Who had this fortune and where the money came from remains secret to this day, thanks to the anonymity of cryptocurrency. Analysts who monitored the transaction in the publicly available registry could only determine that part of the Bitcoins came from the Singapore-based Houbi Global crypto exchange, but everything else remained hidden. Such money transfers would otherwise only be conceivable with offshore accounts, which are outside the usual legal norms.

Bitcoins and cryptocurrencies repeatedly make spectacular headlines, turn nerds into millionaires, and are currently considered by bankers to be the biggest financial market bubble at the moment. Less known is the use of crypto in financial crime, especially since the properties of cryptocurrencies are perfect for disguising illegally generated funds.

Attorney Bartosz Dzionsko of the Winheller law firm in Frankfurt am Main believes that the steep rise in the value of cryptocurrencies also reflects the opportunities that these means of payment offer to white-collar crime.

Studies on criminal connections come to completely different conclusions

Dzionsko represents cryptocurrency holders facing criminal charges. Contrary to headlines about illegal marketplaces, arms, and drug deals with cryptocurrencies, he is primarily approached by clients who became victims of fraud by getting into cryptocurrencies. Most often, Dzionsko deals with bitcoin owners who have failed to deal with the tax aspects and have to defend themselves against accusations of tax evasion.

Just how little is known about the dark figure in economic and financial crimes involving cryptocurrencies is shown by statistics that come to seriously different conclusions. A recent study by crypto analytics firm CipherTrace concludes that in 2020, less than one percent of total crypto transactions were related to crime. In absolute numbers, it sounds more dramatic right away: Bitcoins worth at least $3.5 billion are said to have sent addresses with criminal connections.

The Review of Financial Studies came to a very different conclusion in 2019, estimating that 46 percent of all Bitcoin transactions were related to criminal activity. These highly disparate figures show that it is difficult to make a conclusive assessment of the potential for criminal activity worldwide. The technology is still too new for that, which means there are still too many loopholes and little to no regulation in some parts of the world.

In Germany, regulations bring professionalization

Philipp Sandner heads the Blockchain Center at the Frankfurt School of Finance & Management, and his work includes looking at crime on the platform. “Money laundering is a problem, however, the trend here is going in the right direction. There is more and more regulation, which is an important step to professionalize cryptocurrencies,” he says in an interview with Business Insider.

Germany is even a pioneer in Europe in this regard. The EU Commission only presented a proposal for the regulation of cryptocurrencies in September 2020, while stricter measures have already been in place in Germany since the beginning of last year. “Anyone who relies on Bitcoins or other cryptocurrencies with their business model needs a permit from Bafin. On the one hand, this gives investors protection like no other country, but on the other hand, it results in higher costs for smaller companies in particular,” says Sandner.

Anyone who opens an account with a German provider must provide identification and leave their personal details. “Large or frequently repeated transactions catch the eye of the community and can be monitored; in some cases, algorithms also report corresponding conspicuousness. In this way, authorities receive information about which money flows they should keep an eye on,” says Bitcoin analyst Timo Emden in an interview with Business Insider.

In Germany, investigating authorities in recent years have primarily dealt with cases where cryptocurrencies were the subject of fraud.

BKA describes the highly professional approach of crypto fraudsters

In 2019, the Federal Criminal Police Office (BKA) secured 12.5 million euros in the form of various cryptocurrencies in the course of asset seizures. By comparison, this sum was less than half that amount the year before: 5.5 million euros. The BKA has already identified organized crime structures in 2019 that offer investments in cryptocurrencies, which are in fact Ponzi schemes or other fraud schemes. In its 2019 white-collar crime situation report, the BKA describes a highly professional approach in which perpetrators can move assets from fraudulent crypto transactions in time for investigators to skim nothing. However, authorities are also aware of methods in which so-called Bitcoin mixers or crypto exchange platforms offer to disguise financial flows.

Exposure of the criminal use of cryptocurrencies is still driven by scandals, such as Silk Road or, more recently, the cyber bunker, says Prof. Volker Brühl, executive director of the Center for Financial Studies at Goethe University in Frankfurt am Main. Cases, such as the cyber bunker in Mosel, offer insights into the criminal use of cryptocurrencies.

The bunker in Traben-Trarbach on the Moselle River, which at times hosted the world’s largest illegal marketplace, blew the whistle in May 2020. Investigators from the Cybercrime Unit in Mainz succeeded in getting closer to the criminals precisely through the use of bitcoins. As reported by theNew Yorker magazine, the undercover investigators set up a dubious site on the Darknet, bought a thousand Bitcoins, and turned to the operators of the cyber bunker to keep the Bitcoins safe. This allowed them to make direct contact with the operators of the largest illegal online marketplace and sound them out about their fraudulent tactics. The illegal marketplace, which was hosted on servers in the Moselle cyber bunker, handled transactions in cryptocurrencies worth 140 million euros. The site’s operators, according to the New Yorker, were happy to give advice on how best to hide their identities in such transactions.

Owner anonymous, but transactions traceable

But bitcoin transactions alone would have told nothing about the origin of the funds. That’s because despite regulatory attempts in the EU, it remains possible for individuals to remain incognito in their crypto transactions. “Basically, it is possible to buy cryptocurrencies anonymously and create a wallet that then works like a Swiss bank account,” Dzionsko says.

It is precisely this anonymity and the possibilities for concealment that are attractive to criminals. “While a bank transfer is traceable for the authorities, a transfer of cryptocurrencies between private individuals is possible quickly and anonymously,” says the lawyer. Moreover, it is currently technically almost impossible to uncover who is behind the wallet. So it comes to the fact that the freshly made bitcoin millionaires have no chance to prove that they are the true owners of the crypto assets in case of loss of the hard drive or the password.

However, the basic idea of cryptocurrencies envisioned some transparency. Bitcoin analyst Timo Emden says it is a misconception that transactions on the blockchain are completely secret. “Bitcoin transactions can be seen and tracked by all users. However, you don’t see the names of wallet owners, only their wallet number as a pseudonym.” But if there are repeated anomalies with a pseudonym, authorities or Bafin as a regulatory body can keep an eye on these wallets.

If there are reasonable grounds for suspicion, investigating authorities could learn the name of the wallet owner from the provider as long as that wallet was opened on a German platform. Authorities may also be able to learn a name if wallet owners want to exchange Bitcoin for other currencies or use it as a means of payment. “Criminals can hardly exchange their Bitcoin for other currencies such as euros or U.S. dollars, apart from countries without real law enforcement. If there is an exchange or a payment transaction, there is a contract or an account, which could give investigating authorities the personal details,” Emden says.

More and more loopholes are being closed in the EU

Thus, the criminals have some wealth and can also transact within the blockchain under their pseudonym. However, when interfacing in the “real” world, they run the risk of revealing their identity. “The bottom line is that hackers, extortionists, or money launderers have to keep their Bitcoins in the wallet or on a data carrier. They can then hope for an increase in value, but they only have theoretical wealth because of a lack of withdrawal options,” Emden says.

“It is actually bitcoins stashed on data carriers or held in very old accounts that were opened before regulation that pose a problem for investigating authorities when it comes to money laundering,” Philipp Sandner, head of the Blockchain Center at the Frankfurt School, also confirms. “But the longer criminals don’t convert the money back, the harder it will be for them to do so eventually, as lawmakers recognize more and more loopholes and close them.”

Uneven regulation creates new offshore havens for cryptocurrencies

An important step towards this happened at the beginning of last year: to prevent money laundering with cryptocurrencies, the 5th Money Laundering Directive requires wallet providers and crypto trading platform operators to clarify the origin of the money since the beginning of 2020, explains Prof. Brühl. The directive has been implemented across the EU, and similar regulations exist in the UK and the US. “Nevertheless, bitcoins can be used for money laundering, for example through transactions outside crypto exchanges or on the darknet,” says Prof. Brühl.

As with tax havens, financial regulators face the same challenge: Markets that do not require identification on crypto exchanges will always remain. “Because as long as it is possible to have anonymous transactions on crypto exchanges in individual countries, it will not be possible to prevent the misuse of cryptocurrencies for criminal purposes,” says Dzionsko, a lawyer. In his opinion, the scope of use for criminals could be limited if the exchange of cryptocurrency into fiat money can no longer take place anonymously. By then, at the latest, conspicuous sums would set off alarms at financial institutions.

Philipp Sandner also sees this as a problem: “In some Asian countries, it is still possible to purchase Bitcoins anonymously,” he says. “However, if a person or even a company attracts attention and authorities then come across corresponding accounts and when they were opened, there are many indications that illegal machinations could be linked to this account,” he warns.

What’s important to the head of the Blockchain Center at the Frankfurt School is that anonymity was never the idea behind the technology or bitcoin. “The idea was to create a decentralized and completely transparent system that works independently of central banks – and this basic idea remains after the regulatory measures taken so far,” he explains. Although he also sees a high number of unreported cases and loopholes with regard to crime and money laundering, it is becoming increasingly difficult for criminals.

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