Bitcoin and the World of Sex, Drugs and Organised Crime

If you ever needed any further proof of value … it’s here

There have always been con men, blackmailers, gangsters, drug dealers, wise guys, sex traffickers and everything in between. There always will be.

They all have their own stories as to why they are how they are, whether it’s lack of opportunity, a bad childhood or simply a choice created by the way they are wired, but they all have one thing in common — a desire for something more, often much more.

Many of us might feel the same of course, but these people have the advantage of being able to operate entirely unconstrained by minor inconveniences such as law, conscience and morals. It could be power, reputation, recognition or even simple survival that drives them, but the underlying element of all of this is, of course, money.

Money does it all in one neat package. And lots of money buys all of those things within your social (or, more precisely, “anti-social”) circles that bring you that perceived power. Money makes you the king, and buys you the protection you’ll ultimately need in that position.

At least for a time. Criminal reigns are often spectacular, but rarely long.

As our financial systems have evolved over the centuries, so have the criminals. The form of money is entirely unimportant, the only thing that matters is the accumulation of it. Shells, cigarettes, gold and other precious metals, physical cash, digital numbers in a hidden offshore account — it all works to achieve that goal.

But then, in 2009, a new kid arrived on the block. Not only an entirely new form of money, but an entirely new concept. What would the underworld make of Bitcoin?

Bitcoin solves problems for criminals too

The bad guys didn’t really understand Bitcoin either at first and, for a while, stood shoulder to shoulder with the rest of us, wondering what it was and how this thing was going to unfold.

But it wasn’t long before they realized just how useful this new money was going to be and, arguably, the first major Bitcoin adoption was in the shadows of the dark net.

It quickly became associated with “anything goes” marketplaces like Silk Road, it was a simple way for victims of ransomware to buy back their own data, and even, allegedly, cross border funding of terrorist activities, thereby sidestepping any banking sanctions. Bitcoin could do it all.

Or at least it seemed it could.

The reasons for this were pretty obvious in retrospect. If, for example, you’re going to operate a dark net, off-grid marketplace like Silk Road, you’re not really going to offer easily traceable payment systems like Paypal or Visa, even if you somehow managed to get them to deal with you in the first place. Cash has always worked well, but although untraceable, it is simply impractical for mail order items. Bitcoin makes all of those problems go away.

But there were other advantages too. If you’re a bad guy doing a deal, the very nature of the work you do means that trust will never be a factor in any arrangement. You need a payment system that is final, irreversible and untraceable on delivery of the goods. Traditionally, this has always been cash since there is, by design, no record of dollar bills transferring ownership from one person to the next.

But cash is not as easy to deal with as you would think. Acquiring large sums attracts attention, getting rid of it requires a network of laundering activities and physically moving it can be seriously problematic, as TV series like Ozark and Breaking Bad go to great lengths to show.

A million dollars in $100 bills weighs a fairly manageable 8 kilograms, but once you reach $10 million, you’re at 80 kilograms, an amount that’s impossible for an individual to easily move on their own. And, since $100 bills are fairly tricky to offload in large numbers, you’ll need a mix of smaller denominations, adding to the total weight significantly.

Further, in a “live” situation where a large transaction is done between two parties that don’t trust each other, money and goods need to be checked, verified and counted before they can go their separate ways.

And who’s to say, if you’re the buyer, that you won’t get robbed at gunpoint as soon as you turn up with your cash? If you’re the seller, how do you know the money is not counterfeit? Or whether those gold bars are real? Nothing comes with any sort of guarantee.

Before Bitcoin, the only other option was having a banker on the payroll, making sure that payments went through, bypassing any checks and then finding their way safely to a bank account, usually via a trail of bogus companies and transactions. This is expensive, makes the operation vulnerable to exposure and creates a whole new set of charges that can be added when it ultimately falls apart.

In this context, it’s easy to see why criminals were initially attracted to Bitcoin since it addresses all of these operational problems associated with being a bad guy.

It also had value that could be transferred entirely off grid, could not be intercepted, hacked, reversed or otherwise diverted, and there was no way it could be fake. Using Bitcoin was a no brainer.

Except for one little problem.

The Achilles’ heel (for bad guys)

Both criminals and law enforcement were learning about Bitcoin at the same time, and neither were experts to begin with. Criminals understood the upside, but it was clear that some of them didn’t understand the downside, at least initially.

The Bitcoin network operates entirely out of human hands in an effectively “closed” system, which means it is as untouchable to law enforcement as it is for everyone else. But that doesn’t mean it’s out of sight. The blockchain is, in fact, public and 100% visible to anyone.

It’s a bit like being able to see everyone’s bank accounts, the balances within them and where the money goes, only without any identifying marks for those accounts. They could be your neighbour’s or that of someone in Brazil — you simply have no idea — and there’s no way to match those addresses to an actual person.

However, if you're law enforcement, all you have to do it follow the bitcoin as it moves through the blockchain until someone makes a mistake, such as moving it a known exchange account in an attempt to convert it into dollars. Exchanges, for the most part, have some sort of KYC (Know Your Customer) processes in place, and this information can be revealed under court order.

Even once the criminals worked out this weak point and tried to move to other, often unregulated, off-ramps, the bitcoin remained tagged, so they had to think of something else.

This usually involved “cleaning” bitcoin by using “mixers” or “tumblers” that would bounce it between various addresses and then recombine the full amount through a bitcoin wallet hosted on the dark web.

Other ways require finding unregulated exchanges — much rarer these days — and then swapping bitcoin for other coins, creating as many “hops” as possible in the process.

Unsurprisingly, funds usually end up in countries where KYC and AML (Anti Money Laundering) regulations are lax and can be converted into fiat currency.

It’s certainly still possible, even today, to move stolen or illicitly acquired bitcoin cleanly and properly, but is not easy and requires a skill level most criminals do not possess. And, the fact is, it’s getting harder by the day, as regulations and monitoring get increasingly sophisticated.

It’s estimated that only around 1% of Bitcoin's transactions are considered nefarious (according to Chainanalysis’ Crypto Crime report earlier this year), and this is a huge improvement on the 44% proposed by a 2017 University of Oxford study. But despite this, Bitcoin can’t quite shake that association from its early days. At least, not yet.

Interestingly, while there are no official figures for the percentage of “cash” transactions that are used in illegal activities, it’s almost certain this percentage is growing at a much faster rate as a function of societies as a whole going increasingly cashless.

To stay off that grid, those cash transactions used in dodgy deals are proportionately larger in a pool that is proportionately smaller. Like everyone else, criminals still need to be paid.

And, say whatever you like about them, criminals are some of the most creative and bold people on the planet. They’ll simply adjust tactics to suit the new environment.

It’s entirely likely that as bitcoin becomes simply too hard to mix and hide due to law enforcement agencies getting better and better at tracking it, other cryptocurrencies will step in to fill the void. These coins are naturally resistant to being tracked on the blockchain, and include monero, zcash, komodo, verge and horizen, among others.

In those cases, the technology isn’t entirely untraceable either, but it’s considerably harder than Bitcoin’s. As time goes by, the logical conclusion is that this is the route they’ll go rather than returning to cash or other traditional assets.

And that creates a paradoxical endorsement for the cryptocurrency industry.

Proof-Of-Value

The irony of all of this is that the activities of the very people that most of us would be very apprehensive of dealing with in real life have effectively created a cast iron endorsement for Bitcoin in particular, and cryptocurrencies in general.

Criminals will simply not entertain using anything that is difficult to move, value or verify. They live in a world where one mistake could mean permanent deprivation of liberty, or even death, so they need to be sure that the risks they take are rewarded in a way that is commensurate with that risk. In short, they will only deal in real, hard value.

So the fact that bitcoin is so appealing to these groups tells us everything. Whilst the rest of us argue over technicalities over whether it’s a commodity, store of value, currency or form of digital gold, these people are already adopting and dealing in it. For them, the days of lugging around large bags of cumbersome cash may be over.

Bitcoin’s detractors, of course, would point out that this is a reason not to use it, but this is as daft as saying we shouldn’t use cash for the exact same reason. And, since banks regularly pay massive fines to their respective governments for rate-fixing and money laundering, should we avoid them too?

The problem simply isn’t cryptocurrency. It’s human nature.

And that, sadly, is something that Bitcoin can’t fix.

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Disclosure: The author of this opinion piece has been heavily involved with bitcoin for several years and holds a substantial cryptocurrency portfolio, including bitcoin. He also has a mining operation running the SHA-256 algorithm based in Siberia and is a published author on the subject of promoting the understanding of cryptocurrency. Jason is an analyst at Quantum Economics.

Disclaimer: Investing in any asset class is risky. The above should not be taken as financial advice, nor construed as so. Always do your own research before investing or consult with a professional financial planner.