If the Bitcoin blockchain is anything, it is transparent, but only to a degree. Yes, the history of every transaction since 2009 is present for public inspection at anytime, but only to the extent of endpoint addresses. The owner’s identity is the only thing missing, a fact which government authorities, law enforcement officials, and regulators find extremely worrisome and that must be dealt with in the near-term future. Researchers have attempted from time to time to determine the extent that criminal activities pervade the Bitcoin blockchain with mixed results. One of the more extreme cases of this genre is making the rounds again and was featured in one of the world’s top three finance journals, the Review of Financial Studies.
The May 2019 issue of this journal was devoted to Fintech, Blockchain and Cryptocurrencies and featured a study prepared in 2018 by three academia researchers from universities in Sydney, Australia. The paper was entitled: “Sex, drugs, and bitcoin: How much illegal activity is financed through cryptocurrencies?” The three professor-types go through a lengthy discussion of their methodology, which basically took Dark Web addresses, 200 million or so Bitcoin transactions from 2013 through 2017, applied a few “detection” algorithms, and arrived at conclusions that seem so farfetched that they are difficult to accept as truth. Their findings are summarized in the chart below:
If you average out the ups and downs, they claim 28% of all Bitcoin users are criminals. By deduction, they propose that nearly 50% of all Bitcoin transactions involve illegal activities. They do not question their findings, perform any sensitivity analysis to determine appropriateness of them, and even state that their methods were conservative and that real criminal activity levels could be even higher than their study documents.
They also attribute the apparent slide over the last two years to “the development of other digital currencies where the level of anonymity is higher, so more illegal activity shifted to these currencies (such as Monero (XMR), Dash (DASH), etc.). Despite the decline in the relative share, it should be emphasized that the absolute level of illegal activity continued to rise during this period”.
The authors do list three important reasons why legality is so important for crypto: “The issue of the legality of using digital currencies is important for several reasons. The first is that illegal activities alienate potential legitimate investors from investing in this market. Second, the suspicion of illegal activity has led some governments to prohibit or limit the use of these currencies, which prevents market growth. A third reason is that the lack of regulation in this market may by itself support the growth of illegal activities such as “black e-commerce” and financing of terrorist organizations.”
The methods employed in this study are so convincing and intellectually conceived that it is difficult to assess if there was a basic lack of understanding of a key point in how the blockchain operates, let alone how their algorithms could expand upon the basic data to arrive at such incredible results. It would be nice to know the funding source for the study, as well. Did ASIC need ammunition to further its regulatory assault on the crypto industry down under? It is hard to say, but even the authors did not blink at their own conclusions, nor did they mention that law enforcement officials like the audit trail that exists in the blockchain. It helps them in their criminal investigations.
What have other studies shown to date? In January, an article on “NewsBTC” posited that: “Criminal acts are estimated to account for less than 1% of all transactions on the Bitcoin network”. Cross-border payment fraud on credit and debit cards runs about 1%, as well, and this system has very tight controls to block organized crime from taking too much from the banks and cardholders. Studies have also shown that crooks dealing in large amounts, which are difficult to extract or hide on the blockchain. Professional hacking gangs may use as many as 5,000 “layering” transactions to disguise their trail.
What are the correct figures? More research is needed. Relying on so-called “clustering algorithms” to get a handle on what may or may not be an illegal transaction seems prone to exaggerating results in one direction or another. There is no doubt that criminals hide illicit funds on the blockchain, but organized crime has infiltrated every known financial service on the planet. Security professionals always state that these types of mal-intended transactions can never be eliminated. They can only be managed to acceptable limits. The crypto industry, if it is to prosper, needs to get a grip on this issue and develop the necessary controls to “manage” the problem appropriately.