Updated: Sep 26, 2022
The European Union is in the final stages of discussing how to put new rules in place to combat criminal activity involving virtual assets, but estimates of the share of crypto payments linked to financial crime range from 0.15 percent to 46 percent of total transaction volumes.
There is clearly a lot of illegal activity in the crypto world, some of which is harmful to honest crypto users, such as scams or hacks, while others appear to be a way to get around rules that were unfair in the first place, such as government-imposed capital controls.
People in the crypto industry like to use numbers on the low end of the scale, and Binance's CEO Changpeng "CZ" Zhao used statistics on Friday to argue that crypto is safer than fiat.
However, determining the exact scope of illegal virtual asset activity is difficult. It usually works by identifying suspicious crypto addresses and calculating their trade volume, but illicit users prefer to remain anonymous.
The outcome is determined by how certain you want to be about who the online criminals are. When labeling a wallet address as suspect, you may want to have a smoking gun that serves as absolute proof, or you may be willing to accept something more probabilistic and speculative.
Understanding the problem is critical for regulators, judges, and law enforcement to determine whether new laws requiring crypto users to identify themselves are necessary or even legal.
However, there is a surprising lack of agreement on the size of crypto crime. In terms of money, it is almost certainly dwarfed by the real-life version. Money laundering through traditional finance is worth up to $2 trillion, according to the United Nations Office on Drugs and Crime, which is comparable to the total value of all crypto markets combined.
Regulators, on the other hand, are concerned not just about the overall volumes, but also about how much of the crypto sector they represent. They have noticed how quickly virtual assets are gaining popularity and are considering the problem's scope in the future, not just now.
The European Central Bank's Fabio Panetta cited a wide range of figures for illicit crypto activity, ranging from under 1% to as much as half of all virtual transactions, in a recent speech criticizing the industry as a lawless Wild West.
Panetta of the European Central Bank blasts cryptocurrency as a "Ponzi Scheme" fueled by greed.
One reason for the disparity in figures is whether you consider drug purchases as a percentage of total crypto payments or as a percentage of the overall market. People who buy bitcoin (BTC) just to "HODL" it are not doing anything wrong, but that means a higher percentage of those who use it to buy something are likely to be doing so illegally.
But, beyond the question of what you are counting, there is also the issue of how you are counting these transactions, which is dependent on how you identify the bad actors.
Industry figures and academics, such as CZ and Chris Brummer of Georgetown Law, frequently cite figures from blockchain specialists Chainalysis, which stated in January that illicit address transactions accounted for only 0.15 percent of cryptocurrency transaction volumes last year.
However, Sean Foley, an associate professor of applied finance at Macquarie University in Australia, told CoinDesk that this approach leaves many crimes unaccounted for.
In 2019, Foley's own paper, "Sex, Drugs, and Bitcoin," was peer-reviewed and published in the Review of Financial Studies. It found that one-quarter of bitcoin users are involved in illegal activity, with illicit bitcoin payments accounting for $76 billion, or 46% of the currency's total transactions.
In an interview with CoinDesk, Foley defended his methods, which are significantly higher than others on the market.
He claims that chainalysis are "not necessarily very transparent in their approach. They don't really accurately document how they arrive at their numbers."
"If Chainalysis only looked at Ross Ulbricht’s wallet that was seized by the FBI, but I look at all of his conduct through time. ... I'm going to find a lot more," he said, referring to the Silk Road founder who was sentenced to prison in 2015.
Rather than just looking at suspect addresses, Foley examined each user's networks and behaviors, employing statistical techniques used in fields such as medicine and nuclear safety.
While using a mixer to remain anonymous is not proof of bad behavior, he claims that when multiple indicators are combined, they can give you a good idea of whether someone is up to no good.
"If you look dodgy because you were predominantly interacting with dodgy people, and you look dodgy because you were using a lot of tumbling services, and there was a lot of activity when darknet marketplaces got seized … this gives us the ability to say with a much higher degree of confidence that these are likely illicit actors," he explained.
Others warn that Foley may have gone too far, tainting innocent crypto users unfairly.
"You have to be really careful with crime data and the associations that you make between wallets," Chainalysis's head of research, Kim Grauer, told CoinDesk. According to Chainalysis, illicit wallets received $14 billion in 2021, which is significantly less than Foley's estimate.
"A lot of times people will just see money transacting between a crime wallet and another wallet and they'll say, ‘hey, those must be connected,'" she said, citing examples like when a single service managed millions of different addresses.
"If you are not a crime investigator with blockchain experience, I would be a little bit skeptical of some of the definitive associations," she said, citing the "quirky" nature of blockchain.
In contrast to Foley's, Chainalysis' data "is not extrapolated, it is not statistically determined," she said. "This is the real amount of transactions that are identified as illicit from a data set that's the most powerful data set on cryptocurrency in the world."
She acknowledged that the Chainalysis figure is not complete. It excludes real-life crimes like drug deals on the street that are then laundered through bitcoin, as well as gray areas like wash trading, which appears to be becoming more common in the market for non-fungible tokens.
Scams are frequently discovered after the rug has been pulled from under them, which means that data for a given year may be out of date and needs to be updated. However, she believes that a strategy involving "hundreds of hundreds" of investigators scouring darknet forums for criminal activity is "definitely, definitely fair."
Another complication is how quickly data ages in such a fast-paced market. The data Foley used is from 2017, which seems like an eternity in the crypto world, but he believes the problem has only gotten worse since then.
He admits that illegal bitcoin volumes have decreased over time, but only because criminals have switched to less ostentatious alternatives like ZCash, Monero, and Dash.
"There's a lot of privacy technology that has been developed since the publication of our paper," he stated, and he thinks that generally speaking, criminal use of crypto "is not going down."
"There's still a ton of online marketplaces for darknet products, so I don't think that's gone away," he said, citing the rise in large-scale ransomware, such as the $5 million Colonial Pipeline hack in 2021.
The Financial Action Task Force, the international body responsible for developing money laundering norms for traditional finance and the crypto sector – including the contentious travel rule that the EU is now attempting to implement – is the group that needs to be convinced the most.
FATF noticed significant differences in estimates of illicit crypto trades over time and among different analysts, such as Chainalysis, Elliptic, and Merkle Science, in a report published in July 2021 – which Grauer believes could be because they look at a different universe of transactions or currencies.
Whatever the reason, FATF believes the analysts' estimates of the illegal transaction percentage, which range from 0.1 percent to 15.4 percent, are all too low.
According to the FATF report, "the data provided only relates to identified illicit transactions which the companies are able to identify, based on lists of known or suspected illicit addresses." It concluded that figures from Chainalysis should be "treated as the likely minimum."
Grauer appears to agree, saying that her preferred figure "is a floor for the amount of illicit activity."
She stated, "We would not know how many [illicit actors] were missing. You don't know what you don't know … if we knew about it, we would put it in our system. "
Foley and Grauer may have arrived at different conclusions as a result of their different goals. In the first case, it is attempting to estimate the overall volumes associated with crime, while in the second, it is attempting to identify individual users who may be worth pursuing – a much higher burden of proof.
Grauer said that while methods like Foley's are "certainly extremely useful," "results should not be relied on when it comes to identifying illicit wallets."
"People use our data set to run full investigations, including putting people in jail," she explained, emphasizing that she will not arbitrarily blacklist someone.
This has implications for live policy. The European Parliament voted in March to impose new identity checks on those making even the smallest crypto payments, including, most controversially, transactions made with unhosted wallets not managed by a regulated exchange.
The idea is that law enforcement will be able to more easily track crypto transactions that could be used to fund serious crimes like terrorism or child pornography if the details are worked out with national governments. However, industry players such as Coinbase (COIN) have expressed concern that the bill will stifle innovation and compromise privacy.
Legal experts like Thibaut Schrepel of Amsterdam University told CoinDesk that laws that invade privacy more than they need to could be struck down. That message appears to have reached officials such as Gabriel Hugonnot of the European Commission, who warned lawmakers that any attempt to differentiate crypto from other types of financial transfers would have to be justified.
Figures on the overall scale of the crypto crime problem, as well as other features of crypto tech like network transparency, could sway policymakers – and, eventually, judges – in deciding whether the law is really needed.
Grauer believes that, however imprecise the figures are, the type of analysis possible on the blockchain is still far superior to offline financial-crime statistics.
"There is no equivalent number in the fiat world, because doing this type of research is just not possible," she explained. "Using U.S. dollars, how many drug dealers are there in the world? There's never a number you're going to get."
However, good policies require good data, which may be in short supply.
By fLEXI tEAM