Deep Web

07.25.13

The Government’s Perilous Bitcoin Chase

Federal officials are sounding the alarm about digital currencies, which provide cover for terrorists and other lawbreakers. But regulating them may be a nearly impossible job.

Nothing can strip the shine off a cool trend as quickly as national security officials sharing how it is poised to become a cutting-edge tool in terrorists’ ongoing death-to-America project. As such, I want to thank David Cohen, the Treasury’s undersecretary for terrorism and financial untelligence, and John Carlin, acting assistant attorney general for national security—distinguished and otherwise delightful members of a panel I moderated at the Aspen Institute’s National Security Forum this past weekend—for casting a sinister shadow over what I had previously assumed to be the harmless if quirky Bitcoin craze.

To be fair, there is nothing uniquely nefarious about Bitcoin. It is merely the reigning rock star of the digital currency world, thanks in part to heavy promotion by the Winklevii of The Social Network fame. But, as Cohen and Carlin explain it, digital currencies in general are catnip for all manner of illicit actors: drug runners, arms traffickers, hackers, “carders” (those dealing in stolen credit- and debit-card numbers), child-porn peddlers, terrorists. These days, of course, terrorists are increasingly turning to crime—versus, say, charity groups—to fund their dark efforts, meaning the different strands of bad guys grow ever more entangled.

It makes perfect sense when you think about it. While you and I and Tyler Winklevoss may, for whatever reasons, desire a little extra privacy for our financial transactions, just think of how delighted members of AQIM must be to find a quick, clean, fingerprint-free way to skirt the traditional banking system with all its reporting and regulatory requirements. Screw the Terrorist Financing Tracking Program and other post 9/11 attempts to disrupt the flow of money to the bad guys. Digital currencies hold tremendous promise for all those looking to make global mischief.

Take, for instance, the case of Liberty Reserve. Until recently, the Costa Rican–based firm was, as Cohen put it, “the virtual currency of choice for the bad guys.” Liberty worked more or less like this: Customer A could open an account simply by providing a valid email address and having his bank (or whoever) wire x amount of dollars/euros/pesos/etc. to a currency exchanger sitting in some distant corner of the globe. (Thailand? Nigeria? Uzbekistan?) That exchanger would then convert the real currency into “LR” dollars that could be traded within Liberty’s network. The company charged a 1 percent commission for each transfer, plus a premium for those who wanted their account numbers to remain hidden. Unsurprisingly, the system’s lack of transparency attracted unsavory characters, and in May a joint action by Treasury and the DOJ shuttered Liberty and indicted seven of its operators for running what was effectively a $6 billion money-laundering racket.

The indictment charges, “Through the defendants’ efforts, Liberty Reserve has emerged as one of the principal means by which cyber-criminals around the world distribute, store, and launder the proceeds of their illegal activity.” Treasury declines to say much about terrorists on the network, though spokesman John Sullivan’s acknowledges, “A facilitator of a foreign extremist group in 2013 held a Liberty Reserve account, which may have been used to collect funds for the group.”

Bitcoin is the currency of choice on Silk Road, the black market website hidden on the Deep Web, where anonymous shoppers can stock up on erotica, fireworks, and whatever drugs blow their gown around.

Both Cohen and Carlin are, understandably, pretty pleased that Liberty has been taken down. They also point to a series of new rules announced in March by Treasury’s Finance Crimes Enforcement Network (FinCEN), aimed at imposing a semblance of order on the Wild West of digital currency. Access is a key pressure point, says Cohen, noting that any exchanger offering services to IP addresses in the United States must now register with Treasury and abide by anti-money-laundering rules. “What we’re trying to do,” he says, “is bring into play the basic regulatory structure that we have in place for the formal financial system and make sure that it applies to the new world of digital currency.”

Sounds grand, and I wish them all the best. That said, the road ahead is fraught. Compared to Liberty, Bitcoin is an even more decentralized type of digital currency known as a cryptocurrency. It has no central controlling authority. (Meaning, among other things, it is not overseen by a pack of indictable idiots, as was Liberty.) It is distributed by countless “miners” scattered across the globe. (For a bit more on the regulatory challenges, see here.) And while Bitcoin transactions are currently more public, and thus more traceable, than those in some other networks, laundering services have sprung up to help mask money trails, and code is in the works to render transactions wholly untraceable. (One such add-on, Zerocoin, debuted at a San Francisco symposium in May.)

Already, Bitcoin is the currency of choice on Silk Road, the black-market website hidden on the Deep Web, where anonymous shoppers can stock up on erotica, fireworks, and whatever drugs blow their gown around: diazepam, MDMA, Afghani hash, tar heroin ... Last month, the DEA made its first Bitcoin bust, conducting a sting on a Silk Road user named Eric Daniel Hughes, who was charged with the intent to distribute drugs. The game is afoot, and all concerned parties are watching closely to see how things play out.

Meanwhile, spurred by Bitcoin’s prominence, cryptocurrency competitors are popping up like dandelions: Litecoin, Namecoin, PPCoin, Terracoin, Devcoin. All of which makes it that much harder for national security officials to keep up with who is sending how much of which currency where and for what purposes.

And you thought the most unsettling aspect of Bitcoin fever was the return of the Winklevii.