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Case Study: Should We Embrace Crypto?

• Charles C.Y. Wang

The CFO of an online education platform considers whether to adopt Bitcoin for payments and investments.

The phone buzzed on the nightstand—once, twice, three times—waking Ankit Jain from what had been a restful sleep. Before he could reach the phone, three more texts came through. He knew who it would be: his boss, Thorsten Konig, the CEO of Ivory Tower, the world’s leading online education platform.

• CW Charles C.Y. Wang is the Glenn and Mary Jane Creamer Associate Professor of Business Administration at Harvard Business School.

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Cryptocurrencies and National Security: The Case of Money Laundering and Terrorism Financing

by Shlomit Wagman | Dec 28, 2022 | Main Articles , Volume 14

Shlomit Wagman  [*]

[Full text of this Article in PDF is available at  this link ]

Introduction

Cryptocurrencies can be a haven for criminals, terrorists, and sanction evaders. The early, romantic ideology underlying blockchain technology envisioned a decentralized currency without geographical boundaries, governmental supervision, central bank control, or any identification required. Cryptocurrency was meant to be a fast, cheap, and reliable way of transferring value among strangers.

In 2014, the Financial Action Task Force (FATF), an international organization dedicated to combating money laundering and the financing of terrorism, identified the risks associated with cryptocurrency. By 2018, it developed an overall strategy to manage these risks and countermeasures designed by the FATF were enacted into binding global standards that all jurisdictions must adopt. Since then, the FATF has been leading coordinated implementation efforts around the world. The FATF’s response was the first global, coordinated regulatory response to cryptocurrency risks. Dozens of countries have already adopted the FATF’s cryptocurrency-related measures. It is imperative that the remaining countries follow suit, and that the FATF holds them accountable if they fail to do so.

This Article reviews the anti-money laundering and counter-financing of terrorism (AML/CFT) framework and its application to cryptocurrencies. Then, it presents case studies demonstrating the important contributions that the AML/CFT toolkit has made to countries’ security. The case studies include the seizing of cryptocurrency used by terrorists for fundraising, revealing the identity of attackers in a ransomware cyberattack, and arresting terrorists who were paid through cryptocurrency and tracked before completing their planned attack. The Article concludes with recommendations for further actions that the global community, individual countries, and the private sector should take to better tackle AML/CFT risks, including unaddressed cryptocurrency-related challenges posed by decentralized systems.

[*] Research Fellow, Mossavar-Rahmani Center for Business and Government, Harvard Kennedy School and Faculty Associate, Berkman Klein Center, Harvard Law School. Former Director-General of the Israel Money Laundering and Terror Financing Prohibition Authority, head of the Israeli delegation to the Financial Action Task Force (FATF) from 2016 to 2022, Co-Chair of the FATF’s Research, Typologies, and Methods Group from 2019 to 2022, and former Acting Director-General of the Israel Privacy Protection Authority. The author earned a B.A. from Hebrew University of Jerusalem and an L.L.M. and J.S.D. from Yale Law School. The author would like to thank Professor Howell Jackson, John Haigh, Katherine Ford, and David Izack-Haim for their valuable input and comments.

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Joel Khalili

The Science of Crypto Forensics Survives a Court Battle—for Now

On March 12, Russian-Swedish national Roman Sterlingov was found guilty of money laundering conspiracy and other violations by a federal jury in Washington, DC, for having operated Bitcoin Fog , a service criminals used to launder what authorities claim was hundreds of millions of dollars in ill-gotten gains.

The conviction was heralded by the US Department of Justice as a victory over crypto-enabled criminality, but Sterlingov’s lawyers maintain the case against him was flawed and plan to appeal. They allege that the nascent science used to collect evidence against him is not fit for the purpose.

The DOJ investigation used blockchain forensics, a technique whereby investigators scrutinize the public trail of crypto transactions to map the flow of funds. In a statement , Lisa Monaco, deputy attorney general for the US, described the DOJ as “painstakingly tracing bitcoin through the blockchain” to identify Sterlingov as the pseudonymous administrator behind Bitcoin Fog.

Bitcoin and other cryptocurrencies have acquired an undeserved reputation for being less traceable than conventional money, but evidence collected this way has brought down many criminals over the past decade. Blockchain forensics was crucial to the trial of Ross Ulbricht , founder of the infamous Silk Road marketplace . But in the Bitcoin Fog case, the defense has pulled this investigative technique into the spotlight, effectively putting crypto tracing on trial in place of their client. The case is a “first-of-its-kind,” says Tor Ekeland, legal counsel to Sterlingov. “Nobody has challenged blockchain forensics before, because it’s brand-new.”

Before Sterlingov’s trial, his attorneys asked the presiding judge to determine the admissibility of evidence from blockchain forensics experts that had used software from a firm called Chainalysis, which expedites the otherwise tedious process of sifting through the blockchain. He ruled the evidence was admissible.

That decision has been characterized by Michael Gronager, Chainalysis CEO, as an endorsement of his firm and its methods. “We are now the only company in the world with a stamp of approval for our ability to look at a blockchain and create evidence,” he says. But Ekeland says he will work with Sterlingov to appeal both the guilty verdict and the judge’s ruling on the validity of blockchain forensics. The conviction of Sterlingov is the latest example of the unhappy phenomenon, claims Ekeland, whereby “newly emergent junk science leads to unjust verdicts.”

Beth Bisbee of Chainalysis, formerly the company’s head of US investigations, disputes that characterization. “The evidence that the government presented to the jury demonstrated the exact opposite,” says Bisbee, who testified as an expert witness at the trial. “Our methods are transparent, tested, reviewed, and reliable.”

Natsec Threat

Until it was shut down by US law enforcement in 2021, Bitcoin Fog supplied what's known as a crypto mixing or crypto tumbling service. Funds belonging to many parties are pooled, jumbled up, and spat out into brand-new wallets, masking the origin of the coins held in each. Mixers were originally promoted as a way to improve the level of privacy cryptocurrency could afford consumers, but they have been readily co-opted for the purpose of money laundering . Bitcoin Fog was among the first mixers to emerge, in 2011, making it “the longest-running bitcoin money laundering service on the darknet,” the DOJ says.

In the past few years, the US government has cracked down on crypto mixers, which it considers a threat to national security . After taking down Bitcoin Fog, the US Treasury sanctioned Tornado Cash, another mixer, in 2022. The year after, it took down another , ChipMixer, and charged the founder with money laundering. To identify the individuals behind these operations, investigators had to follow the crypto money.

Angela Watercutter

William Turton

Megan Farokhmanesh

Nena Farrell

In crypto’s earliest years, the pseudonymous nature of transactions—whereby coins are exchanged between wallets identified only by an alphanumeric address—was frequently mistaken for anonymity . But beginning in late 2012 with the work of cryptographer Sarah Meiklejohn , now a professor at University College London, among others, researchers began to figure out ways to group crypto wallets together, revealing connections that implied shared ownership. “Ultimately, you’re trying to link one pile of money to another,” says Meiklejohn. With this new knowledge, it became possible to attribute wallets to specific crypto exchanges or marketplaces, and to follow stolen funds. To identify the people who owned particular wallets, law enforcement could subpoena the exchanges they used to convert crypto into regular money. Logged on an open ledger for all to see, crypto transactions were not remotely anonymous.

This general methodology—which Meiklejohn termed “clustering”—was taken up, further developed, and packaged into blockchain forensics services offered by firms like Chainalysis, which was used by the DOJ to help prosecute Sterlingov. “In academia, we are pretty far behind the state of the art at this point,” says Meiklejohn. “We sort of accept that this is just an industry now.”

The professionalization of blockchain forensics is central to Sterlingov’s defense strategy in the Bitcoin Fog case. It is impossible to audit the clustering performed by the government for accuracy, a report commissioned by the defense submitted ahead of the trial claimed , because the inner workings of Chainalysis’ software are private. There has been no peer review of the specific methodology the company uses, says Ekeland, nor is there any standards body for the blockchain forensics industry. “It should be illegal to use black box software in criminal prosecutions—it should be open source. It violates a defendant’s Sixth Amendment right to confront their accuser. It’s unconstitutional,” he claims. Chainalysis says the hearings on the admissibility of the company’s evidence served as a check on its reliability.

“Mushrooming Effect”

The defense also disputes the way in which blockchain forensics evidence was interpreted, to finger Sterlingov as the operator of Bitcoin Fog. Although wallets belonging to Sterlingov might have interacted with the mixer, that does not prove him the service’s operator, they argue. “The problem isn’t so much that the blockchain is lying,” says Ekeland. “The flow of funds is not the same as the flow of control.”

While the government presented other forms of evidence it said tied Sterlingov to Bitcoin Fog, like analysis of IP addresses linking him to the ownership of the web domain, Ekeland believes the blockchain forensics was critical in convincing the jury of his guilt. “The ‘CSI effect’ really hurt us,” he says. “The jury placed undue importance on pseudoscientific evidence, because it was presented in a fancy chart and by the government.”

The academics with whom the science of crypto tracing originated acknowledge that it should not be applied as evidence in isolation, or mischaracterized as some sort of a smoking gun. There remains some art to interpreting the information produced by blockchain analysis, says Meiklejohn, which introduces the opportunity for error. “You still have to decide if it means what you think it means, or whether there are other explanations,” she says.

“I would not be comfortable [with blockchain forensics being the only form of evidence],” says Philip Koshy, who alongside his wife Diana Koshy demonstrated in 2014 a way to identify the IP addresses associated with certain bitcoin transactions. “It ends up becoming scientific only if you can determine ground truth, using subpoena power.”

The judge in the Sterlingov case pointed out in his ruling on the admissibility of blockchain forensics evidence that the DOJ had additional evidence pointing to the accused. “This is not a case in which the government’s theory that Sterlingov was the operator of Bitcoin Fog turns exclusively, or even primarily, [on blockchain forensics],” he wrote. In order to “establish that crucial point,” the judge noted, the government relied upon a range of information external to any blockchain, from IP addresses to forum posts.

The judge also took issue with the depiction of Chainalysis software as an inscrutable black box, on the grounds that the defense had been given information about its workings—Ekeland disputes this characterization—and pointed out that the underlying heuristics applied by the firm have been subject to peer review, even if its specific clustering methods have not been.

For maximum transparency, Chainalysis could open-source its software, but doing so would risk handing an advantage to bad actors. “This is a cat and mouse game,” says Mieklejohn. “Once you publish the heuristics, people understand how they work, and then they can take steps to evade those heuristics.” In the circumstances, argues Gronager, Chainalysis CEO, the hearings on admissibility—during which the company’s work came under heavy scrutiny—is the next best thing to a traditional peer review.

In the end, the effort to cast doubt over the reliability of blockchain forensics bore no fruit for the defense. “The Court is persuaded that blockchain analytics in general, and [Chainalysis’ software] in particular, is not junk science,” wrote the judge, in his summation on the admissibility question.

The ruling does not set a precedent that other US judges must follow, because the case has been confined so far to a district court. Nonetheless, Gronager is hopeful it will be the “final word” on the admissibility of blockchain forensics evidence, at least until future developments in crypto tracing demand a reevaluation. “This is a landmark ruling,” adds Bisbee of Chainalysis.

While Ekeland is concerned about a “mushrooming effect,” whereby the ruling will figure in the thinking of future judges, he claims the matter “could take years to gel one way or the other.” Among other quarrels with the way the case was tried, the use of blockchain forensic evidence will form part of the basis for Sterlingov’s appeal. “Right now, the momentum is in their favor,” says Ekeland. “But it’s still an open battlefield.”

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Case study of cryptocurrency suggests many do not trust its transparency and privacy

by Bob Yirka , Tech Xplore

A trio of economists and financial analysts, two from Yale University and the other the University of Chicago, has conducted a case study of a nationwide cryptocurrency experiment to better understand why such a monetary system might or might not work as intended. In their paper published in the journal Science , Fernando Alvarez, David Argente and Diana Van Patten, describe their analyses of an attempt by the government in El Salvador to make cryptocurrency a popular choice for the people of that country and what they found by doing so.

Over the past half century, it has become apparent to some that established banks and the banking system in general do not always deal favorably with people on the lower spectrum of the economic scale. Because of that, various alternatives have arisen.

One such alternative is cryptocurrency. It has been championed as a currency for the poor because of its anonymity—people who use it do not have to give up their personal information or credit history. Unfortunately, that same positive attribute has led to accusations by some that cryptocurrency systems (such as Bitcoin) allow criminals and terrorist organizations to move money around without being traced.

In this new study, the researchers wondered how average people view such systems and if they are willing to embrace them. To that end, they conducted a case study of the history of Bitcoin in El Salvador.

In 2021 the government of El Salvador formally recognized Bitcoin as legal tender throughout that country, hoping to give it credibility—as part of that effort they began allowing citizens to pay their taxes using the system. The government also ordered all businesses across the country to begin accepting Bitcoin as a payment method—including debt collectors.

Then, to make it easier for everyone in the country to use the new currency system, they introduced Chivo Wallet, a phone app that could be used to exchange and trade Bitcoin—and U.S. dollars. One thing the government did not do was stop the use of the U.S. dollar as a legal exchange medium—the official currency of the country, the colón, is seldom used and has largely passed out of circulation.

To learn more about the acceptance or lack of adoption of the new currency system, the researchers conducted face-to-face interviews with people living in 1,800 households across the country. They were also given access to transaction numbers for Chivo Wallet.

The research team found that use of Bitcoin in El Salvador has remained low, and its use has been declining since the government began its push. The reason given for refusing to embrace the new currency system, the team found, was mainly transparency and privacy issues—regular people do not trust the people running the cryptocurrency system. Because of that, most still preferred cash—U.S. cash. They also found that most of the people who use Bitcoin in El Salvador are wealthy people who also continue to use the regular banking system.

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Cryptocurrency Compliance and Operations pp 155–170 Cite as

Cryptocurrency Compliance and Operations Case Studies

• Jason Scharfman 2  
• First Online: 27 November 2021

2091 Accesses

This chapter provides an overview of compliance and operations related cryptocurrency case studies. The chapter begins with an overview of cryptocurrency Ponzi schemes. As part of this discussion, the influence of Fear of Missing Out (FOMO), Fear, Uncertainty and Doubt (FUD) and the meme economy were discussed as contributors to creating an environment that supported crypto fraud. Several case studies were then discussed that include the use of crypto-related options, revenue sharing arrangements for capital raising, multi-level marketing (MLM) tactics, affinity scams, crypto lending, clone firm scams, and exit scams. The chapter concludes with an analysis of the continued evolution of Turkey’s crypto regulations and the failure of the Thodex and Vebitcoin crypto exchanges. With an established understanding of crypto operations and compliance that has now been reiterated by real-world case studies, in the next chapter we will not turn our focus to Decentralized Finance (DeFi) Compliance and Operations.

• Ponzi scheme
• Fear of Missing out (FOMO)
• Uncertainty and Doubt (FUD)
• Meme economy
• Multi-level marketing
• Affinity scam
• Clone firm scam

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