The Blocktrain Has Left the Station

Gone are the days when a mysterious internet-based currency called bitcoin was seen simply as a tool used by criminals to purchase illicit goods and launder money. Today, Bitcoin is recognized as a promising innovation and its underlying technology (blockchain) has inspired the design of a multitude of new blockchains that work in nuanced ways to accomplish a multitude of tasks. Successful blockchain-related businesses are blooming across the globe and financial institutions, law enforcement and governments have taken notice. The new discussion is not about whether blockchains are here to stay, the discussion is about the many ways blockchains can be leveraged to create revolutionary new applications and replace antiquated systems. The most prevalent blockchain application to date remains the transfer of value through cryptocurrencies, and it is imperative that anti-money laundering (AML) professionals understand, and keep up-to-date with this technology and the related money laundering risks and solutions. This is particularly true as cryptocurrency valuations have soared as much as 300 percent in recent months, attracting the attention of investors (and possibly criminals) worldwide. This article highlights two events organized by ACAMS chapters in February, which introduced AML professionals to the world of blockchain with a purpose of fostering a culture of learning and collaboration.

The Chicago and Toronto ACAMS chapters hosted an event in their downtown cores, where they highlighted the universe of blockchain applications and their accompanying compliance issues and solutions. The events’ participants were an eclectic group that included financial institutions, government officials, central bankers, Fintech startups, public-private alliances, and compliance and analysis companies. The wide range of professionals who are involved in this space highlights the breadth, sophistication and interest this technology has roused, and signals the staying power of this technology. As AML professional Peter Warrack noted in the Toronto event, “The Blocktrain has left the station and it’s time to get onboard.”

The network of blockchain experts assembled at these events was like a microcosm of the industry. It highlighted how businesses, law enforcement, compliance professionals and governments are working toward the same goal: using blockchain technology to innovate while still safeguarding society.

Learning About Blockchain Technology

In both cities, the audience received ‘Blockchain 101’ lessons that summarized how the technology works and the various benefits offered. Generally, blockchains are a type of distributed ledger that serves as an incorruptible record of transfers of ownership. Perhaps the best way to introduce an audience to blockchain technology is by showing them a live example of how transactions work and this is exactly what Jonathan Solomon, co-founder and CEO of Digital Mint and Joe Ciccolo, founder of BitAML, did in Chicago. By presenting the process of transferring cryptocurrencies through exchanges, it is easier to introduce concepts like wallet ownership and how wallets are generated. Generally, cryptocurrency exchanges create wallets for clients free of charge. Providing wallets is comparable to providing email addresses. A person can have multiple email addresses, email addresses are always unique, and anyone who knows the login information can use them. However, describing the multiple differences and subtleties of the various popular blockchains necessitates much more time and research than a single article can accommodate.

Blockchain-Based Business

While the best-known blockchain-related businesses are exchanges, entrepreneurs have found many other uses for blockchains. Businesses can provide notary-like services, such as time stamping documents1 or track diamonds from the mine to the consumer and beyond.2 For example, Joseph Weinberg, CEO of the Canadian-based money services business (MSB), Paycase, explained how his company makes use of blockchain technology in order to send remittances internationally.

The company offers clients a computer and mobile-based platform that provides a relatively cheap alternative to legacy systems such as wires. The service is fast (sometimes instant) and offers bank-to-bank transfers, cash-pick up and even door-to-door cash delivery. In addition, it allows money to be sent to unbanked areas in the world where few options are available, despite the dire need for financial assistance.

Cryptocurrency Transaction Monitoring and Compliance

This Canadian-based MSB uses blockchain infrastructures to move value across borders, using banks and partners in the beneficiaries’ jurisdiction to get money to its final destination. This business model is different from cryptocurrency exchanges, which are the most popular value transfer mechanism for cryptocurrencies. The main difference between the two is that cryptocurrency exchanges provide clients with cryptocurrency wallets. People can use these wallets to exchange fiat currency into cryptocurrency and use said cryptocurrency to speculate on cryptocurrency value, transfer wealth and purchase goods and services worldwide. Retailers who accept cryptocurrencies, usually bitcoin, range from small shops to Amazon.com.

Wallets can provide a certain amount of anonymity for the wallet owners, and this was once amongst the greatest hurdles exchanges had to get over: how to mitigate criminal use of cryptocurrencies. Ciccolo and Solomon explained that what was once seen as a hurdle has turned out to be a gift to AML investigators. Although it is true that the owners of cryptocurrency wallets are not publicly known, many blockchains offer a complete public record of all transactions that have ever occurred and this information can be leveraged for investigative purposes. In the Chicago event, several free tools were used to trace bitcoin transfers including blockchain.info.com, a free online wallet and a blockchain explorer service. Free tools that share massive amounts of information gave Ciccolo a good reason to call blockchains “314(b) on steroids.”3

As exchanges have evolved, so have companies that provide know your customer (KYC) enhanced due diligence and transaction monitoring services. One such company is Chainalysis—their CRO, Jonathan Levin, joined the Toronto event. Levin explained how the Bitcoin blockchain can be leveraged to risk score and track wallet activity within this publicly broadcasted blockchain. Chainalysis has created algorithms that detect and track activity through scenario-based monitoring and alerts, which can trigger on a multitude of predetermined suspicious and unusual schema. The software is visually intuitive and provides the end user with the ability to find connections and track transactional history quickly and easily. Such software gives exchanges some of the tools necessary to conduct AML investigations. It also gives exchanges the ability to present data from an independent source that verifies their client’s activity. Such reports can be useful in growing or improving relationships with financial institutions, regulators and law enforcement.

In addition, new blockchains have emerged such as ZeroCash, which allow users to transact through payments that reveal neither the origin, destination, or amount of the payment. Because such cryptocurrencies do not provide a public history of transfers, new hurdles dealing with lack of transparency have emerged. That said, the volume of Zcash transferred every day is a fraction of better-known cryptocurrencies, such as bitcoin (~$11.4 million daily vs ~$1 billion daily).4 The low volume suggests there are much fewer Zcash users, in comparison to other cryptocurrencies. The high volume of Bitcoin users suggests that users are willing to give up a certain amount of privacy for the ease of use.

Compliance solutions by companies like Chainalysis are necessary for sustainable growth of cryptocurrencies, as they allow responsible companies to combat the use of cryptocurrencies for nefarious activities. Such companies are looking to create future solutions to blockchain risks and are already helping to combat existing crimes. One such crime that has been linked to the use of bitcoin is human trafficking.

Combating Human Trafficking

Warrack, from the Bank of Montreal, presented in Toronto on the connection between bitcoin and human trafficking.

Some online classified ad platforms have garnered a seemingly endless stream of adverse media, and government and social pressure due to their reputation as facilitators of the online sex trade. While prostitution may be legal in various jurisdictions, human trafficking (coercing a person through threats and violence to perform sexual acts for money) is not, and the illicit profits generated through this crime are often laundered. In recent years, major credit card companies have stopped supporting payments to such platforms, and since then, bitcoin has become the primary method for sending payments to such companies.

Law enforcement and entities that are expected to report instances of money laundering associated with human trafficking should become acquainted with the different ways Bitcoin is used to purchase ads on adult classified ad platforms. While most Bitcoin exchanges have KYC regimes that human traffickers would want to avoid, there are payment methods available to avoid KYC programs. Possibly the most discreet way of accomplishing this is through Bitcoin ATMs. These machines exchange cash for bitcoin and charge a substantial fee (on average 8.4 percent).5 A client deposits cash into these machines and receives a wallet number with the amount of bitcoins equal to their deposit minus a fee. There are also websites6 that will convert payment from one source (e.g., credit card) to credits, for the purposes of buying online adult classified ads. These websites essentially work as brokers that convert fiat currency into bitcoins. Finally, even gift cards can be used to purchase these credits through the use of websites that provide these online conversion services.7

Successful law enforcement investigations involving cryptocurrencies are often aided by services from private companies that track and rate cryptocurrency activity. Many companies offer these services and there are public-private partnerships that help players in the blockchain industry connect with law enforcement worldwide.

Public-Private Partnerships

Alan Cohn, from the Blockchain Alliance (a forum for industry, law enforcement and regulatory agencies for the combating of criminal activity on the blockchain), gave an overview of the goals and services that this group provides. Cohn explained that the inspiration for the Blockchain Alliance stemmed from the lessons learned in the early days of the internet, when criminals exploited the technology for heinous crimes like child pornography. Given the novelty of the internet in its early days, law enforcement reached out to the industry for training and guidance. This time around, the industry has reached out to law enforcement proactively to promote responsible uses of the new technology.

The Blockchain Alliance brings together some of the most lauded players in the blockchain ecosystem to serve as a resource for law enforcement and regulatory agencies. It offers education, technical assistance and informational sessions about the uses of blockchain technology. It has garnered support from industry players including miners, exchanges, analysis companies and many others who participate in this open forum to help combat criminal activity. The alliance also counts law enforcement and government agencies, such as the U.S. Department of Justice, the U.S. Department of Homeland Security Investigations, the U.S. Federal Bureau of Investigation, the U.S. Secret Service and many other parallel international organizations as partners.8 The group serves as an excellent example of the synthesis needed to help to ensure safe growth and adoption of blockchain technologies through awareness of regulatory necessities and a constructive relationship management with law enforcement.

Government Interest

A blockchain’s accurate accounting and tracking abilities can be used for a plethora of different tasks. Government interest for blockchains shows just how many different uses this technology can have. At the Chicago event, Jennifer O’Rourke, from the Innovation & Technology at the Illinois Department of Commerce, and Ciccolo discussed the “Illinois approach” to blockchain. This approach is one that leverages private and public relationships to examine how to advance possible blockchain-related applications without curtailing growth with premature legislation. In fact, the Illinois Department of commerce has begun researching to see if blockchain could be used in the future to house government records.

As governments further explore blockchain solutions, financial institutions may also begin to review potential clients differently. At the Chicago event, Michael Busch of Burling Bank discussed his institution’s yearlong research of the Bitcoin industry, which continues to this day. Such research includes studying the different types of businesses that use blockchains and or cryptocurrencies in their operations. As time passes and greater knowledge is acquired, banking blockchain companies may become less dichotomous if careful reviews of business models are completed in order to recognize companies that offer less money laundering risk.

In the Toronto event, central banker James Chapman from the Bank of Canada displayed the platform the central bank created to simulate central bank loans to banks. The central bank used the Ethereum blockchain, the world’s second largest blockchain by market cap, to create a system where the central bank can create virtual currency, loan it to banks and destroy it. There is no immediate plan to adopt such a platform, but the government’s interest in the technology should serve to remind the reader that the technology is likely here to stay.

The Way Forward

The blockchain industry has quickly matured since the creation of the first blockchain in 2009. Entrepreneurs have largely replaced the rebels who once touted the need for a completely deregulated currency that functioned outside the purview of government, law enforcement and regulators. Compliance is now recognized as a fact of life by most successful companies and AML regulations are an important part of this recognition. The presenters and organizers of the Chicago and Toronto events propagate the need for open dialogue on blockchain and cryptocurrency in order to bridge the gap between the industry, law enforcement and regulators. Educating AML professionals and law enforcement of the various risks and solutions that exist in this space helps to ensure that innovation does not come at the expense of public safety. Communicating trends and indicators of crimes and risks associated with blockchain technology and cryptocurrency transfers helps to enhance reporting standards and criminal investigations and increase public safety. It is important that AML professionals continue learning about this technology. 

Leonardo Real, CAMS, manager—AML, Bank of Montreal, Toronto, Ontario, Canada, leonardo.s.real@gmail.com

Advisor: Joseph Mari, CAMS, senior manager for major investigations, Bank of Montreal, Toronto, Ontario, Canada, joseph.mari@bmo.com

  1. https://bitproof.io/
  2. Luke Parker, “Ten Companies Using the Blockchain for Non-Financial Innovation,” Brave NewCoin, December 20, 2015, https://bravenewcoin.com/news/ten-companies-using-the-blockchain-for-non-financial-innovation/
  3. Section 314(b) of the USA PATRIOT Act provides financial institutions with the ability to share information with one another.
  4. Referenced from coinmarketcap.com on April 10, 2016, https://coinmarketcap.com/
  5. https://coinatmradar.com/blog/tag/fees-2/
  6. https://buybpcredits.com/do-i-need-bitcoins/
  7. https://paxful.com/backpage
  8. Luke Parker, “Controversy Arises as New Blockchain Alliance Engages with U.S. Law Enforcement,” Brave NewCoin, October 24, 2015, https://bravenewcoin.com/news/controversy-arises-as-new-blockchain-alliance-engages-with-us-law-enforcement/

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