The proportion of illicit use seems to be on the decline. Recent recognition by an authoritative legal panel, combined with success in court with tracking and stopping illegal asset flows, promises a better future for cryptoassets.
Cryptoassets offer a combination of new payments systems with novel currencies that are not issued by a central bank. Beginning with the arrival of Bitcoin in 2009, cryptoassets have seen a rapid proliferation, with many digital currencies like LiteCoin, Ether (Ethereum) and XRP now available.
There is still not much you can legitimately buy with cryptoassets – they are mainly held as investments. That’s why institutions like the Bank of England resist the term “cryptocurrencies”. Their extreme volatility makes investing a challenging prospect. Bitcoin has seen changes of +65% and -25% in a single day. So they are seen as seriously risky for inexperienced investors - the Bank of England offers a stark warning: “anyone buying cryptoasstets should be prepared to lose all their money”. But many investors believe that there is plenty more room for growth and cryptoassets are increasingly popular as a speculative investment.
A shady past
Cryptoassets have also developed a reputation for use in criminal activity. The Chainalysis 2019 Crypto Crime Report identifies three main types of cryptoasset crime.
Cryptocurrency exchange hacking remains a serious issue, with two hacking groups thought to be responsible for the bulk of thefts. Stolen cryptoassets are then moved through a complex network of holdings within different exchanges to launder the proceeds. In the last few days, Korean crypto exchange Upbit confirmed a theft of $50 million worth of Ether from its hot wallet. Upbit has stated that it will protect user assets, and the exchange has been temporarily closed.
Darknet platforms deploy cryptocurrencies to facilitate criminal activity. Sales on the now-defunct darknet trading platform, Silk Road, relied on Bitcoin as a payment mechanism for purchases of illegal drugs and fake ID documents. Other platforms offered illegal weapons for sale. Law enforcement agencies have had considerable success in closing down platforms and prosecuting their operators. AlphaBay and Hansa were both closed down in 2017 after coordinated efforts by police forces in several countries. Although other markets often pop up to replace those that have been removed, it seems that the attractiveness of darkweb trading platforms is fading.
Successful criminal prosecutions against darknet operators, alongside a realisation that cryptoassets may not be as anonymous as many thought, means that many believe that darknet crime is falling.
Initial coin offering scams, phishing attacks and ponzi schemes, which (according to the Crypto Crime Report) are particularly rife on the Ethereum platform, have also provided profits for criminals. These types of activity dupe market participants into believing that they are engaging in legitimate financial transactions, only to find that the criminal has emptied their cryptoasset wallets and provided nothing in return.
Why cryptoassets are attractive to criminals and how that might change
The absence of involvement of regulated financial institutions, along with hard-to-crack privacy, goes some way to explaining why criminals have been drawn to cryptoassets. However, this Wild West era may be coming to an end. Research by Chainalysis indicates that the percentage of Bitcoin transactions that are illegal has fallen from 7% in 2012 to under 1% in 2018. While this may be largely due to the increase in legitimate activity, it does seem that law enforcement bodies are fighting back. Building on the progress made against darknet platforms, the US authorities have had considerable success in recent months in tackling the illegal trade in opioid drugs. On top of this, it is becoming more realistic to track and follow cryptoassets with a view to recovering stolen property.
Cryptoassets have always been seen as offering greater secrecy because of the anonymous nature of transactions. But in fact, cryptoasset transactions are pseudonymous rather than truly anonymous. Unlike cash, transactions can potentially be traced, and the transaction record is retained indefinitely. New methods of tracking blockchain-based transactions are becoming available, based on sophisticated new analytics technology.
Moving out of the shadows
For organisations affected by cryptoasset crime, there has historically been little that can be done. However, that picture is changing. The new approaches to track transactions can be combined with legal tools to combat movement of assets.
Over the summer, a landmark ruling saw a UK court grant a freezing order to Liam Robertson, CEO of crypto-fund manager Alphabit. The judgment is not published, although news reports indicate that Robertson had intended to invest 100 Bitcoin in a new fund. Following a successful spear-phishing attack, the Bitcoin went instead to a hacker’s account. From there, 80 were moved to the Coinbase exchange and the other 20 to LocalBitcoins.com and a cold wallet.
The Bitcoin trail was followed using blockchain investigation techniques. Then, in a legal first, London’s Commercial Court recognised that the stolen Bitcoin could potentially be recognised as property. The court granted an Asset Preservation Order to prevent any further dealings. The court also granted a so-called “Norwich Pharmacal Order” to require Coinbase to disclose information about the recipient of the 80 Bitcoin.
This meant that two types of legal order that are traditionally used to trace the movement of funds through bank accounts, and freeze any further dealings, were successfully applied to movements of cryptoassets.
A new legal status
Following that ruling, an influential lawtech task force has underlined the status of cryptoassets as property. In its Legal Statement on cryptoassets and smart contracts, the UK Jurisdiction Task Force gives its support for the idea that cryptoassets are property under English law.
Although they are clearly not physical property, like a sports car or gold bars, and (probably) not “things in action”, like debts owed or contractual rights, cryptoassets are another kind of property. They fall into a third category along with other difficult to characterise assets like carbon emission allowances, patents and milk quotas.
Being confident that cryptoassets are in fact property makes a big difference to how they can be used and managed. This will have important consequences in relation to areas like inheritance and bankruptcy/insolvency. It also means that court orders of the kind granted to Liam Robertson become more likely. Courts will no longer have to go out on a limb to make these kinds of tracing and freezing orders, but can have greater confidence in their validity.
Because cryptoassets are virtual, there are limits to what you can do with them. Granting security rights will be constrained by the features of the cryptoasset, for example, but the task force concluded that some forms of security would be possible.
Controlling and managing risk
In the new world of cyber crime, hacking and virtual property theft, organisations are increasingly looking for ways to control their risk exposure. We have seen a rapid expansion of the market in cyber insurance policies. These may include cover for stolen cryptoassets, although this is not yet standard.
For businesses dealing in cryptoassets, and their insurers, the potential to identify destination accounts, control onward movement of cryptoassets, and obtain further information about illegal recipients offers a powerful toolkit. A situation that might before have led to a serious loss or substantial payout now has the potential to result in successful recovery of stolen assets.