How does Bitcoin Money Laundering work?

Despite the dozens of benefits that Bitcoins and the Blockchain Technology have to offer compared to the traditional banking system, there is a risk that Bitcoins can be used for money laundering. This is because Bitcoins are not linked to a person’s identity and only depend on the private key connected to the Bitcoin account. Since Bitcoin is a decentralized network, there is no central record-keeping mechanism that governments or financial institutions can after.

Mechanism for Money Laundering

Moving large sums of money around has traditionally been a complicated process that involved trusting intermediaries to do the transfer like the Swiss Banking System. Switzerland has a tradition of banking secrecy that dates back to the Middle Ages. This system was codified in the Banking Law of 1934. Up until recently, this made Switzerland the prime hub of individuals looking to evade taxes. But in 2008, this all changed thanks to a multi-billion dollar tax evasion case probed by the Federal Bureau of Investigation (FBI) which involved the Swiss bank UBS. The incident led to stricter money laundering laws for the Swiss banking industry along with more authority to regulators.

So tax evaders are now looking at alternative ways of laundering money like cryptocurrencies. For individuals trying to evade taxes or launder money, Bitcoins provide enormous advantages over the Swiss Banking System. With Bitcoins, individuals do not have to rely on other intermediaries to facilitate the transfer. Cryptocurrencies like Bitcoin and Monero which are focused on privacy allow individuals to become their own banks by holding their own private keys. Since cryptocurrencies make it hard to regulate such transfers, they could attract lots of people who want to evade taxes in their respective countries. However, some startups like Chainalysis are actively trying to come up with solutions to track Bitcoin transactions as they are available for everyone to view on its public ledger.

Need for Regulation

Bitcoins and other cryptocurrencies are decentralized so there is no central organization that is aware of all the transactions happening on its ledger. This makes it especially challenging for regulators to control. Essentially to control Bitcoins, an adversarial government would have to shut down the whole public internet. This is so because Bitcoin does not depend on central servers to function, but instead on its decentralized network of miners to process transactions. In its ten years of operation, no government has been able to regulate Bitcoin efficiently even though several attack vectors have been tried. This shows that Bitcoin can handle scale and is also very resilient to attacks on its network making it a haven for tax evaders.

Prevention and Mitigation

Ever since Bitcoin first made headlines in 2013, regulators across the world have made numerous attempts to try to regulate Bitcoins. However, most of these regulators seem to not really understand the concept of Bitcoins and how these can be controlled. At this point, until techniques like Chainalysis become more advanced, the only way to monitor Bitcoin is to watch the banks for when people make Bitcoin to fiat conversions. When an individual converts their Bitcoin to fiat, banks can see the entire history of how those Bitcoins have been used. At that point, if law enforcement finds that those Bitcoins have been involved in illegal activities like money laundering, they can follow up with the account holder.

Counter Arguments to Regulation

Since its inception, Bitcoin has aimed at becoming digital cash that people could use instead of actual cash. It is important to note that all of the money laundering and illegal activities that Bitcoins can be used for, can also be done via cash. That is, cash has been the primary mode of payment for drug dealers, money launderers, and other violent criminals. But since so many ordinary citizens also rely on cash for everyday payments, governments cannot ban cash. Similarly, even though a small fraction of Bitcoin transactions may be used for illegal activities, it is counterproductive to ban all of the cryptocurrencies as they have the potential to improve the current banking system by a lot. Instead, governments should focus their energies on using this revolutionary technology to bring more transparency into their function, like using public ledgers to show citizens that the taxpayer money is being correctly used.


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