Liberty Reserve, Money Laundering, and Implications for Bitcoin

June 26th, 2013

In April, I argued Bitcoin, one of the world’s most mainstream currencies currently operating, may become a viable, sizeable, and more dangerous alternative to offshore accounts for money laundering and tax evasion. I argued the U.S. government isn’t paying close enough attention to the growing threat posed by these currencies. Yet, just a month later, the Department of Justice arrested the founders of Liberty Reserve, another digital currency, and charged them with money laundering. It might seem I was wrong. I say not so fast. For counter-intuitive reasons, Bitcoin still poses a more serious, and long-term, threat than currencies like Liberty Reserve.

First a recap of what happened. In May, DOJ charged Liberty Reserve, Arthur Budovsky (its founder), and his associates with conspiracy to commit money laundering. According to DOJ, nearly all of Liberty Reserve’s five million transactions were illegal and used to launder more than $6 billion in proceeds from drug trafficking, child pornography, ponzi schemes, and many other crimes. The founders of Liberty Reserve incorporated the company in Costa Rica, which later seized about $19.5 million from the company’s bank account as requested by U.S. government officials.

Liberty Reserve posed obvious money laundering threats. So what does that mean for other online currencies, particularly mainstream ones such as Bitcoin?

Bitcoin and Liberty Reserve are different for three key reasons. (1) Bitcoin is decentralized in a way Liberty Reserve was not; (2) Bitcoin is spuriously transparent compared to Liberty Reserve; and (3) Bitcoin has more legitimate users than Liberty Reserve. On the surface, each of these factors makes Bitcoin appear to pose less of a threat than Liberty Reserve. After all, who doesn’t like transparency and legitimacy? However, I would argue that these characteristics make Bitcoin a greater long-term and riskier contributor to money laundering and tax evasion. Let’s take each of these in turn.

Bitcoin is decentralized. Bitcoin exist completely online, using peer-to-peer networks rather than a centralized system. They are issued by complex computer algorithms, rather than a central agency or government. No one is even really sure who “made” Bitcoin in the first place. In fact, those original programmers specifically engineered the currency so that it wouldn’t have a core group of people who law enforcement officials might target like they did with Budovsky and his alleged co-conspirators. As a result, Bitcoin users don’t face the same kind of accountability. Other future digital currencies, some of whom may wish to follow in the illegal footsteps of Liberty Reserve, will likely use the Bitcoin model of decentralization.

Bitcoin is more anonymous than you think. In the wake of the Liberty Reserve fiasco, a lot of analysts have pointed to Bitcoin’s transparency to argue for its merits. On the one hand, you don’t have to provide a real identity to open an account. On the other, however, Bitcoin transactions are completely public; they are recorded in a public ledger, which make it possible to track transactions years after they took place. It’s also theoretically possible to link these addresses to a person, even if that person doesn’t provide a real identity.

But it’s also not difficult to anonymize Bitcoin transactions, at least superficially, and it’s becoming easier to anonymize them thoroughly. There are literally “laundry services” for Bitcoin users, including “Bitlaundry,” which have no compunctions about the objective of their services—to anonymize transactions and accounts, often for the sake of money laundering. While it’s not clear that those services will continue to escape the scrutiny of law enforcement, there’s a new kid on the block to fill the gaps. Zerocoin, an add-on for Bitcoin written by cryptographers at Johns Hopkins University, makes the tasks of identifying or tracking users virtually impossible. Criminals rejoice, because that leap forward in technology proses some serious obstacles for law enforcement officials looking to trace the proceeds of crime.

Bitcoin is more legitimate. This one’s counterintuitive, but arguably the most dangerous characteristic of Bitcoin. Liberty Reserve served virtually no legitimate purpose, as DOJ noted nearly all of its transactions were related to money laundering. As a result its masterminds were almost destined to get caught. While Liberty Reserve was one of the world’s most egregious examples of digital currencies clearly intended for criminals, there are probably about 100 other similar services for anonymous online payment systems. The blatancy of their wrongdoing will make them just as vulnerable as Liberty Reserve.

Bitcoin, on the other hand, does have legitimate users. Lots of them. Dirty money is a lot more difficult to find when it’s mixed in with clean money, hence the success of the world’s largest secrecy jurisdictions. Law enforcement officials also won’t be able to approach an indictment of money launders in Bitcoin in the same way, since the service itself is not a conspiracy for money laundering.

Combine this characteristic with the fact that Bitcoin has no founders or centralized structure and users will soon be able to use it completely anonymously—and you have a beast that is much more dangerous than Liberty Reserve. And still, potentially at least, more dangerous than offshore.


Written by Ann Hollingshead

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