Financial Transparency Coalition

Undoubtedly, the world has made progress on financial transparency to reduce illicit financial flows in recent years, and the evidence suggests we will continue to do so, at perhaps an even faster rate, in the near future. Yet as these efforts are going strong, threats to efforts to stem illicit financial flows will emerge from technological advancements in currency, most notably Bitcoin. So far, most nations have pursued a piecemeal and largely unilateral approach to regulate digital currency, but this must change. To truly deal with the threat digital currency imposes on continued illicit financial flows, we need an international framework for their oversight and regulation.

At the bilateral and multilateral levels, the world has made clear progress on financial transparency, including in automatic tax information exchange, beneficial ownership, and country by country reporting. The current policies are not sufficient to stem the tide of illicit wealth transfer, but they remain promising. Yet as the world steps up both its proactive and retroactive scrutiny of overseas transfers of wealth, criminals and corrupt politicians will have to become more creative in their approaches to wealth management in order to continue to store illicit funds abroad. With technological advancements in digital currency, there are new ways for them to do so.

There are several forms of digital currencies currently in circulation, but generally when discussing these issues I focus on Bitcoin, the digital currency with the arguably most mature markets. It is also the only truly decentralized digital currency, endowing it with some unique characteristics that make it difficult to regulate and its transactions difficult to track.

Bitcoin is a form of money, with the inherent economic properties of traditional currencies. There are some key differences, though. With digital currencies, users on opposite sides of the globe can use digital currencies to seamlessly and instantly transfer money using peer-to-peer networks. Bitcoin transactions can be anonymous or public, depending on the actions of each individual user. Users don’t need to present an ID to receive a Bitcoin address—or key—so they are not necessarily tied to a flesh and blood person, which makes Bitcoin transactions unidentifiable as long as the user takes care to anonymize his or her IP address.[1]

Fears that digital currencies are susceptible to financial crime are not a future possibility, but a present reality. Chirstin (2012) estimates criminals have used Bitcoin as a medium of exchange for more than $1.2 million in sales of contraband items via the black-market site “Silk Road.” When the U.S. Department of Justice shutdown and charged Liberty Reserve (a digital currency) and its founders with conspiracy to commit money laundering, they wrote that nearly all of the currency’s five million transactions were illegal. The currency was used to launder more than $6 billion in proceeds from drug trafficking, Ponzi schemes, child pornography, and many other crimes.

The long-term risks Bitcoin presents to financial crime is well-understood by law enforcement officials and policymakers, particularly in the United States. Both the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of the Treasury and the U.S. Department of Justice have released official statements regarding the regulation of virtual currencies. FinCEN also imposed money laundering controls on Bitcoin usually reserved for traditional wire transfer services like Western Union. These controls include bookkeeping requirements and mandatory reporting for transactions of more than $10,000.

Outside of the United States, we have seen a mixed response. Last month, Commonwealth Bank, Australia’s largest bank, closed accounts that belonged to Australian Bitcoin payment processor CoinJar. By contrast, Germany’s Finance Ministry has recognized Bitcoin as “private money” and proposed a tax on its users, but otherwise has suggested the currency should be left lightly regulated. The Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) has plainly said that Bitcoin and other digital currencies are exempt from Canada’s strict money-laundering laws. Meanwhile, regulators in India have adopted a wait-and-see approach.

As these cases suggest, the global approach to regulating digital currency has been completely unilateral. That is, each nation has taken a different approach in isolation. There are reasons for this. At the recent Financial Innovators Summit at 10 Downing Street, one participant suggested the UK lead an international approach to regulating digital currency. Tom Robinson, co-founder of the soon-to-be digital currency BitPrice, responded that such a move would be too difficult and would take far too long to envision and implement. He suggested the UK follow in the footsteps of the United States and “make their own decisions.”

Yet an international approach is precisely what the world needs. Any one nation that imposes regulations on digital currency will not substantially reduce the currency’s cross-border risk for financial crimes. Moreover, most developing nations do not have the power and capacity to track illicit activity in digital currencies and regulate transactions.

In the international context, the decentralized nature of digital currencies will create yet another additional regulatory challenge. With secrecy jurisdictions including Cayman Islands and Switzerland, nations have, albeit shaky, political and legal frameworks by which to negotiate over matters of tax and finance. Secrecy jurisdictions are notoriously uncooperative, but the world has made clear progress in beneficial ownership and automatic tax information exchange in recent years and will likely continue to do so.

If digital currency achieved a large enough market share, and became the preferred medium of exchange for money launderers and tax evaders, nations will not have similar legal and political recourses to negotiate on these issues. Bitcoin are not under the jurisdiction of a single government, individual, group, or entity. There simply is no one with the authority to negotiate on behalf of the currency. From the perspective of developing nations in particular, this fact will make the currency exceptionally difficult to regulate and oversee.

I would love to see a way to deal with the problems. Ideally, the G20 would develop a global framework for regulating and overseeing digital currency. I haven’t seen any coherent proposals in this vein. Ideas, both brilliant and otherwise, are most welcome.