Beneath the surface Web populated by social networks, databases, and video-hosting sites, there lies a vast array of the Internet that most people have never seen. Experts estimate that these surface sites—or the portions of the Internet that are indexable by conventional search engines—comprise less than 1 percent of the entire Internet. The remainder, known as the “Deep Web,” has become a haven for purveyors of illegal drugs, weapons, counterfeit currency, and a host of other illicit goods and services.
Access to the Deep Web is free, simple, and secure, and it has consequently become a magnet for cryptocurrency users. Many of these users take advantage of the Deep Web’s secrecy by laundering money or participating in illicit markets. When combined with the high degree of security that the Deep Web and associated technologies provide, the pseudonymity of cryptocurrencies presents a formidable challenge to regulators and anti-money laundering (AML) authorities.
Decentralized virtual currencies like Bitcoin do not require verified user identification in order to transfer funds. The decentralized nature of the transaction system means that authorities cannot target a central entity when investigating suspicious activity. Even the most advanced AML software is incapable of identifying suspicious financial activity in the cryptocurrency sphere, since the software lacks access to the same centralized repositories that exist in conventional finance. This adds immense complication to the AML enforcement process.
A number of proven techniques and anonymization technologies have enabled cryptocurrency users to elude investigators and regulators. Perhaps the most common method for ensuring anonymity is the use of privacy software like Tor. Originally developed by the US Navy to protect government communications, Tor is a free service that routes web traffic through a randomized series of nodes. These nodes repeatedly encrypt and decrypt information along the route, such that each node only sees where it received data from and where it sends data to; no single node sees both the true origin and the true destination of the data.
In addition to Tor, a host of other applications exist for anonymous web communication, site hosting, and file storage. The Invisible Internet Project (I2P) provides users with a secure network layer to access hidden websites and exchange encrypted messages, while software like Freenet enables anonymous file sharing and web browsing on a decentralized network. Bitmessage utilizes Bitcoin-inspired public key cryptography to facilitate secure online communication, and is purportedly complex enough to evade US government wiretaps. These free and easily accessible services facilitate anonymous Deep Web activity, making money laundering, illegal trade, and other forms of illicit finance very difficult to track.
Innovations in transaction secrecy have also complicated the work of investigators. Individuals wishing to throw authorities off their virtual trail can channel their cryptocurrencies through a “mixer,” a service that comingles funds with a variety of users before depositing them in the recipient’s account. By strategically depositing and withdrawing funds in random amounts, users are able to decouple their accounts from tainted funds. This straightforward approach renders investigators’ basic statistical analyses ineffective.
The cryptocurrency industry has also devised a solution to a common problem of public key (or address) transparency. An emerging wallet—or storage and transaction service—known as Dark Wallet will soon allow customers to publish “stealth addresses” on the Bitcoin blockchain, which is simply an encrypted version of the recipient’s actual address. When a payment is sent to a user’s stealth address, Dark Wallet decrypts it and sends the funds directly to the recipient’s actual address. Even if a link can be established between a stealth address and a real one (a difficult feat in itself), tracing multiple transactions to a single recipient is practically impossible given the standard practice of generating a new public key for each transaction.
With each vulnerability exploited by regulators in the world of electronic exchange, a new solution emerges in its place. Thus, the cat-and-mouse game between violators and regulators perpetuates itself. However, one thing is certain: the cryptocurrency market will seek to maintain its defining features of anonymity and decentralization. Judged on that basis alone, the cryptocurrency sphere is likely to remain a step ahead of government regulators and international authorities for some time to come.
https://globalriskadvisors.com/cryptocurrency-and-money-laundering-part-ii/#blog