In 2018, it’s still common for authorities to comment confidently that bitcoin is mostly used by criminals to launder money. The better educated understood that only a simple-minded criminal would use bitcoin to hide transactions.
In 2013 Czech programmer Aleš Janda started a site called walletexplorer.com which anyone can use to explore the bitcoin blockchain and to map bitcoin transactions. If the user has one piece of information, often publicly available, such as a bitcoin wallet address, then it’s possible to track the bitcoin coming in and out of that wallet address, and where it goes.
When the site MtGox went bankrupt in 2014, the Japanese bankruptcy trustee for Mt Gox hired US exchange Kraken to help the trustee understand what had happened at the exchange, and it’s likely that the Kraken team used walletexplorer.com to start tracing what happened to the (many) missing bitcoins. In 2014, Kraken spun off a new business called Chainalysis, headed by the Kraken COO Michael Gronager, with the Aleš Janda joining the new business. With access to the MtGox data, the Chainalysis team was able to establish that the MtGox theft had taken place over a long period. They established too that most of the missing coins ended up passing through BTC-e, an exchange based somewhere in Eastern Europe.
Over the next years, the Chainalysis team discovered that 95 percent of ransomware payouts went through BTC-e. It appeared to be a favoured destination for those who wanted to launder money with no questions asked. Tracing the bitcoins threw up some extraordinary detail on the MtGox and Silk Road investigations. It turned out that at least two of the US agents investigating Silk Road were stealing bitcoin themselves, both from MtGox and Silk Road.
The big fish was Alexander Vinnik, the alleged administrator of BTC-E. In 2017, Vinnik took a holiday in Greece where he was grabbed by law enforcement, and as of the time of writing in March 2018, is awaiting extradition to the United States to be charged with money laundering. Mark Karpelès, the former owner of MtGox, has written on his blog that he believes Vinnik not only laundered the missing coins but did in fact steal the bitcoins himself, as they moved straight from MtGox to BTC-e. The charges against Vinnik, Karpèles surmised, did not include theft as money laundering was an easier charge to prove, in order to get an extradition warrant.
Chainalysis had a hit on its hands. It has raised a relatively small amount for a fintech start-up: just a seed round of $1.6 million early in 2016, following which it closed deals with agencies including the US Inland Revenue Service, Europol, half of the police forces in Europe, and probably several other police forces elsewhere too. For several years before bitcoin really came to broad public attention in late 2017, law enforcement and intelligence agencies had been watching the blockchain and connecting its anonymous actors to bank accounts and other digital identifiers.
So, it’s worth bearing in mind that banking and finance executives warning that bitcoin was dangerous because of its use by criminals were either unaware that this was a bad use of bitcoin from the point of view of a criminal, or knew that this was not the real reason that they wanted to see bitcoin stopped. A reasonable explanation is that they knew bitcoin was something of a threat to the established banking system, but wanted to disable its progress through innuendo.
It’s also worth remembering that banks had something of a legitimate complaint about the burden of compliance with AML and KYC regulations, which compelled them to gather increasing amounts of information on customers depending on the amount of money they wanted to send or pay. In fact, banks had long objected to the paperwork required for accepting money to transmit around the world. The recent multiplication of checks on these transaction can be traced back to the attack in the US on 11 September 2001.
At that time, anti-money laundering legislation had been languishing in Congress for years, opposed by banks because of the additional compliance burden required through the data gathering and verification it required, often for relatively small amounts of money. Following the September 11 attacks, the outcry for legislation to combat terrorism had representatives scrambling to write new laws, which focused on stopping the financing of terrorism. The anti-money laundering legislation suddenly got a new lease of life. It was expanded to cover all financial institutions, bundled into shape, and announced as the Patriot Act. Additional know-your-customer legislation required banks to strengthen their customers identification procedures with additional layers of due diligence for foreign correspondent accounts. (In the intervening years, it’s become clear that this hasty decision ignored major differences between money laundering and terrorist financing.)
As the work of Chainalysis and other blockchain detectives proceeded, leading bitcoin critics - now numbering commercial bank CEOs and regulators - began shifting their narrative away from bitcoin’s shortcomings and towards a new narrative that sounded suspiciously like the early narrative around the internet: bitcoin is bad, but blockchain is good.