There are no statistics inferring the use of Bitcoin as a media for corruption, fraud and illegal activities. The main reason Bitcoin is associated with such activities is mostly due to its decentralized and anonymous nature. We have such an apprehension with these concepts that we have been brainwashed in thinking that anything not being centralized and strictly controlled ought to be negative. However, there exist research and empirical evidences providing an interesting insight over the relationship between democracy and centralization over corruption. As for anonymity, there are various examples of occurrences in society proving that non-anonymous structures do not eliminate the participation in criminal activities.
The objective I am seeking in this post is to provide the reader with an alternative assessment regarding the link between Bitcoin and criminal activities.
Let’s start with facts. The United Kingdom’s National Crime Agency estimated the amount of money laundering in 2009 to be equivalent to 2.7% of global GDP, corresponding to a staggering 1.6 trillion USD. These funds are laundered through banks and their subsidiaries around the world. These banks are typically under the supervision of public institutions and regulatory bodies, including audit committees formed by the banks’ boards of directors, whose purposes is to make sure that the banking system remains stable and that it operates within the boundaries of the rule of law and proper governance. Let’s look at a recent example showing the ineffectiveness of this multi-layer, centralized system.
In October 2018, Reuters revealed that Danske Bank had, over a period of 8 years, seen 200 billion euros of questionable money flowing through its Estonian’s branch, knowingly or unknowingly assisting criminals to re-integrate these funds back in the banking system. And this feat of financial engineering was accomplished by a bank accredited by supposedly trusted third parties / watchdogs reigning over the integrity of the banking system. What happened exactly? A report from the investigation of Bruun & Hjejle is accessible on the website of Danske Bank:
The conclusion of this report is the following:
Nobody will be prosecuted. Yes, the CEO Thomas Bergen resigned in the aftermath of the revelations. I am not accusing him of deliberate wrongful practice since I don’t have all the details and resources to perform that investigation. However, I would have assumed that an investigation over a money laundering scheme worth over 200 billion euros would have reached a different verdict. Well, it hasn’t. Since the filling of the report in September 2018, water continued flowing under the bridge, and we are led to believe that nobody is accountable for what happened. The report clearly identifies the centralization of power in the hand of the CEO of Danske Bank. Is it possible that this corporate structure is directly or indirectly the root cause of corruption?
To answer that question adequately, I have found and read many interesting papers and articles which had as an objective the investigation of the causality between centralization of power and corruption:
Fan, Lin, Treisman (2008) – Political decentralization and corruption: Evidence from around the world
Fisman, Gatti (1999) – Decentralization and Corruption: Cross-Country and Cross-State Evidence
Karlström (2015) – Decentralization, Corruption and the role of Democracy
Although these papers focus on governments, the results are also extendable to companies since they have very similar structures in terms of governance and check and balance of power. Karlström developed a model whereby the results of causality between centralization and corruption are separated into democratic and authoritarian regimes. The results are very interesting:
A high CPI means a better score in reducing corruption. I recommend to anyone interested in the subject to read the three papers named above.
For the purpose of this post, we will leave the result related to dictatorship aside and focus on the result related to democracy, in red. The papers all conclude with strong and consistent positive correlation between centralization and corruption. In other words, the higher the degree of centralization, the higher the level of corruption. The results are fully applicable to governments and other similarly structured company, such as Danske Bank. In this case, if the corporate structure had been decentralized administratively and sub-nationally to the Estonian entity rather than being concentrated in the hands of the CEO, a different outcome would have been possible.
Corruption occurs mostly in structures involving important centralization of power. Implementing decentralized structures, such as Bitcoin, will assist in curbing corruption at every level of society.
Most of the stories I hear from people that are not too familiar with Bitcoin is that the system is plagued with fraud, with Bitcoins being easily stolen from people by hackers in a gross demonstration of personal property appropriation.
The stories involving hacking of Bitcoin are generally not well understood. The general public is led to believe that the Bitcoin network can be easily hacked. What people don’t understand is that for a hacker to steal personal property on the network, namely Bitcoin holdings, they need to steal the private keys of private citizens for the appropriation of assets to take place. The very source of hacking involves the management of private keys, not the security nor the integrity of the Bitcoin network.
The unfortunate story regarding the fall of Mt. Gox, the ex-major Bitcoin central exchange, amplifies the reality of management of private keys. It was not the failure of the Bitcoin network to promote user security that failed, but the incompetence of the exchange management to securely manage the handling of private keys and the misunderstanding by the users of the security protocol at the exchange. By wrongfully managing the storage of private keys, and by centralizing such storage, hackers were left to attack a single point of failure instead of thousands.
I recommend and encourage that anybody who wishes to take part in the Bitcoin adventure carefully reads about managing hot and cold wallets, and to understand the pros and cons each one has. You need to select the good product which will represent the use you want from it.
Yet again, the attacks on Bitcoin regarding its complicity with fraud are just diverting the attention away from the current centralized system. In October 2018, the Breach Level Index published its finding for the first half of 2018. 4.5 billion data records were compromised worldwide from centralized data systems, a staggering increase of 133% from the same period in 2017. In comparison, to this day, the Bitcoin network and its underlying technology, namely the Blockchain, has still not been hacked.
Bitcoin gets vilified as a media prone to fraudulent behaviours, but we tend to forget the worrisome threats to our personal sovereignty with respect to our exposure to the current centralized systems.
There is also a widespread opinion that Bitcoin is the perfect media to engage in unlawful and illegal activities such as drugs, arms dealing, and most notably terrorism. True, such activity can take place over the Bitcoin network. But as anonymous as Bitcoin is, transactions are not impossible to track. In fact, the system is made for transparency to all users. This important aspect makes the anonymous Bitcoin network accountable.
Take the example of the Silk Road website. Even though part of the transactions taking place were dealt in Bitcoin, and that the creator Ross Ulbricht used encrypted tools to hide his activities, he still got caught, prosecuted and sentenced to life in prison, hasn’t he? Law enforcing bodies have the resources and the technology required to project the law onto networks such as Bitcoin while respecting personal freedom.
The most potent attack that Bitcoin suffers is regarding its link to facilitate the financing of terrorism. Let’s take the example of ISIS. How does the group finance its activities? Mostly from robbery and extortion, the sale of oil, ransoms, donations, taxes, etc. Has ISIS requested that payments be made solely in Bitcoins? When ISIS looted the Iraqi Central Bank, did service providers and sellers of goods stopped accepting US dollars from ISIS? Did banks rigorously stop processing transactions and deposits from suspicious ISIS collaborators? The answer to all these questions is no. If the current banking systems stopped processing dirty funds coming form ISIS, the latter would have ceased to exist a long time ago. Maybe some Bitcoins were used in financing part of the activities of ISIS, but so did the current system, and at a much greater extent.
The perception of Bitcoin as corrupted, fraudulent and prone to illegal activities is bound to change with time, and only EDUCATION will resolve the issue of the mistrust of Bitcoin by the general public stemming from incorrect labels and statements made by groups directly threatened by the technology.
As we have seen, decentralization and anonymity are not threating the structure of society. On the contrary, they are tools that can be used to protect ourselves against corruption and fraud. The documentation studying the causality between centralization and corruption are clearly showing the strong positive correlation they share. Fraud, through data breaches and theft of identify in its multiple types, is on the rise. It becomes ever more difficult to protect our personal freedom in the current structures of society especially in the age when personal data is commercialized to industrial levels and is poorly protected.
Regarding illegal activities, anonymity does not necessarily mean impunity. The current centralized systems working through trusted third parties are having difficulty coping with societal problems such as the proliferation of ISIS because the centralization of powers allows groups to advance their self-interests over that of society.
I end this post with the following question: Are we blaming the consequences again instead of dealing with the causes?
In the next post, we will review Bitcoin’s speculative behaviour at this point in its history but reviewing qualitatively and quantitively the reasons behind its high volatility.