Follow The Bitcoin

Or Track Me If You Can

By Mitch Stone

Most everyone has heard the phrase "follow the money," which gained popularity in the 1976 movie "All The President's Men." [i] The phrase was suggested to Washington Post reporters Bob Woodward and Carl Bernstein by their confidential source, "Deep Throat," as a way to discover who was behind the Watergate break-in of the Democratic National Committee headquarters. They followed the money and their investigation ultimately uncovered political corruption that resulted in the resignation of President Nixon.

Some may also recall the movie "Catch Me if You Can," [ii] starring Leonardo DiCaprio as Frank Abagnale Jr., a prolific counterfeiter who eluded law enforcement and stole millions of dollars while posing as an airline pilot, a doctor and a lawyer. The FBI finally caught up to him by following the trail of money he left from his counterfeiting crimes.

Everyone in the criminal justice system knows that following the trail that money leaves often leads to the capture and conviction of criminals. This not only applies to financial crimes, but to all crimes where money changes hands. It is why prosecutors and police often look at financial records, credit card receipts and bank statements for evidence to track and prove money's provenance and destination.

Financial trails tell a tale — sometimes very compelling tales. That is one reason why federal, state and local governments have put in place legal restrictions prohibiting financial transactions from occurring in secret. Banking laws require tax identification or Social Security numbers, IRS form 1099s are required in many business-related payments, and many cash transactions and accounts are subject to additional official reporting requirements (e.g., IRS forms 8300 and 4789).

Statutes criminalizing money laundering, failure to file currency transaction reports and tax evasion provide law enforcement tools to convict even when it cannot pin other substantive crimes such as drug dealing, murder and robbery on a suspect. Case in point: "Public Enemy No. 1" Al Capone committed crimes like murder, bank robbery and racketeering, but he continually escaped justice until he was charged with and convicted of tax evasion. He was one of America's most notorious and violent organized crime figures, but he died in prison only because he had not paid his taxes.

The government, law enforcement and the general public were all fine with that result since that was the only crime that put the elusive gangster behind bars. Since then, numerous laws focused on financial transactions have been enacted around the world to enable law enforcement to investigate, prosecute and convict fraudsters, drug dealers, terrorists and organized crime figures.

So why is this important when it comes to bitcoin, a so-called cryptocurrency? What is it about bitcoin that evokes illegality in the eyes of governments and law enforcement? The basic answer to those questions is because bitcoin and similar "cryptos" facilitate conducting financial transactions anonymously, by occurring outside traditional payment channels.

We can define modern money (currency in metal or paper physical form) as an efficient payment mechanism compared with the barter of goods and services. It can also be an effective and a convenient store of value, based on the presumption of widespread acceptance for payment now and in the future, and a predictable confidence in its value vis-à-vis the goods and services expected to be purchased at a future time.

Currency, nowadays, is mostly moved and stored electronically while always being fully interchangeable between electronic and physical forms. When electronic, a currency is also a ledger system, recording all payment flows and wealth stocks within the system. The system actually consists of government-sanctioned and regulated banks and monetary authorities, using centralized infrastructure (e.g., account databases and payment systems).

Cash in physical form meets the first two of the above definitions, but due to its physicality and potential for anonymity, it does not always or automatically fulfill the "ledger" definition. This is because cash transactions may go unrecorded, and often do. So a monetary authority will know and have recorded in its ledgers how much physical cash and coin is in circulation, but will have incomplete records regarding who has it or what transactions have transpired unless it is deposited into banks or recorded in other ways.

The value of U.S. currency is no longer backed by precious metals. Rather, it is backed by the stability and strength of the U.S. economy. The value of a dollar is based on what can be exchanged for it. Ultimately, currency has value because society agrees it is worth something. It must be issued in limited supply so that it maintains value. The government is in charge of issuing currency, so restrictions are required to ensure against unrestricted printing of dollars.

If anyone could simply print a dollar, there would be no value to the currency. If dollars were printed by the government without any accounting, there would be no way of knowing how much was being distributed to the masses. Essentially, this ledger system of currency requires trust and confidence in governments that issue currency and in the banks that hold, protect and distribute it.

This is known as a centralized system, meaning that the ledgers are in one place, whether that is at the mint, the treasury or the bank. Trust in the government is essential to give value to the currency. Trust in banks to distribute money upon demand is also essential. Obviously, banks do not give back the exact same dollar that is deposited by an account holder, so currency must all have established values, which are set forth by the ledger system.

Before electronic banking, physical passbooks were provided to account holders to document deposits and withdrawals. The passbook was each account holder's evidence of what the bank's internal ledger reflected. When currency is transacted now with electronic banking, a digital ledger is updated to document deposits and withdrawals. The bank's ledger provides evidence of what should be in the account.

Those ledgers are what investigators are looking for to follow the money. Just as a box of cash found in the attic of a suspected dealer's home may be used as evidence of illegal drug sales, currency ledgers also can provide law enforcement with similar evidence. Ledgers can prove that payments were withdrawn from an account of a suspect or deposited into the account of a suspect as payment for the suspected illegal activity.

From the issuance of currency to daily transactions, everything is recorded on ledgers that can be used as evidence. Narcotics detectives copy down serial numbers on the bills used when doing a buy-bust operation to show that the dealer was in possession of the same $20 bill that the informant used to buy cocaine minutes before the take-down. Those serial numbers are based on the U.S. Treasury's ledger system.

Importantly, bitcoin and other cryptocurrencies are also based on recording transactions in a ledger. The technology behind Bitcoin is called "blockchain." However, blockchain technology is not centralized. Unlike with banks and governments, there is no one place where the blockchain ledger is kept.

Instead, blockchain is coded information that is contained on thousands of computers acting as "nodes" around the world. Each computer possesses the identical blockchain. There is no central server maintaining the blockchain so no central server at any one bank can be hacked to change the information contained on the blockchain.

When a transaction occurs, a block is formed reflecting that transaction. If A sends B $20 in bitcoin, this transaction among others will be recorded on a block that is formed. It does not become part of the chain immediately. That new proposed block containing transactions (ledger information) is broadcast to the other nodes and if there is consensus among all nodes containing that blockchain that the information concerning the transaction is legitimate, the block becomes part of the chain and payee B receives the $20 of bitcoin. [iii]

Of course, all of this happens in cyberspace so there is nothing physically presented or accepted. However, the parties to the transaction accept the validity of the information read on a computer screen. That is because of trust formed vis-a-vis that consensus among thousands of nodes participating in the blockchain that must occur before a block can be accepted.

Importantly, no accepted block can be changed, hence, the concept of a block being immutable. That provides the security. A public blockchain like bitcoin's also provides transparency so anyone can see all transactions that have transpired. In this manner, a bitcoin's transaction history can be followed through the chain to see where it has been held, but the identities of who is holding the bitcoin are not revealed in the system.

In that respect, the information concerning the occurrence of a transaction may be transparent, but the individual participants are anonymous because the system uses strings of numbers, letters and symbols instead of names and other identifying information. That means that unless someone wants to be identified, there is little chance of identifying a particular person to any given transaction. [iv] This is why law enforcement communities are so concerned about bitcoin.

In that respect, if A wants to pay B to steal a car, A could use a computer to send a string of letters, numbers and symbols identifying an amount of bitcoin to be sent. That information in computer code is sent electronically over the internet to a digital address, much like an email is sent. That address is also identified by a series of letters, numbers and symbols. When the bitcoin is sent, a block is formed containing the data of that transaction.

Thousands of nodes then communicate to verify the data. [v] Upon verification, the block containing that information becomes part of the chain and the transaction is completed. Thereafter, B will see the amount of bitcoin sent by A in his or her account on a computer screen.

Sounds like anonymous PayPal, right? That is why some believe that bitcoin was designed for illegal activity. Bitcoin can and, in some instances, does provide an effective way to engage in illegal financial transactions anonymously, if that is the user's intent.

However, blockchain technology has vast legitimate uses. In fact, bitcoin was not created for illegal use. Bitcoin's founder, who goes by the name of Satoshi Nakamoto, proposed it as a digital currency that provides (1) the means of payment, (2) a store of value and (3) a secure ledger system.

It does so in a currency context for which a certain amount of work would be required to find it (analogous to mining gold) and a certain amount of network support would be required to move it, spend it and account for its use (the blockchain technology). It also promised an escape from seigniorage [vi] and the inflation that potentially brings. As designed, only 21 million bitcoins can ever exist. It is a popular currency, not a fiat [vii] creation of any centralized authority.

Thus, bitcoin is the first widespread popular currency to emerge in centuries, and by its nature is one that brings no inflation due to there being no possibility of more than the original 21 million ever being emitted. Its emergence into popular use is across borders and includes countries in which current monetary policy by most credible accounts risks aggravating excessive inflation due to corruption. There are countless historical examples of countries oversupplying printed government-issued currency, resulting in severe devaluation and economic disaster. [viii] The limited supply of bitcoin prevents that from happening.

When bitcoin first emerged, people recognized that anything could be bought or sold with it as long as participants agreed bitcoin had identifiable value and could be transmitted as easily as (or more easily than) fiat currency. This realization, in addition to a large majority of legitimate applications, gave rise to Silk Road, a website created as a marketplace for all types of transactions, including illicit drugs, nonsanctioned arms deals, prostitution, terrorism and other criminal activity, all using bitcoin as payment.

Ultimately, Silk Road's founder, Ross Ulbricht, was convicted of running a continuing criminal enterprise, drug trafficking, computer hacking and other crimes. He was sentenced to life in prison as a message to others. [ix] Other prosecutions related to bitcoin have been based on running unlicensed money services businesses, money laundering and drug trafficking. Bitcoin entrepreneur Charlie Shrem [x] was infamously charged with and convicted of money laundering because he was aware of what was happening on the Silk Road website when the exchange he created was used in support of some of the Silk Road transactions.

This also explains why in bitcoin's early years as it gained ground as an internet-based currency, it was considered a tool for criminals to use to make illegal transactions. Media accounts and law enforcement communiqués warning against criminality associated with bitcoin attributed it a nefarious image without explaining or understanding the legitimate uses it offered.

Even though it can be argued that cash and other types of conventional banking-based financial transactions have all been used for centuries to conduct the same type of criminal activities that have involved bitcoin, these comparisons were ignored. Of course, bankers who have engaged in money laundering are prosecuted and securities traders who run Ponzi schemes are sent to prison; however, the currency and transactions systems misused in those crimes have never been considered as nefarious conduits for such crimes the way bitcoin has.

When governments decide to print more of their country's currency in violation of regulations prohibiting such conduct, the ledger system that the currency is based on is not considered illegal. ATMs were created to allow withdrawals of cash during nonbanking hours and are used regularly to withdraw cash to pay for illegal drug deals. That is never interpreted to accuse banks of creating ATMs to enable illegal activity. When money is wired overseas and used to purchase arms for terrorists, that does not mean wire transfers are designed to promote illegal conduct.

In these examples, traditional currencies and conventional banking are indeed a conduit for illegal activity, but that does not equate to identifying the currencies and banks as illegal. Rather, in all those examples, law enforcement had to figure out how to combat the illegal activities without shutting down the currency and banking systems. Law enforcement and governments came up with laws, regulations and investigative methods to combat the illegal activities. The same reasoning should apply to bitcoin, other cryptocurrencies and blockchain technology as a whole.

Bitcoin is thriving despite law enforcement concerns. The cryptocurrency community is using this new technology to create businesses that use and promote the use of blockchain technology. The image of criminality is being replaced by the reality of the secure transaction that does not require the same type of expensive protections that banking and other financial activities necessitate.

Yes, different problems exist in the world of cryptocurrencies. More problems are to be expected as more people engage in this new method of conducting financial transactions. Hackers and high-tech criminals have already figured out ways to defraud and steal bitcoin. They are no different from criminals who have figured out ways to commit fraud, theft and ripoffs in conventional banking with standard fiat currency. The fact that crimes do occur does not mean bitcoin is not a viable currency.

Law enforcement officers may now have a hard time following the money because the money is in the form of a string of numbers, letters and symbols. They also might not be able to easily hack their way into people's cryptoaccounts to discover who they are and what they are doing. However, there is no doubt that given time, law enforcement will figure out how to investigate crimes in blockchain-based systems despite the problems that the anonymity of the cryptocurrency world presents.

As I write this article, bitcoin recently set a record high, selling for more than $19,000 per coin. Alt coin values are also on the rise. Blockchain is being used to create new technologies to streamline transactions and provide less expensive, more secure methods of keeping ledgers to facilitate transactions in business, real estate and sales.

Moreover, government agencies are realizing that people are profiting legally from the blockchain-based cryptocurrency marketplace. In fact, the IRS expects those who are trading in cryptocurrencies to file and pay taxes on the profits realized. Federal, state and local governments are also trying to figure out how to define and regulate the cryptocurrency market.

For these reasons, the criminality associated with bitcoin in the early days may be a thing of the past. People from all over the planet are buying, trading, selling and purchasing with bitcoin and other alt coins. Startup companies are being created every day.

The world is changing and unless the internet is shut down, cryptocurrency is here to stay. Laws can and should be created to provide tools to combat criminal activity and provide regulation where needed rather than attempting to shut it down as an illegal market. Bitcoin and the blockchain technology it is based on are still in their infancy. Governments can either lead, follow or get out of the way.

Attorney Mitch Stone is board-certified in criminal trial law. He practices white-collar criminal defense in federal and state courts. He is a managing partner at Mitchell A. Stone, P.A., located at 1548 The Greens Way, Suite 2, Jacksonville Beach, Florida, 32250. He can be contacted at 904-396-3335, [email protected] and on the web at www.jacksonvilledefense.com

[i] Warner Bros., Alan Pakula, 1976

[ii] Dreamworks, Steven Spielberg, 2002

[iii] Don't expect me to explain how that works. If I could do that, I would be working at a tech company and writing code, not practicing law and writing F Words.

[iv] There are technology companies in existence such as Chainalysis, designing methods to investigate and identify blockchain users so anonymity may be compromised in the future, which will impact users who appreciate the anonymity that blockchain offers.

[v] Again, don't expect me to explain how that works. If I could do that I would be working at a tech company and writing code, not practicing law and writing F Words.

[vi] Seigniorage is commonly defined as the profit made by a central authority from creating currency. Governments profit by creating currency because the cost of minting coins or printing paper money is less than the market value of the money. If the market value of money is higher than the cost of producing the money, the government makes money on seigniorage. Essentially, it is the value the government generates by adding its stamp to an ordinary piece of paper, piece of metal or an electronic bank entry.

[vii] Paper or coins that are created by a central authority and have no intrinsic value and are not convertible into gold or silver, but are made legal tender and considered to have value by fiat (order) of the government

[viii] Germany in the 1920s, and most recently Zimbabwe, where the exchange rate was 35 quadrillion Zimbabwean dollars to $1 U.S. a few years ago

[ix] UNITED STATES OF AMERICA, Appellee, v. ROSS WILLIAM ULBRICHT, a/k/a DREAD PIRATE ROBERTS, a/k/a SILK ROAD, a/k/a SEALED DEFENDANT 1, a/k/a DPR, Defendant-Appellant. (U.S. 2nd Circuit Court of Appeals, Docket No. 15-1815, decided: May 31, 2017)

[x] United States v. Robert Faiella AKA BTCKing and Charlie Shrem, U.S. District Court, Southern District of New York 2014 (14 MAG 0164)