Bitcoin and Illegal Activity

By Gerald P. Dwyer

Bitcoin and other cryptocurrencies have a bad reputation. A recent CNN article titled “How Mexican Cartels Use Chinese Crypto Brokers to Launder Drug Money” notes that Bitcoin is being used to launder drug money. The article also notes, though, that the amount of funds moved this way is “tiny” compared to other ways to launder money.

Although not a big part of any illegal market, Bitcoin first rose to prominence partly because it was the currency of choice on Silk Road, a marketplace for drugs on Tor, the so-called dark Web. Wired magazine contained an interesting and entertaining article that provided lots of detail about that particular use.

More recently, estimates in an article with the lurid title “Sex, Drugs and Bitcoin” attempt to infer the amount of illegal activity that uses Bitcoin. The article tracks small, frequent trades with a single source, as well as other characteristics, as a likely indicator of illegal activity. This would catch repeated small drug purchases, for example, and possibly other illegal activities using Bitcoin as a currency as well. (It’s not obvious what “sex” has to do with it, which appears only in the title.)

Bitcoin’s design limits its usefulness for laundering money. All trades on Bitcoin’s blockchain are visible forever, identified by a public key belonging to the parties to the transaction. While the real-world identity of an owner of bitcoins is not immediately obvious, Ross Ulbricht, the creator of the Silk Road, had all his public and private keys on his computer seized by the FBI. That made it easy for the FBI to seize his bitcoins and to see every Bitcoin transaction on the blockchain that involved him. While this information apparently has not led to many other people’s being charged with drug offenses, the U.S. government currently is attempting to extradite James Ellingson in Vancouver for drug offenses on Silk Road.

The Bitcoin blockchain is not a useful venue for large-scale money laundering. The total number of transactions on the Bitcoin blockchain on January 3, 2018, was 290,861, with an average value of $12,500, hardly making it a useful place for someone to launder tens of millions of dollars on a regular basis. Bitcoin exchanges provide another way to launder money, but it is virtually impossible to do so anonymously.

Setting the wisdom of existing drug laws themselves aside, it is not obvious that all illegal uses of Bitcoin should be regarded as a bad thing. For instance, not all countries have monetary policies as good as the United States’ and Western Europe’s. While hardly unproblematic, inflation rates on the order of 1 to 4 percent are not indicative of serious problems. On the other hand, for example, the inflation rate in Venezuela — estimated by Steve Hanke to be about 65,000 percent per year — implies that prices increase about 2 percent a day. What do people do when faced by such inflation? They attempt to hold as little of the currency for as short a period as possible. This high inflation is accompanied by dire conditions in the country itself; many Venezuelans are leaving, with the poorest walking from Venezuela to Peru. The high inflation is combined with strict capital controls that limit the ability of Venezuelans to hold other currencies or to transfer their funds abroad. While the government is not stopping people from leaving, it makes it difficult for people to leave with any currency other than the largely worthless Venezuelan currency.

Bitcoin makes it easy for Venezuelans to transfer funds abroad. It can be accomplished in as little as an hour with virtually no likelihood that the transfer will be detected and the Venezuelan will be thrown in jail. While some might regard such activity as a bad thing — it is after all illegal — I am glad that people in such terrible circumstances caused by horrible government policies are able to reduce the damage to themselves.

Ironically, the laundering of drug money between Mexico and China is associated with capital controls. The money transferred to China goes through brokers and pays for chemicals to make drugs. And Chinese nationals use the brokers to transfer these funds abroad and avoid capital controls imposed by the Chinese government. If there were no capital controls, transferring money to China to pay for these chemicals might be harder.

Like Venezuela, Argentina in recent years had high inflation and capital controls. Argentinians attempted to avoid the inflation by holding U.S. dollars, but the government went to great lengths to limit imports of dollars. It even trained dollar-sniffing dogs to ferret out importers of this superior currency to the Argentine peso. Bitcoin offers a quasi-anonymous alternative, less prone to confiscation.

Bitcoin can be used to avoid high inflation and the effects of pernicious capital controls. While illegal, that seems like a very good thing indeed.

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Gerald P. Dwyer

Gerald P. Dwyer is a Professor and BB&T Scholar at Clemson University. From 1997 to 2012, he served as Director of the Center for Financial Innovation and Stability and Vice President at the Federal Reserve Bank of Atlanta. Dwyer’s research has appeared in leading economics and finance journals, as well as publications by the Federal Reserve Banks of Atlanta and St. Louis. He serves on the editorial boards of the Journal of Financial Stability, Economic Inquiry, and Finance Research Letters. He is a past President and member of the Executive Committee of the Association of Private Enterprise Education. He is also a founding member of the Society for Nonlinear Dynamics and Econometrics, an organization for which he served as President and Treasurer.

Dwyer earned his Ph.D. in Economics at the University of Chicago, his M.A. in Economics at the University of Tennessee, and his B.B.A. in Business, Government, and Society at the University of Washington.