A recent study set out to determine how much illegal activity is financed through bitcoin. It was found that approximately one-quarter of bitcoin users and one-half of bitcoin transactions are associated with illegal activity. Around $72 billion of illegal activity per year involves bitcoin.
The study also investigated some common characteristics amongst legal and illegal users of bitcoin. By studying these patterns of behaviour, could law enforcement increase its chances of catching those using bitcoin to facilitate illegal activity?
Legal and Illegal Bitcoin communities
While bitcoin is often viewed as the currency of choice for criminals, it does provide some legitimate benefits such as improving payment efficiency and reducing transaction costs. Many legal users also treat bitcoin as an investment or speculative asset.
Bitcoin users that are involved in illegal activity differ from legal users in several characteristics. Illegal bitcoin users:
- Tend to transact more, but in smaller transactions
- Are more likely to repeatedly transact with a given counterparty
- Tend to hold less bitcoin – consistent with them facing risks of having bitcoin holdings seized by authorities.
- Tend to utilize bitcoin mixers and exchanges – typically in money laundering applications
Furthermore, the study found that a user is more likely to be involved in illegal activity if they trade when:
- There are many darknet marketplaces in operation
- There are few shadow coins in existence
- There is little bitcoin hype or mainstream interest, and
- There have been recent darknet marketplace seizures or scams – the study found that in these instances, there is a brief spike of transaction activity by illegal users as they turn to alternative marketplaces or relocate their holdings in response to the incident.
What factors influence the use of bitcoin in illegal trade?
The study found that the proportion of bitcoin activity associated with illegal trade has declined in recent years, which was attributed to two main factors: an increase in mainstream interest in bitcoin, and the emergence of alternative cryptocurrencies.
Increase in mainstream interest in bitcoin
The proportion of illegal bitcoin activity has been found to be inversely related to the Google search intensity for the keyword “bitcoin”.
While the proportion of illegal bitcoin activity has declined, the absolute amount of such activity has continued to increase, indicating that the declining proportion is due to rapid growth in legal bitcoin use.
Alternative cryptocurrencies have emerged that are more opaque and better at concealing a user’s activity than bitcoin.
Such currencies include Monero, which hides user’s public keys among a group of public keys that contain the same amount (known as “Ring Signatures”), and ZCash (launched in 2016), which uses zero-knowledge proofs that hide sender, recipient, and transaction amount (Noether, 2015; Ben-Sasson et al., 2014).
The study found that the emergence of such alternative cryptocurrencies is also associated with a decrease in the proportion of illegal bitcoin activity.