Navigating the landscape of cryptocurrency, technology, and anti-money laundering regulations.
19 August 2021
Justin Yang is currently a first-six pupil barrister at Crucible. He will be on his feet and able to take instructions from October.
In 1648, the Treaty of Westphalia enshrined core international legal principles of non-interference between autonomous sovereign states. The then understanding of international law was restricted to merely managing interstitial relations between sovereigns. Sovereigns were the primary and sole actors scattered throughout the international void; the space between them was an anarchic vacuum. This of course changed with the advent of the current international legal order under the guise of the United Nations following World War II, where states were empowered to intervene in the domestic affairs of other sovereigns. This grossly truncated overview of international legal development is helpful as it allows us to conceptualise a vacuum between states. It is in this empty space, free from the tendrils of nationality and physical territory, where one can begin to contextualise and appreciate the contours of cryptocurrency.
What is cryptocurrency?
There is no universal definition of cryptocurrency. It can be described as being digital assets, virtual currency, coins, tokens, and ledger entries, but there persists an inescapable problem of identity. This question of identity has two aspects. Firstly, there is difficulty in describing what cryptocurrency corresponds to; it simply has no reference to tangible goods. Secondly, there is an unsolvable question of who at any given time owns these indescribable assets. At its very basic core, cryptocurrency refers to an electronic representation of a unit of value, rights, or interests. These entries are often encrypted, and most commonly stored on blockchains. A blockchain is essentially a type of electronic database that stores data in blocks, and links them together in a long chain chronologically. This chain is public, decentralised, and beyond the reach of any government authority. It records all transactions, which remain irreversible and immutable. Crypto coins can be bought from specific exchanges, such as Coinbase or Binance, which are similar to stock exchanges. These exchanges often provide wallets for individuals to keep their coins in. However, it is possible to buy/sell coins directly from other individuals without the need for exchanges. It is also possible to transfer coins into a secure ‘cold’ wallet, which allows the coins to stay disconnected to the internet and as a result impervious to hacking attempts. While coins held in wallets provided by exchanges are ultimately dependent on the exchange permitting transfer and withdrawal, coins in off-line cold wallets would in theory be impossible to gain access without knowing the specific passwords.
Bitcoin, the undisputed market leader, is now 12 years old. Its first transaction was at $0.0009 in 2009. Recently, it reached a peak of $64,863.10 in Q1 of 2021. This has come with increasing levels of retail interest in investing in equity and cryptocurrency markets, which has been largely facilitated by technological advancements that have allowed individuals to invest directly without the need for traditional brokers. Coupled with this increasing exposure, the cryptocurrency market remains unregulated and extremely volatile. The anonymity ingrained in the framework has naturally attracted fraudulent activity as well as provided a convenient method of money laundering. According to United Nations Office on Drugs and Crimes estimates, between US$800 billion and US$2 trillion are being laundered every year across the globe, representing 2-5% of the global gross domestic product.
Current efforts to regulate the cryptocurrency market have largely been patchwork and multifaceted. This has included the introduction of ‘stable coins’, which are digital tokens with reference to physical assets. Another innovation has been the Central Bank Digital Currency, which are digital representations of existing sovereign currencies. These two innovations attempt to harness the digital revolution and combat the volatility, but have not been successful in challenging the anonymised coins. However, the real issue is more existential and conceptual. It cannot be adequately reined in through traditional legislative efforts. In the world of virtual private networks (VPNs), mobile apps, cryptocurrency ATMs, cold storage wallets, and peer to peer (P2P) transfers, anyone can buy, sell, and transfer cryptocurrency across jurisdictions. A potential weakness is that all transactions on blockchains, albeit decentralised, are nonetheless transparent and susceptible to scrutiny. This means that transactions themselves can be viewed and traced, which may ultimately lead to attribution of crypto assets to specific individuals. However, providers such as Monero now offer completely anonymised experiences, where the ledger entries on the blockchain itself is privatised and made untraceable.
Since 10 January 2020, businesses in the UK carrying on activities involving cryptocurrency have had to comply with specific reporting regulations and register with the Financial Conduct Authority (FCA). On 16 December 2020, the Temporary Registration Regime was introduced by the FCA to process applications for businesses to be approved by the FCA to continue carrying on their business. This would allow these firms to continue trading while their application was being considered. The deadline was recently extended from 9 July 2021 to 31 March 2022. On 26 June, the FCA issued a consumer warning against using Binance in the UK, as it was not authorised to carry on regulated activities. For a limited period, users were unable to withdraw capital out of their Binance accounts into their UK accounts. On 13 July 2021, Clearjunction, Binance’s payment solutions provider, stated that they could no longer allow users to withdraw GBP out of their crypto accounts.
In the UK, money laundering offences are primarily regulated by Part 7 of the Proceeds of Crime Act 2002 (POCA). First criminalised in the Drug Trafficking Offences Act 1986, money laundering is https://www.legislation.gov.uk/ukpga/2002/29/notes/division/2, “the process by which the proceeds of crime are converted into assets which appear to have a legitimate origin, so that they can be retained permanently or recycled into further criminal enterprises”. They are also covered by the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, as well as the Terrorism Act 2000. Banks and financial institutions are required to have measures in place to detect money laundering and report it.
Section 47B of POCA lays out specific conditions which, if satisfied, allow enforcement authorities to seize realisable properties.
These conditions give authorities wide powers to seize crypto assets, as early as the investigation stage prior to charge even if there are no restraint orders present. This is only practicable if access to the coins (e.g. passkeys, seed words, encryption codes to the wallets, etc.) is provided either by the exchange or by the owner (or whoever knows the specific passwords). The latter scenario becomes more interesting as the authorities would be unable to gain access to the crypto assets which they suspect to be proceeds of crime without the explicit disclosure of passwords. It simply cannot be compelled from the owner, as such, no seizure can be made.
Even if one is not under investigation, possessing or withdrawing large sums may also attract unexplained wealth orders. Unexplained wealth orders were introduced by the Criminal Finances Act 2017. They are given effect through sections 362A – 362T of POCA. It allows the High Court, on application by enforcement authorities, to require explanations of assets greater than £50,000. This includes the nature and extent of the individual’s interest in the asset and how the assets were obtained. In R v Anwoir  EWCA Crim 1354, the Court of Appeal held, “there are two ways in which the Crown can prove the property derives from crime, a) by showing that it derives from conduct of a specific kind or kinds and that conduct of that kind or those kinds is unlawful, or b) by evidence of the circumstances in which the property is handled which are such as to give rise to the irresistible inference that it can only be derived from crime” (para 21, emphasis added). This ruling provides the view that prosecutors are not required to prove that the asset in question was the result of criminal conduct, as long as there exists circumstantial or other evidence which provides “irresistible inference” of criminality.
There are of course issues regarding capital gains tax at play here as well.
Conclusion and Postscript
Time will tell whether the cryptocurrency market, the world of anonymous of assets moving across borders and jurisdictions, can be successfully regulated by traditional approaches. What remains central is that although authorities are given wide ranging powers in investigating and seizing suspected proceeds of crime, it is entirely dependent on either forcing the exchanges to permit access to wallets, or extracting passwords from people’s possession.
As a postscript, the Metropolitan police recently seized nearly £180 million worth of Bitcoin following intelligence about international money laundering. By "seizure", in the context of cryptocurrency, this will likely mean that the passphrases were either voluntarily disclosed by individuals under investigation, or more likely, taken by officers during a raid.