Bitcoin was designed to be difficult to regulate, in the same way that gold is difficult to regulate. Possession (of a private key) is ten-tenths of the law as far as Bitcoin is concerned, and it can be very difficult to tell exactly how a particular Bitcoin came to be possessed by a particular individual.
This relative opacity is one of the properties that makes Bitcoin and other cryptocurrencies so attractive for criminals, extortionists, tax evaders, and dark markets.
From the point of view of believing Nakamotoans, untraceability is a feature.
From the point of view of the law and society in general, opacity is often considered a bug. Civil society in general has little appetite for unregulated financial systems, so Bitcoin will never succeed unless it can be brought into civil society and the rule of law.
This month researchers at Cambridge University describe how an old legal principle might be applied to Nakamotoan cryptocurrency to rein in abuses and “make Bitcoin legal” .
The researchers point out that many Internet technologies have been put forward as “outside the law”, but this is an assertion not a fact. The fact is that “the law” decides what the law is and how it is applied. No one gets to simply secede from the legal system, at least not without resort to pure power politics.
“we have repeatedly seen a pattern whereby the promoter of an online platform claims that old laws will not apply.”
“The key is making online challengers obey the law – and the laws may not need to change much, or even at all.”
In the case of Bitcoin, the researchers explore how conventional financial controls, especially anti money laundering rules, could be applied to Nakamotoan cryptocurrency. They conclude that it is surprisingly straight forward and does not require changes to the network protocols. I.e., the legal system can adapt to cryptocurrencies as they stand now, without any cooperation or consent from programmers or users.
There is a common legal principle that one may not profit from the fruits of crime. Similarly, you cannot receive goods from someone who does not legitimately own them. If someone gives you a stolen coin, it must be returned to the original owner (and you may well be out of luck). Thus, it is very important not to trade in ill-gotten goods.
It is often the case that the monetary fruits of crime are passed along mixed in with other money. In the case of Bitcoins, this kind of mixing occurs rapidly and across the whole Internet. This presents a dilemma for the law. The funds are “partly” stolen, but which part can be confiscated?
The Cambridge team discusses the history of this problem.
Theft and misuse of Bitcoins are a significant issue, to the point that even most Bitcoin users are concerned. If there is a significant risk that your assets may be stolen (or misplaced), with no possible recourse, then cryptocurrency is unattractive for many uses.
Philosophically, Nakamotoans generally do not want government guarantees (e.g., registration of ownership) or other conventional mechanisms for protecting assets. An alternative would be for courts to enforce rules, e.g., to allow recovery of stolen or extorted Bitcoins. But how would courts adjudicate such a case?
In the past, the general legal approach has been to consider the funds “poisoned” by the presence of illegal money. Someone who holds the funds will have to pay a penalty proportional to the illegal funds. This stands as a deterrent to dealing in potentially “toxic” assets.
One way to do this is to consider all the money to be N% illegitimate, i.e., to confiscate part of the value of the whole batch. This approach can be used with Bitcoin, though it is a blunt instrument. Anderson et al. indicate that a very large proportion of Bitcoins would be touched by such “pollution” (5% in one sample–one in every twenty!)
They propose an alternative mechanism that echoes an approach used in nineteenth century English law: First-in-first-out. The idea is to trace the flow of coins and to assign an order to each transaction. The first coin taken out of an account is equated to the first coin put in, and so on. When a stolen coin is spent, that transaction is identified and the payment is illegal. This is a sort of “reverse lottery” – an unlucky user ends up losing.
This approach is much more precise way to identify and deter accepting ill gotten money. The paper argues that this is quite possible with Bitcoin, using the public blockchain and crime reports. Furthermore, the FIFO principle works even when “mixers” are used to conceal the origins of the Bitcoins. In the end, when this legal doctrine is applied, accepting Bitcoins from a mixer risks losing the entire payment in the unpredictable event that you receive coins designated “poison”.
This approach isn’t “centralized”, and it doesn’t break Bitcoin. It doesn’t even change Bitcoin. It just wraps Bitcoin in a legal framework. Honest users would have a way to behave honestly (use honest exchanges), crime could be punished, and the system functions as efficiently or inefficiently as now.
“In short, we might be able to turn a rather dangerous system into a much safer one – simply by taking some information that is already public (the blockchain) and publishing it in a more accessible format (the taintchain). Is that not remarkable? “
It is difficult to overstate how important it is for Bitcoin and other cryptocurrencies to get “legal”. Whatever the technical merits of Nakamotoan technology, it cannot succeed outside the law.
- Ross Anderson, Ilia Shumailov, and Mansoor Ahmed, Making Bitcoin Legal. Cambirdge University, Cambirdge, 2018. http://www.cl.cam.ac.uk/~rja14/Papers/making-bitcoin-legal.pdf
- Andy Greenberg (2018) A 200-Year-Old Idea Offers a New Way to Trace Stolen Bitcoins. Wired.com, https://www.wired.com/story/bitcoin-blockchain-fifo-dirty-coins/