Cryptocurrencies are some of the hottest commodities among investors, and also the subject of heated debate. While some of the most respected investment banks, such as JP Morgan, are investing heavily into blockchain technology, Chairman of the U.S. Securities and Exchange Commission Gary Gensler has often vocalised his scepticism towards cryptos as an inflated speculative bubble. The stance of regulators is going to be crucial, especially bearing in mind the widely different governmental approaches. While El Salvador has embraced Bitcoin as an official legal tender, the Chinese Communist Party has outlawed all crypto-transactions.
You might wonder why any government would endorse, let alone encourage, the use of cryptocurrencies. The state apparatus often dislikes crypto for two main reasons. Firstly, if cryptocurrency payments become widespread enough to constitute a significant portion of our financial transfers then that will restrict central banks’ ability to conduct monetary policy, which is one of the main tools that governments use to intervene in the economy. Secondly, cryptocurrencies can provide a measure of anonymity and the ability to circumvent the SWIFT System, which means they can be used to facilitate criminal activity like terrorist financing and money laundering.
Since cryptocurrencies have become more widely adopted, ransomware attacks have dramatically increased. In 2010, the year after Bitcoin’s emergence, only 10,000 ransomware attacks were recorded by forensic professionals. Five year later, this number had skyrocketed to 4 million. Recently, major ransomware attacks demanding cryptocurrency transfers have been executed against critical infrastructure. The cyberattack against Colonial Pipeline in April 2021 demanded $4.4 million in cryptocurrency and led to gasoline shortages on America’s East Coast. The cyberattack against the Irish National Health Service in May 2021 demanded £14 million in crypto to restore health services and led to cancellations of patient appointments and the theft of private health data. Governments clearly have a valid reason to regulate and control the use of cryptocurrency.
On the other hand, however, cryptocurrencies offer an undisputable advantage, that is the lack of international transfer fees. Remittance fees can be substantial, often more than 5%, and so the ability to avoid these costs earns cryptocurrency legitimacy among law-abiding citizens and companies as well.
Balancing the risks and benefits associated with crypto is a key undertaking of regulators, and a perfect example of this balancing act can be seen in the case of ‘crypto-tumblers’.
A crypto-tumbler or mixer is a service that allows customers to obfuscate the origin of their funds by pooling funds from multiple sources, and then redistributing those funds at random times to the same people. This process makes it difficult, if not impossible, to trace exact coins, and so increases the anonymity of cryptocurrency by making the source of a transfer hard to determine.
You would be forgiven for assuming that this is merely a tool used for money-laundering, and you are not entirely mistaken. Crypto-tumblers are the second most common destination for ransomware payments, and play a similarly important role for drug dealers and human traffickers. Nevertheless, recent estimates show that these illicit actors only make up around 16% of all crypto-mixing customers, since these services are more commonly used to protect privacy than to launder funds.
In reality, cryptocurrency is not as anonymous as many would think, since all transfers are displayed on a public ledger. The thing keeping the identity of digital wallet holders a secret is encryption, which is indeed nearly unsolvable. However, encryption only really protects the holders of un-hosted wallets, where the identity of the holder is not registered, and this practice is becoming more marginalised. Recently, the EU has introduced legislation restricting the use of un-hosted wallets, and major crypto-exchanges require user identification under US jurisdiction. Therefore, there is a major point of vulnerability when it comes to the privacy of crypto-transfers, which can impact companies making strategic transfers. This begs the question: How can we regulate crypto-tumblers while allowing companies to preserve their financial privacy?
A new, encouraging regulatory take on the issue focuses on the disambiguation of the legal standing of crypto-tumbling, and the distinction between different forms of it. In most jurisdictions, crypto-tumbling is simply not addressed, and therefore belongs in a grey-zone in the crypto ecosystem. One way to change this would be to legalize and fully acknowledge centralised mixers, while criminalizing decentralized ones.
A centralised mixer is administered by a single entity, who is responsible for dealing with customers and managing financial operations. This allows centralised tumblers to identify their clients and comply with anti-money laundering laws. On the downside, however, these mixers expose customers to the risk of being scammed, since the administrator of the platform can simply transfer funds to a private wallet and then disappear. This issue is further aggravated by the shady legal standing of centralised service providers. As a result, it would be highly beneficial to legally recognise centralised tumblers as legitimate and credible firms.
De-centralised mixers, on the other hand, are effectively run by a piece of software, and users arrange their payments in a peer-to-peer fashion. Since there is no central administrator of such a system, incoming transfers are unverifiable, offering a safe-heaven for criminals, and no one to hold accountable for any money-laundering that takes place. One way to address the use of de-centralised mixers would be to criminalise the use of such services, since the programme developers are nearly impossible to find, but transfers pre-mixing are easily traceable. However, enforcing such laws will be challenging due to the significant number of users of crypto mixers, and the potential for new software to further obfuscate user identities.
The United States and the EU have a crucial opportunity to increase certainty and further legitimise the crypto market by regulating crypto mixers. With China exiting the crypto scene, this provides an opportunity for the two giants to set the trend in this newly emerging field by introducing landmark legislation. While crypto can move offshore, such an initiative would nonetheless shape the global crypto market due to the sheer size of the US and the EU.
In summary, the case study of crypto-tumblers shows us how regulators can balance the dangers and the potential of cryptocurrencies, and influence the development of a revolutionary new field by introducing new trailblazing legislation.
Bence Borbély is a Hungarian first-year History and Politics student at the University of Cambridge whose professional fields of interest are management consultancy, public policy-making, politics and international relations.
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