HFSC Hearing: Crypto Crime in Context: Breaking Down the Illicit Activity in Digital Assets

House Committee on Financial Services

Subcommittee on Digital Assets, Financial Technology, and Inclusion

Crypto Crime in Context: Breaking Down the Illicit Activity in Digital Assets

Wednesday, November 15, 2023

 

Topline

• Republicans discussed legitimate uses of anonymizing transactions, citing the right to privacy.
• Democrats raised concerns over the use of crypto mixers and anonymizing technologies and warned of the national security risks related to illicit digital asset activity.

Witnesses

• Bill Hughes, Senior Counsel & Director of Global Regulatory Matters at ConsenSys, previously Associate Deputy Attorney General at the Department of Justice
• Jane Khodarkovsky, Partner at Arktouros, previously Trial Attorney and Human Trafficking Finance Specialist with the U.S. Department of Justice’s Money Laundering and Asset Recovery Section
• Jonathan Levin, Co-Founder & Chief Strategy Officer, Chainalysis
• Gregory Lisa, Chief Legal Officer, DELV (f/k/a Element Finance, Inc.) and Senior Counsel, Hogan Lovells US LLP, Previously Interim Director, Office of Compliance and Enforcement at Financial Crimes Enforcement Network
• Alison Jimenez, President, Dynamic Securities Analytics, Inc.

Opening Statements

Subcommittee Chair French Hill (R-Ark.)

In his opening statement, Hill noted he would be remiss if he began the hearing without acknowledging the reports that Hamas used digital assets to fundraise $130 million for the attacks against Israel. He then explained that even though the blockchain analytics cited in that Wall Street Journal report later corrected its statement saying that there is no evidence that that crypto fundraising raised anything close to $130 million, the Committee would be focused on shutting down all available means to fundraise terror attacks. Hill highlighted a letter sent from him and Senator Lummis to the DOJ on the importance of targeting specific bad actors in the crypto space, as well as an effort that more than 50 members joined to better understand the size, scope, and duration of Hamas’s fundraising through digital assets. He explained that bad actors will continue to use any means possible to conduct their illicit activity, but phones and the internet are not to be blamed for terror financing, and crypto shouldn’t be either. Hill emphasized the need to understand the degree of illicit activity and how we can use blockchain technology and analytical tools to combat illicit activity, and the gaps in our ability to detect illicit activity.  Hill concluded by saying the Treasury Department has confirmed that most virtual currency activity is licit, not illicit and that blockchains provide law enforcement with unique insight into criminal organizations and their funding networks.

 

Subcommittee Ranking Member Stephen Lynch (D-Mass.)

In his opening statement, Lynch said that the Treasury Department continues to evaluate the precise sources of revenue for Hamas and other militant groups, and that Treasury is working with Congress and crypto stakeholders to identify additional actions that might further prevent illicit activity in the digital asset space. He then explained that the Committee had received briefings on how terror organizations are taking advantage of crypto and noted reporting from the Wall Street Journal that digital currency wallets linked to the Palestinian Islamic Jihad received as much as $93 million between August 2022 and June 2023. He noted the crypto industry and its advocates have been quick to defend themselves, claiming that the amount of funding that has flowed through crypto channels is overestimated and small compared to traditional financing for terror organizations. Lynch said he doesn’t necessarily buy that argument, adding that it is beyond argument that crypto remains the preferred currency of organized crime and various cyber-attacks. He discussed how the criminal use of crypto has escalated as high corruption governments that operate as safe havens for money laundering continue to court unvetted crypto investors through deliberate deregulation. Lynch also noted that Treasury has stated that cyber criminals often require ransom payments in the form of digital assets, frequently Bitcoin and that ransomware attacks are up 40% from the same time last year. He concluded by mentioning the recent cyber-attack on the US financial services division of China’s ICBC bank, which disrupted trades in the US treasury market.

 

Full Committee Chairman Patrick McHenry (R-N.C.)

In his opening statement, McHenry explained that there have been conflicting reports regarding Hamas’s fundraising efforts through digital assets. He noted that it’s known that Hamas and other organizations use the traditional banking system and that bad actors will prey on any vulnerabilities wherever they can find them. McHenry explained that there is bipartisan agreement on the commitment to hold bad actors to account in every way possible, and especially when it comes to the digital asset space. McHenry concluded that digital assets are built on transparent open distributed ledger technology, which makes it far easier to detect and track illicit activity.

 

Testimony

Bill Hughes, Senior Counsel & Director of Global Regulatory Matters at ConsenSys, previously Associate Deputy Attorney General at the Department of Justice

In his testimony, Hughes said US-based blockchain projects generally follow the law. He noted that while combating money laundering is a difficult task in any space, digital assets present capabilities with respect to tracking money laundering that law enforcement and the public at large have never had before because open permissionless blockchain ledgers are reviewable by anyone, anywhere. He explained that transactions can be traced using blockchain analytics technology, even those that are purposefully complicated to obfuscate the flow of funds. Hughes emphasized that any policy response to the threat of money laundering should embrace the transparency of the blockchain and bolster the power of transaction analytics if it hopes to be successful. Hughes said the critical weaknesses in the digital asset space remain in the centralized entities that provide exchange services off-chain, specifically those that provide central order book exchange services. He called for increased global uniformity in regulating exchanges and stablecoins. Hughes said policymakers should consider regulatory sandboxes to improve not only blockchain analytics technology, but also technologies around digital identity. He concluded that we must also improve public/private collaboration on difficult policy issues such as those presented by decentralized finance, and bolster intelligence sharing to put law enforcement in the best position to trace, stop, and recover laundered funds.

 

Jonathan Levin, Co-Founder & Chief Strategy Officer, Chainalysis

In his testimony, Levin explained that cryptocurrency transactions are inherently public and the data from those transactions is preserved on a transparent, immutable ledger. He noted the networks of enablers and facilitators who leverage otherwise legitimate businesses, such as hawala services and OTC brokers to move funds for terrorist organizations, have historically been particularly difficult to detect and disrupt. Levin emphasized the government’s new ability to detect this type of terror financing and the supporting networks, noting that in April 2023, Hamas publicly announced that it was shutting down its campaign to accept cryptocurrency donations, citing successful government efforts to identify and prosecute donors. He called on the federal government to provide a path to compliance for the digital asset industry in the US in order to increase the number of domestic touchpoints for US law enforcement. Levin concluded that the US must continue to drive greater international collaboration to tackle illicit actors effectively and should prioritize arming government agencies with sufficient resources and expertise to address the changing dynamics of how value is being transferred over blockchains.

 

Gregory Lisa, Chief Legal Officer, DELV (f/k/a Element Finance, Inc.) and Senior Counsel, Hogan Lovells US LLP, Previously Interim Director, Office of Compliance and Enforcement at Financial Crimes Enforcement Network

In his testimony, Lisa said the characteristics and nature of most blockchains provide significant advantages in helping to detect and prevent illicit finance. He warned that it is critically important not to under-appreciate the risk of digital assets and therefore underreact when regulating them. Lisa emphasized that it is also important not to overreact, as overreaction on regulation can make compliance impossible. He warned an overreaction can jeopardize national security, adding that ceding ground to China, Russia, or many other jurisdictions might be worse than illicit finance itself. Lisa concluded that getting regulations right is existential for the industry, because people won’t invest their money in a system they don’t trust.

 

Jane Khodarkovsky, Partner at Arktouros, previously Trial Attorney and Human Trafficking Finance Specialist with the U.S. Department of Justice’s Money Laundering and Asset Recovery Section

In her testimony, Khodarkovsky noted the United States centralized exchanges and fiat on-off ramps are considered MSBs that must comply with BSA obligations. She added that blockchains preserve all transactions and record them on a public ledger, which means that centralized exchanges or VASPs (as referred to by FATF) can identify and analyze transactions on the blockchain, regardless of whether the specific transaction occurred on their platform. Khodarkovsky pointed out that this contrasts with a traditional financial institution, which may only have visibility into the customers or transactions that occur within that specific banking institution. She said that data from Chainalysis suggests that the percentage of all cryptocurrency activity associated with illicit activity was 0.24%, and noted cryptocurrency, including Bitcoin and Ether, were critical to supporting the Ukrainian people. She concluded that the U.S. must stay at the forefront of innovation to ensure democratic values are preserved while being measured about what steps are necessary to preserve national security interests.

 

Alison Jimenez, President, Dynamic Securities Analytics, Inc.

In her testimony, Jimenez said that when a bad actor wants to conduct a financial transaction, they will assess whether a financial product can move funds: far, fast, in large amounts, irreversibly, anonymously, and to a third-party. She explained that cryptocurrency is attractive to bad actors because it has so many of the features they value in a financial product. Jimenez discussed how blockchain based cryptocurrency transactions move seamlessly across international borders (far) and can be settled in minutes (fast), while there is no cap on the value of cryptocurrency that can be transferred in a transaction (in large amounts), and in most instances, a cryptocurrency transaction cannot be reversed once it has been added to the blockchain (irreversibly). She added that cryptocurrency wallets are pseudonymous, meaning the true owner of the wallet may never be linked to a given wallet address (anonymously) and the same can be true for the recipient (to a third-party). She concluded that dismissing cryptocurrency as a useful tool for illicit finance just because some transactions are pseudonymously recorded on a blockchain is not wise, especially because the attribution and tracing methodology used by blockchain analytics firms is often proprietary and unaudited.

 

Question & Answer

Crypto Mixers and Anonymizing Transactions

Hill cited Jimenez’s written testimony that people use sidechains or chain-mixers to prevent being identified on the blockchain. He asked if Levin agreed, and how Congress can direct the Executive Branch to stop that practice. Levin said agencies need the tools to go after these issues and need better access to data, software, and expertise and that given those tools they can penetrate even the most sophisticated networks. Hill agreed and warned that the Senate is talking about rewriting all the rules of the road on crypto and that he wants to make sure the tail is not wagging the dog.

 

Rep. Warren Davidson (R-Ohio) asked Khodarkovsky to elaborate on the legitimate uses of anonymizing transactions. She explained that the right to privacy is very important and that even in cases where transactions are anonymized, law enforcement can investigate and trace assets on the blockchain because of its traceability and immutability.

 

Rep. Bill Foster (D-Ill.) asked if it was possible to take stolen Bitcoin from a ransomware attack and go through a series of transactions and return it to your bank account in a way that no one could uncover. Jimenez cited instances where money has not been recovered from ransomware attacks and said that while she applauds the efforts of blockchain analytics, there are many instances that are not caught. Khodarkovsky said she believes the U.S. has tools to trace that. Foster pushed back, asking if a person could launder that stolen bitcoin internationally and put it back in their domestic bank account in a way that no one could detect with what’s in place internationally. Lisa stepped in and said yes, explaining that one could go offshore to a non-compliant exchange and bring the money backshore undetected. Foster asked if there were any proposals that would prevent this from occurring. Lisa replied there are ongoing efforts, but noted one potential measure could be sanctioning Garantex, which is a Moscow based crypto exchange known for hosting bad actors.

 

Rep. Sean Casten (D-Ill.) asked how terrorist organizations use cryptocurrency mixers and other anonymizing technologies for other illicit financial activities. Jimenez explained that there are many blockchains that have less transparency and pushed back on the myth that all crypto transactions are recorded on the blockchain, noting this only accounts for about 10% of transactions.

 

Rep. William Timmons (R-S.C.) asked why the Treasury Department and other international law enforcement partners sought a more targeted approach to sanctioning mixers. Lisa noted it’s unclear whether there is justification for a broad approach. He questioned if one could say every mixer is bad, and noted there are good uses for mixers, like personal privacy and so Treasury must strike a delicate balance.

 

Rep. Brad Sherman (D-Calif.) cited comments that there are good uses for mixers, including personal privacy. He asked if that is just a code word for tax evasion. Jimenez said mixers can be used for whatever purpose the end user wants. She noted there are studies, using blockchain analysis, that found a very large percentage of their use was for illicit activities. Sherman said most of the folks in the crypto world think tax evasion is a meritorious use of a mixer.

 

Illicit Activity & National Security Concerns

Hill brought up the recent Wall Street Journal report on crypto in terrorist financing and asked Levin why he felt that the data used in the report was severely misinterpreted. Levin explained that the $130 million number that was quoted includes amounts that can be linked to the terrorist financing that ended up with Hamas as well as the broader network of facilitators and intermediaries that were caught up in the network of financing terrorism. He continued saying that these numbers can contain plenty of legitimate activity over the years those businesses were in operation and the amount that is directly linked to terrorist activity must be investigated by governments.

 

Lynch asked Jimenez to discuss how bad state operators are operating in this space and the threat that they pose to our national security. Jimenez cited North Korea as a prime example, explaining that the North Koreans are advanced in hacking of cryptocurrency exchanges and other virtual asset service providers. She said they use those stolen funds to help fund their nuclear program. Jimenez also cited the transnational organized crime risk, including from drug cartels. She listed sanctions evasion as another issue.

 

Sherman cited figures from Levin’s company that just 0.24% of crypto transactions are illicit. He asked if that number includes tax evasion. Levin said it did not. Sherman said that’s the big market, explaining that cryptocurrency can’t be worth a trillion dollars if it only becomes the currency of drug dealers and human traffickers. He added crypto can only compete with the dollar if it gets the tax evasion market.

 

International Cooperation & Enforcement

Rep. John Rose (R-Tenn.) asked how we can improve coordination with foreign regulators and law enforcement. Lisa said while there are things the U.S. can do unilaterally; we are more limited internationally. He said we can drive capacity building overseas with our attaches and ensure that our blockchain analytics technology is used by our allies and partners around the world. He also urged the U.S. to maintain its leadership in this space. Khodarkovsky said we need to help our foreign partners close loopholes in a way that’s not just focused on cryptocurrency, but on sectors like gold or other commodities that Russia and China are exploiting.

 

Rose asked Hughes if it’s necessary for the U.S. to copy other country’s regulatory regimes in order to effectively combat illicit finance in crypto. Hughes said it’s not necessary to copy them, but noted we can get inspiration and can look to their model to structure our debate. Hughes noted Europe could be an example to look at.

 

Rep. Wiley Nickel (D-N.C.) asked how the U.S. can ensure overseas actors effectively enforce our regulations and how Congress can bolster the jurisdiction of the U.S. enforcement agencies, allowing them to extend their reach internationally. Levin said we need to foster international collaboration on a tactical and operational level to make sure we can freeze and seize assets when we need to.

 

Hill asked witnesses to discuss the importance of Mutual Legal Assistance in Criminal Matters treaties with jurisdictions. He also asked them which other tools we should use in combatting crime in that manner. Lisa said FinCEN and Treasury and DOJ have the necessary expertise and the use of sanctions and have legal attaches in every country where there is a U.S. embassy. He said they can build better capacity building with other jurisdictions.

Bank Secrecy Act (BSA)

Davidson asked if our current Bank Secrecy Act / Anti-Money Laundering (BSA/AML) framework allows for sufficient reporting requirements in the digital asset space. Hughes said the big exchanges in this country are subject to the BSA, adding that blockchain analytics are crucial. He said everyone in the industry uses it, and that it will improve as more collaboration between private industry and law enforcement occurs.

 

Hill asked if all the witnesses agree that we need a regulatory framework that clearly outlines regulatory oversight and AML/BSA compliance for digital assets. All the witnesses agreed.

 

 

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