Crypto vs Fiat: Is One Or The Other More Of A Haven For Illicit Finance?

UPDATE: Since I published this article and posted it on LinkedIn about four hours ago, I’ve had many comments and suggestions. Some have pointed me to articles and papers I didn’t cite, and to transcripts of Congressional testimony I missed. So I’ve updated this article. Anything you see in blue italics has been added.

I stumbled upon an April 2021 Coinbase Blog titled “FACT CHECK: Crypto is increasingly being used for criminal activity and is more of a haven for illicit finance than cash”. It caught my eye, and I immediately thought “false and true” – the first notion that crypto is increasingly being used for criminal activity” is false if you believe (and there is no reason not to) the work of such solid firms as Elliptic, ChainAlysis, and CipherTrace. But the second notion that crypto is more of a haven for illicit finance than cash may, in fact, be true. But it depends on whether you are strict in your use of the term “cash”, and what is meant by “haven”.

Before you go any further: take a breath, stay calm, and try to keep an open mind. I realize that crypto enthusiasts have a lot of strong thoughts and opinions, and telling a crypto enthusiast that there is anything dodgy about crypto is like telling a parent that their child isn’t perfect: thems are fightin’ words! But take a breath, and carry on …

The Coinbase blog had the intent, and effect, of countering “one of the most common but false notions about crypto is that it is mostly used by bad actors for illicit financing.” Coinbase concluded that “this is just not true” and supported its conclusion with “a few key data points”. Where did Coinbase get this “most common” notion that crypto is mostly used by bad actors? They hyperlinked the phrase “the most common” to a CoinDesk article that in turn referenced three statements by Treasury Secretary Janet Yellen, none of which actually said that crypto is mostly used by bad actors for illicit financing. Among other things, she said, “I see the promise of these new technologies, but I also see the reality: Cryptocurrencies have been used to launder the profits of online drug traffickers; they’ve been a tool to finance terrorism.”

But Secretary Yellen did make a critical, and very subtle, remark about cryptocurrencies being used for illicit purposes. In her January 2021 Senate confirmation hearing, she said this: “Cryptocurrencies are a particular concern … I think many are used – at least in a transactions sense – mainly for illicit financing.” Note her limiting phrase “in a transactions sense”: I won’t go down this rabbit hole, but the vast majority of crypto activity – perhaps as much as 99% by value – is not transactional in the sense of exchanging crypto for something other than crypto, but is the buying, selling, or trading of crypto.

(Thanks to Bob Seeman for providing the link to Secretary Yellen’s testimony).

Leaving aside whether anyone of any authority has started or contributed to this “common notion” or not, I’ll lead with this: Coinbase’s first fact check is correct. It is false that cryptocurrency is mostly used by bad actors for illicit financing. Most crypto transactions, whether buying crypto with fiat money on a regulated exchange, or trading one crypto for another on that same exchange, or buying and selling crypto futures, are legitimate, legal transactions. That most of those transactions are the trading of crypto as an asset or commodity is an issue for another day.

But Coinbase – and many other crypto proponents and enthusiasts – then drift into some comparisons of cryptocurrencies to fiat currencies to bolster their claims that crypto is far superior to fiat. It is the comparison of crypto to cash as havens for illicit finance, and the apparent conclusion that cash is more of a haven than crypto, that needs some discussion.

The first key point Coinbase relied on was that “according to research conducted by numerous blockchain analytics companies, illicit activity accounts for less than 1 percent of cryptocurrency transactions.”

To support this point, Coinbase hyperlinked the word “research” to point to a December 2020 Elliptic report that provided, in part, “while the total volume of illicit activity in cryptoassets has grown in absolute terms; illicit activity today still accounts for less than 1% of all transactions. A dramatic reduction from 2012, when 35% of cryptoasset transactions were illicit.”

They also hyperlinked the word “conducted”, to point to a February 2021 CipherTrace report that provided, in part, that “in 2020, major crypto thefts, hacks, and frauds totaled $1.9 billion—the second-highest annual value in crypto crimes yet recorded.”

In the next paragraph they write that “fiat currency (good old-fashioned cash) continues to be the funding of choice for criminals. The UN estimates that ~$1.6 trillion is laundered each year, or 2.7% of global GDP. In contrast, criminal activity in cryptocurrency actually fell quite dramatically — from 2.1% or $20 billion in transaction volume in 2019 to less than half a percent (0.34%, or $10 billion) in 2020.” Their source for this (the hyperlinked words “criminal activity”) is a February 2021 ChainAlysis report that provided, in part: “In 2019, illicit activity represented 2.1% of all cryptocurrency transaction volume or roughly $21.4 billion worth of transfers. In 2020, the illicit share of all cryptocurrency activity fell to just 0.34%, or $10.0 billion in transaction volume. One reason the percentage of illicit activity fell is because overall economic activity nearly tripled between 2019 and 2020.”

Finally, they correctly point out that “traditional payment networks, like SWIFT (Society for Worldwide Interbank Financial Telecommunication), have found that ‘cases of laundering through cryptocurrencies remain relatively small compared to the volumes of cash laundered through traditional methods.’” Correct – no argument there. But for that argument-for-another-day, remember that total crypto transactions are measured in the trillions (of dollars, ironically), while the total fiat transactions are measured in quintillions (of dollars, obviously). By the way, “trillion” is twelve zeros: “quintillion” is eighteen zeros. It’s like the difference between one dollar and one million dollars.

So Coinbase appears to have refuted the (false) notion that crypto is more of a haven for illicit finance than cash by favorably comparing the absolute amount of $1.6 trillion in illicit fiat currency transactions, and the relevant amount of that being 2.7 percent of global GDP – to “just 0.34%, or $10.0 billion in transaction volume” in illicit cryptocurrency transactions.

Coinbase seems to be comparing the $10 billion and 0.34% numbers from the crypto world to the $1.6 trillion and 2.7 percent numbers from the fiat world to support its position that cash is more of a haven for illicit finance than crypto.

This is where I’ll step in and add a different perspective.

First is the UN’s estimate that ~$1.6 trillion is laundered each year, and their comparison of that dollar amount and global GDP. This UN estimate has been around for about ten years, so it now has a sheen of respectability and immutability. But if you actually stop and think about it, describing the volume or value of transactions as a percentage of the value of goods and services produced doesn’t make a lot of sense. I’ve written about this before: see https://regtechconsulting.net/aml-regulations-and-enforcement-actions/proceeds-of-crime-and-gdp-are-we-comparing-apples-to-oranges/.

Which leaves Coinbase with its reliance on “just 0.34%, or $10.0 billion in transaction volume” is illicit cryptocurrency transactions. This is better: comparing criminal activity in crypto transactions compared to the value of all activity in crypto transactions. And $10.0 billion is 0.34% of $2.94 trillion. So we have a bad/total crypto ratio of $10.0 billion/$2.94 trillion.

Or do we? Other sources that Coinbase didn’t rely on suggest that the numbers, and ratio, are quite different. One source is an excellent article written by Paul Marrinan titled Crypto-crime & Caveats published by the Thomson Reuters Institute on March 29, 2021. There, Paul notes that: “it is important to question where this 0.34% figure came from. It is effectively a summary of all activity which has been positively identified as being linked to an opaque category of transactions referred to as illicit … From a law enforcement and compliance officer perspective, however, there are a number of concerns arising from such reports.” Paul also notes that “it is reasonable to estimate that crypto-crime maybe a modest 1.4% to 2% of all activity, or representing $40 billion to $59 billion. There is a possibility that the real figure could be higher than this, but in absence of better data it is at least in line with the estimates in the traditional financial system, if not slightly lower.”

And the crypto community itself, at least the regulated part of that community, may be reporting a level of illicit crypto activity that indicates almost 12 percent of total crypto activity might be tied to a possible violation of law or regulations. Craig Timm, the Financial Crimes Compliance Executive at Bank of America, has pointed out that a December 2020 Treasury Notice of Proposed Rulemaking for Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets (85FR 83840 at 83842, December 23, 2020) provided that:

“Determining the true amount of illicit activity that is conducted in cryptocurrency is challenging. One industry estimate is that approximately 1% of overall market transaction volume, or $10 billion, in CVC activity conducted globally in 2019 was illicit. This figure, however, may underestimate such illicit activity. Despite significant underreporting due to compliance challenges in parts of the CVC sector, in 2019, FinCEN received approximately $119 billion in suspicious activity reporting associated with CVC activity taking place wholly or in substantial part in the United States. By industry measures, this would equate to approximately 11.9% of total CVC market activity being relevant to a possible violation of law or regulation.”

But let’s stick with the Coinbase-approved rate of 0.34%: is that good or bad? Apparently it is quite a reduction from the rate of 2.1% from the previous year (2019). But if Coinbase is using it to support its argument that cash is more of a haven for illicit finance than crypto, it is only instructive if we compare it to the rate of fiat criminal funds flowing through the mainstream financial system as a percentage of the total amount of funds flowing through the mainstream financial system.

Where do we get that information?  The 2015 National Money Laundering Risk Assessment is a reasonable source. And I’ve written about this report, and the 2018 version of the NMLRA, and how they provide a useful look at the rate of fiat criminal funds flowing through the mainstream United States financial system as a percentage of the total amount of funds flowing through the mainstream United States financial system. See https://regtechconsulting.net/uncategorized/2018-national-money-laundering-risk-assessment-aml-2018-looks-very-similar-to-aml-2015/. In that article I wrote:

“The United States continues to estimate that domestic financial crime, excluding tax evasion, generated approximately $300 billion of proceeds for potential laundering, based on the sources and analysis cited in the 2015 NMLRA.

So over the last 2 1/2 years, the size of the AML problem in the US hasn’t changed – it remains $300 billion of proceeds for potential laundering. In other words, not all of the proceeds of criminal activity make it into the financial system for potential laundering. But for arguments sake, let’s assume that all of the proceeds of criminal activity in the US make it into the financial system (and of course the NMLRA notes that proceeds of criminal activity from outside the United States are laundered through financial institutions based in the United States, and much of that simply passes through US-based financial institutions that are facilitating US Dollar-based transactions). Three hundred billion dollars is a lot of dirty money to go into, pass through, and/or end up in US financial institutions … but how much total money flows through those institutions? The 2015 NMLRA gives a clue: at page 35 is a reference to the volume of funds flowing through Fedwire, CHIPS, and ACH. The Fedwire and CHIPS numbers are daily volumes: $3.5 trillion per day and $1.5 trillion per day, respectively (ACH is measly $10 trillion per year). By my math, the three main US-based financial payments systems move ~two quintillion dollars a year, which means that criminal proceeds make up about $3 for every $20,000 that flow through US based financial institutions.  To put that in perspective, $300 billion in criminal proceeds out of $2 quintillion in total proceeds means that 99.999985% of dollars moving through US financial institutions are ‘clean’.”

I’ve tried to find estimates of the total global fiat transaction activity, and can’t find anything. But let’s be as favorable to Coinbase and its crypto argument, and use the largest fiat numerator – $1.6 trillion in global illicit activity – and the smallest fiat denominator – $2 quintillion in US-only fiat activity. That will drive up the illicit fiat ratio, but you’ll see that it doesn’t make a difference to the perspective I’m providing.

So let’s compare Coinbase’s illicit global crypto activity with the National Money Laundering Risk Assessment’s illicit US-only fiat activity:

The total amount of illicit fiat activity dwarfs that of the total amount of illicit crypto activity: billions of dollars versus trillions of dollars. But the relative amount of illicit fiat activity is miniscule compared to the relative amount of illicit crypto activity: for every one million dollars of crypto-related activity, $3,400 is “illicit”, but for every one million dollars of fiat-related activity, only 80 cents is illicit.

The crypto community must be applauded for its focus on identifying and measuring – and mitigating – illicit crypto activity. And the fiat community has much to learn from the crypto community. But any comparisons of illicit crypto activity to illicit fiat activity must have the same focus and rigor. Apples to apples.