Sex, Drugs and Bitcoin. The Numbers.
Bitcoin has a bad "rep". A lot of people view it as a black market currency, which to be fair isn’t false. The first place Bitcoin was widely accepted post its inception was on dark net markets such as Silk Road, where pretty much anything was available for sale. The idea of these sites was that you used an anonymous web browser to keep your location invisible and an anonymous currency to keep your transaction invisible.
Here’s a screenshot of Silk Road, with all prices stated in BTC.
Given the rise of the Bitcoin price since, at today’s exchange rate, the 3 grams of "B Grade" hash for sale would equate to over $32,000. Times have clearly changed. A lot of dealers on dark net sites could be extremely wealthy today if they held onto some of their coins. You have to wonder if they did.
Here's an example of a gun available on a different dark net site...
Or if you didn't want to pull the trigger yourself...
These are all real sites and it gets a lot worse if you dig deeper into what was available. The fact that Bitcoin was used in an "anonymous" manner to pay for these transactions is a serious issue and one which will continue to kill its reputation and prevent adoption if not addressed.
There’s two questions I want to cover here....
1. How much illegal activity takes place on the blockchain, historically and today?
2. How difficult is it for law enforcement to trace and act on this activity?
To answer these questions, I'm going refer to a study from the University of Sydney, who published a paper on this topic. You can read the full text here but below is a simplification, plus my own thoughts.
How to figure out which activity is illegal
Bitcoin is not as anonymous as you might think. It's certainly isn't as anonymous as dark net market users once thought. I mentioned in a previous post that the blockchain is available for all to see and download. That’s one of its key features and how it stays secure.
There’s no identifying information connecting individuals to their wallets / addresses, so your identity does remain anonymous if you hold coins. However, your addresses are visible (with random identifying numbers), as are the transactions associated with movements of coins in and out.
Law enforcement has been successful in taking down these dark net marketplaces. Silk Road was busted in 2013 and many others were taken down since. Bitcoin from these sites were seized (e.g. by the FBI) and later sold or auctioned in the markets.
The guys at the University of Sydney had an idea from which this study was born. They started with the addresses that identified the seized coins, made public via court records and news articles. They then worked backwards, through the transaction history, to figure out which addresses the coins initially came from. In turn this could identify those addresses that were regularly involved in activity on the dark net sites, i.e. the "dealers".
Taking it to the next level, they figured out all the addresses associated with transactions to / from those "dealer" addresses, thereby identifying those used by the dark net "customers".
You get the picture. It's not really anonymous.
This study wasn’t yet complete. They also scraped dark net forums for other illegally active addresses and implemented a model which looks at addresses which became unusually active around FBI seizure events, as well those involved in shady activity such as "wash trades" or "tumbling".
The result is a large dataset of illegal users and transactions. There’s clearly some level of error around it, but it's in the right ball park.
Over to the results....
At the top level they sound very, very bleak....
One quarter of all users (26%) and close to one half (46%) of all transactions are associated with illegal activity.
Furthermore, approximately one-fifth (23%) of the total dollar value of transactions and approximately one-half of bitcoin holdings (49%) through time are associated with illegal activity
In April 2017, there are an estimated 27 million bitcoin market participants that use bitcoin primarily for illegal purposes. These users annually conduct around 37 million transactions, with a value of around $76 billion
However, let's dig deeper. These are top level statistics and don’t really show the trends over time. So to expand on that...
Illicit activity is clearly large part of Bitcoin's history, half of all past transactions is a HUGE number. Bitcoin was a crack addict. However, looking at the trend over time shows that the illicit proportion has declined as mainstream interest has increased. There’s clearly a shift in illegal Bitcoin use which has played out in three phases. 1. Early days, 2. Darknet growth, 3. Recent decline. It's slowly reforming.
This study also provides a framework for forensic investigation on the blockchain. Government agencies have almost certainly performed similar analysis. Potentially, if you traced a coin right back to the exchange on which it was initially bought, you could connect the individual. That's a big deal.
Side note on privacy coins
In my previous post about alt coins I only touched on the top 5. I should flag that there are other coins out there with the sole purpose of making privacy a key feature, meaning that the above investigative work would be impossible. Monero and Zcash are the primary examples, much smaller than Bitcoin in terms of market size but 100% opaque and private. Arguably, it's these networks that could face the most regulatory pushback given their inability to be traced.
Let's wrap this up...
Dark web sites needed Bitcoin to thrive at the same time Bitcoin needed the dark web to survive. The dark web might be anonymous but it's not decentralized, the result being that it was repeatedly taken down. Authorities could not take Bitcoin down as the issue with a decentralized network is a total loss of control.
Despite its unquestionably shady past, Bitcoin lives on and if anything the experience has made it stronger. Law enforcement tools and techniques will have to adapt accordingly and will continue to evolve over time. In turn, by addressing this issue, crypto technologies will hopefully be given a chance to reach their full potential.
Like it or not, we now see Bitcoin emerging from the crack dens in which it once hung out, to the real world.