Recently, Alaric Snell-Pym published a thought-provoking piece on bitcoin and whether or not law enforcement would be embracing it or not. In his article, "Bitcoin Security", he concludes that the authorities will most likely revel in its transactional tracing potential thereby providing an electronic trail that regular paper cash simply cannot beat. Just take a look at the Bitcoin Block Explorer. Predicting a laundering technology arms race, Alaric writes:
"Indeed, I could make my bitcoin client sit there creating new addresses and transferring random chunks of my wealth to random new addresses 24x7, to effectively launder all my money through a few thousand identities. If I give somebody some money and, ten hops later, some of it is used to buy porn, I can't tell what those ten hops were - they might be ten transfers to different people, in which case, well, aren't we all six or so degrees apart anyway? It could be anyone. Or it could be the same person, laundering his money.
So isn't that a nightmare for law enforcement? Won't they have to crack down on this and make it illegal, before it's used to FUND TERRORISM and DESTROY CAPITALISM?!?!
Well, no. Perhaps they will do that anyway as a knee-jerk reaction. But I think it's just like cash, but a little easier for them to trace. If they realise it, they'll be behind it, which I think will be a good thing - as I think Bitcoin is a good currency that will enable all sorts of cool things that can't currently be done practically.
For a start, those laundering transactions are exactly the kinds of things intelligence services are good at figuring out. They can put supercomputers to work analysing the global transaction stream (all available in ONE place; no need to talk to lots of banks - or worry about infiltrating uncooperative foreign banks). Some value that goes into an account then buzzes through a self-contained pool of accounts for some time then zooms out to somewhere else can probably be traced through analysing the timings of transactions and the like; the pattern of automated laundering will be different from actual spending, if you have enough computer power to find the patterns. Imagine drawing a diagram with a blob for each address you know something about (eg, can tie to a person or organisation), and drawing arrows for all the transactions between them. Any single-use addresses can just be chained together as part of the same arrow. Any unknown addresses can be given small blobs on the diagram. Colour the arrows with the magnitude of the amount transferred, on a log scale. Arrange the diagram so the minimum of arrows overlap. Do this for the transactions in each day, and then make a movie of them changing over time. Take a given known-suspect transaction and treat it like a drop of dye, colouring it strongly, and mixing it with the light grey of other money flowing through the system as it dissipates, and see where that dye spreads to. Then get computers automating the analysis even further."Another article by Mencius Moldbug, "On Monetary Restandardization", seems to reach the same conclusion with respect to money laundering and bitcoin users doing the authorities a massive favor.
"What is Bitcoin's only chance? Perhaps that Bitcoin is not really anonymous. In fact, it is anything but. All transactions, though pseudonymous (named by a random key), are public and can be tracked by anyone, including said authorities. There is no financial secrecy in Bitcoin - it's a completely transparent system.However, as I state in my comment to Alaric below, I believe that this reasoning is flawed. Law enforcement seeks 'link-ability' to a physical individual -- not mere 'traceability' -- and with a hyper-pseudonymous distributed bitcoin architecture, many avenues exist to obscure transactions:
Which means that, if money launderers try to launder money through Bitcoin, they are actually doing the authorities a massive favor. It is very easy to track dirty bitcoins. If you know Pablo, a drug dealer, is using Bitcoin address X, you can download the entire graph of parties that X trades with, and roll up Pablo's whole network. Instead of shutting down the real-money exchanges, you can secretly force them to send you their entire customer database. That way, the terrorists, drug dealers, etc, are not hiding their transactions at all - they are sharing their most intimate details with the government. Heck, the DEA probably understands Pablo's finances better than Pablo's own people. That's what he gets for using Bitcoin."
"Your point on transactional tracing definitely made me think about 'self-contained pools' and 'transaction timing'. However, I don't think you are considering a structure of unrelated, unconnected mutual offset accounts as are used today in correspondent banking. For example, a Pound Sterling transaction comes in and a Japanese Yen transaction goes out without the two ever connecting because the offset is conducted off the grid.
Also, as more 'mixer' services -- http://bitcoinlaundry.com/ and http://app.bitlaundry.com/ -- come on line, the greater the pool of dead-end transactions and the greater the opportunity for unrelated, off-the-grid offsets."
For further reading:
"With The Napster of Banking Round The Corner, Bring Out Your Popcorn", Rick Falkvinge, May 11, 2011