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Bitcoin, Crypto-Currencies and Law Enforcement

Bitcoin, Crypto-Currencies and Law Enforcement

The following article first appeared on Policeone.com in January 2014. It is being re-posted on lawenforcement.social with the authors approval. Crypto-currency is a fast paced and evolving platform. Information contained in this article may be a bit outdated, but certainly worth the knowledge for law enforcement.

Since 2011, I've been studying and investigating a new form of digital currency, often referred to as crypto-currency or Bitcoins.  Since then, crypto-currency has seen a boom in popularity and acceptance by merchants as well as everyday Internet users. 

Recently a Police Chief requested that his entire salary be paid in the form of Bitcoins. In March 2013, the Federal Bureau of Investigation (FBI) seized over170,000 BTC after arresting the alleged mastermind of an online black market website, “The Silk Road”.  Often referred to as, “the eBay of the deep web”, the Silk Road dealt in illicit drugs,weapons and hacking services.  Visitors to the website would purchase these illicit goods using Bitcoins.  At the time of this writing, Bitcoin was valued at $802 a coin or BTC according to variousBitcoin exchanges.

So what are Bitcoin’s and crypto-currency and why should the everyday patrol officer be concerned?  For starters, crypto-currency poses a real threat to conventional ways with which law enforcement detects, prevents, and investigates crime involving currency.  There are many aspects of Bitcoins, but I will discuss 4 reasons why law enforcement should be concerned about the growth of digital currency and why, contrary to financial sector analyst, I think crypto-currency will continue to increase in popularity and acceptance worldwide.

Because Bitcoin is considered the first form of crypto-currency, I will focus on the development of Bitcoin from this point forward.  However, several other crypto-currencies have come into existence using Bitcoin’s “proof-of-concept”with over 60 different variations. Also, I refer to Bitcoin as a“Crypto-Currency” and not as a “Virtual” currency because virtual currencies don’t involve Cryptography in their proof-of-concept.  Examples of virtual currencies might be Linden Dollars used in the online game Second Life or Amazon Coins which are used for app purchases via the Kindle Fire and Amazon App Store and controlled by a central authority.

So, what are Bitcoins? Bitcoin is the first open-source and decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen. It is not backed by any government nor is it controlled by any regulation.  Think of it as a new payment system that operates as a consensus network without the need of someone checking transactions.  For example, if I wanted to send you money using PayPal, I would have to either use PayPal’s website or mobile application, but that transaction would have to be verified by PayPal and whatever credit card or bank account system you have tied to PayPal and would include extensive fees.  With Bitcoin and crypto-currency, the “middleman” is removed from the equation, allowing individuals to be their own bank, operating on a system of trust.  The first Bitcoin transaction occurred on or about January 3, 2009, and is referred to as the “Genesis Block”.

Bitcoin was developed in 2008 by Satoshi Nakamoto.  Since that time, there has been much speculation as to the identity of Nakamoto.  No one knows his/her true identify and since Nakamoto left the project in late 2010, early collaborators of Nakamoto continued the development of the platform

So how does crypto-currency work

Bitcoin’s are sent using a “Wallet Address”,which is a digital signature consisting of a SHA256 encryption hash called a Public Key. It would look something like this or in the form of a QR Code:

·      1AqUgDZPS4KwhDT9HSyna3pFkRL3ehNmRz

Sample of a paper wallet

Sample of a paper wallet

That public key has a corresponding private key that allows the user to sign transactions, transferring money out of their wallet address and into another in the form of a payment or transfer.  This transaction takes place and is logged publicly in a ledger called a “Blockchain”.  Bitcoin was designed to allow users to send and receive payments anonymously, but because Bitcoin transactions are published in the blockchain, anyone can see what address and amounts were sent.  This makes them pseudo-anonymous.  Bitcoins can be obtained with cash through various crypto-currency exchanges such as Mt. Gox or Coinbase, or they can be “mined”.  Mining involves your computer performing very complicated mathematical computations to solve a problem submitted by the network.  If your computer solves the problem, you are awarded 25 Bitcoins.

This is a very brief explanation of how Bitcoin and crypto-currencies work but look for future articles covering the Bitcoin protocol.  So, let’s start to answer some obvious questions like, why law enforcement should be concerned.

Is Crypto-currency legal?

Although there has been much debate over the legality of crypto-currencies, the U.S. District Court, Eastern District of Texas recently ruled on the legality of Bitcoin in a case brought by the Securities and Exchange Commission. In that case, Trendon Shavers was charged with the operation of a“Ponzi Scheme”, using the name Bitcoin Savings & Trust. His scheme managed to bilk more than 4,100 customers out of millions of dollars.  The SEC argued that Bitcoin’s were an “investment contract” and an exchange for conventional currencies and the court agreed, citing, “It is clear that Bitcoin can be used as money.  It can be used to purchase goods or services. Therefore, Bitcoin is a currency or form of money,and investors wishing to invest in BTCST provided an investment of money.”

So what about theft? Is it theft of currency, property or financial investment?

Just like cash, theft of Bitcoins has already occurred and will more than likely occur in the future.  Although theft may be more cyber related in the form of malware designed to compromise a victims computer, the basic premise of theft has occurred.  So what if you respond to a call indicating Bitcoins where stolen? Would your report indicate cash, fiat or investment vehicle was taken? Based on the U.S. District Court decision, one could definitely argue that position.  Or what if while conducting a narcotics investigation, you discover several Bitcoin wallet addresses and QR codes in the suspect’s possession or Bitcoin mobile applications on his phone.  Taking into consideration other key factors with regards to sales, would you arrest for Possession of A Controlled Substance for Sales?  Could the suspect be negotiating drug sales via Bitcoin? Would you know how to somewhat trace those transactions?  I discuss briefly what I’ve done next.

Anonymous, it is not. (Kind of)

Criminals looking to hide their tracks might be lured to the pseudo-anonymity of Bitcoin, but because transactions are published in the blockchain, it gives law enforcement some means of tracking transactions.  With the assistance of an academic abstract published by researchers from the University of San Diego, I have been able to successfully track certain Bitcoin transaction patterns in the deep web.  Using cloud analysis and simple search algorithms, tracking the history of a Bitcoin address is definitely possible.  However, to obtain the identity of the Bitcoin address owner, one would have to wait for the individual to convert the Bitcoins for fiat.  This can be done at exchanges such as Mt.Gox, U.S. Based Coinbase and others. However, trading person-to-person for cash is also a possibility via Localbitcoins(dot)com. This same concept, although extensive, can easily be adopted by law enforcement to track patterns of local drug dealers and other criminals drawn to the potential anonymity using Bitcoins.

It’s more than currency.  It’s a new internet platform.

Because the Bitcoin protocol is versatile and open source, uses for other platforms have already been developed.  From new encrypted messaging systems such as Bitmessage, toNamecoin, a new web Domain NameService (DNS) used to register websites without a central registering authority. And with increased threat to one’s identity, Internet users are demanding a return of anonymity to the Internet.  Groups like Dark Wallet are designing new ways to increase the anonymity of Bitcoin users.  I foresee a time when the Bitcoin protocol will change the way we traverse the Internet. Like email and social media changed the way we communicate, Bitcoin will change the way we transact.  This could very well create a challenge for law enforcement.  But by knowing the protocol and understanding it’s function, can allow us to be ahead of the game.

Bit me: 15DvkPdWomGmHxQ17TkEoLt19AoaL82znQ

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