US Treasury Department assesses ‘crypto’ money laundering, terror financing risks

Digital assets will figure prominently in the U.S. government’s new strategy for combating illicit financing, based on the contents of three new reports.

This week, the U.S. Treasury Department issued a series of reports detailing its 2024 National Risk Assessments for Money Laundering (NMLRA), Terrorist Financing (NTFRA) and Proliferation Financing (NPFRA). In the coming weeks, the Treasury plans to release its 2024 National Strategy for Combatting Terrorist and Other Illicit Finance, which will be based on these risk assessments.

Anyone reading the tea leaves—like the pre-Christmas comments by Treasury’s Deputy Secretary Wally Adeyemo slamming “dollar-backed stablecoin providers” based in foreign territories (we’re looking at you, Tether)—will have guessed that each of the new reports contains detailed sections on the unique and growing threats posed by bad actors’ use of digital assets.

The NMLRA notes that token prices tumbled in 2022 and stayed low through most of 2023 but have since made significant increases in value. Oddly enough, the fact that moon-boys’ bags are pumping again may increase the likelihood of further crackdowns on the digital asset sector. Careful what you wish for…

While the NMLRA acknowledges that “the use of virtual assets for money laundering remains far below that of fiat currency,” it warns that the sector is subject to “inconsistent compliance with domestic laws and international AML/CFT [anti-money laundering/
combatting the financing of terrorism] obligations, obfuscation tools and methods, mixing, disintermediation, and other aspects of purported decentralized finance (DeFi).”

There’s been a lot of talk regarding Mexican cartels using digital assets to buy fentanyl precursors from Chinese manufacturers. While the NMLRA admits that “the laundering of drug trafficking proceeds is predominantly cash-based, the use of virtual assets is a growing concern for U.S. law enforcement.”

The NMLRA notes that “investment fraud involving virtual assets has rapidly increased in both the number of victims and losses, rising 183 percent between 2021 and 2022.” FBI data shows that “virtual asset-related losses reported by older adults increased by 350 percent from 2021 to 2022.” And remember, senior citizens vote in far higher numbers than any other age demographic.

Virtual Asset Investment Schemes (VAIS) ranging from old-fashioned Ponzis to newfangled ‘pig butchering’ are increasingly on the Treasury’s radar. The NMLRA says consumer losses from VAIS “accounted for nearly 75 percent of all internet-enabled investment fraud in 2022.”

A report earlier this month by cybersecurity firm Sophos suggested that pig butchering has become so popular among Asian crime rings that other groups are now doing a brisk business selling pig-butchering-as-a-service ‘kits’ on dark web marketplaces. This reportedly leads to the geographic spread of groups orchestrating these scams from their hubs in southeast Asia to regions as far afield as West Africa and even the United States.

Erin West, deputy district attorney in California’s Santa Clara County and a member of the REACT High Tech Task Force, recently told Ars Technica that when it came to pig butchering, “It’s always, always, always Tether. I’ve never heard of pig butchering that isn’t Tether.”

West added that dollar-denominated stables like Tether allowed scammers “access to the very units of currency that we’re trying to prevent them from accessing. This is exactly what sanctions are meant to stop, and they’re able to bypass it.”

Terror

Turning to terror, the NTFRA notes that terror groups like Hamas and the Afghanistan-based ISIS-K “still prefer traditional financial products and services” over digital assets. This is partly due to the latter’s price volatility and the fact that you still can’t buy a significant variety of goods and services using tokens. Here again, stablecoins are proving a popular alternative, and the NTFRA singles out Tether as a preferred means of moving or storing terror funds.

The NTFRA notes that despite the Financial Action Task Force (FATF) extending global AML/CFT standards to virtual asset service providers (VASPs) in 2019, most jurisdictions currently rate as only partially or not compliant on this front.

Many countries have made “limited progress” in applying these standards, failing to take “basic steps to assess risk or determine an approach to virtual assets.” The result is that many non-US VASPs have “substantially deficient AML/CFT programs.”

The use of ‘anonymity-enhancing technologies’ such as coin mixers by terror groups “has been limited so far,” but Treasury says it’s watching these operations closely.

The NTFRA wasn’t entirely negative on digital assets, noting that “certain elements of virtual assets,” such as the public nature of blockchain transactions, “may support tracing funds associated with terrorist financing.” But it also noted that much of this illicit activity takes place off-chain, including on centralized exchanges, decentralized exchanges, and over-the-counter brokers.

Proliferation

The NPFRA cites “cyber-enabled” proliferation financing by rogue states such as North Korea as an area of mounting concern. In recent years, North Korea has become so adept at hacking digital assets that the Hermit Kingdom now derives billions of dollars in hard currency it otherwise could not obtain.

The NPFRA also cites North Korea’s use of ransomware, although it concedes this area of focus is “to a lesser extent” than the regime’s hacking of exchanges, DeFi protocols, cross-chain bridges, venture capital funds investing in virtual assets, and high net-worth individuals with large quantities of tokens or non-fungible tokens (NFTs).

The NPFRA likely isn’t sitting well with Ethereum co-founder Vitalik Buterin, who last September described Ethereum developer Virgil Griffith—currently sitting in federal prison for teaching North Korea how ‘crypto’ could be used to evade economic sanctions—as just someone who is “more geopolitically open-minded than a lot of other people.”

Stop your Yellen

The Treasury reports were released the day after Treasury Secretary Janet Yellen appeared before the House of Representatives’ Financial Services Committee. The hearing was convened to consider the annual report of the Financial Stability Oversight Council (FSOC), of which Yellen serves as chairperson.

A section of Yellen’s written testimony addressed “digital assets and related risks,” including her belief that “applicable rules and regulations should be enforced, and Congress should pass legislation to provide for the regulation of stablecoins and of the spot market for crypto-assets that are not securities.”

Committee chair Patrick McHenry (R-NC) has been pushing for a floor vote on his Clarity for Payment Stablecoins Act of 2023 before he retires at the end of the current term. This week offered vivid illustrations of Congress’s inability to pass any legislation, but Rep. Maxine Waters (D-CA) set ‘crypto’ hearts a-fluttering on Wednesday by telling Politico that the two warring factions are “very, very close” to agreeing on a stablecoin plan.

One of the sticking points is whether the federal government (the Democrat-preferred option) or individual states (the GOP’s preference) take the lead in regulating so-called ‘payment stablecoins’ (aka the U.S.-based Circle’s USDC and not the foreign interloper Tether). McHenry’s bill would grant states significant latitude in deciding what locally licensed stablecoin issuers could and couldn’t issue.

On Tuesday, Yellen told the Committee that “it’s critical for there to be a federal regulatory floor that would apply to all states.” Noting the threats posed to the wider financial system by digital assets, Yellen suggested that “a federal regulator should have the ability to decide if a stablecoin issuer should be barred from issuing such an asset.”

Sound and fury, signifying nothing

For years now, the FSOC has been strongly hinting that if Congress doesn’t get its act together regarding stablecoins, the feds will take matters into their own hands. Following Yellen’s appearance, a quarter of Republican committee chairs sent Yellen a letter rebuking FSOC’s threats to intervene and asking Yellen a number of questions they want her to answer by February 20.

The questions largely involve the tired pursuit of ‘regulatory clarity,’ including the perennial issue of whether certain tokens are commodities or securities and why Securities and Exchange Commission (SEC) chair Gary Gensler insists that existing laws apply just fine to digital assets. (But not to Beanie Babies?)

With the exception of McHenry, the letter’s authors are all recipients of Coinbase execs’ personal campaign contributions in the current cycle. However, McHenry is so far the main beneficiary of funds doled out by Fairshake Super PAC, a political action committee formed by Coinbase (NASDAQ: COIN), Circle, and other ‘crypto’ notables. In December, Fairshake announced that it had raised $78 million, which it plans to distribute to pro-crypto candidates in 2024.

This fiscal generosity is primarily responsible for the invention of the ‘payment stablecoin’ subterfuge, which attempts to distinguish between Circle’s noble USDC and Tether’s dastardly USDT. Circle likes to claim that USDC is being used for all sorts of wonderful, legitimate purposes, but these claims generally fall apart on close inspection. The sad reality is that USDC has become exit liquidity for USDT holders who want to cash out to dollars but can’t because Tether lacks access to U.S. banking.

But we suppose the phrase ‘crime-adjacent stablecoins’ didn’t test well in focus groups.

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