On November 15, the House Financial Services Committee Subcommittee on Digital Assets, Financial Technology, and Inclusion held a hearing entitled “Crypto Crime in Context: Breaking Down the Illicit Activity in Digital Assets.” Witnesses in the hearing were:
· Bill Hughes, Senior Counsel & Director of Global Regulatory Matters, ConsenSys
· Jane Khodarkovsky, Partner, Arktouros
· Jonathan Levin, Co-Founder & Chief Strategy Officer, Chainalysis
· Gregory Lisa, Chief Legal Officer, DELV
· Alison Jimenez, President, Dynamic Securities Analytics
Below is a summary of the hearing prepared by Delta Strategy Group. It includes several high-level takeaways from both panels, followed by summaries of opening statements and witness testimonies and a summary of the Q&A portion of the hearing.
Key Takeaways
The following is a summary of the main topics explored in today’s hearing. Each is discussed in further detail in the Discussion section below.
- This hearing touched on concerns regarding illicit activity conducted using cryptocurrency. Members on both sides of the aisle expressed that crypto should not be used to conduct illicit activity, but Republicans suggested that blockchain can be leveraged to combat illicit activity as it is an immutable record of transactions. Democratics highlighted that the anonymous nature of blockchain and expressed concern that this facilitates illicit activity.
- Republicans highlighted that illicit activity makes up a small percentage of cryptocurrency use and advocated for a stronger domestic regulatory regime to prevent illicit activity in the digital asset space.
SummarY
Opening Statements and Testimony
Subcommittee Chairman French Hill (R-AR)
- This Committee is in support of shutting down illegal illicit terror finance. That said, criminals will continue to use any means possible to conduct their illicit activity. Phones on the Internet are not to be blamed by terror financing, and crypto should not be either. We must examine these issues and separate fact from fiction. Based on the engagement on this issue from both sides of the aisle, our fact-finding mission is not partisan in any way. Blockchain can be leveraged to combat illicit activity.
- As the Department of Treasury (Treasury) itself has acknowledged, most virtual currency activity is not illicit, and blockchains do provide law enforcement with the unique and novel insight into criminal organizations and their funding networks. Law enforcement has been very adept at leveraging this information to clamp down on criminals, in part by choking off their access.
Subcommittee Ranking Member Stephen Lynch (D-MA)
- While we will continue to evaluate the precise sources of revenue for Hamas and other militant groups, public reports do indicate that there is some cause for concern. There are key features of crypto assets, such as inherent pseudonyms, pseudonymity, and their decentralized nature that make them vulnerable and highly useful for illicit activity, including ransomware attacks. Treasury’s recent statement on crypto recognizes that cyber criminals often require ransomware payments in the form of bitcoin. According to an industry report, payments to ransomware attacks reached $449 million in the first half of 2023, which is up forty percent from the same period last year.
Committee Chairman Patrick McHenry (R-NC)
- We want to know the extent of to which crypto is being used for illicit purposes and ways that we combat it. There have been conflicting reports regarding Hamas’ fundraising efforts through digital assets. We know they use the traditional banking system. We know that they misused cash and other forms of currency, and we know that bad actors prey on vulnerabilities wherever they can find them. There is a bipartisan agreement that we must hold these bad actors accountable in every way possible, specifically when it comes to digital assets and the digital asset ecosystem. It is important to note that digital assets are built on transparent, open, distributed ledger technology, making it far easier to detect and track illicit activity.
Bill Hughes, Senior Counsel & Director of Global Regulatory Matters, ConsenSys
· Combating money laundering is a difficult task in any space, but digital assets present capabilities with respect to tracking money laundering that law enforcement and the public at large have never before had. Because open, permissionless blockchain ledgers are reviewable by anyone, transactions can be traced using blockchain analytics technology, even those that are purposefully complicated to obfuscate the flow of funds. Any policy response to the threat of money laundering should embrace the transparency of the blockchain and bolster the power of transaction analytics if it hopes to be successful. We need more global uniformity in regulating exchanges and stablecoins.
Jane Khodarkovsky, Partner, Arktouros
· There are already robust enforcement mechanisms enshrined in U.S. law to deal with the issues we are discussing today. The bigger question is whether U.S. authorities and law enforcement are adequately empowered and funded to enforce those laws that are already on the books. Blockchain can and does help combat illicit finance as its ledger is permanent and unalterable. It is crucial to ensure that compliant U.S. based companies and projects in the digital asset ecosystem remain in the U.S. so we do not lose the upper hand in innovation.
Jonathan Levin, Co-Founder & Chief Strategy Officer, Chainalysis
· Cryptocurrency transactions are inherently public and the data from those transactions is preserved on a transparent, immutable ledger. the amount of illicit activity constitutes only a small fraction of all cryptocurrency transaction activity. In 2022, the amount of illicit activity involving cryptocurrencies was approximately $20.6 billion. The vast majority of that activity was attributable to ransomware, scams, and theft. Terrorism finance only made up a very small portion of the total volume of illicit activity.
· The federal government should provide a path to compliance for the digital asset industry in the U.S. in order to increase the number of domestic touchpoints for U.S. law enforcement. The U.S. should prioritize arming government agencies with sufficient resources and expertise to address the changing dynamics of how value is being transferred over blockchains.
Gregory Lisa, Chief Legal Officer, DELV
· It is important to accurately acknowledge that crypto carries illicit finance risk, like, as with gold, and shell companies can be addressed. The proper role of an AML regime is to assess the risk and to build appropriate controls to mitigate it. There is a real chance that regulatory overreaction will simply serve to drive crypto underground, offshore, and beneath the radar. Regulation can work, and it should work. Overreaction with regulation can make compliance impossible, divert resources away from real risks, and make unregulated environments the only places where companies can survive. Blockchain analytics can be used for the detection and investigation of crime and terror finance.
Alison Jimenez, President, Dynamic Securities Analytics
- The vast majority of crypto transactions are not subject to blockchain analytics. Blockchain analysis, while helpful in certain situations, cannot and does not provide the complete picture of the use of cryptocurrency in illicit finance. Suspicious Activity Reports (SAR) form should be updated to include crypto as a financial product and should have a specific category for crypto institutions. Proposed legislation should not provide weaker oversight to stablecoins given their growing use in illicit finance.
Discussion
Hill (R-AR): There has been a lot of press on terrorist organizations’ use of crypto over the years. Specifically, you have stated that the Wall Street Journal story saying that $130 million worth of digital assets over the past few years has been sent to ISIS was misinterpreted. Can you tell us how that is the case? Levin: The information in the figures quoted are a representation of both the amounts that can be linked to actual terrorist financing, and the broader network of facilitators and intermediaries that were caught up in the network of financial terrorism.
Hill (R-AR): Do you agree that criminals will use various services to get off of the blockchain to inhibit being identified on the blockchain? If so, how can this Committee direct the administration to stop that? Levin: The administration needs better access to data, better access to software and expertise to affect those types of operations. You can find ways to penetrate these networks, particularly those that are sophisticated and large scale because they are ones that the government can actually put resources behind.
Lynch (D-MA): Can you explain how illicit activity through crypto poses national security threats? Jimenez: If you do not have intelligence that is external to the blockchain which will identify ledger transactions as suspicious activity, it blends in with the rest of the ledger.
Casten (D-IL): Is cryptocurrency inherently ineffective for terrorist activity? Levin: Crypto has been ineffective as a tool for funding for Hamas.
Casten (D-IL): How do terrorist organizations use mixers and other anonymizing technology? Jimenez: There are blockchains that have less transparency. Criminals can also go off-chain entirely. Blockchain does not give a full picture of illicit activity.
Hill (R-AR): Can you discuss the importance of mutual legal assistance treaties (MLAT) and other tools we should use in combating crime? Lisa: FinCEN and the Department of Justice already have expertise and authority, but they need additional resources.
Timmons (R-SC): Can you describe what information is available to law enforcement and how it can be used to stop criminal activity? Levin: Blockchain has an immutable ledger, and you can link transactions to the entities that have put them there to determine if they are illicit.
Davidson (R-OH): Is it true that the preferred currency for illicit activity is crypto? Levin: Only .24 percent of the transactions in cryptocurrency can be linked to explicit activity.
Davidson (R-OH): Do you agree that digital asset related SARs demonstrate U.S. based exchanges are trying to comply with Bank Secrecy Act or AML frameworks? Jimenez: Yes, but there are enforcement actions against some entities for failing to file SARs.
Sherman (D-CA): What percentage of the U.S. dollar transactions are illicit? Levin: The estimate is somewhere between three and five percent; Jimenez: This number is inflated and is an estimate by U.N. not actual recorded transactions.
Davidson (R-OH): Do you think that the current AML framework allows for sufficient reporting in this space? Hughes: I think you see the majority of blockchain activity on centralized exchanges, so they are subject to submit SARS. Blockchain analytics is crucial, but it can be improved by speeding up the delivery of which transactions may be illicit.
Davidson (R-OH): Can you speak on legitimate uses of anonymizing transactions? Khodorkovsky: Because of its traceability and immutability, even if individuals are using self-hosted wallets, they will interact under our current U.S. robust AML framework with centralized exchanges when they exchange their digital assets.
Sherman (D-CA): What are your thoughts on mixers and personal privacy? Jimenez: Mixers can be used for any purpose the end user wants it to be.
Lynch (D-MA): Are there more large participants using off-chain transactions? Jimenez: Yes, and, if it is off the blockchain, U.S. regulators would not get data from those transactions.
Lynch (D-MA): What do you recommend Congress to do respond to these illegal activities? Jimenez: Congress should empower the SEC. The SEC is much more used to deal with SAR filings as the CFTC barely gets a couple hundred a year.
Foster (D-IL): What regulation could prevent non-compliance regarding on and off-ramp interactions? Levin: We need to be focused on the disruption efforts that are possible with the existing authorities, both in the intelligence community and law enforcement.
Rose (R-TN): How can we improve coordination with foreign regulators? Lisa: We can drive capacity building overseas and driving expert building so that firms are being used elsewhere with our foreign allies; Khodarkovsky: It is important to look inward first, but we should look at other commodities being traded internationally to close loop-holes.
Rose (R-TN): Do you believe that it is necessary for the U.S. to copy foreign nations’ regulations of the digital asset space? Hughes: No, we should not copy, but it is important to start engaging in these conversations.
Nickel (D-NC): How can the U.S. ensure overseas actors effectively enforce its regulations? Levin: We need to foster international collaboration on a tactical operational level to ensure we can freeze and seize assets when they are illicit. We need a better regulatory regime domestically.
Timmons (R-SC): Why did Treasury and other law enforcement partners seek a more targeted approach to sanctioning mixers? Have they been effective? Lisa: If there is a broad-based approach, you are throwing out a lot of good activity and second could be drifting into an area that regulates software. There is limited evidence of their efficacy.
Hill (R-AR): Do you think it is better for the U.S. to have our own digital asset framework to hold out to other international leaders in the space? Levin: Yes. Jimenez: Yes. Lisa: Yes. Khodarkovsky: Yes. Hughes: Yes.