[PDF]BLOCKCHAIN TECHNOLOGY AND MONEY LAUNDERING

Bjelajac Zeljko" UDK: 004.738.5:(343.53:336.741.1)
https://orcid.org/0000-0003-4953-8779 Original scientific paper
Bajac B. Moméilo™* DOI: 10.5937/ptp2202021B


. : _ is 7 Received: 07.05.2022.
https://orcid. org/0000-0003-2 115-6373 Approved on: 17.06.2022.


Pages: 21-38


BLOCKCHAIN TECHNOLOGY
AND MONEY LAUNDERING


ABSTRACT: In this paper, we want to break down certain prejudices
against new blockchain technologies and cryptocurrencies, especially
the Bitcoin, as instruments having mostly negative connotations and
representing an opportunity for various criminal activities, including the
cases of money laundering where money has been acquired in unethical
and illegal ways. According to that aim, there were applied the methods
of genetic, structural and functional analysis, the method of correlative
variations, as well as the analogous and normative method. A significant
part of the paper is dedicated to an introduction to DLT — (Distributed
Ledger Technologies), i.e. a distributed book of records technologies, on
which the blockchain and its most important exponent — the Bitcoin —
rests. Also, we had to touch upon the second most important contribution
to this technology, namely the Ethereum blockchain, which expands the
perspectives opened by the Bitcoin, and thus the possibilities for misuse of
this technology, primarily due to its constitutive principle of anonymity.
In the paper, we have shown the fact that despite inadequate legislation,
both nationally and globally, the blockchain and cryptocurrencies have not
significantly supported the paths of illegal money laundering, especially not
related to serious crimes, in particular drug trafficking and terrorism. We
mostly see the contribution of this paper in the typologization of possible


* LLD, Full Professor, The University of Business Academy in Novi Sad, The Faculty of Law for
Commerce and Judiciary in Novi Sad, Serbia, e-mail: zdjbjelajac@gmail.com
“ PhD, Associate Professor, UNION Nikola Tesla University in Belgrade, The Faculty of
Management, Sremski Karlovci, Serbia, e-mail: momcilo.bajac@famns.edu.rs
OE © 2022 by the authors. This article is an open access article distributed under the
terms and conditions of the Creative Commons Attribution (CC BY) license (https://
creativecommons.org/licenses/by/4.0/).


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money laundering procedures, especially by using the NFT (Non-Fungible
Tokens), non-exchangeable tokens whose hype, in last two years, might be
the result of a perceived opportunity for a new way of money laundering.
We conclude that we should not be afraid of the Bitcoin, but it should be
accepted as an integral part of a peaceful and prosperous futurity for it
opens new perspectives for humanity burdened with bigger problems than
money laundering, which had existed to the same degree even before the
appearance of the Bitcoin.


Keywords: The Bitcoin, money laundering, Distributed Ledger
Technologies, algorithm, the Ethereum


1. Introduction


Our old institutions, like the law, havent evolved to keep pace with the
rate of change (brought about by technology).
Google CEO Larry Page


The dynamic growth of the technology industry, which is becoming
decentralized and global, is increasingly at odds with current national
legislations aimed at providing people with legal certainty, as one of the
primary principles of law.

The emergence of new technology called Blockchain can radically
modify the way we think about legal norms and redesign basic concepts of law.
Especially those concerning the issue of jurisdiction of courts “to guarantee
the defence of the rights and interests of citizens, protected by law”, and the
issue of territoriality “in which the State exercises its power by attributing
internal jurisdiction to facts that happen under its territory” (Ferreira, 2021,
pp. 2-3), so legal certainty could be achieved when using this new technology.
Blockchain’s feature, as a supranational decentralized concept of algorithmic
validation of information (financial and other transactions without built-in
regulatory principles), to come into conflict with national civil law systems,
in which the Law refers to clear and coherent norms, makes it difficult to
understand this phenomenon.

In recent years, cryptocurrencies have emerged as a new phenomenon
in the global financial system. Since the first decentralized cryptocurrency,
Bitcoin, was released into the hacking community by a mysterious person
or an entity under the pseudonym Satoshi Nakamoto in 2009, the total
value of cryptocurrency in circulation and the variety of different types of


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cryptocurrencies have increased dramatically. At the time of writing this
paper, the global market capitalization of cryptocurrencies has exceeded two
trillion dollars, half of which goes to Bitcoin and Ethereum.

Cryptocurrencies are becoming a very important source of wealth
through mining or skilful trading on virtual stock exchanges, as well as
starting businesses on platforms that gather start-up capital through the Initial
Coin Offer (ICO). There is also a wide range of companies that are directly
or indirectly involved in the development of cryptocurrency markets, such
as cryptocurrency stock exchanges and exchange offices (VCE — Virtual
Currency Exchange) and companies in retail, banking, video games and
computing sectors. The growth of such markets has increased the interest
of investors so many include cryptocurrencies in their investment portfolios
(Tesla, Microsoft, Facebook).

“For regulated financial institutions (“FIs”), the opportunities presented
by cryptocurrencies and distributed ledger technology (‘DLT’) are tied to
significant operational and regulatory challenges” (Holman & Stettner,
2018, p. 26), the most significant being the fight against money laundering
and terrorist financing. Key aspects of the cryptocurrency ecosystem differ
from previous Internet-based platforms, primarily in terms of the degree of
centralization. The decentralized Peer-to-Peer network allows owners of
Bitcoin and other cryptocurrencies to avoid key control factors in the global
Anti-Money Laundering (AML) regime. “The potential for mutual anonymity
among counterparties can frustrate the Know-Your-Customer (‘KYC’) and
customer identification procedures (‘CIP’) on which existing AML regimes
depend” (Holman & Stettner, 2018, p. 26).

Most technological ecosystems, such as DLT, do not have special liability
regimes. Who will be responsible for the damage caused by a situation in
which users are damaged for hundreds of millions of dollars, as in the case
of hacking of VCE Live Coin in December 2020? Given that DLT is just a
technology that does not have coded principles of law in it, this question is not
easy to answer. A classic example, in this case, are smart contracts that the law
treats like any classic contract or signature, and are created on a decentralized
platform, with an anonymous administrator, run by a self-executing algorithm
without the possibility of revocation.

To understand the real place of cryptocurrencies in the processes that
enable the laundering of illegally acquired money, it is necessary to get
acquainted with the DLT on which they are created and maintained. In this
paper, we want to break down prejudices against new blockchain technologies
and cryptocurrencies, especially Bitcoin, as instruments that have mostly


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negative connotations and represent an opportunity for various criminal
activities, including laundering of money acquired in unethical and illegal
ways. To that aim, the methods of genetic, structural and functional analysis,
the method of correlative variations, as well as the analogous and normative
method were applied.


2. The term blockchain


Blockchain technology is based on the ability of the algorithm to reach
consensus in a decentralized network without resorting to external authority
to testify and conduct the transaction. As such, blockchain technology not
only solves some technical aspects of the system but also touches on very
important societal issues of “trust”, “authority” and “consensus”. If the
mathematical algorithm allows no one to have special control over the
network and the transactions that take place in it, then it acquires the status
of a neutral (trustless) mechanism for any potential application, facilitating
connections between people. More precisely, a “blockchain” is an immutable
irreversible linear chain of cryptographically hashed “blocks” on which
transactions are recorded. This linear history of time-stamped events is
verified and stored in a decentralized DLT-based manner, and network
nodes “witness” transactions and reach consent on which transactions are
considered regular through a consensus “Proof of Work” algorithm. The
ability to reach consensus on transactions algorithmically, and not through
the external mediation of an authority or a third party, gives blockchain the
name “trust machine” (Vigna & Casei, 2018). In this case, the code replaces
the law, intermediary person, institution or authority, and cryptographic
evidence! ensures the authenticity of the record and organizes consensus. In
such a way, transactions take place directly between participants, bypassing
the control of financial institutions, and most importantly, the very creation
of money is determined and executed through an immutable protocol, and
not through government or state intervention. In fact, Bitcoin was the first
to break the basic deception of Modernity, based on Keynesian and Marxist
ideas “that government needs to manage the money supply” (Ammous, 2018,


' Cryptographic proof is the ability to prove something with mathematical certainty. This is what, in
his Bitcoin White Paper, Satoshi Nakamoto means by an electronic system based on cryptographic
evidence instead of trust. Data integrity is checked by mathematical probability, not by trusting an
authority or someone’s word. Add a timestamp and it can be proven when a given record was made.
Hash them together into a “chain” or a “tree” referring to the hash output of the previous record, and
you have a linear history of proven secure records, “a new block in the chain” (Nakamoto, 2008).


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p. 136), which proves its continued success and disruptive power that caused
a turmoil in the world of finance. The creation of Bitcoin by mining is built
into the code which, by determining the weight of mining, dictates the pace
of currency emission. “Bitcoin can thus be understood as a technology that
converts electricity to truthful records through the expenditure of processing
power’ (Ammous, 2018, p. 219), whereby it generates cryptocurrency as a
reward to miners for the money invested in processing power (hardware) and
electricity consumed. By monetizing the processing power, Bitcoin has in
fact become the largest single-purpose computer network in the world. This
way, a part of the internet community creates a currency that is liquid and
parries traditional fiat currencies issued and controlled by states. Hundreds of
respectable cryptocurrencies and thousands of tokens have been created in the
wake of Bitcoin over the last decade, with very creative ideas and successful
business ventures behind them.

Mining is one of the most important activities in creating cryptocurrencies.
It is in fact a transaction verification competition in which incentives aim to
deter potential attackers from the system, through a consensus-based process
of the Proof of Work.’ This implies the introduction of economic dynamics, i.e.
cryptocurrency in network security engineering, an area of crypto-economy
that relies on incentives for decentralized or distributed protocol designs. The
difficulty of the computer problem that miners solve is set so that it is solved
on average every ten minutes, and for their “work” miners are rewarded with
cryptocurrency. At the same time, this determines the rate of Bitcoin creation
in the network, until a total of 21 million Bitcoins are in circulation, which
will happen in the middle of the 22nd century. The “consensus” reached by
the consensus algorithm should not be misunderstood as a kind of agreement
on the truth of the event, but rather as an incentive-driven settlement, the
truth of which is decided by random attempts to consume CPU power. The
“fairness” of the consensus algorithm, or rather its legitimacy, does not lie in
negotiations, the consensus of opinion or some notion of justice or objective
truth, but in coincidence and large numbers that create an operational
consensus of computers online (Brekke, 2019).


> Proof of Work is one of the lesser-known aspects of bitcoin architecture. It is a form of
cryptographic evidence, which uses hashing. Nodes in the Bitcoin network must do some “work”
which allows them to verify the transactions being tracked and then group them into blocks and
let them pass through the SHA-256 hashing algorithm to produce a valid output. This computer
“work” of hashing transaction data to find a valid way out is called mining, which is associated
with gold mining.


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Public key cryptography ensures that the message cannot be intercepted
and can only be read by its authorized recipient. Cryptographic hashing is
used to create a set of keys: one that can encrypt (the public key) and the other
that can decrypt (the private key that is kept a secret). The public key encrypts
messages sent to the owner; the owner then uses the private key to decrypt
the messages (Brekke, 2019). The main goal of Bitcoin is to build a network
without the need to trust any authority, third party or intermediary, which it
perceives as a security weakness, unnecessary cost and potential uncertainty.


3. Basic characteristics of blockchain sensibility


The Internet has enabled Google, Facebook, Amazon, and Apple to
connect the world under their guardianship. Blockchain will enable the
connection of the world under the guardianship of the participants.

Jon Choi, Ethereum, 2017.


Decentralization. Decentralization is part of the network culture and
involves distributed systems resistant to any form of control, censorship
or extinguishing by any authority. We can also call it disintermediation.
Technically, peer-to-peer systems such as Bitcoin are made up of network
participants who communicate directly with each other. Unlike server-to-
client models, where servers hold and deliver content to different clients,
they do not exist in peer-to-peer networks. There is an important difference
between decentralization conceived in blockchain network protocols and
decentralization as an ethical, political, social or economic goal or principle
that such a protocol may or may not support.

Openness. In a decentralized system, no entity can prevent individuals
from joining the network as it is possible with traditional institutions, thus
specially constituting the idea of neutrality.

Trust. Decentralized and open systems imply a certain level of mistrust. It
is ideal to reduce the amount of needed trust as much as possible, approaching
complete distrust and security. Relationships based on trust never have an
absolute degree of certainty of outcome. Bitcoin is 100% based on verification
and 0% on trust (Ammous, 2018, p. 174).

Immutability. The Bitcoin chain of blocks must be immutable, to
function autonomously outside the control of any external authority. It is
based on the idea of immutable code that is performed exactly as it is written.
Immutability ensures that the consensus on the state of the network, reached
by the consensus protocol on Proof of Work, cannot be changed arbitrarily.


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Privacy. Computer technology provides the opportunity for individuals
and groups to communicate with each other in a completely anonymous way.
Privacy is the power to selectively reveal yourself to the world online with
the help of cryptography, which is especially important at a time when the
Internet is being used as an infrastructure for mass surveillance and narrowing
the field of freedom. In case of Bitcoin, which operates on a peer-to-peer
payment system, instead of a third party keeping records of transactions, the
entire network does so, making all transactions completely public. To preserve
privacy in such a radically transparent system, the computers themselves
remain anonymous.

Anonymity. Anonymity is closely related Bitcoin was initially considered
anonymous and infamously became a means of payment for “Darknet” and
Internet black markets. However, the transaction can be tracked today until
the moment of exchange and be deanonymized at this time. To avoid that and
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