Crypto crimes are no excuse for taking away digital asset fungibility

The rise of crypto-related crimes and money laundering cases is the result of the increasing mass crypto adoption.

The modern world has become too small for comfort. The truth is that technological advancement is a double-edged sword, which has the potential to enhance human lives drastically at many levels and disrupt them in the blink of an eye, shaping things on a global level to an extent yet not seen. 

Even though we enjoy fast progress in crypto services and digital asset fields, constant security breaches and hacks pose a severe threat to market participants. The very essence of safety in the modern world is questioned. Therefore, it’s about time we clarify the complex topic of fungibility in the digital asset field.

How it all went downhill

Everything is online nowadays. We’ve been focusing on the future so hard that we’ve failed to recognize the point of no return. Back in the 90s, the internet was something of a miracle, an arcane original development. Today, in the mobile-driven social media age, we can hardly imagine our existence without the need to interact or communicate with somebody every two minutes.

Nowadays we see that Web 2.0. development is not only about benefits since many professionally organized criminal groups have generated an infamous wave of hacking attacks in the digital world. Mid-level companies are not the only ones faced with danger anymore — top brands are targeted by hackers to get millions in ransom, and even the most well-known crypto exchanges are affected. Media stars and politicians have also become victims of such unpleasant events, having experienced Twitter hacks earlier this summer, which proved to be a well-coordinated social-engineering attack.

Related: Crypto Twitter hack recap: A ‘wake up call’ for centralized platforms

Meanwhile, the emergence of cryptocurrencies and their slow but steady way to mainstream adoption has raised funds security questions. The advent of mobile internet resulted in the success of neo-banking among populations who previously weren’t able to get a checking account in euro or dollars — such as in emerging markets like Africa, India and South Asian countries. Cryptocurrency apps became of major significance as people trusted currencies that aren’t subject to harsh volatility. With the introduction of stablecoins, opening a checking account in euro, for example, became possible within a minute.

Still, security and decentralization are topics that had been discussed long before cryptocurrencies became popular. This goal was set as one of the crypto revolution’s primary targets, but it is often misunderstood in the modern world.

Understanding the fungibility layer

The technical process involved in crypto ecosystems’ functioning is tough to judge from the outside. But we can definitely be sure from a high-level perspective that when decentralized finance or permissionless finance faces an existing legal system, there is always room for some compromise. If legal authorities ask a particular platform to react, they either take some bureaucratic action or cease to exist because the court orders them to shut down their activities.

This questions the fundamental ability of digital assets to be fungible. When a specific manipulation or theft happens, some of these assets become nonfungible. Since a centralized platform that has facilitated such trades has been unknowingly involved in helping thieves, it’s required to take action requested by law enforcement. It must then provide evidence in court that the team did everything it could to stop fraud.

What happens next? A certain platform reaches out to another platform or centralized counterparty and blacklists the digital assets that were stolen. Other exchanges will start refusing to credit those digital assets to accounts, ultimately making them nonfungible. In the real world, money laundering is when the so-called “dirty money” is mixed with “clean money.” Everybody has touched bills that have been involved in some illicit trade at least once throughout their lives; since it’s effortless to mix cash, we can never reveal that it actually happened.

With digital assets in place, it’s much easier to trace everything. The biggest fundamental question arises: At what level should we break that fungibility for digital assets and at what point? It takes some time for the authorities to release some action items, and counterparties have to prepare or do something in advance to make sure they are justified in court.

The current state of money laundering in crypto

The new age, indeed, brings more opportunities than problems. But is the evolution of crypto responsible for the increase in money laundering more than the traditional finance industry? I don’t think so. It’s important to realize that U.S. banknotes are still the most difficult to counterfeit in the world. And the recently leaked documents from the U.S. Financial Crimes Enforcement Network indicated that many banks “enable” money laundering with fiat currencies.

Related: Comparing money laundering with cryptocurrencies and fiat

Speaking about crypto, it’s inevitable that at the intersection of traditional markets and emerging ones, illicit actors would use any arising opportunity and illegal funds stolen from the traditional financial world to launder them. So far, such activity is not big enough in terms of relativity to digital instruments. It will grow; the number of cases will rise; and the crypto community will have to choose an effective approach to dealing with crypto transactions originated by bad actors.

Still, money laundering schemes that fraudsters mostly use are related to good old classic fiat methods. Interestingly enough, the same goes for SWIFT fraud activities. Do we really have to worry about crypto money laundering when there are more unresolved problems in traditional financial channels?

Numerous researches conducted in this area over the last few years prove that despite many institutions still see cryptocurrencies as an unregulated Wild West territory and that traditional banking institutions pose a much greater risk for money laundering activities. Moreover, it’s too early to talk about the severe danger coming from such activities in crypto. While not denying it, it’s worthwhile to acknowledge the rotten underbelly and shadow activity of many financial institutions.

Laws or lawlessness?

What’s the possible way out of this situation? The emergence of self-regulation solutions might be a possible answer. For example, when exchanges receive information that a certain hack has occurred, they can secretly blacklist the addresses and later ask the client for the source of funds or force the transfer owner to reveal the identity. If the owner acquired the funds dishonestly, the exchange would get a chance to use that information for users’ protection.

The natural pace of progress will settle issues with illicit activities as self-regulation must sooner or later be developed, but it’s already necessary to put rigid barriers in place. The most straightforward approach will be government bodies that regulate the process of obtaining investors’ money to fulfill investment promises. This will significantly cut off the opportunities for further theft as it happened with initial coin offerings and Ponzi scheme projects that existed in a universe of their own.

Moreover, it is also necessary to clean up under-leveraged loans and to regulate any venture that people can pour money into and lose it — not by incompetence or financial illiteracy, but by fraud activities committed by third parties.

The state can really help by creating a comprehensive tool to analyze and prevent scam schemes and issue regulatory policies that complicate launching and operating such projects. Weapons trading policies are a great example; comprehensive and strict rules for purchasing and storing make access to such tools very complicated, but it works and helps to protect people’s lives.

Fungibility is violated in the modern world — a consequence of globalization trends, increased internet penetration, and the intersection of real money with the crypto world, where users’ funds are unprotected.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.