Coin Mixer

Introduction

Cryptocurrencies and money laundering are often discussed together. Bitcoin and most cryptocurrencies do not allow anonymous transactions, but rather pseudonymous ones.

In addition, transactions that take place on the blockchain, balances, and addresses are generally public, facilitating further analysis. This limits money laundering operations that can be carried out using the Bitcoin, Ethereum or other blockchains.

The term pseudonymous refers to the fact that addresses on the blockchain do not explicitly communicate the user’s identity, but it is still possible and not too difficult to link this data to sensitive information that allows the user to be identified.

To identify a user, one must think outside the blockchain box.

Let’s take a look at some of the methodologies used to do this.

• When purchasing cryptocurrencies using an exchange, the platform retains data that allows the user’s identity, passport, credit card, and many other pieces of information that the exchange requires to register and enable them to make purchases, to be recognized. This information can be used by authorities for investigations.
• By analyzing transactions that occur within a blockchain, it is possible to link pseudonymous data to real-world data referring to actual people.
• Associate a particular address with information present on social media, for example when requesting donations in cryptocurrencies using one’s identity in clear text.
• The I.R.S can avail itself of start-ups’ services such as Elliptic and Chainalysis (https://fortune.com/2017/08/22/irs-tax-cheats-bitcoin-chainalysis/).
• Since September 2020, the United States government has been experimenting with using artificial intelligence to identify users behind transactions (https://www.vice.com/en/article/wxq9xx/the-irs-wants-to-buy-tools-to-trace-privacy-focused-cryptocurrency-monero).

Let’s focus on the Bitcoin blockchain, what weaknesses can favor money laundering?

In summary (someone will rightly turn up their nose at the simplistic explanation), the Bitcoin blockchain has implemented a transaction model by design that does not allow input to be directly linked to new output. This makes it possible, for example, for an address to receive a multitude of transactions and return just as many without showing any connection between what has been received and what has been sent (https://arxiv.org/pdf/2010.15082.pdf).

Coin Mixers and their different types of strategies

The mechanism described above is the basis for how Coin Mixers work.

There are different Coin Mixer strategies that can range from centralized to fully decentralized and distributed solutions.

The most common are centralized solutions: these services happily accept payments in Bitcoin and send coins in response; the more people use a similar service, the more difficult it will be for an outsider to link the input coins with the output coins.

However, a similar centralized solution still presents problems because it is not a completely trustless system. The Coin Mixer and whoever manages it could retrace the traces of the operations, so an authority could force a company that offers this type of service to show the data that allows the recognition and traceability of the users who have used it.

Another issue arises when a centralized Coin Mixer simply does not return payment, effectively stealing cryptocurrencies from users.

Some solutions have tried to solve these problems by allowing groups of users to cooperate in a large direct payment to themselves using a decentralized system in fact.

As an example, we could imagine a thousand users all sending the same amount to a new address, merging into a large transaction where everyone receives the same amount sent back: a literal exchange of cryptocurrencies to lose traces, exploiting the weakness described above in the design of Bitcoin blockchain transactions.

Why use a mixer

The most stereotypical and superficial answer would be to launder money, but the reality is always more complex. Let’s see some of the reasons:

• The simple right not to want to let others know how much money you are spending, especially if the user lives in places where it is easy to be persecuted by governments that are little or not at all democratic.
• Journalists and/or activists whose bank accounts have been blocked but not wallets where they can receive cryptocurrency payments can use coin mixers to be paid and/or pay without suffering retaliation.
• Another case is that of restrictive tax regimes. One of the most common is that relating to “sex workers”: there is the common problem of how to pay taxes in a state that may not have legislated in that sector; in this case, cryptocurrencies and coin mixers allow these professionals to be correctly paid for their service without fearing fines due to cultural stagnation.
• Finally, the simplest and most predictable motivation for “why use a coin mixer” is to launder dirty money from activities recognized as universally illicit.

Therefore, let us remember that the term illicit does not always correspond to something that can be morally and totally condemned, sometimes an illegality is judged as such by a judicial system that systematically violates people’s rights. This is easy to see in countries where there is strong repression, perhaps on issues widely accepted in the rest of the world such as the freedom to have an abortion or to love a person of the same sex. In these cases, Coin Mixers can finance activism operations considered illicit by a fundamentalist government.

Measures against Coin Mixers

In 2019, there were numerous initiatives to combat Coin Mixing services, especially in Europe by Europol and FIOD (https://cointelegraph.com/news/europol-shuts-down-200-million-crypto-mixing-service-bestmixer).

In February 2020, Larry Harmon was arrested for facilitating millions of dollars in money laundering on his platform Helix (https://www.justice.gov/opa/pr/ohio-resident-charged-operating-darknet-based-bitcoin-mixer-which-laundered-over-300-million).

In the summer of 2019, we witnessed the announcement of the closure of Bitcoin Blender after years of activity.

It should be noted that decentralized solutions are much more difficult to combat than centralized ones because in the case of a centralized service, it is possible to target the individuals and infrastructure that provide this service with precision. In the case of decentralized solutions, however, this becomes more complicated.

Possible future developments in combating money laundering using Bitcoin:

Coin Mixers are not perfect tools, but they can ensure a high level of privacy, although not total.

An effective tool to explore will certainly be the use of artificial intelligence. We will see the emergence of models that can quickly and accurately counter known patterns used in evasion and obfuscation strategies.

More effective international regulations, not only for the problem of money laundering on blockchains but for a broad spectrum of global tax harmonization, putting an end to tax havens that contribute to money laundering within and outside of blockchains.