Virtually Invisible? Crypto-Assets and Open Government

Regulators can limit the contribution of virtual assets to corruption and other crimes if they want to. It will work better if they take a collaborative approach.

Credit: Kanchanara via Unsplash

By Joseph Foti

Virtual assets (VAs) — including cryptocurrencies — may make corruption even easier. People may use virtual assets to hide bribes and VAs help move dirty money back into the regular economy (money laundering). Dirty money often includes bribery, kickbacks, or embezzled money. Non-Fungible Tokens can be appraised at any value (like art) or tokens, which represent real world assets, allowing easy cross-border movement of money when they are over-appraised.

Governments are learning, however, that anonymity may be greatly exaggerated. Those of us that are working against corruption and money laundering can fool ourselves into thinking that these issues are overly difficult, technical, or require a radical overhaul of our financial intelligence and law enforcement systems. However, this is not the case.

Just reach out and grab it

Virtual assets have an Achilles heel. Major elements of the virtual asset market still need to interact with the formal economy — for example, in exchanges with fiat currency or to access capital. In addition, the market has quickly become concentrated at certain points (such as wallets, exchanges, and mixers) and this means that these points of concentration are subject to regulation as well as sanctions. Consequently, there are certain points or nodes that allow for regulation. (Farell and Newman outline where these points exist in detail in their 2019 book, Underground Empire.)

Existing financial laws can do much of the work — with updated regulation. It is still illegal to launder money. As long as the companies promoting virtual assets need to interact with the main part of the economy, they will need to operate in a world where warrants still exist, banking and finance regulations still apply, and predicate crimes are still crimes.

Even where an individual country may not have an updated set of laws, money still crosses borders, especially if it is virtual. Transboundary exchanges are particularly important, as they represent the significant point of major transactions — money leaving a country or money coming into a country. This means that, should OECD and FATF member countries want to tackle this problem, they will often have a claim to jurisdiction.

This is evident in recent cases:

• EU and TrustCom Financial (2024): The European Union, led by authorities in Italy, Latvia, and Lithuania, froze more than €11 million in assets and arrested 18 people suspected of helping launder €2 billion. EuroJust, which coordinates enforcement actions across national borders, stated that the exchange was established by an Italian crime syndicate that helped launder money into real estate and cars.
• Bitzlato vs US FinCEN and French Department of Treasury (2022): The Russian founder of Bitzlato (registered in Hong Kong) was charged with facilitating hundreds of millions of transactions for known criminals through Hydra, a market operating in the dark web.
• PayPal (2015–2022): PayPal reached a US $7.7 million settlement for sanctions violations with the Office of Foreign Assets Control on Iran Sanctions. This settlement led to a shift in PayPal’s actions — in 2022, when Russia invaded Ukraine, PayPal did not wait to cut off Russian PayPal accounts.

The fact that things are not overly technical does not mean that they are easy, however. Detection will continue to be an issue, as will information exchanges between governments and between governments and non-governmental parties. This will be doubly difficult in countries where financial intelligence units, law enforcement, and watchdog groups have less capacity or may face significant interference.

Establishing a precedent is important. The longer we wait, the more difficult regulation may become. As the market concentrates at certain points, powerful players in the industry who sell financial secrecy may increasingly try to bend policy to ensure that these protections are not put in place or that law enforcement is underpaid and overstretched.

Safeguards for civil liberties

There is a darker scenario of regulation, as well. Just as with counter-terrorism, anti-corruption, and concerns with public safety, there is the risk that a public value — in this case, limiting money laundering and bribe paying — is turned into a cudgel to bludgeon dissidents, opposition parties, and watchdog groups.

In these cases, it will benefit society to build these systems with an eye toward a cross-sectoral approach — not just financial service providers and industry regulators, but also those watchdog groups, investigative reporters, and policy experts who can help buttress the efforts of their government and curb its excesses.

This means having an open government approach at all levels — building transparency and public oversight into the regulatory process from the start.

A first attempt at guidance

To meet this challenge, we have put together this basic explainer for the Open Government Partnership community and beyond on where, when, and how open government can help to ensure that we apply the rule of law to these new technologies.

Crypto-markets need to be regulated. But it matters how those markets are regulated. It can be done in an arbitrary, ad hoc manner, or it can be done in a way that balances competing rights and favors democracy and fairness. The explainer above offers cases of enforcement and guidance on how civil society, journalists, and other watchdog groups can ensure that innovation does not reward unlawful behavior.

The explainer’s recommendations on open government include the following.

Transparency

• No secret laws: Create clear and public rules, laws, and case law (where applicable) on when and where controls on virtual assets can be put in place. FATF Recommendation 15 provides guidance for OGP members on putting in place a legal and administrative framework. (For more guidance, see the FATF interpretative note, which develops the application of Recommendations 1 (Mitigating AML/CTF Risks), 10 (Customer Due Diligence), 16 (Travel Rule), 35 (Sanctions) and 36–40 (International Cooperation) for virtual assets.)
• Corporate reporting standards: Transparency reports from major companies (similar to social media platforms and other big tech) can help the public understand where enforcement and information requests come from, as well as what compliance actions companies are taking to prevent illegal activity. Governments can facilitate the development of these standards according to FATF Recommendation 20 (Suspicious Transactions Reports (STRs).
• Agency transparency: Publish transparency and performance reports from prosecutorial bodies.
• Impact analysis: Publish safeguards to ensure that rules are applied in a non-discriminatory, legal, proportional, and risk-based manner, where such rules might disproportionately affect particular groups (for example, religious organizations or credal groups).

Participation

• Consultative bodies: Where possible, develop multi-stakeholder processes, including with civil society, to prioritize threats, responses, and safeguards.
• Notice and comment: Maintain or enhance regular administrative law in the development of regulations or crypto-market regulation.
• Oversight: Public oversight committees can ensure that agencies and courts continue to follow established and legal due process in carrying out crypto-market regulation.

Public Accountability

• Judicial forums: Establish clear lines of judicial oversight through regular processes to ensure that agencies follow the due process of law in instituting sanctions and asset freezes, among other actions.
• Public parliamentary oversight: Establish standing mandates to compel testimony, carry out oversight of the executive, and prepare legislation to ensure that laws are being enforced in a legal, proportionate, and non-discriminatory fashion.
• Remedies for rights violations: Ensure that there is clear guidance for agencies to redress and remedy violations of rights to speech, assembly, and association. The public should also have access to channels to report violations and request redress from agencies.
• Public interest standing and citizen suits: In cases where there may be illegality (or extra-legality) on the part of government action, parliaments may establish a public right of action. In cases where the law enforcement fails to take action against egregious illegal activities, parliaments may choose to support a public right of enforcement.

We here at the OGP Support Unit know that this is a fast-evolving field and welcome your inputs and insights. Did we miss any threats? Open government approaches? Success stories? We want to hear from you. Leave your thoughts in the comments or reach out to me directly at joseph.foti@opengovpartnership.org.