The seizure of more than $3.6 billion in bitcoin allegedly stolen from Hong Kong-based Bitfinex has led to the arrest of a New York couple charged with conspiracy to launder the cryptocurrency fortune. The Bitfinex breach in 2016 was among a flood of hacks into currency exchanges that resulted in the theft of large amounts of digital currency highlighting the security vulnerabilities in the fledgling world of cryptocurrency. Bitcoin is an open source code that runs on a global network of private computers and the cryptocurrency of choice among ransomware hackers.

1. Introduction

On February 8, 2022, Ilya “Dutch” Lichtenstein and his wife, Heather Morgan, were arrested in New York on money laundering conspiracy charges in what the United States Department of Justice described as its largest financial seizure in history. They were instantly dubbed the “crypto couple”. He is a dual U.S.-Russian citizen and a self-described technology entrepreneur, coder and investor. She, more flamboyant with a penchant for cringe, is known as a self-styled “raunchy rapper” called Razzlekhan. (here) They have both been reported as “deeply involved” in the tech startup ecosystem. He founded a Y Combinator-backed sales software company called MixRank. She founded startup SalesFolk where Mr. Lichtenstein has served as an advisor. (here) The scope of the alleged fraud, and Ms. Morgan’s lurid online presence, has “positioned their story as a perfect synecdoche for everything anyone doesn’t like about an attention economy in which anything can be – and is – financialized.” (here)

2. The Bitcoin Controversy

Bitcoin is a form of digital currency. It enables peer-to-peer exchange of value through the use of a decentralized protocol. Transactions are verified by network nodes through cryptography and recorded in a public transaction ledger called a blockchain. According to Bitcoin.com, bitcoin is a form of digital money that: (1) exists independently of any government, state or financial institution; (2) can be transferred globally without the need for a centralized intermediary; and, (3) has a known monetary policy that arguably cannot be altered. (here) Bitcoin is based on the ideas developed in a whitepaper titled Bitcoin: A Peer-to-Peer Electronic Cash System (2008) published under the presumed pseudonym, Satoshi Nakamoto. The technologies deployed solved the double-spend problem enabling scarcity in the digital environment for the first time. (here) The term bitcoin can be used to refer to the Bitcoin software protocol and to the monetary unit that goes by the ticker symbol “BTC”.

(a) Bitcoin as Legal Tender

On September 7, 2021, El Salvador became the first country to mandate Bitcoin as legal tender. (here) The controversial move also involved the launch of a national virtual wallet called Chivo that offers no-fee transactions and allows cross-border payments. On January 25, 2022, the International Monetary Fund urged El Salvador to abandon the project stressing bitcoin’s significant risk to “financial stability, financial integrity, and consumer protection”. (here) Earlier today, U.S. Senators Jim Risch (R-Idaho), Bob Menendez (D-N.J.) and Bill Cassidy (R-La) introduced the Accountability for Cryptocurrency in El Salvador Act that would mandate a report to Congress on El Salvador’s adoption of bitcoin including an assessment of the country’s capacity to “effectively mitigate the financial integrity and cyber security risks associated with virtual-asset transactions”. (here) In a concurrent press release, Senators Cassidy and Risch said the recognition of bitcoin as official currency “opens the door for money laundering cartels” and has the potential to weaken U.S. sanctions policy. (here)

(b) Bitcoin Mining and Climate Change

Bitcoin mining is the process of creating new bitcoin by solving complex mathematical puzzles. It consists of computing systems equipped with specialized chips competing to solve the puzzles. The first “bitcoin miner” to solve the puzzle is rewarded with bitcoin. The mining process confirms transactions on the cryptocurrency’s network. (here) Bitcoin mining is notoriously energy intensive. In a recent article for The Guardian, Brussels bureau chief Dan Boffey reported that the bitcoin electricity consumption index maintained by the University of Cambridge suggests that “the sector consumes more energy in a year than many countries, including Argentina, Pakistan and Poland.” (here) The electricity consumption required to sustain bitcoin mining has heightened criticism about the use of fossil fuels, particularly coal, for both bitcoin mining and transactions. Tesla and Uber have suspended the use of cryptocurrency as a result of concerns about its impact on climate change.

(c) The Ransomware Problem

Ransomware is a type of malware that prevents a victim from accessing computer files, systems or networks. When it is loaded on a computer, it will lock access to the computer itself or the data stored on it. Ransomware is often downloaded by opening an infected email attachment, clicking an advertisement or following a link. The hacker who deployed the malware will typically demand that a ransom be paid in cryptocurrency for a decryption tool. Bitcoin figures prominently in these cases as the digital currency of choice. The combination of widely availability online information, anonymous communications and cryptocurrency provide a high level of impunity for ransomware hackers according to Peter Van Valkenburgh, the director of research at Coin Center. “Ransomware hackers are rather like the proverbial rumrunners of prohibition,” he said. “[T]hey like fast custom cars because almost everyone else is still driving a Model T.” (here) The U.S. Justice Department has emphasized that although cryptocurrency and virtual currency exchanges represent advancements in innovation, the trend has been accompanied by money laundering and ransomware heists. The Justice Department therefore announced the formation of the National Cryptocurrency Enforcement Team last year. (here)

4. The Crypto Couple Indictment

On February 7, 2022, the criminal complaint was filed in the United States District Court for the District of Columbia, the day before Mr. Lichtenstein and Ms. Morgan were arrested in New York. (here) The complaint alleges in the Statement of Facts that the defendants employed laundering techniques including fictitious identities to set up online accounts and then used computer programs to automate transactions allowing for multiple transactions to take place in a short period of time. Stolen funds were deposited into accounts at a variety of virtual currency exchanges and darknet markets and then withdrawn. The transaction history was obfuscated by breaking up the fund flow. Bitcoin was converted to other forms of virtual currency, including anonymity-enchanced virtual currency (AEC), in a practice known as “chain hopping”. The complaint asserts that the defendants used business accounts based in the U.S. to legitimize the banking activity. (here and here) I will give you three extracts from the complaint that summarize the key allegations.

• In or around August 2016, a hacker breached Victim VCE’s security systems and infiltrated its infrastructure. While inside Victim VCE’s network, the hacker was able to initiate over 2,000 unauthorized BTC transactions, in which approximately 119,754 BTC was transferred from Victim VCE’s wallets to an outside wallet (Wallet 1CGA4s). At the time of the breach, 119,754 BTC was valued at approximately $71 million. Due to the increase in the value of BTC since the breach, the stolen funds are valued at over $4.5 billion as of February 2022.
• U.S. authorities traced the stolen funds on the BTC blockchain. As detailed below, beginning in or around January 2017, a portion of the stolen BTC moved out of wallet 1CGA4s in a series of small, complex transactions across multiple accounts and platforms. This shuffling, which created a voluminous number of transactions, appeared to be designed to conceal the path of the stolen BTC, making it difficult for law enforcement to trace the funds. Despite these efforts, as explained further below, U.S. authorities traced the stolen BTC to multiple accounts controlled by ILYA “DUTCH” LICHTENSTEIN, a Russian-U.S. national residing in New York, and his wife HEATHER MORGAN.
• The 2017 transfers notwithstanding, the majority of the stolen funds remained in Wallet 1CGA4s from August 2016 until January 31, 2022. On January 31, 2022, law enforcement gained access to Wallet 1CGA4s by decrypting a file saved to LICHTENSTEIN’s cloud storage account, which had been obtained pursuant to a search warrant. The file contained a list of 2,000 virtual currency addresses, along with corresponding private keys. Blockchain analysis confirmed that almost all of those addresses were directly linked to the hack. Between January 31, 2022, and February 1, 2022, law enforcement obtained approval to execute a lawful seizure supported by probable cause under exigent circumstances and used the private keys from LICHTENSTEIN’s file to seize Wallet 1CGA4’s remaining balance of approximately 94,636 BTC, worth $3.629 billion. On February 2, 2022, the government requested, and on February 4, 2022, a court issued a seizure warrant authorizing the seizure of those funds. (paras. 4-6)

The complaint alleges the defendants provided false information to the VCEs and other financial institutions regarding the source of their funds and the nature of their transactions. One purpose of the deceptions was to frustrate the VCE’s due diligence efforts and prevent the transmission of SARs mandated under the Bank Secrecy Act to FinCEN and the U.S. Treasury Department. (para. 59)

5. Conclusion

Bitcoin is often described as anonymous because transactions can be made without disclosing personally identifiable information. However, complete anonymity is not possible. Although bitcoin users can send and receive payments with a certain level of privacy, bitcoin is not anonymous and does not purport to offer the same degree of privacy as cash. Bitcoin is traceable and every transaction is publicly viewable in real time. As Deputy Attorney General Lisa O. Monaco said in the press release announcing the indictment last week, the Department of Justice “can and will follow the money, no matter what form it takes.” Mr. Lichtenstein and Ms. Morgan appeared in federal court in Manhattan on February 8, 2022, and were released on bond: $5 million in Mr. Lichtensteiin’s case and $3 million in Ms. Morgan’s. They are not charged with carrying out the Bitfinex hack itself.