If you follow financial news you’ve probably at least heard of Bitcoin. If you don’t or haven’t, Bitcoin is a digital currency, or cryptocurrency, that allows users to conduct electronic transactions anonymously and efficiently, without any involvement by banks or other financial institutions, and without any hard currency changing hands. Bitcoin began in 2009 and today has a capitalization of about $15 billion.
The Downside of Bitcoin
The fact that Bitcoin lets users bypass traditional financial institutions has made it an attractive option for those participating in the illegal drug trade, child exploitation and other nefarious activities in which the ability to conduct financial transactions anonymously is highly desired. You can read more about The Risks and Threats of Cryptocurrencies, a report co-authored by the Homeland Security Studies and Analysis Institute and Hillard Heintze.
While Bitcoin has garnered plenty of attention for its potential to disrupt the traditional banking industry and cause headaches for law enforcement, the technological infrastructure undergirding it may have implications that are even more profound. So says Peter Kofod, founder and CEO of The Sixth Flag, Inc., a data and desktop security firm based in Raleigh, North Carolina.
Kofod was a featured speaker last week at a meeting in Chicago of InfraGard, a partnership between the FBI and the private sector. Kofod explained how the underlying structure of Bitcoin, called a blockchain, could potentially revolutionize other types of transactions beyond just currency. Briefly, a blockchain is essentially a master ledger that records all the transactions made between parties using Bitcoin. Each block in the chain represents a collection of digital transactions that has been audited and is therefore considered to be sound. A new block is added to the chain each time an auditor (also known as a miner) completes an electronic review of not only the most recent set of transactions but also all those that came before it. The term “blockchain” refers to the fact that all these blocks of transactions are linked to earlier blocks, in effect creating a chain.
Making Deals without Financial Institutions
Kofod explained that the blockchain structure could be applied to other types of so-called smart transactions through a platform called Ethereum, which uses a generic, customizable currency called ether. As an example of how this might work, he described the following scenario: Let’s say a business executive on his way to make an important deal wanted to buy insurance in case he missed his flight, causing the deal to fall through. The executive could take the cost of the deal, add in the cost of the airplane ticket, and put it up for bid on a blockchain dedicated to such insurance transactions. Bidders could then offer to insure the deal and airplane ticket for a given price. The business executive would presumably choose the lowest bidder and the transaction would take place electronically on the blockchain. No financial institution would need to get involved and there would be no need for the usual underwriting process and paperwork associated with traditional insurance policies, making for a much quicker, and quite possibly cheaper, transaction.
This is just one way the blockchain structure could allow for all sorts of financial transactions that are currently possible only through financial institutions to happen on a direct, peer-to-peer basis. (As a matter of fact, says Kofod, some financial institutions are patenting their own block chains). As Kofod puts it, “The blockchain is much, much bigger than Bitcoin. It’s the first real internet-native technology that you can build smart rules into.”
Of course, such a system poses a challenge to law enforcement and investigators as participation in the blockchain is anonymous, or more precisely, pseudo-anonymous. In essence it represents addresses interacting with other addresses, with real, live, but unnamed humans controlling those addresses. At some point, however, each of those real, live humans will likely want to convert his or her cryptocurrency into real-world currency through an exchange, at which point that human’s identity becomes discoverable to law enforcement or anyone else with the legal authority to access such records.
This doesn’t mean real, live humans don’t or won’t still try to use bitcoin or the blockchain for criminal purposes. Whether in the real world or the virtual, law enforcement professionals and investigators will have to become educated on how systems like Bitcoin work to keep pace with those who are already one step ahead.