Abstract
The rise of cryptocurrencies, driven by blockchain technology, has transformed the financial landscape, offering decentralized peer-to-peer transactions. The significance of cryptocurrencies in the modern financial landscape lies in their potential to reshape the way we perceive and engage with money and transactions. Their innovative characteristics make them attractive alternatives to traditional forms of currency, offering the possibility of financial inclusion and reduced transaction fees, especially in underbanked regions. As a result, they have the potential to provide a more balanced understanding of emerging financial systems and to play a pivotal role in modern finance. While promising benefits such as financial inclusion, lower transaction costs, and access to credit, cryptocurrencies present challenges in cybersecurity and their association with illicit activities. This paper explores the cybersecurity threats associated with cryptocurrencies, emphasizing the risks of phishing, hacking, and fraud and how the European Union has responded with regulatory measures signaling a commitment to address these challenges. Globally, the need for a unified approach to crypto-asset regulation is emphasized by international organizations like the IMF and IOSCO, focusing on comprehensive definitions, regulatory consistency, and integration with existing legal frameworks. As the cryptocurrency landscape evolves, a proactive and collaborative approach is vital to balance innovation and regulation, ensuring responsible integration into the global financial ecosystem.
Chiara Bianco - Senior Researcher, Mondo Internazionale - G.E.O. Economics
Federico Scarpa - Junior Researcher, Mondo Internazionale - G.E.O. Economics
Introduction
Cryptocurrency is a digital currency based on a payment system that doesn’t rely on banks to verify transactions; it is a peer-to-peer payment system that allows anyone to send and receive money from anywhere. Cryptocurrencies are built on blockchain technology, a decentralized, distributed ledger that records transactions across a network of computers. This technology ensures the security and integrity of the data it stores. Each block in the blockchain contains a list of transactions, a timestamp, and a reference to the previous block, creating a chain of blocks. This structure makes the data resistant to modification, providing transparency in the transaction records, but still allows anonymity.
In 2009, Bitcoin was used to launch this peer-to-peer cash system for the first time. Its implementation was prompted by an ambitious aim to eliminate the inefficiencies of the intermediated banking system, which relied on commercial banks and central banks' abilities to mediate the relationship between money supply and demand. This desire arose in the aftermath of the 2008 financial crisis. Since then, the cryptocurrency market has experienced rapid evolution, with the introduction of numerous other cryptocurrencies and the development of blockchain technology. Not all sources agree on the exact number of active cryptocurrencies as of now, but it is generally estimated to be between 8,000 and 10,000. Furthermore, over 420 million cryptocurrency users worldwide, and roughly 18,000 companies already accept cryptocurrency as payment (Josh Howarth, 2023).
According to the literature, cryptocurrencies have the potential to promote financial inclusion by lowering entry barriers, being decentralized, facilitating cross-border transactions, providing access to credit, empowering the unbanked, and potentially serving as a store of value. They provide an option for people who do not have access to traditional banking services owing to financial or geographical constraints, and they can lower the cost of financial transactions, making them more accessible for low-income individuals and small enterprises (Edul Patel, 2023). However, challenges exist, including regulatory standards, criminal activity risks, high energy costs, and high volatility. Cryptocurrencies allow for complete anonymity in ownership and use, raising serious concerns about their possible use in illegal operations and commerce, nonetheless, not all existing cryptocurrencies provide complete anonymity. Bitcoin is an example of a ''pseudonymous'' currency, in which encrypted accounts can still be tracked back to their owners while being anonymous. Furthermore, the price of cryptocurrencies is determined by supply and demand laws, which may be advantageous in countries where the currency is heavily influenced by inflation. Still, it impacts the riskiness of the currency, which is vulnerable to considerable price changes.
Cryptocurrency and cybersecurity
The identities of the parties taking part in cryptocurrency transactions are represented by digital signatures. They are made up of two keys that are used to sign transactions: the public key and the secret key. The same person can take on multiple identities since these keys can be granted as often as necessary. Since these fictitious names are used to record transactions, it is believed that the transactions may not be connected to the real identities, thus ensuring anonymity.
The cybersecurity challenges associated with cryptocurrencies are significant and diverse. The main threats come from the risks of phishing attacks – individuals tricked into revealing their login credentials or private keys, which can lead to unauthorized access to their cryptocurrency accounts –, and illegitimate trading platforms – when using them, users may face financial losses or theft –, and hacking and theft – cryptocurrency exchanges and systems are frequent targets for cyberattacks, leading to the theft of large amounts of cryptocurrency. For example, in 2018 the hacking of Coincheck, a Japanese cryptocurrency exchange, resulted in around 530 million dollars being stolen and money laundered.
Since digital currency is decentralized, no governing organization or administration oversees its formation, movement, and management. Cryptocurrency exchanges are regulated inconsistently around the world, or even not regulated at all; they lack the same level of government regulation and auditability as traditional banks. Furthermore, with the introduction of new technologies, the complexity and the rate of cyberattacks is increasing. The evolving nature of cryptocurrencies makes it insufficient for traditional cybersecurity solutions to handle them (Kyle Chin, 2023).
Cryptocurrencies and illegal practices connected with them
Despite their potential, cryptocurrencies have seen a concerning rise in illicit use, in the last years, by international organized crime and global terrorist organizations. More specifically, they have become the main tool for money laundering and illicit financing. That is possible because of the identity protection behind the security protocols of the main decentralized finance (DeFi) operators. More specifically, if it’s possible to find and track a blockchain activity, it’s not possible to identify users, and, as a consequence, law enforcement and financial/banking security agencies aren’t able to know where the money comes from and where it goes. Plus, financial criminals, thanks to the possibility of online anonymous transactions are even more difficult to locate because they may not operate from their national states and/or use articulated cybersecurity protocols for self-defense from cyber-investigations.
If this isn’t enough, some states do not guarantee the fair use and correct monitoring of online transnational financial markets, making them more prone to host and encourage financial crimes like money laundering via cryptocurrencies. That’s the reason why law enforcement refers to this illicit practice as “cyberlaundering”: dirt money is “washed” via online cryptocurrency buying (anonymously) and then, these last ones, are sent to a “cold wallet” (the most used type of virtual wallet where the decrypting codes aren’t shared online with the service provider, making it very secure for the operator). Therefore, they’re converted into “clean” money, ready to finance illegal activities and/or buy items (such as weapons, drugs, etc.) on the dark web. It’s also reported the use of cryptos themselves as a payment method in the dark web. To make cyberlaundering happen, there must be 3 key moments:
- Placement stage: this corresponds to the moment when dirt money is materially used to buy a certain and well-fractioned quantity of cryptos.
- Layering stage: this phase refers to the moment when cryptos are redistributed in very few quantities to “clean and secure” cold wallets around the world, accurately selected by a mixing service provider, whose main task is to identify the selected wallets and fraction of the cryptos. This way makes it virtually impossible for investigators to discern between fair and suspicious transactions, due to the very few amounts of money converted per operation. Basically, criminals make a high number of transactions worldwide, by redistributing low quantities of cryptos per wallet. Finally, the dirty money is “washed” once cryptos in the “clean” wallets are reconverted into legal currency.
- Integration stage: this is the final step, which corresponds to the use of the fully washed money in apparently legal financial transactions and for the financing of illicit activities and/or criminal organizations and terrorism.
According to what is explained, is not difficult to understand that the high level of privacy behind the use of cryptocurrencies is, in fact, a serious threat to a Nation’s financial security and the brand-new frontier, for organized crime and international terrorism, to efficiently cover the illegal money laundering and illicit financing of their criminal activities.
How the EU fights the illegal financing of organized crime and international terrorism
The very first significant step in the European Union, to fight financial crime inside the union, was made in 2015 by issuing the n. 849/2015/EU regulation, basically establishing the first steps to create a more connected and powerful net of the national finance/banking monitoring agencies and enhance the previous regulations regarding the financial security of the EU. Despite this, no effective actions against the illicit use of cryptocurrencies were taken until 2018, when the n. 843/2018/EU regulation came into force. This was the first time that cryptocurrencies were explicitly mentioned in European law, because of the clear evidence of how organized crime and international terrorism use this asset to finance their illicit activities.
Along with these communitarian laws, member states of the EU possess a powerful tool to fight financial crime: the Financial Intelligence Unit (FIU) which constantly monitors the national/international financial and stock markets with the main purpose of following the “path” of the money/assets and track what is commonly known as “cash flows”. This vital task brings advantage to national law enforcement to tackle the illicit use of financial assets (even cryptocurrencies, as this is our analysis subject) and potentially dismantle the illegal activities of organized crime and terrorist organizations. Plus, FIUs share a common-use database to create a supranational network to be more effective in fighting transnational financial crime. Most national FIUs (Italian included. The UIF-Unità d’Informazione Finanziaria) are contributors to the Financial Action Task Force, an international financial intelligence unit under OECD coordination, whose main goal is to internationally pursue financial crimes and terrorism financing.
In June 2023 a crucial milestone in ruling the use of the cryptocurrencies “euro-wide” was laid, issuing the “Markets in Crypto Assets Regulation” (MiCAR). This is the very first European regulation that strongly aims to rule the use and circulation of crypto assets (not only cryptocurrencies) inside the European Union. An outstanding step to strengthen the FIUs and law enforcement work against financial crime, upgrading the safety of the communitarian financial tissue and, wider, the communitarian security. At the time this paperwork was written, a new proposal by the European Council was made in December 2023 to improve the previous regulations and strengthen the national financial authorities' controls on cryptocurrencies, illicit financing activities, and other financial crimes connected with them.
Policy recommendations for cryptocurrency regulation
The technology's international nature and the prospect of links with the traditional financial ecosystem all support the case for a worldwide approach to crypto-asset regulation. There are however different obstacles to a global approach, as not even the classification or definition of the cryptocurrencies coincide between countries. In the absence of a unified approach, rising compliance costs for small and medium-sized enterprises seeking to establish themselves in a global setting may impede innovation and growth. since not only do most governments use more than one type of regulatory strategy, but also the difference in market maturity and capacity of regulations between countries is substantial, it would be wise to cooperate within the international organizations' framework among national and regional regulators and relevant stakeholders (Arushi Goel, 2023).
In February 2023, the IMF delivered to the G20 presidency an evaluation of the impact of crypto assets, together with suggestions for effective policies. In the elaborate, four key policy recommendations are outlined: to not substitute sovereign currencies to maintain the domestic institutions' reliability, to not give legal tender status to crypto assets as to maintain national sovereignty and avoid financial instability or rising inflation, to include cryptocurrencies into existing regimes and laws to maintain stability and reduce disruptions and, finally, to ensure compliance with tax policies.
On November 16, 2023 “Policy Recommendations for Crypto and Digital Asset Markets” was published by the International Organization of Securities Commissions (IOSCO) – an international organization that brings together the world's securities regulators and develops, implements, and encourages compliance with internationally recognized securities regulation standards. The eighteen policy recommendations are intended to promote greater consistency and focus on six key areas:
- Conflicts of interest caused by vertical integration of activities and responsibilities;
- Market manipulation, insider trading, and fraud;
- International risks and regulatory cooperation;
- Client asset protection and custody;
- Operational and technological risk;
- Retail access, suitability, and distribution.
From the existing literature, the main recommendations for international institutions are to first give comprehensive and global definitions and classifications of crypto-assets. Then, they should identify best practices providing stability and incentivizing actors to act appropriately. Thirdly, regulators should implement automated systems of reporting on compliance, real-time alerts, and regulatory change tracking. This will increase transparency, minimize risk, and boost industry trust.
Conclusion
In conclusion, the advent of cryptocurrencies has revolutionized finance, offering decentralized transactions via blockchain. Despite their potential benefits, cryptocurrencies pose significant challenges in cybersecurity and are exploited for illicit activities. Cryptocurrencies expose users to phishing, hacking, and fraud risks, demanding innovative cybersecurity strategies. They have become a tool for money laundering and illicit financing by international criminals due to their inherent anonymity. The European Union has responded with regulations like the Markets in Crypto Assets Regulation to combat these issues. However, global collaboration is essential. International organizations, such as the IMF and IOSCO, stress the need for comprehensive definitions, regulatory consistency, and integration with existing legal frameworks. As the crypto landscape evolves, proactive global collaboration is crucial to harness the benefits while effectively mitigating risks. Striking a balance between innovation and regulation will ensure responsible cryptocurrency integration into the global financial ecosystem.
Source classification
Information Content | ||
1 | Confirmed | Confirmed by other independent sources; logical in itself; coherent with other information on the topic |
2 | Presumably true | Not confirmed; logical in itself; coherent with other information on the topic |
3 | Maybe true | Not confirmed; reasonably logical in itself; coherent with some other information on the topic |
4 | Uncertain | Not confirmed; possible but not logical in itself; no other information on the topic |
5 | Improbable | Not confirmed; not logical in itself; contradicts with other information on the topic |
6 | Not able to be evaluated | No basis to evaluate the validity of the information |
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