Unmasking the Shadows: How Cryptocurrency Fuels Terrorism

Introduction

Following the deadly attack in Israel by Palestinian militant group Hamas, it has put cryptocurrency’s role in terrorist financing back in the spotlight. The U.S. Treasury Department recently announced its investigation on the $165 million in cryptocurrency which the agency believed to have helped Hamas before the militant group’s Oct 7 attack against Israel. The frequency of cases regarding the misuse of cryptocurrency for illicit financing has been on a steady rise in recent years, and this has raised the eyebrows of many people. So then makes cryptocurrency such a useful tool, and should we as investors be concerned?

Crypto used in terrorism

Although cryptocurrency is used in a myriad of ways for illicit purposes, we can narrow it down on just two primary mechanisms: complex organization-level financial facilitation and small crowdfunding campaigns.

In June 2023, Israel’s National Bureau of Counter Terror Financing (NBCTF) announced the first ever crackdown of cryptocurrency illegal funding linked to Hezbollah and Iran’s Quds Force. Looking into this seizure has provided us with a unique insider scoop of Hezbollah’s cryptocurrency financing infrastructure, which builds itself on a mix of service providers and mainstream exchanges. Disguising itself as an ordinary consumer, the organization processed their financial transactions through service providers and stealthily managed to go under the radar and avoid being detected.

This false persona of being just an ordinary user engaging with service providers has created a difficult dilemma for law enforcers, as it makes their job of determining the number of illicit transactions based on the flow of funds through these intermediary services providers a mission impossible. This has resulted in a tendency to overestimate the terrorism related activities as these service providers generally also process transactions of everyday users who have no illicit intents.

The second mechanism that terrorism organizations use is something called small-scale crowdfunding campaigns. Disguised as charities or crowdfunding campaigns, these organizations are able to channel illicit money into their pockets.

One of their favorite breeding spots is social media. Hay’at Tahrir Al-Sham (HTS) for example has previously leveraged on social media to disperse propaganda and solicit donations on behalf of HTS through a specific bitcoin address.

Social media has become a powerful tool of choice because of the ability to stay anonymous online. With little to minimal information about the operator and ultimately the use of all funds raised, it makes it very hard to clearly determine the nature of the transaction and come to a decision to either block the funds or allow the transfer. This difficulty in determining the nature of the transaction is further aggravated when the transaction is conducted in war-torn regions. Their best bet would be to make an intuitive guess based on the value and volume of the flow of crypto associated with the terrorist financing. Even with the new clauses and regulation put in place by the Office of Foreign Assets Control (OFAC) proves to be futile as the vague and loose provision lacks the teeth to curb all the illicit funding activities.

Leaving a trail behind?

The short answer is yes, every transaction does leave an online trail. As every bitcoin transaction is linked to a unique wallet address, it is practically impossible for you to hide your transactions. Crypto exchanges can thus refer to their records and identify which address belongs to which customers, unmasking those behind the wallet. However, cryptocurrency users could still use crypto “mixers” to keep their anonymity online by obfuscating the trail of their transaction on the blockchain.

Other forms of illicit finance?

While cryptocurrency does contribute to a small percentage of illicit financing, traditional methods of illicit financing remain prevalent. In October 2022, the UN Counter-Terrorism Committee Executive Directorate estimated that crypto was used to finance accounts for just 20% of all terrorist attacks, which was a significant increase from the 5% recorded a few years ago. Nevertheless, we have to first acknowledge that cryptocurrency is a very small piece of a much larger terror financing puzzle, which includes hundreds and millions in nation state support, donations from a diaspora of individual donors, taxes that these terrorist organizations levy on their population, and investment portfolios.

What are some of the solutions available to counteract this?

Although cryptocurrency might not be as prolific as the other illicit financing crimes, any amount of funds sent to terrorists can have a devastating effect. Thus this would require the cooperation between the public and private sector to identify, analyze and validate potential terrorist financing risks. Without the public sector, the private sector would struggle to make informed, risk-based decisions, resulting in either mistakenly blocking legitimate funds or inadvertently allowing funds to reach the hands-off terrorists. Furthermore, the communication of the public sector maintains the pendulum of evaluating financing risks, ensuring that the financial ecosystem does not inadvertently support terrorism while also facilitating the flow of legitimate, critical humanitarian aid to its intended recipients.

This collaboration has already its success story, as this symbiotic partnership has resulted in the seizure of funds from groups like Hamas and Hezbollah, showing that the deconstruction and disruption of financial infrastructure supporting terrorism is not an insurmountable task.

Would this impact the future prospect of cryptocurrency?

While the use of crypto in terrorism presents significant challenges and raises valid concerns about its potential misuses, its impact on the future prospects of crypto is not necessarily deterministic. Instead, it pivots upon the responses and actions taken by the various stakeholders, including governments, regulatory bodies, and the broader community.

First, the regulatory responses will play a pivotal role in shaping the future trajectory of cryptocurrency. While it might be a natural response for government and regulatory bodies to enforce stricter rules aimed at illicit activities, but a good balance between improving transparency and accountability with the freedom for innovation and mainstream adoption must be maintain to ensure that the vivacity of cryptocurrency is not suffocated by a stack of rules and regulations.

Secondly, the future prospect of cryptocurrency also hinges on the opinion of the general public and investors. It is inevitable that illicit funding cases often generate negative sentiments that erodes the trust and confidence the general public has in crypto, which ultimately deters them from investing in cryptocurrencies. Thus, this would require an open conversation to highlight the benefits of crypto technology and the industry’s commitment to combat illicit activities to mitigate concern and foster greater acceptance.

Thirdly, the collaboration between crypto companies and law enforcement agencies and regulatory bodies is also essential for effectively addressing the challenges posed by crypto-related terrorism. By their partnership to develop and implement a robust regulatory framework, compliance standards, only then can they mitigate the risks and foster a safer and more sustainable crypto ecosystem.

In essence, while use of cryptocurrency in terrorism shows the need for greater vigilance and proactive measures, it should not overshadow the transformative potential of crypto technology. By navigating through these challenges thoughtfully and collaboratively, stakeholders can help ensure that cryptocurrency continues to evolve as a force for positive change.