What If Blockchain Cannot be Blocked? Cryptocurrency and International Security

A key challenge of law enforcement has always been to make sure that crime never pays, at least not well.  When law enforcement could not succeed at monitoring and preventing crime and even if there were no smoking gun tipping off who committed a particular crime, the high card was always their ability to track down criminals.  Usually the best way to do that was to heed the admonition of skilled investigators everywhere—follow the money.  Fast forward to today as new forms of digital money—known as cryptocurrency—are now making the money harder and potentially in the near future impossible to follow.  The counter-crime implications of these developments are already apparent and significant national security implications are becoming clearer.  What is just starting to come into focus are the vast implications for international security. Unlike bank issued currencies, cryptocurrencies such as Bitcoin are not the product of a single fiscal authority.  Cryptocurrencies also share the unique characteristic that they can be transferred between parties without oversight or even a third party having any evidence that a transfer occurred.  When combined with cryptocurrencies, new ways of disguising e-commerce transactions through encrypted and anonymizing applications, make it possible for parties who cannot even identify one another to conduct business beyond the ken of law enforcement and regulatory authorities. Revolutionary change itself is not new.  Nearly a century ago the great Austro-American economist Joseph Schumpeter spoke of the evolutionary development of economies as being driven by the capacity to achieve new efficiencies through change, which may at times include almost convulsive change. Schumpeter argued that one of the great advantages of capitalism was the dynamism it gained from the “creative destruction” of new, efficient practices by replacing less efficient practices.  More recently, Clayton Christensen and others have shown how breakthrough technological innovations can supplant less adept and less agile technological processes by unleashing “disruptive innovation.”  Disruptive technology can swiftly upend even seemingly stable commercial relationships by rapidly shifting market shares. But change in the way money functions is new and the risks associated with this change are an order of magnitude more important than products, companies, monopolies or even whole sectors being replaced by competitors.  In less than a decade since Bitcoin was created, the emergence of cryptocurrencies has already challenged traditional ways of tracking criminals.  It is less than five years since the first large criminal market place, Silk Road, sprang into action in late 2011 until it was shuttered in November 2013.  Silk Road was the first large illegal internet market place conducting transactions out of open view and concealed through the use of a cryptocurrency, but it was most certainly not the last. In July 2017, U.S. Attorney General Jeff Sessions announced that the FBI in league with other law enforcement agencies seized and shuttered AlphaBay, a successor criminal enterprise to Silk Road.  AlphaBay was similar to Silk Road with one important difference—the volume of activity was ten times the size of Silk Road’s operations.  It is true that law enforcement has quickly gotten much better at the sleuthing work of identifying cyber criminals, but it is also true that criminals are often the first to adopt technologies, innovate and share expertise and so are increasingly more adept at what they do.  Risks of cryptocurrencies to law enforcement are now apparent.  What is less apparent is that just around the corner is a new phase of cyber security that will be even more disruptive on an international basis.  This new aspect of crypto innovation is going beyond national security to the area of international security. Bitcoin is only one of a growing number of cryptocurrencies, all of which work essentially along the same essential lines but through different platforms and processes.  The underlying logic of cryptocurrency is based on blockchain, a distributed public ledger technology that puts the movement of value—“money” if you will—to work in a way that simulates a conventional currency.  Every 10 minutes or so the current, encrypted ledger is distributed to all the holders in such a way as to prohibit double spending and maintain provenance without permitting ready identification.  If cryptocurrency is not money, it does not matter because it can be exchanged for money, fungibles, and objects. The growth of the currencies has been phenomenal: as of August 2017, the total value of crypto assets topped $116 billion. Money has always been an abstract commodity, but digital money is dramatically different.  When Claude Shannon in the late 1930s as a young researcher on signal theory at MIT realized that physical signals such as telegraph transmissions could be represented as numerical code he initiated the digital revolution. Advances in cryptography and computing in World War II opened the information age.  The subsequent creation of semiconductors and integrated circuits made possible vast increases in computational power. From there, linking individual computers into networks facilitated the creation of the Internet, web and cloud computing.  The invention of asymmetric public key encryption made it possible to conduct ecommerce online with the assurance that transactions could take place with a high degree of confidentiality. Because of their extreme volatility, cryptocurrencies carry a high investment risk that is compounded by the absence of transparency.  The private sector financial industry has not embraced cryptocurrencies as such but have tinkered and adopted some Blockchain technology. That said, the private sector is clearly not prepared to ignore cryptocurrencies’ future implications.  For instance, the fast growing “fintech” sector is represented in every major commercial and investment bank and has been working to monetize and absorb the opportunities presented by the blockchain and crypto.  In contrast, the public sector financial management and oversight community has been slow to respond to the implications raised by the emergence of cryptocurrencies.  Many central banks, including the U.S. Federal Reserve as well as other international financial organizations, are wary of cryptocurrencies but nevertheless see the blockchain technology as playing a role in the future.  Nonetheless, throughout the entire financial community there is an emerging consensus that distributed ledger technology, DLT, is as an inevitable stage in the future evolution of money.  Even Russia’s Federal Security Service (FSB) recently has acknowledged that it is directly involved in the International Standards Organization (ISO) efforts to create a global standards for new “blockchain” technology for Bitcoin and other cryptographic currencies winning international attention. National central banks in most countries play the key role of serving as the gatekeepers in their role as overseers of monetary policy through managing capital flows in the form of setting currency exchange rates for the purposes of export and import management.  There is a wide variety in the differences of central banks among countries.  Some central banks stipulate and enforce currency exchange rates directly.  In other countries, central banks function in parallel with secondary currency markets in which supply and demand autonomously play a role in establishing exchange rates. Despite the variety of monetary arrangements, in all cases national financial authorities need to have visibility with respect to financial transfers in order to properly do their job. The same is true for the public international financial institutions with which they work, such as the International Monetary Fund.  Cryptocurrencies may deprive these institutions of the necessary level of visibility. The settlement of accounts among central banks, commercial banks, and retail banks continues to exist in the context of national central bank authorities. Dynamic changes in legal and observable payment processing technologies and mechanisms are increasingly relying on private firms such as Apple Pay, Android Pay, PayPal, Square, Stripe, Vantiv, and WorldPay and others in adopting recently developed peer-to-peer services such as Venmo, all of which continue to be observable exchanges.  Cryptological transfers such as those through blockchain can be conducted within the legitimate and observable processes but, technologically, can also be conducted outside this circle in a way in which they are not necessarily visible. The present scale of these illegal transfers currently appears to be small.  That is a conjectural rather than empirical conclusion because, obviously, if they are not visible they cannot be counted.  However, there are no technical constraints which ensure that the scale of unmanaged financial transfers will remain small.  If blockchain transfers are not visible, it follows that some at least will not be blocked.  The question is how big is the scale? World practice in controlling capital mobility is varied but is increasingly diverging between the more democratic, market-driven processes of the western world in which the use of cryptocurrencies is only officially endorsed with reservations as opposed to some of the more authoritarian and state-driven processes of the eastern world in which electronic transfers not under the control of the state are widely viewed as categorically unacceptable.  The creation of a “Great Firewall” to use state control over the telecommunication infrastructure to establish filters and blocks to eliminate ostensible risks to national security is an example of how a state can employ its administrative capacity to control the cyber revolution.  Rumors recently circulated in the press and were then explicitly denied by Chinese authorities that there was a plan to eliminate the use of VPNs, virtual personal network services, located outside of the physical territory of China.  However, measures have been taken in China to block such applications as WhatsApp and chat services. These steps fall short of addressing the emerging and growing role of peer-to-peer (P2P) communications through wireless electromagnetic space that does not rely upon servers, optical fiber or copper wires, or relay transmissions systems.  Such P2P transmissions, including the transmission of monetary value through cryptocurrencies is outside of the view and thus the control of government authorities. In Russia officials have referred to cryptocurrencies in the past in very hostile terms. Now, however, there are indications that a shift in perspective is now taking place as illustrated by Vladimir Putin’s recent meeting with the creator of Bitcoin’s closest competitor, Ethereum.  The recent interest of Russian officials in cryptocurrency as means of exchange may be less important than the interest in understanding the potential of cryptocurrencies as instruments of disruptive intervention in international markets. Consider the history of the Russian government’s goal of pairing up with China to displace the U.S. dollar as the de facto global reference currency. So far, apparently, the wide-scale use by criminals of cryptocurrencies has been nominal.  This may be primarily because the financial technology is so technically advanced and complicated that it requires substantial technical expertise to master.  Empirical instances of the use of cryptocurrencies by terrorists, global criminal groups, illegal economic cartels, traffickers in weapons of mass destruction, and other global syndicates either acting on their own in conjunction with rogue or otherwise disruptive states, is not something that has captured much international attention. As an indicator of interest in the technology, criminals have already started stealing crypto from each other. Rogue states and those involved in narco-trafficking will surely be paying attention and experimenting. As such, a new focus on crypto is direly needed if we are going to be smart in addressing these threats. The risks of emerging cryptocurrencies to international security can only be properly addressed in the context of international diplomacy and cooperation.  But in all diplomatic agreements, big and small, in the end there is no right without a remedy.  If there is no fall back to hard consequences, any soft power diplomacy is little more than a bromide. All international agreements in a world as dynamic as that of the present must be, to some extent, self-enforcing and based on the self-interests of all participants prepared to defend them.  Any confidence that a new global treaty on cyber security will in itself be sufficient to address the risks of the disruptive potential of cryptocurrencies to our national and well as international security interests is surely naive.  More research needs to be done on what individual and independent steps can be taken to protect national and international security interests.  It is time to get smart about these disruptive technologies before the costs become more than we can afford. About the authors: Gregory Gleason and Sean S. Costigan are Professors at the George C. Marshall Center.