Game Theory of Financial Crime: Policy Implications of Bitcoin

There is a significant shift underway in the ecosystem of illicit actors using cryptocurrencies. Bitcoin is no longer the asset of choice for criminals, according to a 2023 report from TRM Labs.

In the report, “The multi-chain era has had a significant impact on the overall distribution of illicit cryptocurrency trading volume, with Bitcoin’s share plummeting from 97% in 2016 to 19% in 2022. In 2016, two-thirds of cryptocurrency hacks were on Bitcoin. In 2022, it accounts for less than 3%, with Ethereum (68%) and Binance Smart Chain (19%) dominating the field. Bitcoin was the exclusive currency for terrorist financing in 2016, but by 2022, 92% of Bitcoins have been largely replaced by assets on the TRON blockchain..”

ripple effect of change

Clearly, this turns the adage that Bitcoin is synonymous with criminal activity on its head.

Since its inception, Bitcoin has served as a Schelling Point due to its network effects, market power, and liquidity, making it a natural choice in cryptocurrency finance.

(In game theory terms, a Schelling Point is a natural solution in situations where multiple parties must make decisions without direct communication. These points are intuitively obvious and often rely on shared expectations or common sense.)

But now it appears that the balance is constantly splitting apart, with malicious actors choosing different points of convergence.

Policy Implications

This move offers several important lessons from a policy perspective.

This highlights the need for policymakers to closely study the specific assets and blockchains currently favored by illicit actors and take appropriate action. More importantly, it provides an opportunity to replace the current prevailing view of digital assets with a more nuanced one, while also shaping the policy narrative on their criminal use.

For example, in the ongoing discussion about the use of cryptocurrencies to finance terrorism, it is often missed that Hamas actually stopped accepting Bitcoin donations to prevent its backers from being revealed.

But most importantly, the movement of illicit funds in Bitcoin is the first recorded case of major criminal substitution in the cryptocurrency world. This highlights the fluid nature of financial crime as it adapts to the path of least resistance.

A game theory perspective

As a result, a holistic and nuanced view of the space is possible through a game-theoretic lens (where players are product developers, regulators, good and bad actors). In these settings, we see that the interaction of independent actions and perspectives creates countless scenarios because the system is so intertwined that no set of players can control the outcome on their own.

A game-theoretic perspective on illicit finance explains the need to get inside the minds of criminals to predict their next steps and prepare accordingly. Establishing policies to prevent illicit financial flows is typically applied retroactively, with the first few actions taken by malicious actors, which are then studied as new risks and regulations are developed accordingly. However, as the digital asset space evolves at an exponential rate, we cannot afford to follow this whack-a-mole approach (which has become the norm in the design of existing financial regulations).

The trend of crime moving away from Bitcoin highlights the need to arm policymakers with predictive systems that predict future patterns of illicit financial flows. This approach significantly minimizes response time to new threats.

crime response activities

Lessons learned from Bitcoin’s changing usage may also help crime response experts identify the distinguishing characteristics of criminal organizations. For example, criminal organizations still relying on Bitcoin mean they lack leadership agility. Additionally, positioning on the ‘agility spectrum’ can help you infer actionable insights such as resource levels and technical expertise for any syndicate. This can also help law enforcement determine the unique scale of effort needed to combat each criminal organization. For example, criminal organizations pioneering and (eventually) leading the way in the transition away from Bitcoin will continue to adapt to slip through the cracks while operating with a relatively higher level of ingenuity.

concluding thoughts

The shift from Bitcoin to financial crime highlights the need for a more nuanced approach to managing appropriate and dynamic regulatory and policy frameworks for digital assets and blockchain. It also highlights the dangers of applying broad coverage to the entire spectrum of cryptocurrency finance in the context of policy discussions on criminal activity.

This is a guest post by Debanjan Chatterjee. The opinions expressed are solely personal and do not necessarily reflect the opinions of BTC Inc or Bitcoin Magazine.