APPLYING LESSONS FROM COMBATTING CONFLICT DIAMONDS TO LEGITIMIZE CRYPTOCURRENCIES

By Andrew Balthazor*

Cryptocurrencies like Bitcoin have a legitimacy problem that makes governments and mainstream financial institutions leery.[1] Their portability, quasi-anonymity, and irrevocable transactions make cryptocurrencies attractive to criminals as both a target for theft and as a means of exchange.[2] Controlling cryptocurrencies’ use as the black-market coin of choice will help speed the adoption of these still-fringe virtual currencies.

The diamond industry faced a similar challenge regarding conflict diamonds. In some areas, rebel groups and unscrupulous governments were using diamond mines under their control to finance illegitimate wars.[3] Restricting the purchase of conflict diamonds would stem the financing of these conflicts. However, diamonds’ proportionally high value-to-size made them easily smuggled and thus difficult to curb using traditional customs methods at ports of entry.

In response, countries, industry groups, non-government organizations, and the United Nations created the Kimberley Process (KP).[4] KP tackles the problem of an illegitimate supply—diamonds being used to fund conflicts—by certifying diamonds as conflict-free at their source. Participants only purchase certified diamonds or agree to trade exclusively with other KP participants. Although imperfect—for example, criminals counterfeit KP certificates with occasional success[5]—the KP’s demand-side controls have virtually eliminated the demand for conflict diamonds, reducing the trade in conflict diamonds by as much as 99.8%.[6]

The blockchain technology underpinning cryptocurrencies is a near-perfect vehicle for implementing a virtual currency Kimberley Process. A blockchain is a permanent and public ledger of all transactions, allowing the tracing of cryptocurrencies back to their source.[7] It is possible to implement the flagging of transactions on the blockchain as illegitimate. These transactions would remain flagged and tainted forever. Flagged transactions could include theft, ransom payments, digital black-market payments, or payments from known criminals or terrorists.[8]

Participants in this digital Kimberley Process—governments, financial institutions, and exchanges (the logical choices)—would only accept incoming transactions of cryptocurrencies if their audit trail is free of flagged illegitimate activity. Furthermore, digital Kimberley Process participants would only accept cryptocurrencies that allow a transparent transaction history. Efforts to thwart blockchain transaction tracing, like the cryptocurrency Monero,[9] would fall into disuse because there would be no legitimate way to introduce that virtual value into the conventional economy.

This demand-side control of illegitimate cryptocurrencies would disincentivize their theft and use as a means of black market exchange. The inability to introduce tainted cryptocurrency into the mainstream would reduce its attractiveness to criminals and encourage wider adoption of this proposed digital Kimberley Process. There would be little point in stealing millions of dollars of virtual currencies if there was no way to spend it. Tainted cryptocurrency owners would be reduced to dealing with one another in a secondary market whose value would be as limited as their utility.

Creating a digital Kimberley Process would accelerate adoption of cryptocurrencies by giving owners confidence that their assets are legitimately sourced. But the blockchain’s transparency and permanency offers advantages to the diamond industry, as well: an immutable audit trail of every transaction back to the source would combat KP certificate fraud and ensure participants’ compliance.[10] Melding the technical capabilities of cryptocurrencies with the demand-side controls of the diamond industry’s fight against conflict diamonds is an opportunity to further the legitimacy of both sectors.

* Law Clerk, Holland & Knight LLP (focusing on litigation, blockchain technologies, cryptocurrency assets, and recovery); Florida International University (FIU) College of Law, J.D. Candidate 2019; United States Military Academy, B.S. (Computer Science) 1999. I am indebted to Professor Hannibal Travis for the inspiration of this article.

[1] See Frederick Coleman, The Dark Side of Bitcoin: Illegal Activities, Fraud, and Bitcoin, Blockonomnics (June 16, 2017), https://perma.cc/4HND-JDJD.

[2] Jason Bloomberg, Using Bitcoin or Other Cryptocurrency to Commit Crimes? Law Enforcement is onto You, Forbes (Dec. 28, 2017), https://perma.cc/4DXT-DPMY; see Kate Rooney, $1.1 Billion in Cryptocurrency Has Been Stolen this Year, and it Was Apparently Easy to Do, CNBC (June 7, 2018), http://perma.cc/6ZUM-J4JY.

[3] Jordan Pearson, The World’s Blood Diamond Watchdog is Looking to the Blockchain, Vice: Motherboard (Aug. 31, 2016), https://perma.cc/KJ9V-KB3F.

[4] What is the KP, Kimberley Process, https://perma.cc/88RZ-B42H (last visited Sept. 9, 2018).

[5] Jon Yeomans, War on Blood Diamond Trade Loses Its Lustre in Age of Digital Smuggling, Telegraph (Jan. 28, 2018), https://perma.cc/F2MJ-JY3L.

[6] What is the KP, Kimberley Process, https://perma.cc/88RZ-B42H (last visited Sept. 9, 2018).

[7] See Jemma Green, Blockchains, Diamonds and the New Transparency, Forbes (Aug. 20, 2017), https://perma.cc/G7L6-2FW3.

[8] See Bloomberg, supra note 2 (discussing the types of criminal activity for which cryptocurrencies are used).

[9] Olga Kharif, The Criminal Underworld is Dropping Bitcoin for Another Currency, Bloomberg (Jan. 2, 2018), https://www.bloomberg.com/news/articles/2018-01-02/criminal-underworld-is-dropping-bitcoin-for-another-currency.

[10] Blockchain in Action: IBM’s New ‘TrustChain’, CryptoLearningAcademy, https://perma.cc/D2P6-EDXP (last visited Sept. 9, 2018); see Green, supra note 7; Pearson, supra note 3; Yeomans, supra note 5.