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Why is Cryptocurrency under Scrutiny? Hawala Explained

Bitcoin Bitcoin on a motherboard. Credit:

After the People’s Bank of China (PBoC) imposed a temporary rule that initial coin offerings (ICO) are illegal and that startups must refund all ICO investments to contributors, The Central Bank of Russia also said that it “monitors” the cryptocurrency market and is continuing to develop a regulatory framework for cryptocurrencies. There is a question though – what are central banks over the world exactly scared of?

Russia’s central bank is against allowing cryptocurrencies or any related financial instruments within the Russian Federation. In that way, they reiterated statement from January 2014 which
explicitly compared bitcoin to a “money surrogate”, rendering it illegal in the Russian state. “Cryptocurrencies are issued by an unlimited circle of anonymous entities and due to the anonymous nature of the issuance of cryptocurrency, citizens and legal entities can be involved in illegal activities including legalization (laundering) of proceeds from crime and financing of terrorism.” said the part of the central bank notice.

During the past several years there were some examples of how terrorist groups could have benefited from cryptos. Terrorist groups in Gaza have solicited support in Bitcoin and there were isolated reports that Dae’sh (ISIS) used the cryptocurrency. Even though that these are still isolated examples, there has to be the awareness. If and when cryptocurrencies start to compete with cash and other readily available means of financing in terms of market capitalization, liquidity, convertibility, and network effects that add up to ease of use, they can be considered as a real threat.

Then, there is a question of transparency. It is true that with some virtual currencies, it is possible to transfer money instantly around the world without making use of institutions like banks, which require more transparency and have obligations to report suspicious transactions. It is known that terrorist organisations traditionally use hawala networks, conventional banking systems and smuggling of cash over borders to fund their activities.

Hawala money transferring system

Explanation of Hawala money transferring system. Credit: Taru Bakshi.

Hawala is a funds exchange system which evolved in Indian and Chinese societies and was used to transfer funds across borders in a safe and convenient manner. People in various parts of the world are using their corporate accounts to move money internationally for third parties. The practice of hawala is vulnerable to terrorism financing and money laundering because funds do not actually cross borders, removing the international money trail. Additionally, records are not stringently kept providing high levels of confidentiality to the sender and receiver of funds.

Blockchain and associated technologies hold great promise for low cost, high speed, verified transactions that can unite counterparties around the world. For this reason they could appear appealing to terrorist groups (as they are at present to cybercriminals). However, bare in mind that this technology is quite recent and requires a degree of understanding by the user, and this knowledge would have to be end-to- end for all parties involved in the financing acts. Certain parties may not want to get paid in cryptocurrencies due to not knowing how to handle transactions, and more importantly how to then turn it into fiat. Large sums have become more susceptible to being noticed as all credible exchanges now follow AML and KYC compliance unless limiting users to negligible amounts.

So, at least for now, it seems that virtual currencies are really tough go-to solution for terrorist financiers. However, even though they remain anecdotal at the moment, that does not mean
the strategic threat that extremist groups use of the technology could pose should be ignored.