Cryptocurrencies have grown rapidly in price, popularity, and mainstream adoption. The total market capitalization of bitcoin alone exceeds $250 billion as at January 2018, with a further $400 billion in over 1,000 other cryptocurrencies. The numerous online cryptocurrency exchanges and markets have daily dollar volume of around $50 billion. Over 170 “cryptofunds” have emerged (hedge funds that invest solely in cryptocurrencies), attracting around $2.3 billion in assets under management. What was once a fringe asset is quickly maturing.
Illegal activity accounts for a substantial proportion of the users and trading activity in bitcoin. For example, approximately one-quarter of all users (25%) and close to one-half of bitcoin transactions (44%) are associated with illegal activity. The estimated 24 million bitcoin market participants that use bitcoin primarily for illegal purposes (as at April 2017) annually conduct around 36 million transactions, with a value of around $72 billion.
To give these numbers some context, the total market for illegal drugs in the US and Europe is estimated to be around $100 billion and €24 billion annually. Such comparisons provide a sense that the scale of the illegal activity involving bitcoin is not only meaningful as a proportion of bitcoin activity, but also in absolute dollar terms. The scale of illegal activity suggests that cryptocurrencies are transforming the way black markets operate by enabling ‘black market e-commerce‘. In effect, cryptocurrencies are facilitating a transformation of the black market much like PayPal and other online payment mechanisms revolutionized the retail industry through online shopping.
The rapid growth in cryptocurrencies and the anonymity that they provide users has created considerable regulatory challenges, including the use of cryptocurrencies in illegal trade (drugs, hacks and thefts, illegal pornography, even murder-for-hire), potential to fund terrorism, launder money, and avoid capital controls. There is little doubt that by providing a digital and anonymous payment mechanism, cryptocurrencies such as bitcoin have facilitated the growth of “Darknet” online marketplaces in which illegal goods and services are traded. The recent FBI seizure of over $4 million of bitcoin from one such marketplace, the “Silk Road“, provides some idea of the scale of the problem faced by regulators.
The “Darknet” is a network like the internet, but that can only be accessed through particular communications protocols that provide greater anonymity than the internet. The darknet contains online marketplaces, much like eBay, but with anonymous communications, which also makes these marketplaces less accessible than online stores on the internet. The Darknet is estimated to contain approximately 30,000 domains.
In recent years (since 2015), the proportion of bitcoin activity associated with illegal trade has declined. There are two reasons for this trend. The first is an increase in mainstream and speculative interest in bitcoin (rapid growth in the number of legal users), causing the proportion of illegal bitcoin activity to decline, despite the fact that the absolute amount of such activity has continued to increase. The second factor is the emergence of alternative cryptocurrencies that are more opaque and better at concealing a user’s activity (eg, Dash, Monero, and ZCash). Despite these two factors affecting the use of bitcoin in illegal activity, as well as numerous darknet marketplace seizures by law enforcement agencies, the amount of illegal activity involving bitcoin at the end of our sample in April 2017 remains close to its all-time high.