Crypto’s Valachi Papers

Mafia Witness Joseph Valachi Taking Oath
Bettmann Archive / Getty

In September 1963, Joseph Valachi became the first mobster to testify against the Mafia. In addition to his testimony, Valachi documented his knowledge of what he called La Cosa Nostra, Italian for “our thing,” as a way to encourage leaks and make it more difficult for mob bosses to hide from the law. But at the last minute the publication of his detailed 1,000-page memoir, dubbed the Valachi papers, was deemed too dangerous to share with the public. While a heavily abbreviated, 300-page book based on Valachi’s conversations with a reporter was later published, the original document, which purportedly revealed new details about internal Mafia operations, was never released. 

Now the underworld of bitcoin and other cryptocurrencies has its own Valachi papers, detailing how criminals laundered a record $3.7 billion so far this year, but with a blockchain twist. Instead of a mobster with an axe to grind detailing how his bosses initiate new members, commit crimes and hide each other from law enforcement, companies including traditional financial institution Scotiabank, cryptocurrency exchanges Binance and Bitfinex and blockchain investigation firms Chainalysis and Bitfury Crystal assembled a crack team of compliance officers—dubbed Project Participate—to compile the results of their own investigations into a secretive document, simply titled “Indicators of Suspicion.”

In the two months since the report was published, it has been slowly making the rounds among law enforcement and regulators, with copies clandestinely sent to the U.S. Treasury Department and the Financial Crimes Enforcement Network, and is already being implemented by many of the partners who participated in its creation. A complete copy of the report was provided to Forbes on background to verify its contents, though if the authors have their way, the details will never see the light of day. Like the Valachi papers, the report could not only help investigators around the world identify and prosecute crimes but also help criminals get away with murder and more.

The timing of the report is no coincidence and not a moment to soon, according to Leonardo Real, the chief compliance officer of controversial cryptocurrency firm Tether Ltd., who conceived of Project Participate. Earlier this year the Financial Action Task Force (FATF), an international group of governments, said it would require cryptocurrency companies to share suspicious activity with each other just like banks do or face being banished to the depths of the dark Web. 

“We thought that putting our heads together would be beneficial so that we can help to train compliance programs worldwide and ensure that as an industry as a whole we're better able to fight money laundering and terrorist financing,” says Real, 34, who previously worked for the Bank of Montreal to identify and prevent money laundering, and who in addition to conceiving of the project helped recruit its participants.

Formally known as the Cryptocurrency Indicators of Suspicion (CIOS) Working Group, Project Participate, also includes cryptocurrency exchanges Bitpay and Paxful, the nonprofit Blockchain Alliance and security firms Ciphertrace and Elliptic. In addition to the corporate participants, two members of Coinbase’s compliance team, including a senior director of investigation, reviewed the published document, attended strategy meetings and recommended new members. Deutsche Bank global head of market advocacy Boon-Hiong Chan, also contributed in a personal capacity.

Instead of the firsthand account of a vindictive gangster, the report, whose full title is “Indicators of Suspicion for Virtual Asset Service Providers,” is based on the record of illicit transactions committed by modern-day criminals and captured forever in the public record on a number of blockchains. After four years helping the Bank of Montreal implement its anti-money-laundering (AML) strategy, Real joined Hong Kong-based Tether in June 2018, the same month FATF published its requirements that, like banks, virtual asset service providers (VASPs) share information with each other about how users move funds from one place to another, called the travel rule. 

Founded in 2014, Tether Ltd. mints the tether cryptocurrency (originally called realcoin), which is a stablecoin,  meaning it has the stability of a U.S. dollar but, like its traditional cryptocurrency cousins bitcoin and ether, trades and settles nearly instantly. In addition to being a popular way to enter and exit a cryptocurrency position, this role as a way to move between cryptocurrencies and potentially obscure transaction origins has made the stablecoin popular among money launderers, and left Tether and its sister company, Bitfinex, open to a number of ongoing legal battles alleging the company inflated the amount of Tether in circulation and manipulated prices.

While skeptics will undoubtedly call into question Tether’s credibility over the spate of recent lawsuits, Real says it is exactly the perspective of dealing with these accusations that makes the techniques detailed in the report so potentially useful. “I see no reason why we can't talk about how we ought to fight crime,” says Real, who positions the report as an industry-led effort to show that the participants are willing to cooperate with regulators and law enforcement. “If anything, the fact that we are a large and professional company may give us some insight as to how to control the kind of risk that we see.”

The report details 86 indicators of suspicious activity, or patterns of transactions on the blockchain. Several patterns show how so-called politically exposed persons (PEPs), politicians and others who are particularly susceptible to bribery and corruption, can accidentally reveal information about their own illicit behavior on a blockchain. Others patterns can be indicative of perpetrators using anonymous email servers like Protonmail or disposable email services like Tutanota to obscure their identities. While others describe how funds move from exchanges and other platforms to the Darknet. The report then groups those activities into typologies that make it easier for VASPs to report suspicious activity, giving recommendations for how to prevent such behavior, and how to train compliance officers, as explained by former U.S. Department of Justice deputy assistant attorney general Jason Weinstein, who is now director of Project Participate member Blockchain Alliance and represents several of the other participants.

For example, Weinstein says some patterns of transactions in certain regions could be evidence that a shell company is using layers of fiat currencies and cryptocurrencies to obscure illicit proceeds. Though details about the typologies were only provided on background, Weinstein reviewed the higher-level descriptions, including how criminals might conceal their identity using privacy coins zcash, monero and dash; suddenly change their behavior to commit a crime; use bitcoin ATMs to make anonymous withdrawals; peer-to-peer exchanges to find accomplices, and initial coin offerings and phishing scams to dupe victims. “This report is a road map for the kind of things that virtual asset companies look for in trying to identify and faithfully detect suspicious activity,” says Weinstein. “And so if you’re a bad actor and you have access to this road map, you can use it for the wrong purposes.”

Data provided to Project Participate by exchanges tended to be limited to illicit behavior on the exchanges themselves, while cryptocurrency investigation firms Ciphertrace, Chainalysis, Elliptic and Crystal provided a broader perspective based on the data between exchanges, according to Bitfury Crystal CEO Marina Khaustova, whose firm provided information for the report specifically on phishing scams and anonymous users, she says. Information about how quickly a user logs in and how frequently he or she changes location was then used to develop algorithms that help collaborators track down criminal behavior as easy as an online search. “Looking for crime on a blockchain is similar to Google search in that if you’re looking for it, someone else has been looking for it as well,” says Khaustova.

In Valachi’s case, by the time he testified in front of Congress in the winter of 1963, law enforcement had intensely interrogated him. However, Valachi’s own manuscript, obtained by reporter Peter Maas, who broke the story, was supposedly filled with additional information. Following a long legal debate, Maas was eventually allowed to publish a book based exclusively on interviews with Valachi, but prevented from publishing the document itself. 

By contrast, the indicators of suspicion report was produced by the private sector and handed directly to a broad array of corporate and government representatives. The office of the director of the U.S. Financial Crimes Enforcement Network (FinCEN), Ken Blanco, confirmed it has a copy of the report. Project Participate members say a copy was also given to former undersecretary of the U.S. Treasury Department for terrorism and financial intelligence, Sigal Mandelker, before she resigned in October, though department representatives were unable to confirm whether the document had been handed over to others. Other regulators and law enforcement agencies in North America and Europe also received a copy, according to Project Participate members, though they declined to share the names of additional recipients.

“In the dream scenario, law enforcement agencies and global governments in general are going to become more familiar quickly and their maturity is going to rise rapidly along with their ability to mitigate criminal activity,” says Jesse Spiro, global head of policy and regulatory affairs for Chainalysis, who sees the report as crucial to laying the foundations for more mainstream adoption. “If that happens, the end result is going to be more institutional and widespread adoption of cryptocurrency.”

As an example of how the report is already being used, peer-to-peer cryptocurrency exchange Paxful’s chief compliance officer, Lana Schwartzman says she used the contents to refine the way the exchange tracks criminal activity in geographic regions. Estonia-based Paxful is a cryptocurrency exchange that helps specific buyers of cryptocurrency meet specific sellers and conduct transactions using traditional methods such as a bank account or alternative methods like gift cards for iTunes and mPesa phone credits popular in regions where traditional banking services are rare. Schwartzman says Paxful’s clientele largely comes from these developing areas where not only a large percentage of the population doesn’t have access to traditional banking services but are known centers of money laundering. “With the FATF travel rule and some of the other regulations that are coming down, the need for collaboration truly exists,” says Schwartzman. “We’re not as mature as banks, so we have to combine our heads together.”

While many early bitcoin adopters have attacked the FATF travel rule, which takes effect in June 2020, and undermines the cryptocurrency’s original promise of anonymous global transactions, a number of begrudging efforts to comply are already under way. In June, several industry leaders, including Project Participate member Bitfinex, accounting firm Deloitte and cryptocurrency exchanges Circle, Coinbase, Kraken and others, gathered in Japan for the Virtual Asset Service Providers Summit, or V20, to explore possibilities. One result of that event is called OpenVASP, a group of software developers writing open-source code to directly connect virtual asset service providers in a similar way that the Swift interbank messaging platform connects banks, helping those cryptocurrency companies share pertinent information while protecting user privacy.

“The transfer of data between VASPs adds costly and cumbersome processes that are not only unnecessary for investigations, but put data security and privacy at risk,” says Chris Gschwend, senior compliance advisor of Swiss law firm, MME, who is helping build OpenVASP. “Nevertheless, as the rule is here to stay. OpenVASP provides a road map to maintain privacy and avoid the surveillance of centralized third parties.”

To give an idea of how much illicit activity is currently being transacted using cryptocurrency, Project Participate contributor Chainalysis looked at 27 different assets and found that with a month still left in the year a record-breaking $3.7 billion, or 0.44% of all transactions, were used for illicit activities this year alone, largely as a result of an increase in scams, but also from sources including terrorist financing, stolen funds, sanctions evasion, ransomware and a variety of Darknet purchases. The previous record, according to Chainalysis data, was in 2017, when $2.1 billion or 0.26% of all funds were spent on illicit transactions. While the percent of illicit cryptocurrency transactions has decreased by 57% since 2015, there’s been a 76% jump in the past two years.

Though bitcoin crime has certainly caught a lot of attention, neither the problem nor the proportion is unique to cryptocurrency. Back in Valachi’s time, Attorney General Robert F. Kennedy described organized crime as “a private government with an annual income of billions of dollars resting on a base of human suffering and moral corrosion.” In a speech about the Valachi hearings on September 25, 1963, Kennedy called the former mobster the first “racketeering insider” to break the “underworld’s code of silence,” expanding the information presented by the mobster to its broadest possible impact.

“When racketeers bore their way into legitimate business, the cost is borne by the public,” said Kennedy, according to his prepared remarks. “When the infiltration is into labor relations, the racketeers’ cut is paid by higher wages and higher prices—in other words, by the public. When the racketeer bribes local officials and secures immunity from police action, the price exacted by corrupt law enforcement—incalculable in dollars—is paid, again, by the public. In short, organized crime affects everyone. It cannot be the concern only of law enforcement officers. It must be the urgent and active concern of every citizen.” 

Forbes CryptoAsset & Blockchain Advisor cuts through the hype and identifies real investor opportunities in the emerging world of blockchain and crypto assets. Click to learn more.

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In September 1963, Joseph Valachi became the first mobster to testify against the Mafia. In addition to his testimony, Valachi documented his knowledge of what he called La Cosa Nostra, Italian for “our thing,” as a way to encourage leaks and make it more difficult for mob bosses to hide from the law. But at the last minute the publication of his detailed 1,000-page memoir, dubbed the Valachi papers, was deemed too dangerous to share with the public. While a heavily abbreviated, 300-page book based on Valachi’s conversations with a reporter was later published, the original document, which purportedly revealed new details about internal Mafia operations, was never released. 

Now the underworld of bitcoin and other cryptocurrencies has its own Valachi papers, detailing how criminals laundered a record $3.7 billion so far this year, but with a blockchain twist. Instead of a mobster with an axe to grind detailing how his bosses initiate new members, commit crimes and hide each other from law enforcement, companies including traditional financial institution Scotiabank, cryptocurrency exchanges Binance and Bitfinex and blockchain investigation firms Chainalysis and Bitfury Crystal assembled a crack team of compliance officers—dubbed Project Participate—to compile the results of their own investigations into a secretive document, simply titled “Indicators of Suspicion.”

In the two months since the report was published, it has been slowly making the rounds among law enforcement and regulators, with copies clandestinely sent to the U.S. Treasury Department and the Financial Crimes Enforcement Network, and is already being implemented by many of the partners who participated in its creation. A complete copy of the report was provided to Forbes on background to verify its contents, though if the authors have their way, the details will never see the light of day. Like the Valachi papers, the report could not only help investigators around the world identify and prosecute crimes but also help criminals get away with murder and more.

The timing of the report is no coincidence and not a moment to soon, according to Leonardo Real, the chief compliance officer of controversial cryptocurrency firm Tether Ltd., who conceived of Project Participate. Earlier this year the Financial Action Task Force (FATF), an international group of governments, said it would require cryptocurrency companies to share suspicious activity with each other just like banks do or face being banished to the depths of the dark Web. 

“We thought that putting our heads together would be beneficial so that we can help to train compliance programs worldwide and ensure that as an industry as a whole we're better able to fight money laundering and terrorist financing,” says Real, 34, who previously worked for the Bank of Montreal to identify and prevent money laundering, and who in addition to conceiving of the project helped recruit its participants.

Formally known as the Cryptocurrency Indicators of Suspicion (CIOS) Working Group, Project Participate, also includes cryptocurrency exchanges Bitpay and Paxful, the nonprofit Blockchain Alliance and security firms Ciphertrace and Elliptic. In addition to the corporate participants, two members of Coinbase’s compliance team, including a senior director of investigation, reviewed the published document, attended strategy meetings and recommended new members. Deutsche Bank global head of market advocacy Boon-Hiong Chan, also contributed in a personal capacity.

Instead of the firsthand account of a vindictive gangster, the report, whose full title is “Indicators of Suspicion for Virtual Asset Service Providers,” is based on the record of illicit transactions committed by modern-day criminals and captured forever in the public record on a number of blockchains. After four years helping the Bank of Montreal implement its anti-money-laundering (AML) strategy, Real joined Hong Kong-based Tether in June 2018, the same month FATF published its requirements that, like banks, virtual asset service providers (VASPs) share information with each other about how users move funds from one place to another, called the travel rule. 

Founded in 2014, Tether Ltd. mints the tether cryptocurrency (originally called realcoin), which is a stablecoin,  meaning it has the stability of a U.S. dollar but, like its traditional cryptocurrency cousins bitcoin and ether, trades and settles nearly instantly. In addition to being a popular way to enter and exit a cryptocurrency position, this role as a way to move between cryptocurrencies and potentially obscure transaction origins has made the stablecoin popular among money launderers, and left Tether and its sister company, Bitfinex, open to a number of ongoing legal battles alleging the company inflated the amount of Tether in circulation and manipulated prices.

While skeptics will undoubtedly call into question Tether’s credibility over the spate of recent lawsuits, Real says it is exactly the perspective of dealing with these accusations that makes the techniques detailed in the report so potentially useful. “I see no reason why we can't talk about how we ought to fight crime,” says Real, who positions the report as an industry-led effort to show that the participants are willing to cooperate with regulators and law enforcement. “If anything, the fact that we are a large and professional company may give us some insight as to how to control the kind of risk that we see.”

The report details 86 indicators of suspicious activity, or patterns of transactions on the blockchain. Several patterns show how so-called politically exposed persons (PEPs), politicians and others who are particularly susceptible to bribery and corruption, can accidentally reveal information about their own illicit behavior on a blockchain. Others patterns can be indicative of perpetrators using anonymous email servers like Protonmail or disposable email services like Tutanota to obscure their identities. While others describe how funds move from exchanges and other platforms to the Darknet. The report then groups those activities into typologies that make it easier for VASPs to report suspicious activity, giving recommendations for how to prevent such behavior, and how to train compliance officers, as explained by former U.S. Department of Justice deputy assistant attorney general Jason Weinstein, who is now director of Project Participate member Blockchain Alliance and represents several of the other participants.

For example, Weinstein says some patterns of transactions in certain regions could be evidence that a shell company is using layers of fiat currencies and cryptocurrencies to obscure illicit proceeds. Though details about the typologies were only provided on background, Weinstein reviewed the higher-level descriptions, including how criminals might conceal their identity using privacy coins zcash, monero and dash; suddenly change their behavior to commit a crime; use bitcoin ATMs to make anonymous withdrawals; peer-to-peer exchanges to find accomplices, and initial coin offerings and phishing scams to dupe victims. “This report is a road map for the kind of things that virtual asset companies look for in trying to identify and faithfully detect suspicious activity,” says Weinstein. “And so if you’re a bad actor and you have access to this road map, you can use it for the wrong purposes.”

Data provided to Project Participate by exchanges tended to be limited to illicit behavior on the exchanges themselves, while cryptocurrency investigation firms Ciphertrace, Chainalysis, Elliptic and Crystal provided a broader perspective based on the data between exchanges, according to Bitfury Crystal CEO Marina Khaustova, whose firm provided information for the report specifically on phishing scams and anonymous users, she says. Information about how quickly a user logs in and how frequently he or she changes location was then used to develop algorithms that help collaborators track down criminal behavior as easy as an online search. “Looking for crime on a blockchain is similar to Google search in that if you’re looking for it, someone else has been looking for it as well,” says Khaustova.

In Valachi’s case, by the time he testified in front of Congress in the winter of 1963, law enforcement had intensely interrogated him. However, Valachi’s own manuscript, obtained by reporter Peter Maas, who broke the story, was supposedly filled with additional information. Following a long legal debate, Maas was eventually allowed to publish a book based exclusively on interviews with Valachi, but prevented from publishing the document itself. 

By contrast, the indicators of suspicion report was produced by the private sector and handed directly to a broad array of corporate and government representatives. The office of the director of the U.S. Financial Crimes Enforcement Network (FinCEN), Ken Blanco, confirmed it has a copy of the report. Project Participate members say a copy was also given to former undersecretary of the U.S. Treasury Department for terrorism and financial intelligence, Sigal Mandelker, before she resigned in October, though department representatives were unable to confirm whether the document had been handed over to others. Other regulators and law enforcement agencies in North America and Europe also received a copy, according to Project Participate members, though they declined to share the names of additional recipients.

“In the dream scenario, law enforcement agencies and global governments in general are going to become more familiar quickly and their maturity is going to rise rapidly along with their ability to mitigate criminal activity,” says Jesse Spiro, global head of policy and regulatory affairs for Chainalysis, who sees the report as crucial to laying the foundations for more mainstream adoption. “If that happens, the end result is going to be more institutional and widespread adoption of cryptocurrency.”

As an example of how the report is already being used, peer-to-peer cryptocurrency exchange Paxful’s chief compliance officer, Lana Schwartzman says she used the contents to refine the way the exchange tracks criminal activity in geographic regions. Estonia-based Paxful is a cryptocurrency exchange that helps specific buyers of cryptocurrency meet specific sellers and conduct transactions using traditional methods such as a bank account or alternative methods like gift cards for iTunes and mPesa phone credits popular in regions where traditional banking services are rare. Schwartzman says Paxful’s clientele largely comes from these developing areas where not only a large percentage of the population doesn’t have access to traditional banking services but are known centers of money laundering. “With the FATF travel rule and some of the other regulations that are coming down, the need for collaboration truly exists,” says Schwartzman. “We’re not as mature as banks, so we have to combine our heads together.”

While many early bitcoin adopters have attacked the FATF travel rule, which takes effect in June 2020, and undermines the cryptocurrency’s original promise of anonymous global transactions, a number of begrudging efforts to comply are already under way. In June, several industry leaders, including Project Participate member Bitfinex, accounting firm Deloitte and cryptocurrency exchanges Circle, Coinbase, Kraken and others, gathered in Japan for the Virtual Asset Service Providers Summit, or V20, to explore possibilities. One result of that event is called OpenVASP, a group of software developers writing open-source code to directly connect virtual asset service providers in a similar way that the Swift interbank messaging platform connects banks, helping those cryptocurrency companies share pertinent information while protecting user privacy.

“The transfer of data between VASPs adds costly and cumbersome processes that are not only unnecessary for investigations, but put data security and privacy at risk,” says Chris Gschwend, senior compliance advisor of Swiss law firm, MME, who is helping build OpenVASP. “Nevertheless, as the rule is here to stay. OpenVASP provides a road map to maintain privacy and avoid the surveillance of centralized third parties.”

To give an idea of how much illicit activity is currently being transacted using cryptocurrency, Project Participate contributor Chainalysis looked at 27 different assets and found that with a month still left in the year a record-breaking $3.7 billion, or 0.44% of all transactions, were used for illicit activities this year alone, largely as a result of an increase in scams, but also from sources including terrorist financing, stolen funds, sanctions evasion, ransomware and a variety of Darknet purchases. The previous record, according to Chainalysis data, was in 2017, when $2.1 billion or 0.26% of all funds were spent on illicit transactions. While the percent of illicit cryptocurrency transactions has decreased by 57% since 2015, there’s been a 76% jump in the past two years.

Though bitcoin crime has certainly caught a lot of attention, neither the problem nor the proportion is unique to cryptocurrency. Back in Valachi’s time, Attorney General Robert F. Kennedy described organized crime as “a private government with an annual income of billions of dollars resting on a base of human suffering and moral corrosion.” In a speech about the Valachi hearings on September 25, 1963, Kennedy called the former mobster the first “racketeering insider” to break the “underworld’s code of silence,” expanding the information presented by the mobster to its broadest possible impact.

“When racketeers bore their way into legitimate business, the cost is borne by the public,” said Kennedy, according to his prepared remarks. “When the infiltration is into labor relations, the racketeers’ cut is paid by higher wages and higher prices—in other words, by the public. When the racketeer bribes local officials and secures immunity from police action, the price exacted by corrupt law enforcement—incalculable in dollars—is paid, again, by the public. In short, organized crime affects everyone. It cannot be the concern only of law enforcement officers. It must be the urgent and active concern of every citizen.” 

Forbes CryptoAsset & Blockchain Advisor cuts through the hype and identifies real investor opportunities in the emerging world of blockchain and crypto assets. Click to learn more.

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