The Bonnie and Clyde of Crypto Laundering

Last week the Department of Justice arrested a husband and wife, Ilya “Dutch” Lichtenstein and Heather Morgan, and charged them in a massive cryptocurrency money laundering case. The government alleges the defendants were involved in laundering Bitcoin that was stolen in a 2016 hack of Bitfinex, a virtual currency exchange. At the time, the stolen Bitcoin was worth about $71 million; today it would be worth about $4.5 billion. DOJ also announced that law enforcement had seized about $3.6 billion of the stolen cryptocurrency, the largest financial seizure in the Department’s history.

Last October Deputy Attorney General Lisa Monaco announced the formation of the National Cryptocurrency Enforcement Team to strengthen DOJ’s ability to pursue and disrupt criminal activity in the crypto markets, including money laundering. This case is significant evidence of DOJ’s growing ability to trace illegal activities that use blockchain technology. Those who thought crypto markets and blockchain provide a safe haven for criminal activity may need to think again.

These defendants are not charged with the Bitfinex hack, only with the subsequent laundering of a portion of the stolen Bitcoin. Whether they were involved in the actual hack, and whether there are others involved in the attempted laundering, are just a couple of the questions left unanswered by the court filings thus far. It will be interesting to watch this one unfold.

Lichtenstein and Morgan
Lichtenstein and Morgan

Facts of the Case

Lichtenstein, 34, is a citizen of both Russia and the United States. He works as an entrepreneur and technology investor; one of his early companies was supported by the prestigious start-up funder Y-combinator. His wife Morgan, 31, is a U.S. citizen. She apparently wears many hats, promoting herself as an economist, entrepreneur, writer, rapper, artist, and social-media influencer. In a nice bit of irony, she once wrote an article for Forbes magazine about how to protect your business from cyber-criminals. At the time of their arrest the couple were living in Manhattan.

Bitfinex is a large virtual currency exchange, or VCE – a business that allows customers to buy, sell, and trade cryptocurrencies. In 2016, a hacker breached Bitfinex’s system and ultimately stole nearly 120,000 Bitcoin. The stolen Bitcoin were transferred to a digital wallet – basically a secure online account —  that, at least at the time of his arrest, was under Lichtenstein’s control. Starting in 2017, about 25,000 of the stolen Bitcoin were then transferred out of that wallet in a series of complicated transactions, with some of it ultimately ending up in accounts controlled by the defendants.

The criminal complaint alleges the defendants used a variety of methods to move the cryptocurrency around and ultimately have it end up under their control while trying to conceal its origins. These techniques included using computer programs to engage in thousands of transactions between multiple accounts; depositing and then withdrawing the funds at a variety of different VCEs and “dark web” markets; using accounts opened in the name of businesses and fictitious people; converting the Bitcoin to other cryptocurrencies that provide additional anonymity; and splitting large transactions into many smaller ones. Ultimately, according to the complaint, law enforcement traced the stolen funds through thousands of transactions to over a dozen different VCE accounts controlled by the defendants.

The complaint also recounts how on several occasions VCEs the defendants were using questioned them about the source of their funds, pursuant to various “know your customer” (KYC) and anti-money laundering (AML) obligations. The defendants allegedly lied, claiming the funds were the result of their legitimate investment and business activities or, in Morgan’s case, that the Bitcoin was a gift from her husband. On a few occasions, when the defendants could not provide satisfactory answers or when the true owners of accounts involved in the scheme could not be verified, the VCEs froze those accounts. This allowed law enforcement to later seize the funds, and likely directed their attention to these defendants.

In January of 2022, law enforcement officers used a search warrant to obtain access to Lichtenstein’s cloud storage account. They recovered an encrypted document that contained a list of 2,000 virtual currency addresses (basically online account numbers), along with the private keys to unlock those accounts. Virtually all of those accounts ended up being linked to the 2016 Bitfinex hack. In particular, the list included the information required to access the original wallet where the stolen Bitcoin was moved when the hack first took place. This allowed the government to seize that wallet and recover the $3.6 billion in Bitcoin that still remained there. The list also included accounts that different VCEs had frozen and that law enforcement has linked to the 2016 hack, with a notation “frozen” next to them.

The Charges

The complaint charges the defendants with one count of conspiracy to commit money laundering, in violation of 18 U.S.C. § 1956(h), and one count of conspiracy to defraud the United States, in violation of 18 U.S.C. § 371.  The money laundering charge carries a maximum penalty of twenty years in prison, and the 371 conspiracy charge carries a maximum penalty of five years.

These are just the charges in the complaint to support the arrest warrant. Once the case is indicted, it’s likely prosecutors will add additional charges.

The government chose to arrest the defendants based on a complaint, rather than waiting until the case was indicted and issuing arrest warrants at that time. That was likely due to a desire to have the defendants detained as soon as possible to ensure they did not flee the country. Under the Speedy Trial Act, the government will now have thirty days from the date of arrest to obtain an indictment.

Money Laundering Basics

I’ve written about the basics of money laundering before, including posts here and here. The crime takes different forms. But the activity alleged in this case is heartland money laundering: taking “dirty” money and trying to clean it up so you can spend it without arousing suspicion. The blockchain technology is relatively new, but the basic laundering techniques are familiar.

(And as my students will attest, I can’t talk about the basics of money laundering without linking to the classic explanation by noted expert Saul Goodman.)

This kind of laundering charge requires the government to prove four elements:

1) The defendant conducted a financial transaction;

2) The defendant knew that the property involved was proceeds of criminal activity, or “dirty money”;

3) The property being laundered was in fact proceeds of a “Specified Unlawful Activity” (which includes a long list of federal crimes); and

4) The defendant knew the transaction was designed, in whole or in part, to conceal the nature, location, source, ownership, or control of the illegal proceeds.

In this case, the various transfers of Bitcoin and other cryptocurrencies through different accounts would constitute financial transactions. It appears that, by tracing the transactions back through the blockchain, the government can prove that the Bitcoin involved in at least some of those transactions was in fact taken in the Bitfinex hack. That would make it proceeds of an SUA, in this case wire fraud or the computer fraud and abuse act. That takes care of elements one and three. This case is likely to hinge, as so many do, on the evidence of the defendant’s knowledge – elements two and four.

The nature of the transactions would be substantial circumstantial evidence of an intent to conceal the nature, origin, and ownership of the proceeds. Just as when traditional money launderers run their funds through multiple bank accounts in different countries owned by shell corporations, the unnecessarily complicated transactions demonstrate a desire to make it difficult to determine where the funds originated. There’s generally no legitimate reason for such convoluted transactions, and so the very fact that the defendant engages in them is circumstantial evidence of intent to conceal.

The one element where the complaint is a bit light is the evidence that these defendants knew the Bitcoin in question was criminal proceeds. The complaint doesn’t allege they were involved in the initial hack, which would of course give them the requisite knowledge. It says the stolen Bitcoin ended up in a wallet ultimately controlled by Lichtenstein, but doesn’t specify exactly how that happened. When it comes to Morgan in particular, the evidence of her knowledge is actually quite thin. She may be able to defend by basically blaming everything on her husband.

The government is going to have to prove the defendants knew they were dealing with stolen Bitcoin. Once again, the convoluted nature of the transactions themselves can be circumstantial evidence of that knowledge. And clearly they knew the Bitcoin did not just magically appear in their accounts. Their lies to various currency exchanges about the origin of the crypto would be further circumstantial evidence of their knowledge that the money was dirty. And if necessary the government can rely on willful blindness to argue that the defendants deliberately closed their eyes to the fact that the Bitcoin in question was criminal proceeds.

The Conspiracy to Defraud the United States

The second crime charged in the complaint is conspiracy to defraud the United States in violation of 18 U.S.C. § 371. There’s no allegation of a monetary loss to the United States, which would be required for a traditional fraud. But this charge is based on the legal doctrine that one can conspire to defraud the United States by conspiring to impair, obstruct, or defeat the government’s lawful functions. This is the theory that was used, for example, to charge the Russians who conspired to interfere with the 2016 presidential election through social media and other methods – they were charged with conspiring to defeat the lawful functions of DOJ, the State Department, and the Federal Election Commission.

The theory here is that by lying to various virtual currency exchanges, opening accounts in fake names, and through their other laundering activities, the defendants impeded the lawful functions of the Treasury Department to monitor and maintain the integrity of the nation’s financial system and combat criminal activity. Bringing this charge strikes me as a little odd, because it is basically redundant of the money laundering charge – all money laundering, by definition, is designed to defeat those lawful government functions. I’m not clear why the government thought it needed to add this charge.

I’ll be watching to see if prosecutors expand on this theory once the case is indicted, or if the charge ends up getting dropped.

Protect your Passwords!

One surprising aspect of this case is how the government finally cracked it open. When announcing the charges, the government rightly trumpeted its impressive ability to trace thousands of complex transactions on the blockchain. But their big break in the case came from an old-fashioned source: a screw-up by the defendant. A search warrant of Lichtenstein’s cloud storage account discovered his spreadsheet listing all the crypto account addresses and private keys. That was what ultimately allowed the government to link the defendants to most of these accounts, including the one that still held $3.6 billion of the stolen Bitcoin.

This document was a classic “smoking gun” and finding it was a lucky break for the government. Even I, with my limited Boomer-era knowledge of crypto and blockchain technology, know that you never leave your wallet and key information in a cloud document that someone else might be able to hack. This is sort of the digital equivalent of the masked bank robber who hands the teller a stick-up note written on the back of one of his own business cards.

Okay, true, the file was encrypted, so it’s not quite that bad. But still, for someone as tech-savvy as Lichtenstein, this can only be considered a serious security breach and a real bone-headed move – one that will end up being very costly for him and his wife.

The Crypto Launderer’s Dilemma

Deputy Attorney General Monaco, when announcing the arrests, highlighted another important aspect of this case. The VCEs the defendants used in their alleged laundering activities are financial institutions subject to federal regulations, including AML and KYC rules. The defendants could move cryptocurrency around freely on the dark web and between different unhosted wallets, but ultimately if they wanted to cash out and convert it to dollars or other more readily-usable currencies, they had to deal with one of these regulated VCEs. And it was those VCEs, seeing to comply with AML and KYC rules, that led to some of the accounts being frozen and ultimately led law enforcement to the defendants’ door. As Monaco noted, if the government and reputable financial institutions work together, they can defeat a lot of attempted laundering activity.

Despite the new technology, therefore, these defendants still faced the classic money launderer’s dilemma: you can just sit on your money, but what fun is that? If you want to actually spend and enjoy it, at some point your activity will be detected. Indeed, this is the entire point of the crime of money laundering: trying to figure out a way to do that without attracting attention. Even with the new cryptocurrency technologies, for now, at least, this problem remains for the potential launderer — at least unless and until a lot more online merchants start accepting cryptocurrency as payment.

One of the flowcharts from the criminal complaint showing the path of the proceeds

Things to Watch

There are several interesting things I’ll be keeping an eye on as this case progresses.

Were they involved in the hack? 

The complaint doesn’t allege these defendants were involved in the initial hack that stole the Bitcoin from Bitfinex. It will be interesting to see when more blanks get filled in about the connection between these defendants and the hack itself, and how Lichtenstein ended up getting access to the wallet with the stolen Bitcoin.

One relevant detail is that the hack took place in 2016, which is now outside the five-year statute of limitations. Whoever was involved in that hack – whether it was these defendants or someone else – it may no longer be possible to charge them with that offense.

Why so slow? 

I’m curious why so much of the Bitcoin remained in the original wallet to which it was first transferred, allowing the government to seize back $3.6 billion of it. If the defendants were really aggressively laundering all of the funds, it seems like they could have spread much more of it around into different accounts over the past six years.

The headlines you’ve seen may claim the couple is charged with laundering $4.6 billion in Bitcoin, but the amount they are actually accused of laundering is only a fraction of that. That they may have laundered less than 20% of the stolen Bitcoin is kind of curious. It makes me wonder whether something else was going on – were they working for someone else? Were they authorized to transfer only small portions at a time, perhaps in payment for other services?  There has to be more to this part of the story.

Where Did the Money Go?

Typically in a case like this, you might expect to see the government alleging all of the flashy, expensive things the defendants purchased with their laundered funds – the boats, the art, the fancy cars and homes. There is very little of that in this complaint. There are some references to Lichtenstein using some of the Bitcoin to buy gold and NFTs (non-fungible tokens, a very trendy kind of digital art), but there are few specifics.

The most detailed allegations of where the money went are almost comical: the complaint describe how the defendants used some of the accounts funded with stolen Bitcoin to purchase gift cards for Walmart, Uber, and Play Station worth a few hundred dollars. This is hardly “Wolf of Wall Street” stuff.

According to court papers, there are still hundreds of millions in the stolen Bitcoin that are unaccounted for. Will we learn where it is? Do these defendants have access? The government claims they do – part of the reason prosecutors wanted them detained prior to trial is their fear that, with access to those millions, the defendants might flee the country.

Connecting More Dots

The complaint does a painstaking job of demonstrating that at least some of the crypto stolen in the initial hack ended up in accounts controlled by these defendants. It provides a lot less detail on how that actually happened and who made some of the various transfers. I’ll be watching for the indictment and future court developments to shore up the government’s allegations on this point, including whether any others were involved.

Warren Beatty and Faye Dunaway in 1967’s “Bonnie And Clyde”

Conclusion

This will be an interesting case to watch. I’m struck by the fact that, despite the new technologies involved, the challenges for the aspiring money launderer – and for the government in proving allegations of money laundering — remain largely the same. New wine in old bottles, or something like that.

In the meantime, there’s a Netflix series about the couple already in the works — because of course there is.

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One thought on “The Bonnie and Clyde of Crypto Laundering

  1. Great post.

    But if it is really based on intent and circumstantial evidences, then, leaving that spreadsheet on a cloud (listing crypto account addresses and private keys) may suggest that there is potential for good faith in his conduct. If he was, or is, such a cunning and sophisticated tech-savvy with such illicit intent, how could he done such reckless thing his lawyer may wonder in court ? Such mistake, characterizes rather an innocent person one may argue.

    Thanks

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