Preventing Terrorist Financing Through Regulation

Terrorist organizations have increasingly turned to cryptocurrency for fundraising. For example, Hamas, a group designated as a terrorist organization by the U.S. Department of State, received $41 million through cryptocurrency transactions between 2020 and 2023. The State Department fears that Hamas has resumed actively soliciting cryptocurrency contributions to fund its current conflict with Israel.

How can policymakers cut off this rising source of terror financing? According to three scholars, private regulation may address the significant national security concerns raised by cryptocurrency.

In a forthcoming article, Emily Fletcher and Charles James Larkin of Johns Hopkins University and Shaen Corbet of Dublin City University investigate the relationship between the regulation of cryptocurrency—which can facilitate anonymous financial transactions across the globe—and terror financing. They observe that numerous federal agencies have attempted to regulate cryptocurrencies through a patchwork of different regulations. None of these measures have prevented cryptocurrencies from reaching terrorist pocketbooks, according to Fletcher, Corbet, and Larkin.

Rather than attempting to regulate the unique properties of cryptocurrency through ill-equipped public agencies, Fletcher, Corbet, and Larkin argue that the international community should facilitate a private regulatory regime that could address the transnational and anonymous nature of cryptocurrency transactions.

Cryptocurrencies, such as Bitcoin, facilitate digital, peer-to-peer transactions without the need for a bank or other financial intermediary. Parties to a transaction can deposit “coins,” or unique lines of code which represent a unit of cryptocurrency, into another user’s “wallet,” a sort of digital bank account where people can store their cryptocurrencies. Blockchain technology validates and records the transaction creating a secure financial network.

Terrorist organizations use Bitcoin and other cryptocurrencies for several reasons, according to Fletcher, Corbet, and Larkin. First, cryptocurrency allows terrorists to pay for goods and raise funds anonymously. Even though law enforcement and financial regulators can trace a crypto transaction to a specific computer, regulators may struggle to identify the actual user of that computer.

Second, Fletcher, Corbet, and Larkin point out that because cryptocurrency transactions do not use traditional financial intermediaries—such as banks—terrorist organizations can bypass several regulatory safeguards that focus on these traditional financial intermediaries.

Finally, anyone with a computer can navigate the cryptocurrency marketplace, making it a cheap and easy method of soliciting donations for terrorists.

Concerned with the use of cryptocurrency by terrorist organizations, regulatory agencies such as the U.S. Securities and Exchange Commission (SEC), the U.S. Department of Treasury, and the U.S. Commodity Futures Trading Commission (CFTC) have issued regulations aimed at preventing terrorist organizations from using cryptocurrency. But Fletcher, Corbet, and Larkin argue that cryptocurrency’s unique properties renders these regulations either illegal or ineffective.

For example, the Treasury Department issued guidance stating that the Bank Secrecy Act can regulate cryptocurrency businesses as money services businesses (MSBs). The Bank Secrecy Act places substantial reporting requirements on entities classified as MSBs, including mandatory reporting of transactions over $10,000.

Even though regulating cryptocurrency servers as MSBs would expose numerous transactions to financial regulators, Fletcher, Corbet, and Larkin argue it will still prove ineffective at preventing terrorist financing for at least two reasons.

First, cryptocurrency companies may challenge the legal basis of the Treasury guidance. The Treasury Department’s guidance relies on characterizing cryptocurrency as a “currency” under the Bank Secrecy Act. Because very few countries accept cryptocurrency as legal tender, cryptocurrency does not meet the legal definition of currency, these opponents argue.

Second, the Bank Secrecy Act only requires MSBs to report transactions over $10,000, so terrorist organizations could engage in smaller transactions to avoid law enforcement and regulators claim Fletcher, Corbet, and Larkin.

Fletcher, Corbet, and Larkin argue that other attempts to regulate cryptocurrencies under current regulatory regimes suffer similar problems,.

For example, CFTC considers cryptocurrency a commodity and subject to reporting requirements under the Commodities Exchange Act. Fletcher, Corbet, and Larkin point out that the Commodities Exchange Act, however, does not regulate transactions under $5,000 or cash transactions. The SEC has attempted to regulate Bitcoin as a security, but Fletcher, Corbet, and Larkin argue that Bitcoin likely does not meet the legal definition of a security because it is not an investment in a company.

Concluding that existing regulatory regimes fail to prevent terror financing, Fletcher, Corbet, and Larkin propose a novel method of regulating  cryptocurrency.

Rather than state regulatory agencies struggling to monitor transactions between anonymous users located around the world, one international organization could oversee a system of self-regulation by cryptocurrency companies themselves, according to Fletcher, Corbet, and Larkin.

Under Fletcher, Corbet, and Larkin’s proposal, a company such as Bitcoin would regulate user activity through updated user contracts. A private, international organization would regulate cryptocurrency companies by requiring their user contracts meet certain standards for the company to receive accreditation, they posit. For example, these standards could address required disclosures, they argue, such as of the user’s identity.

States could support this regime, Fletcher, Corbet, and Larkin claim, by requiring accreditation for Bitcoin and other companies to operate within their borders and agreeing to issue fines and other sanctions against companies that the international organization found noncompliant.

Fletcher, Corbet, and Larkin argue that their proposal provides several benefits over the existing regulatory regime. An international organization can better address the transnational nature of cryptocurrency transactions compared with a state agency, they claim. Furthermore, facilitating a system of self-regulation by companies such as Bitcoin will likely save states substantial resources, according to Fletcher, Corbet, and Larkin.

They also point to research indicating that over 70 percent of people prefer their personal data to be stored by private companies than by state actors. A reporting system operated by a private organization will likely generate more accurate user data, Fletcher, Corbet, and Larkin claim.

Fletcher, Corbet, and Larkin propose an entity like the Worldwide Web Consortium serve as a model of an international organization uniquely suited to oversee cryptocurrency regulation. The Consortium already handles a variety of emerging technologies, they argue, and its global reach would maximize compliance. They conclude that authorizing decentralized, private regulation through the Worldwide Web Consortium will optimize compliance and best prevent terror financing.

Fletcher, Corbet, and Larkin ultimately claim that without a significant shift toward private regulation, Bitcoin and other cryptocurrencies will continue to pose significant national security concerns.