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How ICO’s were used for money laundering in China

October 27, 2017

At the Legal Tech panel, I made a statement that one reason the Chinese government cracked down hard on ICO’s was because ICO’s allowed for money laundering in ways that were impossible with BTC and ETH alone, and when someone asked me to explain why, I gave a bad explanation.

First of all, it’s important to point out that the money being laundered was “gray money” and not “black money.”  We aren’t talking about drug money or terrorist money, but merely some super-rich guy in China or Russia that perhaps wasn’t all that diligent about filing taxes, and also may have been an official with extra sources of income.

The fact that the money was “gray” rather than “black” is important because the ultimate destination of the money was Australia, Europe and the United States, and Western countries are extraordinarily welcoming of this type of money, provided you are willing to pay your taxes. You use this money to move your money to the West, where you will get citizenship and as long as you are taxed people will take your money with open arms.  Funny thing about US/UK/AU anti-money laundering law.  If you are a rich person that moves “gray money” into those countries and you declare it for tax purposes, then you have broken no laws.  It’s against US/UK/AU law for a Western company to bribe an official, but it turns out not to be illegal under US/UK/AU law to be a foreign official who has received a bribe.  It’s also not illegal to pay a bribe as an individual.  Funny that.

So it’s important to not get too moralistic about this, since Western countries are more than happy to take the money and the tax revenue associated with this.

Also there is an entire industry private banks, consultants, and lawyers that is involved with moving this money, and so what happened was that money that used to go through private banking and VC firms just got switched over to ICO’s.

So lets start with why it doesn’t work just with bitcoin and ethereum.  If you want to move USD 2 million out of China, then fine.  You find a bitcoin or ethereum broker, you buy and sell ethereum and your money is out, and the only problem is that there are a dozen ways of moving USD 2 million that are easier and cheaper than cryptocurrency.

The problem comes when you want to move USD 30 to 100 million out.  At that point Chinese bitcoin/ethereum exchangers won’t touch you.  The reason is that if you are USD 2 million, you are “ordinary rich.”  If you are trying to move USD 30 to 100 million out and you don’t want the Chinese government to know, then there is a very, very high chance that you are someone that the anti-corruption people at the Communist Party will find interesting.  So if you help someone move USD 100 million out of China, and the CCP can’t put that person in jail because they now are living in New York City with American citizenship, they will put you in jail.

It’s also the situation that it’s hard to disguise buying USD 30 million in ethereum.  What’s worse is that if you *try* to disguise it, then you’ve just put a big target on your back when the anti-corruption people come around and haul you to jail.

So ICO’s changes the equation….

First of all, it’s important that the people running the ICO’s are typically not Chinese and don’t live in China.  That means that if things go bad it’s going to be difficult to toss someone in jail.  They have to hire some local people to help run the ICO, but the person in China can claim (honestly) that they were just small fish and weren’t really involved in the decisions.

The way the ICO transaction works is that you have a smart contract that creates tokens in response to a deposit of ethereum.  So you have a rich guy make a deal with the ethereum promoter.  The rich guy will buy some ethereum send it over to the ICO, get tokens, and the ICO will end sell some of the ethereum back to the rich guy, who will then move it into the ICO.  Also, all of the transactions between the ICO and the rich person gets split up, and there is this huge stream of non-rich people trying to buy the ICO so that all of the money gets mixed in.  You can also deal with a promoter in Mainland China who promised a lot of small investors, and this lets them mix big fish money with little fish money, and unlike your normal OTC bitcoin trader, the promoter likely has plane tickets to the United States all ready.

So at the end of this the ICO has a bunch of money in a Chinese bank account.  The Chinese official has a bunch of tokens that they can sell once they arrive in the US.  At that point the ICO can spend the money to hire programmers and do other business in China, and the Chinese government has no way of tracing the original source of funds.  It’s worth noting that all this works better if the ICO is in fact going to spend their money on something useful.  You can try to do a simple “pump and dump” but then you run into the problem that if the ICO looks like they are just going to take the money and run, the Chinese rich person doesn’t know whether to trust the ICO.

One thing about this system is that it’s really difficult to figure out where to regulate it to stop the flow, so what ended up happening was that it was such a mess, that the Chinese government just put a stop to this.  It’s like the “I won the money in Macau” excuse.  That stopped working when the Chinese government made it clear that it wasn’t going to try to figure out who really won money in Macau, and if you were a Chinese official that set foot in Macau, you were finished.  They did the something for ICO’s.

Also this probably ended quite badly for the Chinese rich person.  Not only were the ICO’s shut down, but also the Chinese government forced them to turn over all records, and this isn’t the Italian mafia with a code of silence.  Once it’s clear that you didn’t get out in time, and that you are going to be in jail for a very long time if you don’t cooperate, then people start naming names.



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