Earlier this week, a federal grand jury in Brooklyn returned an indictment criminally charging a self-described “day trader” with various offenses in connection with an alleged computer hacking scheme involving more than 50 online brokerage accounts. The indictment further alleges that the defendant laundered the proceeds of his crimes using Bitcoin, a cryptocurrency.
The indictment alleges that the defendant and others conspired to hack into victims’ online securities brokerage accounts and used them to place unauthorized trades. As a part of the conspiracy, the defendant is alleged to have used brokerage accounts in his name to place “short sale” offers for publicly-traded companies’ stock at artificially high, above-market prices. Simultaneously, the defendant’s co-conspirators are alleged to have hacked into victims’ online brokerage accounts and used them to place buy orders for the stock at the artificially high prices, matching the defendant’s short sale offers. After using the victims’ accounts to purchase the stock, the defendant and his co-conspirators then re-purchased the stock from the victims’ accounts at market or below-market prices. This series of fraudulent trades usually took place within minutes, and the defendant immediately profited based on the difference between his artificially high short sale price, and the lower price at which he subsequently re-purchased the stock. While discussing the scheme in private messages on Twitter, one of the co-conspirators stated: “legal trading too hard.” The defendant responded that he would be a “good trading partner.”
Shortly before the defendant began the securities fraud scheme, he allegedly agreed to pay one of his co-conspirators one-half of his trading profits. Court documents indicate that the defendant was concerned about sending money to his co-conspirator, noting in a message sent via Twitter direct messaging that it was “sketchy but there are ways.” To mask these payments, the co-conspirator instructed the defendant to pay him in Bitcoin. The defendant opened an account at Coinbase, which is an online platform that allows users to convert currency such as U.S. dollars into Bitcoin, and to send and receive payments in Bitcoin. In total, the indictment alleges that the defendant paid his co-conspirator approximately $237,120 in Bitcoin through his Coinbase account. The defendant’s payments to his co-conspirator using Bitcoin is the basis for the indictment’s conspiracy to commit money laundering in violation of 18 U.S.C. section 1956(h).
Numerous government agencies have expressed concern that the anonymous nature of Bitcoin and other virtual currencies facilitates money laundering and other illicit activity. Most recently, the Drug Enforcement Administration published a report that drug trafficking organizations are increasingly using virtual currencies to enable easy transfer of illicit funds internationally, and that Bitcoin is also being used to facilitate trade-based money laundering schemes, particularly those based in China.
In addition to money laundering, Bitcoin and other virtual currencies can readily facilitate tax evasion by users. In 2013, the U.S. Government Accountability Office issued a report concluding that “some taxpayers may use virtual economies and currencies as a way to evade taxes. Because transactions can be difficult to trace and many virtual economies and currencies offer some level of anonymity, taxpayers may use them to hide taxable income.” In 2014, the Internal Revenue Service published guidance on the tax consequences of the use of virtual currencies, making clear that Bitcoin and similar currencies are property for tax purposes, and a taxpayer can therefore have gain or loss on the sale or exchange of a virtual currency, depending on the taxpayer’s basis.
In late 2016, a federal judge authorized the IRS to serve a “John Doe summons” on Coinbase – the same virtual currency exchanger used by the day trader charged this week in the case described above – seeking information about U.S. taxpayers who conducted transactions in virtual currency during 2013, 2014, and 2015. In court documents, the Justice Department stated that Coinbase was the fourth largest exchanger globally of Bitcoin and the largest exchanger in the United States. The Justice Department further stated that Coinbase offered buy/sell trading functionality in 32 countries, maintaining over 4.9 million wallets with wallet services available in 190 countries, serving 3.2 million customers, with $2.5 billion exchanged in Bitcoin. According to the IRS, only 2,500 taxpayers reported transactions in Bitcoin on their U.S. income tax returns during the three years in question, as compared to nearly 500,000 U.S. customers reported by Coinbase during the same period. Coinbase has vigorously resisted the John Doe summons, and the matter has been in litigation for the past year. Just yesterday, the federal judge overseeing the litigation indicated in a hearing that she is inclined to permit the IRS to proceed with its investigation of Coinbase customers.
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