The dark side of cash

During last week's G20 summit in Turkey, representatives from the G7 Canada, France, Germany, Britain, Italy, Japan and the US reportedly excused themselves from proceedings to hold a meeting behind closed doors.

Now, it usually takes something pretty special to gather leaders from seven of the world's most powerful nations around a table perhaps an urgent diplomatic incident, or an imminent economic crisis.

But, this time, there was something rather different on the agenda: how to tighten their grip on digital currencies.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

For months now there have been rumours that Isis has dabbled with virtual currencies such as bitcoin to fund its criminal activities. These have intensified now that a prominent hacktivist group has come forward with a striking new claim. The Ghost Security Group says that it has managed to track several bitcoin addresses related to the terrorist organisation one of which contains a whopping $3m-worth of bitcoins.

This isn't the sort of news that governments are going to take lightly particularly given that Brussels remains in lockdown', and Europe's terrorist threat dial has been cranked up to severe'.

And the G7 isn't the only international body looking to clampdown on the illicit use of technology. On Friday, EU countries held a "crisis meeting" in Brussels at which they urged the European Commission to crack down on non-banking payment methods.

The EU specifically pinpointed virtual currencies as an area of concern, stressing that they will be "subject to particular attention" in the fight against money laundering and terrorist financing.

Does Isis really use bitcoin?

You see, with bitcoin, every transaction is recorded on the blockchain. It's attractive to criminals, because these records are branded with a digital code rather than personal details. You might be able to track them from wallet to wallet you just won't know who those wallets actually belong to.

If you're trying to keep your transactions secret, this works a treat. But there comes a point in the process at which you will probably want to exchange the virtual currency for a more conventional one. Once you reach this stage, using bitcoin becomes no more secret than using part of the conventional banking system. That's not enormously helpful to those using the technology for dodgy dealings.

Moreover, bitcoin is far more volatile than any other currency. It would make the system tricky to use on a practical basis. Even groups like Isis have little interest in using a means of payment that can lose half of its value in just one day.

The appearance of doing something'

In October, the UK government published its first-ever risk assessment of money laundering and terrorist financing. The document ranked virtual currencies as a "low" risk. The traditional banking system was deemed a "medium" risk. And cash was labelled as "high" risk.

The two reactions are pretty incongruous. It suggests one of three things: the original report is wrong, new information has since come to light, or the current furore over bitcoin is a political move.

Financial journalist Martin Tiller argued the latter on Nasdaq's blog this week, where he suggested that politicians need to give the impression that they're doing something' anything to combat the threat of terrorism. Tiller notes:"We all know that fear sells and we instinctively know that people are most scared of things that they do not understand. A scary story about virtual currency, therefore, is almost bound to generate views and clicks, and addressing those fears makes the politicians look like men of action; just what the voters want to see."

Regulation stifles innovation

President of the CDC, Perianne Boring, said that despite its slightly shady reputation, bitcoin is actually one of the most transparent currencies available. It's not anonymous merely pseudonymous:"This gives law enforcement a greater chance at following, tracing, and ultimately apprehending criminals that use bitcoin, as opposed to cash, where there is no digital trail."

The appeal of cash

The organisation is understood to have a number of international bank accounts, but deals primarily in cash. It uses so-called "backdoor banking" whereby operatives travel to states bordering Isis strongholds to make cash transfers.

Analysts also suggest that, until now, it has tended to use US dollars partly because of their proliferation worldwide, and the currency's relative stability compared to regional markets.

What does this mean for us?

If international organisations are really serious about tackling terrorist funding, it could be bad news for paper money.

Bloomberg View columnist Leonid Bershidsky makes an interesting point:"Cash use is shrinking in the developed world, anyway. So perhaps attempts to cut off terrorist funding will usher in a cashless financial system earlier than it would have developed by itself."

It will be worth keeping an eye on the subject of terrorist financing, which could open a whole new front on the government's war on cash.