PYMNTS Crypto Crime Series: Bitfinex Using $3.6B Seized in Hacking Arrests to Cover Shadow Banking Losses

The timing of the arrests of Ilya Lichtenstein and Heather Morgan on charges that they stole $4.5 billion in bitcoin from cryptocurrency exchange Bitfinex in 2016 couldn’t be more auspicious.

In just three weeks, the Department of Justice (DOJ) is set to bring Reggie Fowler to trial for allegedly defrauding Bitfinex in a 2018 scheme that saw the exchange borrow from sister company Tether in order to avoid going belly-up after $850 million in U.S. dollars went missing. That loan from Tether to Bitfinex led New York Attorney General Letitia James to investigate Tether, revealing that its USDT stablecoin was not 100% backed by cash.

The money was allegedly lost by a payments processor Bitfinex used to offramp U.S. dollars to customers as banks were aggressively dropping corporate and consumer crypto customers.

At last count, Bitfinex was still trying to recover much of the $850 million reportedly seized by four foreign governments. As that money may have been used by alleged drug smugglers further up the money laundering line, Bitfinex may need some luck to see its funds again — although the company insists it will get it back in due course.

At least in the case of Lichtenstein and Morgan, the DOJ was able to recover some 94,000 of the 120,000 bitcoins the exchange lost, worth $3.6 billion, it said Tuesday (Feb. 8).

See also: Two New Yorkers Arrested for Alleged Conspiracy to Launder $4.5B in Hacked Crypto

Sophisticated Money Laundering

In the current hacking case, it’s worth pointing out three things: First, Lichtenstein and Morgan allegedly used a wide variety of “sophisticated” crypto laundering techniques, according to the DOJ. This included automating a huge number of bitcoin transactions, sending it through exchanges and darknet markets, exchanging bitcoin for other cryptocurrencies — including “privacy coins,” such as Monero, that are designed to hide the user’s identity — using bitcoin ATMs, and more standard money laundering techniques once fiat was obtained.

Second, the pair was tracked down by blockchain tracing techniques, which investigators from private blockchain intelligence firms like Chainalysis and law enforcement agencies, including the FBI and IRS, use to track down drug dealers, terrorists and child pornographers.

At their core, these techniques rely on the fact that bitcoin and most other cryptocurrencies are not anonymous but pseudonymous — each transaction is recorded on the publicly accessible blockchain. This allows investigators to follow that chain from wallet to wallet, looking for anything that will give a clue to the sender’s identity. This often includes finding a wallet that was used to send BTC to an exchange or other payment processor to receive dollars — a process that can often lead to a name or bank account.

Also read: PYMNTS Crypto Crime Series: When Privacy Counts, Crypto Users Turn to Mixing Services

Third, Lichtenstein and especially Morgan were confident enough in their alleged laundering techniques that they didn’t bother to keep a low profile.

As a journalist, Morgan referred to herself as an “economist, serial entrepreneur, SaaS investor, & rapper.” She wrote articles published on Forbes, notably a June 2020 article titled “Experts Share Tips To Protect Your Business From Cybercriminals.” In that, she interviewed BitGo Chief Compliance Officer Matt Parrella, whose firm was providing security services and blockchain intelligence for Bitfinex at the time of the hack.

In her other identity as rapper Razzlekhan, Morgan referred to herself as “the infamous Crocodile of Wall Street,” adding that she is “more fearless and more shameless than ever before.” Her music she said, targeted “everyone from big software companies to healthcare to finance bros.”

The Shadow Bank

The story of the 2018 theft runs straight through the payments industry, starting with an alleged scheme by shadow bank Crypto Capital Corp. to sneak Bitfinex fund transfers through U.S. banks that had stopped doing business with crypto exchanges. After being booted by Wells Fargo in 2017, Bitfinex turned to very small banks in the Bahamas and Puerto Rico. But even those partnerships didn’t last long as U.S. banks threatened to cut off the offshore banks.

The DOJ alleges that the payments processor then turned to Reggie Fowler, who opened accounts at banks claiming they were for real estate transactions. Fowler, a former limited partner in the Minnesota Vikings, tried to buy the team for $625 million in 2005, but withdrew it after questions about his own finances arose, according to reports.

At the time of Fowler’s indictment, then-U.S. Attorney for the Southern District of New York Geoffrey Berman said he and a partner “allegedly ran a shadow bank that processed hundreds of millions of dollars of unregulated transactions on behalf of numerous cryptocurrency exchanges.”

In doing so, Berman alleged, the pair and the crypto exchanges they were working with bypassed U.S. know your customer (KYC) and anti-money laundering (AML) laws, “and did so through lies and deceit.”

The DOJ also alleged that Fowler worked with Crypto Capital Corp.’s Principal Oz Yosef and President Ivan Manuel Molina Lee to drain $850 million from the funds Bitfinex possessed to pay customers.

Read more: Bitfinex Must Answer NY AG Allegations It Hid Over $800M In Lost Funds

Fowler withdrew from a plea deal in February 2020, and is scheduled to go to trial on fraud and AML violation charges March 1. Yosef and Lee’s indictments was announced on Oct. 23, 2019. At least $350 million of Crypto Capital’s funds were seized by Polish authorities in an alleged and unrelated money laundering scheme. Other funds were seized in the U.K. and Portugal.

Connecting the Losses

To cover its $850 million loss, Bitfinex turned to sister company, the stablecoin-issuer Tether, for a loan. That meant the reserves backing USDT were no longer backed one-to-one by U.S. dollars, as Tether claimed, leading to the NYAG’s lawsuit.

To repay that loan, Bitfinex issued $1 billion of a new cryptocurrency token, UNUS SED LEO, which provided user benefits on the exchange. It has been buying and destroying those tokens over time, raising their value on the market.

Bitfinex had long promised that it would use the 80% of any recovered funds from the 2016 hack to burn more LEO tokens.

Today, UNUS SED LEO is up about 70%.