The ghastly events of this past month raise again some troubling questions: Does crypto have a terrorist fundraising problem? Are its networks really being exploited by terrorists to wreak global havoc? If so, what must it do better?

On the other hand, maybe the problem is one of perception — more appearance than reality — because public blockchains, after all, are transparent and traceable. In that event, how does the industry turn around a less-than-sterling reputation?

Cryptocurrencies like Bitcoin ( BTC ) have been associated with illicit activities almost from their inception. This image has been difficult to shake, even as analytical groups like Chainalysis assert that “terrorism financing is a very small portion of the already very small portion of cryptocurrency transaction volume that is illicit.”

But in early October, the world awoke to Hamas’ incursion into southern Israel, and shortly after, Israeli police announced it had frozen cryptocurrency accounts used by Hamas as part of its ongoing efforts to locate the “financial infrastructure in cryptocurrencies used by terror entities to fund their activities.”

A week later, a group of 28 United States senators and 76 Congressional representatives — led by Senator Elizabeth Warren — sent a letter to high-level Biden administration officials asking what steps are being taken “to address the use of cryptocurrency by terrorist organizations.”

The Congressional letter to President Biden’s administration. Source: U.S. Senate

So once again, the industry finds itself on the defensive as governments, legislators and even asset managers are asking: Are crypto’s networks again being exploited by the worst of the worst?

“Out of proportion to the facts”

“If any terrorist organization is using crypto for fundraising, then I’d argue it’s a problem,” Cody Carbone, vice president, policy at the Chamber of Digital Commerce, told Cointelegraph. But recent reports, including those appearing in The Wall Street Journal and later cited in the Warren coalition’s letter, were inaccurate. Carbone said: 

“I believe the numbers being used by WSJ and Senator Warren’s coalition are skewed or downright incorrect. According to Chainalysis, of the roughly $82 million in cryptocurrency received by the WSJ posted address, about $450,000 worth of funds were transferred from the known terror-affiliated wallet.” 

Kristin Smith, CEO of the Blockchain Association, told Cointelegraph: “We view the hysteria around the links between crypto and Hamas as out of proportion to the facts.” Like Carbone, Smith said any funding of terrorist organizations “is too much,” but she also asked why the focus of some legislators and policymakers was so narrow. 

“Why not ask the [Biden] administration for details on ALL sources of Hamas funding? We want the entire picture, which would put the role of digital assets into proper perspective.”

One often hears this argument from industry supporters. Crypto’s contribution to terrorist coffers — whether those groups are based in North Korea, Iran, Lebanon or Gaza — is trivial compared to the volumes raised via fiat currencies that use more traditional means of transfer. 

“Terrorist organizations have historically used and will likely continue to use traditional, fiat-based methods such as financial institutions, hawalas , and shell companies as their primary financing vehicles,” said Chainalysis in an Oct. 18 blog.

“The reality is that this [crypto] is just a tiny piece of the larger terror financing puzzle,” Ari Redbord, global head of policy and government affairs at TRM Labs, told Cointelegraph. What about nation-states like Iran? Or global mega-donors? Or Hamas raising millions through taxing Gaza residents? “Crypto plays a tiny part in all this.”

There’s an irony at play here, too. Raising illicit funds via public blockchains like Bitcoin or Ethereum is actually a boon for law enforcement agencies. Modern analytic techniques employed by specialty firms like Chainalysis, Elliptic and others often make it easier to identify and seize funds bound for designated terrorist groups.

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“What’s missing from the conversation is that our ability to track and trace on open blockchain has far better than anything we are able to do with fiat,” said Redbord. Tracing illicit funds through shell companies or stolen art is much more problematic. By comparison, “blockchain allows for tracking.”

“Previous efforts of law enforcement and private industry [...] have been successful in detecting Hamas’s terrorist financing activity on the blockchain — leveraging the transparency of crypto assets to freeze and confiscate related funds,” Elliptic’s David Carlisle wrote in an October 11 blog.

In fact, Hamas said in April that it was giving up crypto-related fundraising and would no longer receive funds via Bitcoin, “citing an increase in ‘hostile’ activity against donors,” reported Reuters.

“The industry needs to be more vigilant”

But even a relatively small amount of crypto usage by Hamas, Palestinian Islamic Jihad (PIJ), et al. appears to be enough to stir the waters. 

“There is an opportunity to address this issue constructively,” Carbone told Cointelegraph, “but I fear that some anti-crypto policymakers in Washington are using the crisis to push their agenda and significantly restrict crypto use in the U.S. or eradicate it completely.”

Chainalysis’ analysis of a wallet suspected of terrorism financing found 20 suspected service providers. Source: Chainalysis

How does one set the record right then? More education and more data answered Carbone. “More education on how blockchain technology is a terrible tool for terrorists because of its public nature, but also identify the pain points.”

Some steps need to be taken. The industry still has to deal better with the dangerous use of mixers and tumblers that can hide wallet addresses from law enforcement agencies by developing better cybersecurity controls and operational risk procedures, said Carbone. “Everyone in the industry needs to be more vigilant. We also need more data to identify how serious the problem really is.”

There are signs that some of these things are already happening, added Redbord. Binance has recently been working with Israeli authorities to freeze the crypto accounts of a number of terror-designated groups, including PIJ and Hamas, for instance.

It wouldn’t hurt to be more assertive in the court of public opinion, too.

“We believe crypto is here for good,” said Smith. “The technology is neutral, the protocols are open and can be used by anyone, just like the internet itself. As time goes on, given its ability to lower financial barriers, protect Constitutional rights to privacy, and finally provide an opportunity for users to claw back power from Big Tech and its monopoly over our digital lives, the value of crypto to humanity will become self-evident.”

Is reform crypto legislation in the U.S. dead for now?

But the conflagration in the Middle East may have already torpedoed prospects for comprehensive crypto reform legislation in the U.S. — at least for now.

Analyst Mark Palmer from Berenberg Capital markets was one of the first to warn of the potential impact of political headwinds from the Israel–Hamas conflict on the crypto reform efforts in the U.S. More recently, Palmer told Cointelegraph:

“Coinbase is likely facing an uphill battle in its effort to lobby Congress in the hope that it would draft legislation that would bring regulatory clarity around the question of whether crypto tokens are securities or not, especially now that recent media reports have put a spotlight on how Hamas used crypto as a means of fundraising in recent years ahead of its attack on Israel.”

Palmer wasn’t really surprised to find crypto opponents redoubling their efforts now to crack down on it in Washington, DC. What’s more alarming, though, is that “the reports appear to have encouraged more lawmakers to join in that effort.”

In other words, momentum could be building against the industry. “None of this is helpful to Coinbase’s cause as it seeks to better position itself in the U.S., and now the potential for new legislation that could undermine the company’s prospects appears to be growing,” Palmer said.

Is it too soon to say that reform legislation in the U.S. is dead on arrival?

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“Not dead,” said Carbone. “But we’re running out of time. Forget the chaos of the speakership; we’re nearing the end of the year, the government needs to be funded again next month, and there are other priorities. And then it’s an election year.”

Carbone says there’s still a chance for stablecoin legislation, but even that will likely need “to be traded for either a non-crypto bill — safer banking, credit card legislation — or paired with an illicit finance bill.[...] The issue is becoming more partisan.”

Ultimately, it is voters who will decide, Smith concluded. “Industry builders should continue to build applications that are of mainstream, tangible value to society. Policymakers ultimately serve their voters. The more voters want to use this technology, the better chance we have of protecting it.”