Binance Freezes Hacked Cryptopia Funds, Raises Questions Around Cryptocurrency Fungibility

Part of the funds from the Cryptopia hack were recently sent to the Binance cryptocurrency exchange. In response, Changpeng Zhao (CZ), the CEO of Binance froze the funds, raising questions around cryptocurrency’s anonymity and fungibility.

Cryptopia is a tiny exchange with a daily trading volume averaging around $2 million. The exchange was hacked on the evening of Jan. 13th for an estimated $3.5 million in cryptocurrency. The company announced the hack on Jan. 15th.

Now, the hackers are likely looking for ways to launder, convert, and obfuscate the source of these funds. Especially now that authorities in New Zealand are involved.

As part of this process, the hackers sent 31,320 Metal (MTL) ERC20 tokens to Binance. Trading at approximately $0.24 at press time, this amounts to roughly $7,500 in stolen cryptocurrency. After receiving a tip-off on Twitter, Changpeng Zhao immediately froze the funds:

Implications for Fungibility

Fungibility, as it applies to cryptocurrency, is the concept that any given coin is identical and substitutable for any other coin in the same denomination. To give a non-cryptocurrency example, an ounce of pure gold is equivalent to any other ounce of pure gold. Correspondingly, someone might think that one bitcoin is equivalent to any other bitcoin.

The problem boils down to traceability. If that bitcoin is tainted by money laundering or criminal activity, then it is not equivalent in value or utility to another ‘clean’ bitcoin. These tainted coins could result in blacklisting on exchanges. If they are found to be involved in criminal activity, future receivers could face legal consequences.

Frozen Funds Demonstrate Non-Fungibility

There is no doubt that freezing the hackers’ funds were justified. Exchanges should collaborate to inhibit illegal activity and make it as difficult as possible to engage in harmful criminal behavior.

Yet, the very fact that Binance was able to identify the stolen funds and freeze them at all could be cause for broader concern.

If someone receives $20 in cash, the previous owners of that cash are largely untraceable. If someone receives $20 in bitcoin, all previous wallet addresses attached to that transaction are visible. And, if bitcoin is treated as a commodity, then this could have interesting legal ramifications.

If someone unknowingly receives illicit funds, how will law enforcement treat these cases, and who does the onus for checking fall on?

For other commodities, if stolen goods are purchased unknowingly, law enforcement has the right to seize those goods and return them to the original owner. Those who intend to resell goods have an even higher responsibility to evaluate whether purchased goods are stolen.

Yet, it’s still unclear whether exchanges, businesses, and individuals need to go through similar processes. If they do, it introduces yet another complication and cost for transacting in cryptocurrency.

Potential Solutions

Privacy coins such as Monero and Zcash offer one potential solution: using technology to obfuscate transaction history.

But, both of these coins need to catch up to the network effects already established by Bitcoin and Ethereum—which are already accepted at a larger—albeit still limited—number of vendors. Moreover, there is still a non-zero risk that regulators succumb to the public perception that these coins are used by “criminals and tax-evaders,” and place a blanket ban on privacy coins.

Other ways crypto users have tried to limit personal liability include maintaining anonymity between wallet addresses and personal identification, using new wallet addresses for each transaction, using cryptocurrency mixers, washing coins in a loosely regulated exchange, or other systematic ways for obfuscating the transaction history of funds before making a purchase. Whether these activities fall into a legal gray area is another question.

There still isn’t a clear solution to the issues of fungibility. Until then, it is likely that, over time, regulators and law enforcement will set a clearer precedent through doled-out enforcement actions.

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