It is customary for government officials around the world to profess their disdain for crypto on the grounds that it is widely used to facilitate crime and finance terrorism. Although (government-backed) cash still remains criminals’ preferred financial tool by a wide margin, it is true that nefarious actors also turn to digital assets. When corrupt plans go sideways, law enforcement and other government agents can find themselves in possession of hefty sums of crypto.

It appears that reports of such instances are becoming more common as crypto adoption widens. In August alone, the United States Department of Justice announced the “largest-ever seizure of terrorist organizations’ cryptocurrency accounts” and a Tokyo court ordered Japan’s first-ever seizure of digital assets in a precedent-setting ruling. How do officials go about confiscating crypto, and what implications do their actions have for the contentious relationship between government institutions and the world of decentralized finance?

Source of state revenue

Regardless of how various states define cryptocurrency legally, they are still faced with addressing economic activity that involves borderless digital money. In the most frequently occuring scenario, crypto is seized alongside other property belonging to the exposed criminals.

Oftentimes, government institutions do not have the expertise or specific rules for crypto in place, so they have to deal with it ad-hoc. For example, when the Latvian tax authority seized Bitcoin (BTC) from a convict for the first time, reports emerged that officials let it sit in the criminal’s wallet even after having secured access to the funds.

Recognizing that cryptocurrency seizure done right could make for a steady flow of revenue, some jurisdictions are amending the rules around property confiscation to accommodate digital assets. In Russia, a somewhat controversial bill is in the works that would equip law enforcement agencies with a mechanism to forfeit crypto. The new rules could come into effect as early as 2021.

Other governments are finding creative ways to profit from digital money. A bill currently under consideration by the state of Illinois extends the list of assets that can be considered abandoned property and eventually claimed by the state treasury.

Cars, boats and crypto

In the United States, when law enforcement seizes cryptocurrency involved in illegal activity, it is generally auctioned off in largely the same manner as other seized assets. U.S. crypto lawyer Dean Steinbeck told Cointelegraph, “It is common to see law enforcement agencies like the U.S. Marshals Service (USMS) sell cars, boats and crypto to the highest bidder. I believe in February 2020 the USMS auctioned over 4,000 BTC.” Steinbeck added that he was not aware of any specific rules governing liquidation of seized crypto that are distinct from those of other asset types.

Jorge Pesok, a counsel in digital assets practice at law firm Crowell & Moring, told Cointelegraph that U.S. Marshals have authority over any property that has been forfeited under laws enforced or administered by the Department of Justice and its investigative agencies. Pesok said that there are experts at USMS who can handle pretty much any kind of confiscated property:

“It is unlikely that cryptocurrency specific liquidation rules will be developed, or need to be developed, because the Complex Asset Team within the USMS Asset Forfeiture Division is tasked with disposing of assets that require specialized knowledge and expertise, including operating businesses, stock and bonds. They now have added cryptocurrencies to the list.”

Elsa Madrolle, international general manager at blockchain security company CoolBitX, said that the liquidation of digital assets may be quite challenging due to a variety of factors ranging from “delays in prosecution to custody requirements to wildly fluctuating asset values.” Still, Madrolle noted, it’s estimated that well over $1 billion of digital assets have transited through the U.S. Marshals agency.

In 2013, when the online black market Silk Road was taken down, the U.S. government even became a top 10 Bitcoin holder. Madrolle added that auctioning off crypto is fairly common outside of the U.S., and some governments rely on well-known consulting companies as intermediaries in the process:

“Many other countries have also used auctions to sell seized digital assets: Australia (who opted to use Ernst & Young to do so), South Korea, the U.K., Bulgaria (using Deloitte), etc. In other countries, seizing digital assets is fairly new. In Taiwan interestingly, price volatility interrupted an attempted auction in 2018 and the courts opted to liquidate the seized Bitcoin instead.”

Effects on the market and beyond

Opinions diverge on how consequential the movement of seized crypto funds is for the digital asset market. Dean Steinbeck opined that the amount of digital assets moved around by law enforcement agencies is “typically tiny compared to the global marketplace.” At the same time, he doesn’t believe that government agency activity could have a significant impact on Bitcoin or other liquid cryptocurrencies.

In contrast, Madrolle pointed out that U.S. government agencies seem to be concerned with the potential repercussions of releasing extra liquidity into the crypto market. In 2016, the U.S. Marshals Service even signed a memorandum of understanding with the Treasury Executive Office for Asset Forfeiture and has been holding auctions to sell seized Bitcoin at regular intervals to limit impact to the market.

Madrolle thinks that the sentiment driving this policy is the most important takeaway here: By reinjecting seized crypto back into the system in a non-disruptive way rather than removing them from the marketplace altogether, law enforcement agencies globally “recognize them as a genuine asset.”

Steinbeck largely agreed with this interpretation, saying that government-backed auctioning are sending a “signal to the marketplace that they view cryptocurrency as a legal asset,” which is a small but positive step:

“Consider for a moment that law enforcement does not auction off the marijuana or cocaine it seizes. Illegal contraband is destroyed. So at least at the most rudimentary level law enforcement agencies are signaling that they view cryptocurrency as legal assets and they have no legal, moral or ethical issues selling and distributing as part of their routine operations.”

Indeed, there is some indication that in rare cases when government agencies oppose digital assets ideologically, such considerations can outweigh the obvious monetary benefits. One example is the Finnish Customs’ refusal to auction off some 15 million euros ($18 million) worth of Bitcoin due to the belief that it would go straight into the money laundering ecosystem.