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Money Laundering and Tax Evasion possible by-products of “Exclusive Mining”

Cryptoasset miners are incentivized to keep transactions secret, said a recent paper, warning that the type of mining called “exclusive” allows them to do so. At the same time, it can also be used for tax evasion and money laundering.

The authors observe that blockchain nodes have no incentive to forward new transactions to their peers. In fact, miners have an incentive to do the opposite and keep transactions secret in the hope of being the only one who can earn the associated transaction fees,” 

said in a paper Dr. Elias Strehle of the Blockchain Research Lab and Lennar Ante of the University of Hamburg.

Following a new blockchain transaction, “the next step usually is to make miners aware of it by having it propagated through the blockchain’s peer-to-peer [P2P] network” – but there is “an unintended alternative to peer-to-peer propagation,” they argue, called “exclusive mining.

Private mining works through a “collusion between a transaction initiator and a single miner (or mining pool),” whereby this initiator sends a transaction through a private channel outside the blockchain immediately to this miner or mining pool, and not through the P2P network. That way, the miner gets the exclusive right to confirm that transaction and collect the reward. Soonest it gets verified, the transaction is already added to the blockchain like any other, and that’s when other people learn of it.

As per the report, there are three possible motivations behind exclusive mining:

  • Reducing transaction cost volatility
  • Hiding unconfirmed transactions from the network to prevent frontrunning
  • Camouflaging wealth transfers as transaction costs to evade taxes or launder money

Since transaction costs represent regular income for miners, significantly increased transaction costs could be used to launder money by colluding with a miner,” said the paper. All of the initiator’s funds can be transmitted to the miner via transaction fees; the miner declares those together with “clean” fees as regular income and then exchanges them to fiat on crypto exchanges.

“While Bitcoin and Ethereum are currently most suitable in this regard, they are also the two blockchains where it is most difficult to mine blocks at regular intervals. […] Criminals may see smaller blockchain networks as more suitable vehicles for money laundering or tax evasion via exclusive mining,” the paper said.

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