How to trace stolen bitcoin? The answer may be a 200-year-old U.K. law

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A Cambridge professor has found how a 200-year-old legal ruling can be used to trace stolen bitcoins, thus potentially making it easier for governments to legislate bitcoin exchanges.

Bitcoin isn’t only attractive for libertarians and technophiles: It has also opened many opportunities for online criminals. It is an easy, relatively anonymous way to facilitate extortion payments, for example in the case of ransomware, while cases of bitcoin thefts have led to thousands and in several cases millions of pounds worth of the digital currency being stolen.

It is therefore natural that many governments have attempted to regulate bitcoin exchanges, where bitcoin and other cryptocurrencies can be traded for "real" money. The easy part of this is the enforcement of know-your-customer rules, which require users of exchanges to prove their identity.

But how does one go about recovering stolen (or illegally obtained) bitcoins from such exchanges? Unlike banknotes, bitcoins don’t come with identification numbers that would allow one to determine which bitcoin had been stolen and thus shouldn’t be accepted by an exchange.

But an important feature of bitcoin is that all transactions are traceable. Ross Anderson, professor of Security Engineering at Cambridge University, found an 1816 court ruling set an interesting precedent to determine which bitcoins can be traced back to a theft.

In the court ruling, which dealt with matching deposits and withdrawals in a bank that had gone bust, it was determined that a first-in-first-out (FIFO) rule was to be applied: Withdrawals from an account are drawn against the deposits first made into it.

This is immediately applicable to bitcoin: if someone steals 10 bitcoins and then obtains 10 other bitcoins through legitimate means, the purchases up to a value of 10 bitcoin are deemed to have come from the stolen bitcoins; any purchase thereafter would have been paid from the legitimately obtained bitcoin.

And because of the traceability of bitcoin, those stolen bitcoins can be followed as payments continue to be made.

This can be used by regulators to "taint" stolen bitcoins and to require exchanges to refuse to purchase any such tainted bitcoins. This would then likely force anyone wanting to accept payments in bitcoin to check those same blacklists for tainted bitcoin and thus would lead to some separation between the legitimate and illegitimate uses of bitcoins, as well as other cryptocurrencies that share bitcoin’s traceability.

But cryptocurrencies and the attempts to regulate them are still very much a work in progress.

This ruling, if it were to be applied to bitcoin, could be an important step in making bitcoin more viable as a payment method. A method that, thanks to the traceability, could actually hinder illegitimate use rather than support it.

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Bitcoin Compliance U.K.