What does the U.S. government do with its massive crypto vaults?

summary

• The U.S. government regularly holds auctions of its seized stockpiles of Bitcoin, Ethereum, Litecoin and other cryptocurrencies.

• The auctions began with the 2013 takedown of Silk Road, a dark web marketplace for illegal goods.

• "It could be 10 boats, 12 cars, maybe some bitcoin," said Jarod Koopman, chief of the IRS's cybercrime unit.

The U.S. government has been auctioning off Bitcoin and other cryptocurrencies for years. Historically, Uncle Sam has done a pretty terrible job of timing the market.

Remember in 2018, when the U.S. government sold Riot Blockchain 500 bitcoins for about $5 million? Today, those bitcoins are worth over $23 million. And the 30,000 bitcoins that billionaire venture capitalist Tim Draper acquired for $19 million in 2014? That would be over $1.3 billion today.

The U.S. government seized all of these Bitcoins, along with a number of other common assets one could easily imagine, and they were all sold in a similar manner.

“It could be 10 boats, 12 cars, and then one of the items is X amount of bitcoins,” said Jarod Koopman, chief of the IRS’s cybercrime unit.

Next up, the government will sell $56 million worth of previously confiscated cryptocurrencies at an auction. The cryptocurrencies were seized by authorities in a Ponzi scheme case involving offshore crypto lending project BitConnect. Unlike other auctions, where the proceeds are redistributed to different government agencies, the cash from this cryptocurrency sale will be used to compensate victims of the scam.

The government’s cryptocurrency seizure and sales business has grown so quickly that it has begun looking to the private sector for help managing the storage and sale of its hoarded tokens.

Seizing and storing Bitcoin

For the most part, the U.S. has been using traditional crime-fighting tools to track and capture crypto tokens, some of which are inherently designed to evade law enforcement.

“When it comes to innovation and technology, the government is often more than a few steps behind criminals,” said Jud Welle, a former federal cybercrime prosecutor.

“It’s not something that you’re going to see in your basic training,” Welle added. But he predicted that within three to five years, “there will be edited and updated operations manuals that will inform law enforcement on how to handle encrypted pursuits and seizures.”

There are currently three main stages in the circulation of Bitcoin and other cryptocurrencies in the U.S. criminal justice system.

The first phase is search and seizure. The second phase is liquidation of the confiscated cryptocurrencies. The third phase is deployment of the proceeds from the sale of those cryptocurrencies.

In practice, the first phase is a collective effort, according to Koopman. He said his team often conducts joint investigations with other government agencies. This could be the FBI, DHS, Secret Service, DEA, or ATF.

“A lot of cases, especially in the cyber space, become ... joint investigations because no one agency can do it all,” said Koopman, who worked on the government’s Silk Road case and the 2017 AlphaBay investigation that ultimately led to the shutdown of another popular, sprawling dark web marketplace.

Koopman said his division at the IRS typically deals with crypto-tracking and open-source intelligence, which includes investigating tax evasion, false tax returns and money laundering. His team is made up of sworn law enforcement officers who carry weapons and badges and execute search, arrest and seizure warrants.

Others, with greater funding and resources, focus on the technology component.

"We all come together when there's a need to do any type of enforcement action, whether it's an arrest, a seizure or a search warrant. It could be national or it could be global," he said.

During the seizure, multiple parties are involved to ensure proper oversight. This includes administrators who set up the necessary hardware wallets to protect the seized cryptocurrency.

“We maintain the private keys only at our headquarters so they can’t be tampered with,” Koopman said.

The U.S. government has confiscated record amounts of cryptocurrency in recent years.

“In fiscal 2019, we seized about $700,000 worth of cryptocurrency. In 2020, it was $137 million. So far in 2021, it’s $1.2 billion,” Koopman told CNBC in August. The fiscal year ends on September 30.

With the rise of cybercrime — and the digital tokens that come with it — government crypto coffers are expected to fill further.

Cryptocurrency auctioned in batches

The U.S. Marshals Service is the primary agency responsible for auctioning off the government’s cryptocurrency assets once a case is concluded. To date, the agency has seized and auctioned more than 185,000 bitcoins. Those cryptocurrencies are currently worth about $8.6 billion, though many were sold in bulk at prices far below today’s prices.

It’s a big responsibility for a government agency to shoulder, which is part of the reason why the Marshals Service is no longer tasked with this task alone.

The General Services Administration, an agency that typically auctions off surplus federal assets such as tractors, added confiscated cryptocurrency to the auction block earlier this year.

In July, after more than a year of investigation, the Justice Department hired San Francisco-based Anchorage Digital as a custodian for cryptocurrency seized or confiscated in criminal cases. Anchorage, the first federally chartered crypto bank, will help the government store and liquidate this digital property. The contract was previously awarded to BitGo.

“The Marshals Service is recruiting professionals to help them, and that’s a good sign that this will continue,” said Sharon Cohen Levin, who worked on the first Silk Road prosecution and served as chief of the money laundering and asset forfeiture unit at the U.S. Attorney’s Office for the Southern District of New York for 20 years.

According to Koopman, the process of auctioning off cryptocurrencies in batches at fair market value will likely not change.

“You basically have to line it up to be auctioned off. We don’t want these assets flooding the market, which could affect pricing.”

But Koopman said that aside from spacing out sales, his goal is not to try to “time” the market to sell at price peaks. “We’re not trying to manipulate the market,” he said.

In November 2020, the government seized $1 billion worth of Bitcoin associated with the Silk Road. As the case is still pending, the Bitcoins are sitting idle in a crypto wallet. If the government sold its Bitcoin holdings when the price of Bitcoin reached a high of $67,000 last month, the "crypto vault" deposit would be far higher than if it were liquidated at today's prices.

Where did the money go?

Once a case is closed, the cryptocurrency is converted into fiat currency, which the federal government redistributes. The proceeds from the sale are typically deposited into one of two accounts: the Treasury Forfeiture Fund or the Department of Justice Assets Forfeiture Fund.

"The relevant investigative agency decides which fund the funds flow to," Levin said.

Koopman said his team tracks and seizes about 60% to 70% of the cryptocurrency held by the U.S. Treasury’s forfeiture fund, making it the largest individual contributor.

After the confiscated Bitcoin is placed into one of these two funds, the liquidated cryptocurrency can be put into a variety of projects. For example, Congress can cancel the money and use it for other projects.

“Intelligence agencies can submit requests to get some of the funding for operations,” Koopman said. “We can also submit requests, for example, ‘We’re seeking additional licenses or equipment,’ and then the Treasury’s executive office reviews it.”

Some years, Koopman's group would receive different tranches based on the proposals. Other years, they would get nothing, as Congress would choose to remove all funds from the account.

Tracking the money is not a simple process, said Alex Lakatos, a partner at Washington law firm Mayer Brown who advises clients on forfeiture matters.

The Department of Justice hosts the Forfeiture.gov website, which provides some information on current seizure actions. For example, this document outlines a case in May where 1.04430259 bitcoins were seized from a personal hardware wallet in Kansas. In April, 10 bitcoins were also seized from a resident of Texas. But it is unclear whether this list includes all active cases.

“I don’t think there’s any single place that has all the cryptocurrency that the U.S. Marshals Service holds, let alone the different states that may have seized cryptocurrency. It’s just a hodgepodge,” Lakatos said. “I don’t even know if anyone in the government would want to support this and how they would do it.”

A Justice Department spokesperson told CNBC he was “pretty sure” there was no central database of confiscated cryptocurrency.

But one thing that is clear is that more and more cryptocurrency seizure cases are being publicized to the public, such as the FBI’s cracking of Bitcoin wallets held by the Colonial Pipeline hackers earlier this year.

“In my experience, people who hold these positions at the top of government, they’re probably only there for a short period of time, and they want to accomplish something during that time,” Welle said. “This is the kind of thing that certainly gets the attention of journalists and cybersecurity experts.”

This article is from CNBC, original author: MacKenzie Sigalos

Translator | Nian Yin Si Tang