On November 7, 2022, the US Attorney for the Southern District of New York announced that James Zhong (“Zhong“) plead guilty to one count of wire fraud for stealing over 50,000 Bitcoin (valued at the time of seizure at over USD 3.36 billion) from the now defunct Silk Road dark web marketplace. Zhong has not yet been sentenced but could face a maximum of 20 years in prison. This marks yet another major victory for the US government in its continued battle against crimes involving blockchain technologies and highlights the US government’s resolve and ability to investigate and prosecute these crimes.
The Scheme
Zhong’s crime dates back to 2012 and involved a simple, yet effective, fraud against the Silk Road marketplace, described in detail in this affidavit.. Silk Road was notorious for facilitating the purchase and sale of illegal substances on the dark web, notably drugs, weapons and stolen items. When Silk Road was active, each user was required to register for an account and Bitcoin was the only possible method of payment.
In September 2012, Zhong created nine Silk Road accounts with the purpose of masking his identity. He then manipulated a loophhole in Silk Road’s withdrawal-processing system to steal Bitcoin. Zhong’s scheme involved him depositing small amounts of Bitcoin into his Silk Road accounts and then making withdrawals within the same second of the deposit which resulted in him being able to withdraw more Bitcoin than he deposited. As an example, Zhong would deposit 500 Bitcoin into one of his accounts and then make 5 withdrawals of 500 Bitcoin within that same second, leaving him with a net positive of 2000 Bitcoin. Over the course of a few days, this method allowed Zhong to eventually steal over 50,000 Bitcoin from the Silk Road marketplace. Soon thereafter, Zhong withdrew all of his Bitcoin from Silk Road and consolidated it into two high value accounts.
Zhong’s windfall did not end there, however, as in August 2017, Bitcoin underwent a hard fork coin split which left Zhong with 50,000 Bitcoin Cash on top of the 50,000 Bitcoin. Zhong then used a non-US cryptocurrency exchange to trade the Bitcoin Cash for an additional 3,500 Bitcoin, bringing his total haul to 53,500 Bitcoin.
Zhong’s theft remained a mystery for almost a decade until sophisticated cryptocurrency tracing software and a years-long investigation eventually pointed to Zhong. On November 9, 2021, law enforcement eventually caught up to Zhong and executed a search warrant on his Gainesville, Georgia house. The search revealed approximately 50,491 Bitcoin valued at over USD 3.36 billion. Law enforcement found the Bitcoin in an underground floor safe and on a single-board computer hidden under blankets in a popcorn tin stored in a bathroom closet. During the raid, law enforcement also seized 25 Casacius coins (a physical form of bitcoin), over USD 661,900 in cash as well as several gold and silver bars.
Key Takeaways
The investigation and guilty plea highlight a few key items those in the blockchain technology world should note:
Although Bitcoin has declined in value this past year, Bitcoin and other blockchain-based currencies and tokens remain an enticing target for criminals. Hence, it is important for all financial institutions and platforms trading in these items to have updated security measures in place to protect themselves and their clients against theft.
All crypto trading platforms, wherever located, need to have adequate KYC measures in place and adequately examine the source of funds. Although Zhong was located in the United States, he made use of an overseas platform to exchange his Bitcoin Cash into Bitcoin. It is likely other criminals are using a multi-jurisdictional approach as well to mask their ownership in an attempt to launder the proceeds of crime. As these investigations continue to emerge, it is likely the US government, and other governments with strong enforcement agendas, will ask exchanges and platforms for information on existing accounts. It is unlikely such governments will look favorably on exchanges or platforms that have turned a blind eye to KYC and source of funds measures. Hence, platforms should have these measures in place to be able to provide the authorities with the information when asked to cooperate in an investigation.
The case highlights yet again the US government’s commitment to investigating and prosecuting crimes involving Bitcoin. The US government employed sophisticated cryptocurrency tracking software to unravel Zhong’s complicated web of obfuscation, which resulted in recovering almost all of the stolen Bitcoin and obtaining a guilty plea. Hence, we can expect this area to remain under close scrutiny for some time as the US government has shown to have both the means and desire to regulate this area.
