Earlier this month, one of the world’s largest cryptocurrency exchanges, FTX, crashed. While the sudden implosion of FTX sent shock waves across the cryptocurrency industry, its demise also has implications for North Korea’s ability to continue to exploit weaknesses in the virtual asset ecosystem.
Due to the self-imposed isolation of the Kim Jong Un regime during the pandemic, North Korea has struggled to acquire the hard currency needed to finance its weapons programs and its trade deficit. in chasing a zero covid strategyNorth Korean exports dropped to only tens of millions dollars during 2020 and 2021, while the regime ability to participate smuggling was also hampered to evade UN sanctions.
To make up for its currency losses, the regime has increasingly resorted to theft of cryptocurrency to fill its coffers. According to Chainalysis, a blockchain analytics firm, North Korea stole around $300 million in virtual assets in 2020 and nearly $400 million in 2021. So far this year, Chainalysis estimates that North Korea has stolen approximately $1 billion in cryptocurrency.
Hacking cryptocurrency exchanges and exploiting DeFi, or decentralized finance, are attractive options for North Korea for a number of reasons. While not totally anonymous, these new finance tools are largely unregulated. They also use mixers that can hide the origin of the funds on the blockchains. Know your own client and anti-money laundering practices have not been universally adopted by the industry, making them attractive to players like North Korea seeking to avoid detection in the financial system.
DeFi specifically enables North Korean money laundering and hacking. DeFi platforms enable North Korea trade stolen less liquid coins for those that are more easily convertible into cash. They also tend not to follow the protocols of knowing their own customers. Furthermore, DeFi is particularly vulnerable to hacks due to flaws in its code and open source software that allows would-be hackers to search for vulnerabilities to exploit.
North Korea uses the funds stolen and laundered on these platforms to finance its illicit activities. The UN Panel of Experts has noted that funds acquired of stolen cryptocurrencies “remain a major source of revenue” for North Korea and, along with other illicit activities“directly and indirectly supports the country’s weapons of mass destruction and ballistic missile programs.”
Concerns that North Korea will use funds stolen from cryptocurrency exchanges for its nuclear weapons and ballistic missile programs are shared by the US government. The Office of the Director of National Intelligence noted in a unclassified report that the stolen funds are “probably [used] to finance the government’s priorities, such as its nuclear and missile programs.” Deputy Homeland Security Advisor for Cyber and Emerging Technologies Anne Neuberger it suggested the stolen funds can provide up to a third of the funding for North Korea’s ballistic missile program.
While the focus on North Korea’s weapons programs is understandable, the money is fungible, and stolen North Korean cryptocurrency likely also helped the regime finance your trade deficit during the pandemic. In 2020 and 2021, North Korea ran a trade deficit with China of $645 million, but stole close to $700 million worth of cryptocurrency. As North Korea has opened its border for longer periods this year, trade has grown. Imports from China through October rose to $657.4 million, while North Korea’s exports to China rose to $103.4 million. However, the nearly $1 billion worth of cryptocurrency North Korea has stolen this year is more than enough to cover its $554 million trade deficit with China.
On the surface, the demise of FTX would appear unrelated to North Korean crypto activities, but given the regime’s heavy reliance on cryptocurrencies, it has three implications.
First, in a problem shared by all cryptocurrency investors, the FTX crash has reduced the value of North Korean cryptocurrencies. Chainalysis notes that North Korea does not immediately cash out all of its holdings and estimates that Ether has become the most common cryptocurrency stolen by North Korea, accounting for 58 percent in 2021. Ether was also one of the most common cryptocurrencies in North Korean Ronin Hack at the beginning of this year. His value was down 20 percent immediately after the FTX accident and has continued to decline.
It is unclear how significantly the FTX collapse will impact the value of the cryptocurrency as the contagion continues to spread. Crypto lender BlockFi has declared bankrupt, while Genesis has suspended the origination of new loans and redemptions (regular payments in fixed income products). Gemini has also suspended redemptions on its Earn program. As crypto companies continue to face FTX contagion issues, cryptocurrencies will continue to come under pressure as well.
Second, companies will seek to improve their systems. FTX was once one of the most respected crypto exchanges, but it is now known to have been extremely poorly managed. His new director, who also oversaw the dissolution of Enron, described the situation as the worst corporate failure have ever seen. FTX was essentially run as a private company without proper internal accounting or security. To avoid contagion from the FTX liquidity crisis, crypto companies are already moving to show your reservations, but will probably look to improve other systems as well. North Korea has exploited poor security and processes in the industry, and that should become more challenging over time.
Even if crypto companies do not take steps to improve their internal systems, the demise of FTX is creating increased regulatory scrutiny. Whether developing existing regulations or more tailored regulations for the cryptocurrency industry, the new regulations will require greater internal controls than seen at FTX and likely to exist at most cryptocurrency companies. This would also bring cryptocurrencies more in line with the traditional financial system and its regulatory structure, closing some of the loopholes that North Korea has exploited to launder money.
All these changes are likely to take time, and vulnerabilities in open source software may be a permanent feature of the industry, but the scale of the FTX collapse will likely result in the kinds of corporate and regulatory changes that will make cryptocurrencies less useful to North Korea.
For a regime that has become so reliant on cryptocurrencies to avoid sanctions and steal currency, the collapse of FTX could not be more untimely.