Can Feds Take Your Crypto? + How They “Recover” Stolen Bitcoin

“Un-confiscatable” is a term often used by proponents of Bitcoin.

This means that if you hold Bitcoin in self-custody, nobody can take it away from you.

But this has not been the case in practice, with many examples of the United States Federal Government (The Fed) recovering stolen Bitcoin.

The Fed recovered most of the billion-dollar Bitfinex hack six years after the fact. 

And The Fed also partially rescued the $600M Axie Infinity hack in 2022. 

So if even experienced and careful criminal groups get caught, what does that mean for the average user that disregards privacy and security?

Quick Takes:

• The Fed can search and seize crypto assets with a court order as long as the wallet is custodial. If the funds are in cold wallets, they can either ban the address or wait for potential cash-outs to confiscate.
• Federal agents have only intervened for crime prevention purposes. CeFi and DeFi platforms are both within their indirect control.
•  You can protect crypto from confiscation despite anti-Bitcoin laws, CBDCs, and address blacklisting. There’s no authority that controls cold wallets unless you stored keys digitally or once used custodial platforms.

Can the Fed Take Over Blockchains?

Despite the authority, federal agents do not have as much control as it seems. It might seem that way because the blockchain shows everything, so there’s less detective work to follow the money. For a criminal, it’s more difficult to launder the money than the actual robbery.

If the feds took down a blockchain permanently, then all apps and tokens kept there would be lost. For this to happen, there have to be a few nodes, all identified, and a way to prevent new ones from restarting the network. Impractical.

Instead, the feds can:

• Access hot wallets. The platform hosting your wallet could send them your private keys or seize assets themselves.
• Discover cold wallets. Unless you keep your keys engraved or on paper, investigators will find a way to decrypt those secrets. That’s how thousands of wallets were repossessed by the US Department of Justice (DoJ).
• Sanction crypto platforms. That means it’s illegal and subject to penalty for citizens to use that platform. Which is easy to know because of public blockchain records. This typically follows the suspension of DNS, websites, accounts, and dev repositories.

Let’s look at some cases where they have already intervened.

Examples of Fed Intervention on Decentralized Platforms

• In late 2022, the DoJ took down Tornado Cash for money laundering charges and froze all its assets, including USDC. The  Office of Foreign Assets Control ("OFAC") also created sanctions to prevent US people from interacting with the contract. This token mixer helped users anonymize transactions and was supposedly decentralized.

• In June 2022, the UK High Court requested a software update for Bitcoin SV that allows freezing assets by court order. Essentially, the court order would pass to a validator (the Notary Service Provider) and then to all miners to follow. The network won’t accept blocks from those who ignored the order. This already-active recovery tool puts centralization in question.

• In 2021, the Security Exchange Commission (SEC) alleged that the ICO (initial coin offering) of ETC was illegal. Ethereum Classic was the first important fork from Ethereum, and this event would lead to a similar division: Ethereum Classic Vision (ETCV). Miners lost confidence after the ETC lawsuit, now with lower security, performance, and user base.

• Since 2013, The FBI and law enforcement agents have taken down several dark web peer-to-peer (P2P) marketplaces based on crypto payments. The Silk Road, Hydra Market, AlphaBay, and Wall Street Market were taken down despite their encryption. 

• In 2018, The DoJ charged LocalBitcoins for operating without anti-money law (AML) compliance. This is now a regulated P2P marketplace with user verification required.

Examples of Fed Intervention on Centralized Platforms

• In January of 2023, the DoJ charged Bitzlato for +$700M in criminal activity and money laundering. Criminals may no longer access the funds, but neither can the legitimate users who trusted the exchange.

• In January of 2023, hundreds of Bulgarian prosecutors raided the Nexo offices in Sofia. The crypto lender was linked to ~$94M in terrorist funding, tax crimes, and money laundering. The SEC followed with a $22.5M charge for offering unregistered lending products.

• In December 2020, the SEC filed against Ripple Labs (XRP) for selling $1B of XRP as an unregistered security. The company considered it a cryptocurrency despite its centralization. And it did win the lawsuit, investor uncertainty still remains.

• In 2020, the SEC prevented the Telegram token launch (the Gram) claiming the ICO was illegal. While it slowed down Telegram’s plans, the token eventually launched by 2021 (now called Toncoin) with its own layer-1 blockchain.

• The DoJ has been taking down exchanges since 2013 for doing unlicensed business and money laundering. Some of them are Liberty Reserve, Bitinstant, BTC-e, Bitsty, Bitfunder, and GBL.

What Regulators Think About Crypto

Regulators don’t lack reasons to intervene in blockchain projects. The biggest one is that crypto and fiat interact with each other, and what affects one does the other. You can’t effectively regulate traditional money unless you also control crypto on and off ramps.

The problem regulators have with crypto is that there’s no direct way to minimize risk. If a scam project is successful, there’s little to no opportunity to:

• Seize cold-storage funds
• Protect users against investment traps
• Shut down operations in a way that can’t resume from alternate accounts

That’s why regulators are wary of crypto. The countries that still don’t know how to deal with it have either banned Bitcoin, created centralized versions, or remained neutral until their development. As regulated as crypto may seem today, it’s nowhere as controlled as it might be years ahead.

Does that mean the feds will go after your crypto? Unlikely. So far, the FBI and DoJ have only intervened to stop criminals. The court has to warrant the search and seizure of assets before agents take action. Without a suspicious profile, you can even use a custodial exchange without fear of confiscation.

Now, is it possible that this crime investigation expands to others like tax evasion? It wouldn’t surprise many. Regulators are already increasing their efforts with crypto laws and central currencies. 

If governments could track and control blockchain balances, many would try to extend their fiat regulations to cryptocurrencies.

3 Ways Regulators Plan To Control Crypto

Just because blockchain is decentralized, that doesn’t mean the feds can’t intervene or that regulators can’t impose rules. It’s easier than it sounds because a lot of coins are in centralized, crypto-fiat platforms. Any cryptocurrency converted to fiat becomes regulated.

Here are three indirect ways they achieve control:

Laws Banning Cryptocurrency

The purpose of banning cryptocurrency isn’t to prohibit but restrict it until new laws come out. Once regulators understand how to control cryptocurrencies, their policies eventually become more neutral. As for 2023, cryptocurrency payments or businesses are illegal in several countries.

Thankfully, it’s unlikely that every government bans cryptocurrencies. As long as one country supports decentralized blockchains, they will be adopted. Even if all countries regulated crypto, there will be differences. It’s not the same to browse the Internet in the US as in China, register a company in California or the Virgin Islands, nor it will be with blockchains.

Central Bank Digital Currencies (CBDCs)

CBDCs are centralized versions of cryptocurrencies that allow central banks to regulate both their supply and demand. This would help governments regulate the economy and prevent criminal activity, all at the unreasonable cost of individual freedom. The feds would have no problem enforcing digital laws against criminals, but also limit what citizens can do with their money.

An overwhelming number of CBDCs are either launched or in development. But adoption ultimately depends on public acceptance, and whether or not the masses fall for the default effect.

Wallet Address Blacklisting

Developers can update blacklists and program smart contracts to refuse those addresses. For example, Tether has banned +$400M USD after several incidents:

None of the 829 banned addresses can send, convert, or receive USDT. Any attempt would ban the destination address. Unless Tether decides to unlist these, all that USDT is forever frozen.

Can You Protect Crypto From Confiscation?

This isn’t meant to worry investors, but rather show the different ways the feds can intervene in crypto. Because there are ways to protect your coins from confiscation, especially after learning from recent cases like the Bitfinex or Sky Mavis attack.

The best advice is to keep coins in cold wallets and never store digital private keys. Whether it’s a note app, a cloud document, or Ledger Nano X, prosecutors can break and decrypt almost any device. If it doesn’t work for them, the last resort is to freeze or blacklist the address on different CeFi/DeFi apps.

Chances are they already have it depending on (1) who you send crypto and (2) if you’ve used CEXs before. 

But they can’t blacklist every single dApp— just like they can’t force every country to have the same crypto laws. So your crypto isn’t trapped in a cold wallet. You can still use dApps and even spend crypto without any fear of asset seizure.

If tracking is your concern, there are coin mixer alternatives, mixnets, and privacy projects you can leverage. If you also follow the 9 security tips the pros use, you leave no opportunity for anyone to take away your coins.