Bitcoin a Shadowy Realm as U.S. Weighs Security Clearances

(Bloomberg) -- As the Pentagon struggles to recruit a more tech-savvy workforce, it's facing the confusion of many an old-timer: What to make of people who invest or trade in Bitcoin.

The question is whether owning Bitcoins or lesser-known cryptocurrencies such as Ripple and Ethereum is an indicator of risky personal behavior -- one that should flag extra scrutiny in security clearances -- or just another investment choice.

“There are a lot of good things about cryptocurrencies, but at the same time there are these security risks,” said Param Vir Singh, director of the PNC Center for Financial Services Innovation at Carnegie Mellon University. “Think about a knife: It could be used for good things and it can be used for bad things as well.”

The debate is playing out across the government, as the Defense Department and other agencies struggle to define the currencies. Some see them simply as new investments and payment methods, while others worry they provide potential vehicles for illegal activities, from money laundering to drug-dealing.

It's a debate that matters for the sprawling U.S. national security apparatus, which has to keep track of more than 4 million people with some form of security clearance. That includes workers who, at least in theory, could sell secrets to America's enemies with the aid of anonymous transactions facilitated by cryptocurrencies.

Terrorists, Cybercriminals

Terrorists and cybercriminals use cryptocurrencies to shield their transactions from investigators and often demand payment in Bitcoins and other digital assets, according to international law-enforcement groups including the Paris-based Financial Action Task Force and Europol's European Cybercrime Centre.

At the same time, young investors have decamped from the halls of prominent financial institutions for the evolving world of cryptocurrency investing, and entire states have pegged their futures to its popularity. The instrument is going mainstream as Goldman Sachs Group Inc. moves forward with Bitcoin trading operations.

QuickTake: Bitcoin's Wildest Days Are Over as Regulators Circle

Nevertheless, Bitcoin has fallen about 50 percent from its December high to about $8,200 as regulators around the world continue to evaluate how to manage digital assets and some Wall Street pros dismiss the market. Warren Buffett, for example, has likened Bitcoin to “rat poison squared.”

If the U.S. government were to decide that owning cryptocurrencies is a security risk, it could have a “huge negative impact” on the growing market, according to Singh.

Any move to more closely investigate job applicants who own cryptocurrencies also could hamper the Pentagon's efforts to expand its operations in cyberspace, a goal that Secretary of Defense Jim Mattis has made a priority.

“If we're going to say that if you've got a Bitcoin or another digital currency account that could be a signal or shoot up a red flag for a security clearance, guess what? Those people aren't going to sit around waiting to try to onboard for a government job,” Greg Touhill, a retired Air Force general who was the first Federal Chief Information Security Officer, said in an interview. “It would grow the backlog considerably, in my view.”

Conflicting Messages

The Pentagon has sent conflicting messages about how it's handling the matter.

After a Defense Security Service employee suggested in an email that Bitcoin be considered a foreign currency and reported on the lengthy SF-86 security form filled out by clearance applicants, DSS quickly countered by issuing official guidance saying...there is no official Department of Defense guidance, according to ETHNews, an online cryptocurrency news site.

“There is no current Department of Defense guidance related to the reporting of ownership of cryptocurrencies,” according to a statement posted to the DSS website. “DSS is working with DoD policy offices for further clarification and once such guidance is issued, DSS will ensure the widest dissemination to industry.”

The equivocation has been cited by law firms and job search sites. ClearanceJobs.com put it bluntly: “Should you report your Bitcoin to your security officer? It depends upon who you ask.”

Huge Backlog

The lack of clear direction from the Pentagon only adds to the headaches already faced by government contractors that need to hire workers with security clearances.

Their top priority is overhauling a clearance system with a backlog of more than 700,000 background investigations and billions of dollars in associated costs.

Raytheon Co. Vice President Jane Chappell told the Senate Intelligence Committee in March that fixing the clearance system should be a priority for the country and that the backlog was hurting “programs that provide critical warfighter capabilities.”

For now, it appears the Pentagon needs further information from the country's financial regulators. Without a clear policy from the Treasury Department, Securities and Exchange Commission or other agencies, it will be very difficult for the Pentagon to issue guidance, according to Singh.

In the U.S., Bitcoin isn't treated as a foreign currency for tax purposes, according to a Treasury Department spokeswoman, but Treasury's Financial Crimes Enforcement Network monitors virtual currency exchanges to counter money laundering and terrorist financing.

If the U.S. government were to assess that BitCoin is a form of foreign currency, “such activities could have an impact on a security clearance determination,” Major Audricia Harris, a Pentagon spokeswoman, said in a statement.

Bad Intent

The government should keep in mind that owning cryptocurrencies may not indicate bad intent, said Steve Aftergood of the Federation of American Scientists.

“I don't know if the government has a clear understanding of what makes a person actually a security risk,” Aftergood said. “Instead they look at proxy factors like excessive debt, drug use and contact with the criminal justice system, which don't necessarily translate to risk.”

But Nicholas Weaver, a researcher at the International Computer Science Institute at the University of California, Berkeley, said the Pentagon is right to scrutinize clearance applicants who own cryptocurrencies, even those who are buying and holding them as investments, known as "HODL'ers."

“Since Bitcoin's only real use is to buy drugs, etc., it deserves suspicion,” he said. “As for the HODL'ers, eh, they will pass through the clearance process OK because its clear they are just little speculators. Or outright delusional speculators, in which case, do you really want that type in government?”

--With assistance from Saleha Mohsin.

To contact the reporter on this story: Daniel Flatley in Washington at dflatley1@bloomberg.net

To contact the editors responsible for this story: Bill Faries at wfaries@bloomberg.net, Larry Liebert

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