​Echoes of Silk Road. How the largest cryptocurrency confiscation in history took place

In early November, the US Department of Justice reported the seizure of $3,36 billion worth of bitcoins from the hacker who broke into the now-closed Silk Road dark web marketplace. It was the largest seizure of digital assets in history. A crypto enthusiast on Twitter under the nickname FractalEncrypt studied the details of the case and found out who the mysterious hacker turned out to be and how he was discovered.

The court documents state that the person arrested is James Zhong, a US citizen who is also known under the nickname Loaded on the crypto forum Bitcointalk. The search and arrest of the suspect took place last November, and during a recent trial, Zhong pleaded guilty to wire fraud. The hacker could face up to 20 years in prison on those charges.

According to the investigation, in September 2012, the defendant used a bug in Silk Road’s withdrawal algorithm. The hacker made a deposit of up to 500 BTC and then immediately make multiple withdrawal requests. Because of the marketplace bug, the chargeback exceeded the deposit many times over. After each manipulation, Zhong registered a new account. As a result, he conducted about 140 transactions and withdrew a total of 50 676 BTC to his wallets. At the time, the first cryptocurrency was worth about $10.

FractalEncrypt noted that authorities call Zhong “a very sophisticated hacker,” even though he only took advantage of a bug that any of the platform’s users could have discovered. It is also not entirely clear what specific actions the hacker is accused of, the blogger noted. The documents allege that the defendant “transferred at least approximately 50 000 Bitcoin from Silk Road’s Bitcoin addresses into Individual-1’s own addresses, without ever providing any goods or services in return.”

After receiving the stolen bitcoins, Zhong sent them to three different addresses. He would later move the assets several more times in 2013, 2015, and 2017, according to law enforcement. Ultimately, Zhong split them into 40 000 and 10 000 BTC, the latter he also distributed equally among the 10 addresses.

Many things indicate that Zhong was an outspoken Bitcoin maximalist and holder. He had held bitcoins in every bear market since 2012 and had not sold during periods of growth. In 2017, Zhong immediately converted all 50 000 Bitcoin Cash (BCH) accrued to him when creating a bitcoin fork into 3 500 BTC.

The authorities were able to track down Zhong from a trail of interaction with an unnamed exchange. The hacker had an unspent transaction output (UTXO) of 118,077 BTC. It was through this exchange that Zhong sold 118 bitcoins, and the balance of 0,077 BTC was sent to one of his personal wallets. The investigation linked this address to the one “used to transfer 1,000 BTC that Individual-1 had unlawfully obtained from Silk Road.” The exchange later provided its customer’s IP address at the request of authorities, which led to Zhong’s discovery.

On November 9, 2021, police raided Zhong’s home and found a cache in the bathroom. The authorities seized a hardware wallet containing bitcoins, $661 900 in cash, and 25 physical Casascius coins equivalent to 174 BTC.

After nearly 6 months in custody, Zhong agreed to provide private keys to police, and as early as March 25, 2022, all of his assets were transferred to a bitcoin address controlled by the US government. FractalEncrypt also highlighted that of the 53 500 bitcoins stolen, the hacker held on to 51 500 BTC until last.

Throughout the Twitter thread, the blogger unequivocally implied that the US IRS was trying to appropriate private assets, framing this situation as the largest confiscation from a notorious drug marketplace. The authorities eventually claimed that the bitcoins could be legally seized because they were in the accounts of Silk Road users and actually belonged to the founder of the marketplace, Ross Ulbricht.

Ulbricht himself was sentenced to life in prison back in 2015, and in August of this year, he waived his rights to 69 370 BTC that had been withdrawn from Silk Road. According to the deal with the authorities, the confiscated assets will go to pay for the restitution of the creator of the first dark web marketplace. According to FractalEncrypt, it was a long scheme to get the legal right to seize assets from Zhong.

What happens to confiscated bitcoins

Cryptocurrencies are regularly confiscated by law enforcement agencies around the world. The US government has repeatedly organized auctions for the sale of confiscated bitcoins, including coins obtained from a major hack of the Bitfinex exchange in 2016 or from the same Silk Road. As of November of this year, US law enforcement agencies have about $4 billion worth of confiscated cryptocurrencies in their official wallets.

The Chinese government may be secretly holding about $6 billion worth of confiscated cryptocurrency, the CEO of analytics firm Cyptoquant Ki Young Ju pointed out.

FUN FACT: Government of China🇨🇳 is a crypto whale.Chinese authorities seized 194k BTC, 833k ETH, and others from the PlusToken scam in 2019. They forfeited these $6 billion-worth assets to the national treasury.FWIW, MicroStrategy has 130k $BTC. pic.twitter.com/Ilqp7EnenL — Ki Young Ju (@ki_young_ju) November 2, 2022

The PRC received these funds as a result of cryptocurrency seizures from the Ponzi scheme PlusToken in 2019. According to the analyst at Cyptoquant, China is a true crypto whale, holding 194 000 BTC, 833 000 ETH, and other digital assets, surpassing such industry giants as MicroStrategy and Galaxy Digital.

According to some reports, China may have already sold off the coins. Sources from local journalists and researchers indicate that the Huobi exchange may have helped the government do so.

In July, the Finnish government reported the sale of 1889,1 confiscated bitcoins worth $47,5 million. These assets were obtained when drug dealers and other criminals were apprehended and then confiscated by the state by court order. Finnish authorities even set a tender for brokers to sell the assets, choosing two unnamed companies. At the same time, the country is still holding 90 BTC awaiting confiscation.

So far, US authorities have not announced what they will do with the bitcoins confiscated from Zhong. The digital assets will likely be auctioned off in the same way that authorities in Finland did. One of the biggest buyers of the coins confiscated from Silk Road became investor Tim Draper, who predicts that the first cryptocurrency will exceed $250 000 as early as next year, even despite the consequences the market has faced since the collapse of the FTX exchange.