Blockchain Investigators Put a Wrinkle in Crypto-Laundering

One of the larger appeals to transacting via cryptocurrencies versus fiat currency is the pseudonymity crypto provides. Pseudonymity, however, is not synonymous with anonymity. A blockchain’s security is ensured, in part, by the transparent, open-source nature of the blockchain and every transaction that happens on that ledger. And though actual identities are not publicly shown, every party to a transaction on the blockchain is represented by their pseudonym, or the public wallet address used in the transaction.

Just as the crypto market has developed over the years, so have the techniques and tools used to track down owners of or associations between crypto wallets. Investigators have various options regarding investigative approach, but those with access to and expertise of blockchain analytics tools can build a timeline and comprehensive profile based on a wallet address by analyzing the transacting patterns of those wallets, as well as other wallets that may appear earlier or later in the blockchain’s history. Most blockchain analytical tools rely on proprietary data collection, categorization and risk profiling, which often assist with determining the “location” and/or cash-out point (i.e., the last known wallet and where it’s hosted) of digital assets on a particular blockchain, and in some cases, across multiple blockchains.

Private sector investigators and financial institutions are not the only ones harnessing the power of blockchain analytics. Numerous state and federal agencies and regulators leverage blockchain analysis tools and/or investigators in their pursuits. During 2021, blockchain investigators enabled the IRS to locate and seize approximately $3.5 billion pursuant to non-tax investigations and led to OFAC’s sanctioning of crypto OTC broker Suex based on the observed activity associated with Suex wallet accounts.

Rise in illicit activity—a boom and a bust for investigators

Despite the rising threat of detection, criminals do not appear deterred, and cryptocurrency continues to be a popular choice for those wishing to launder any ill-gotten gains. In its 2022 Crypto Crime Report, blockchain analytics firm Chainalysis estimates that total laundered cryptocurrency increased by approximately 30% in 2021, and that only represents the laundering of funds derived from cryptocurrency-related crime, and not criminal proceeds subsequently converted into a digital asset.

The likely reason many offenders are not scared by the presumed transparency of their crimes is because they are enabled by various entities that specialize in anonymity and obfuscation services, like so-called mixers or tumblers. These services often operate in under-regulated jurisdictions or nest themselves within larger exchanges. Criminals usually try to hide their crypto transactions by complicating the process of tracking and by moving assets as quickly as possible, and these mixing services, peer-to-peer transaction schemes, layering transactions and other techniques can be used to make fund tracing more complicated. This is illustrated through Chainalysis’ report that estimates that a group of about 580 wallet addresses received over 50% of all funds sent from illicit wallet addresses in 2021, and a smaller group of 45 addresses received almost a quarter of all illicit funds sent, for a total of approximately $1.1 billion. In other words, some, or all those 45 destination wallets are likely hosted by services that specialize in obfuscation, or are unknowing participants based on insufficient or a lack of compliance programs.

These loopholes exploited by hackers, scammers, and other criminals are tightening. As cryptocurrency adoption continues to grow, regulations tighten, compliance improves, and enforcement increases, the data available for use by investigators in blockchain analytics will shine a light on those aiding and abetting the unlawful movement of criminal proceeds and currently hiding behind their present pseudonymity.

Despite the recent extreme volatility in the crypto market, use of digital assets continues to rise. And as mentioned above, many blockchain analytical programs rely on data collection, including web scraping and clustering algorithms, and therefore as adoption grows, so does the universe of data available for collection. Further, progress on certain regulations, like the FATF’s so-called “Travel Rule,” will present investigators with critical identifying information regarding parties to certain transactions. The Travel Rule requires virtual asset service providers to exchange information regarding the personally identifiable information, or PII, of the originator and beneficiary for amounts greater than $1,000 (though in the U.S. the threshold is for amounts greater than $3,000). Though this will take time, as FATF announced on June 30, 2022 that only about 30% of member jurisdictions have passed the Travel Rule, and just over a third of those have enforcement and supervisory programs in place.

The ingenuity of bad actors, coupled with crypto’s pseudonymity, has historically outpaced regulations and compliance in the digital asset ecosystem. But, bad guys, beware! The gap is narrowing, with the anticipation of more regulation, including increased compliance requirements, and the growing use of blockchain analytics and the cross-border sharing of a growing data set between providers, investigators, regulators, and law enforcement.