Preventing illicit money from entering a country is the cornerstone of modern approaches to money laundering. financial system. This is a reasonable argument: criminals will eventually have to give up their illegal activities and find a job.
The levels of drug usage, organized crime and tax evasion have not declined despite 20 years of increasingly strict (and expensive) AML laws. Despite the fact that the right to privacy has been violated daily, and without protest, financial No matter the size of an operation, it will be subjected to thorough verifications, as well as tons of paper work. See Part 1 for more details.
Should we reconsider the AML Strategy?
David G.W. Birch published an article entitled “The Fintech Author’s Guide to Investing in Bitcoin”. article for Forbes, reflecting on the main principle of AML – gatekeeping. It could be summarized by “instead of trying to prevent criminals from getting into the system, we let them in and monitor what they are up to.”
We could simply allow them to enter and track the money they are using to find them. We can do this by using both the traditional reporting system and on-chain analysis within blockchain. The former, however, is more or less understood, while the latter remains a mystery to most people. It’s not just that politicians and banks accuse cryptocurrency of being an instrument for tax evaders and criminals.
We need to understand the on-chain analysis process in order to shed light on this issue. This isn’t easy, as blockchain analytics methods are usually proprietary. Analytics companies who share them risk losing the competitive advantage they have. Scorechain in Luxembourg, for example, has agreed to give us some information about their business. This data combined can help us understand the limitations and potential of on-chain analysis.
On-chain Analytics: What are the benefits? work?
Blockchain is transparent, and anyone can audit it. Not everyone can draw meaningful conclusions out of the large number of datasets that are part of it. The specialty of the on-chain analytical firms is to gather data, identify the entities, then put the conclusions in a readable form.
All of it starts by getting a duplicate ledger. The internal software is synchronized with the Blockchains.
After that, the tedious mapping stage begins. How can we know that this address belongs to an exchange, and this one – to a darknet marketplace? They use their imagination and creativity to attempt as many de-pseudonymizations as possible. Open-source data collection is a good technique as long as you can collect it.source data from law enforcement, scraping websites, navigating Twitter-X and other social media, acquiring data from specialized blockchain explorers like Etherscan, following the trace of stolen funds upon requests from attorneys… Some services are identified by interacting with them, i.e. To identify addresses, send funds to exchanges centralized. The data is usually cross-checked to minimize errors.
When the transaction hashes are sorted out, it becomes easier to see the picture. But the picture remains incomplete. Unlike account-based blockchains such as Ethereum where identifying the address of a user allows them to track their funds, UTXO chains like Bitcoin make it much harder.
Bitcoin Blockchain, as opposed to Ethereum blockchain which maintains track of addresses (UTXO), keeps track on the unspent transaction outcomes. Every transaction sends the entire amount of coins that are associated with an account. The unspent coins are sent to the address of the person who wishes to use only part.
On-chain analysis firms are responsible for analyzing these transactions and identifying clusters of UTXO that belong to the same entity.
Can you trust on-chain analysis?
It is important to note that on-chain analysis isn’t an exact science. The clustering and mapping of UTXO rely both on experience, and a calibrated set heuristics developed by each company.
The issue of forensics was raised in court last July, when Chainalysis provided their forensic expertise to the US v Sterlingov Case. The firm’s representatives admitted Chainalysis’ defense is that the first point, which was made by its critics, is understandable: not only were its methods not peer reviewed or scientifically validated but it also failed to keep track of false positives. Chainalysis’ defense is that the company uses trade secrets to protect its methods of analyzing the blockchain. False positives are a problem that must be addressed, particularly if they could lead to someone being sent to prison.
Scorechain has a completely different method. They err on the side caution, and use only the methods, which don’t generate false-positives, in clustering, for example, the Multi-Input Heuristics, (which assume that, in a transaction, all input addresses are from a single entity). Chainalysis does not use change heuristics that can lead to false positives. Their team may be able to manually track UTXOs in some instances if a person operator is motivated enough. However, overall this method tolerates blindspots, relying on future information that will fill in any gaps.
The very notion of heuristics – i.e. strategies that employ a practical but not necessarily scientifically proven approach to problem-solving – implies that it cannot guarantee 100% reliability. The outcome is what determines its efficiency. FBI statement that Chainalysis is not effective “generally reliable” Can serve as proof This is not to say that the quality of on-chain analyses will be improved, but rather it would improve if firms began measuring and reporting their rates of false positivities and false negativities.
The fog is a good way to see through.
It is possible to hide or make it more difficult for someone to locate funds. Crypto hackers and scammers are known to use all kinds of techniques: chain hopping, privacy blockchains, mixers…
Some, such as the swapping of assets and bridging, are traceable by firms that provide on-chain analysis. Other chains, including Monero and various mixers or tumblers that protect privacy, are not as easily traceable. However, there were some. instances Chainalysis claimed it was able to separate transactions that had been mixed through a mixer. announced They have been tracking Monero transactions in an investigation.
The very act of masking is visible, and it can be a warning sign for AML. One example is the US Treasury’s addition of the smart contract addresses for Tornado Cash mixers to OFAC last year. When the history of the coins is tracked down to the mixer, funds are now suspected to belong to illegal actors. The news isn’t great for privacy enthusiasts, but reassuring in terms of crypto AML.
You might wonder what the point is of flagging and tracking the coins across blockchains, when we do not have an identifiable person like in banking? Because criminals interact with people in the world of commerce, the tainted coins will end up somewhere, whether it’s a service provider, a bank, or a retailer. The law enforcement is able to identify these individuals. Here’s how the FBI scored its largest-ever seizure of $4.5 billion worth of Bitcoin After the Bitfinex hackers, we can now see what prices would be (in 2022). The reverse is also possible: if the law enforcement has access to private keys for a criminal they can go backwards in the history of the blockchain and identify addresses that have interacted at one point. The London Metropolitan Police discovered a drug-dealing network with just one arrest.source: Chainalysis’ Crypto Crime 2023 report).
Since the beginning of time, crime has been a part of human history. It will continue to be a problem until its demise, as it uses ever-evolving techniques for camouflaging. It’s a good thing that crime detection techniques follow the same trend, as it turns out, blockchain is a great environment to deploy digital forensics. The blockchain is accessible and transparent to all (which, by the way, cannot be stated about the banking system).
One can argue that current on-chain analysis methods need to be improved – and that point holds true. It is evident that this tool is effective in its current imperfect state, and is a great way to track bad actors on the blockchain. It’s possible that it’s now time to rethink our AML approach and bring criminals onto the blockchain.
Scorechain is a great team that has shared their expertise.
The guest blogger is Marie Poteriaieva. The views expressed here are solely theirs. own The views expressed herein do not necessarily represent those of BTC Inc. or Bitcoin Magazine.
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Source: bitcoinmagazine.com