Blockchain Forensics Is The Trusted Informer In Cryptocrime Investigations

The US Justice Department’s seizure of $3.6 billion worth of Bitcoin (BTC) lost during the 2016 hack of Bitfinex’s cryptocurrency exchange has all the makings of a Hollywood movie — dazzling amounts of money, colorful protagonists, and crypto cloak — and dagger — so much so that Netflix has already ordered a docuseries.

But who are the unsung heroes in this action-packed thriller? Federal investigators from multiple agencies, including the new National Cryptocurrency Enforcement Team, have been closely following the money trail to round up the case. The FBI also seized the Colonial Pipeline ransom paid in crypto and made headlines last year. The Internal Revenue Service (IRS) seized $3.5 billion worth of crypto in 2021 in non-tax investigations, according to the recently released Chainalysis cryptocrime 2022 report.

The trends point to the diminishing ability of nefarious criminals and terrorists to use cryptocurrencies as safe havens to keep their ill-gotten gains, illicit gains, donations and funding away from law enforcement. For example, the Bitfinex hackers would have moved a small part of Bitcoin to darknet exchange Alphabay and from there to regular crypto exchanges. This is one of the leads the FBI has used to arrest the defendants.

Related: How Will DOJ’s New Crypto Enforcement Team Change the Game for Industry Players, Good and Bad?

Law enforcement agencies are getting better at investigating crypto crime

Regulators and law enforcement agencies in a select few countries have really raised the bar in blockchain forensics. Although initially lost at sea, some G-men and women have tightened the playbook on asset search and seizure, prosecution in courts, and removal of seized digital currencies after winning the case. Each of these specific steps demonstrates a deep understanding of this disruptive technology.

There are several considerations during the research process and all of them require a deep understanding of the blockchain space. The blockchains can be transparent, but different techniques such as tumblers, mixers, chain hopping and structuring (doing multiple small transfers to avoid checking) need to be understood and analyzed. The suspects may be physically detained, but law enforcement officers must also ensure that digital assets are not taken out of the reach of the suspects or their alleged accomplices. The seized crypto assets must be kept safe during the ongoing case.

Related: Crypto in the crosshairs: US regulators look at the cryptocurrency sector

The financial police certainly do not want the crypto assets stolen while the case is being prosecuted. Usually seized crypto assets are: auctioned and proceeds go to designated government accounts. But when there are innocent victims, a process of restitution is essential for trust in the judiciary.

Blockchain forensics is part of the larger digital forensics domain

Blockchain analysis and forensics don’t just live on a desert island. It takes several layers of cooperation to bring offenders to justice. First, the growing success of law enforcement in detecting crypto crime is due to the tightening of the Know Your Customer (KYC) standards of entities handling fiat-to-crypto and crypto-to-fiat currency conversions. Then there are other digital forensic technologies, such as collecting data and evidence from seized cell phones and computers.

Then there are private sector partners that support crypto monitoring, enforcement actions and cases. There are now several companies offering blockchain intelligence tools such as identifying compromised wallets, assigning risk scores to wallet addresses, using analytics and artificial intelligence techniques to highlight suspicious patterns, and much more. With such tools and techniques, investigative authorities can be more effective. Armed with KYC intelligence under the Anti-Money Laundering (AML) laws, prosecutors and their colleagues in regulatory agencies related to securities, commodities, taxes and foreign exchange continue to investigate in the real off-chain world.

Related: Lost Bitcoin Could Be A ‘Donation’, But Is It Hindering Adoption?

International cooperation is also crucial. Criminal actors like to keep their assets out of the reach of the long arm of the law. Law enforcement agencies must work with partner agencies in other countries. The Financial Action Task Force (FATF), which helps harmonize rules and assist in the prosecution of money laundering and countering terrorist financing, is an important intergovernmental policy-making body. It has made recommendations regarding virtual assets, for example the case of the travel rule, but countries are still in various stages of implementing it. These are the vagaries of sovereignty and sovereignty in a financial world in transition, whose rules of engagement are still under development.

Blockchain forensic expertise is unevenly distributed

The recent success of the agencies in the US and some other countries may give the impression that law enforcement agencies everywhere are aware of blockchain forensics. In reality, specialized teams armed with advanced blockchain analysis tools are the exception. Many National Agencies have yet to start building capacity in this area.

Related: FATF Virtual Assets Guidelines: NFTs Win, DeFi Lose, Rest Unchanged

As of 2022, more than 50 countries will have: set absolute or implied ban on cryptocurrencies. Ironically, even countries that ban or view crypto with suspicion will have to master blockchain analysis, as digital assets easily cross borders. Watch out for law enforcement agencies hiring more blockchain specialists and White Hat hackers.

The intricate dance involved in investigating the Bitfinex hack shows that they can even become BFFs. In financial crimes, the mantra for the judicial authorities has always been to “follow the money.” In fact, the public nature of blockchain transactions makes it easier to track and trace criminal activity. Working with technologists who know what they’re doing makes it even easier.

Crypto libertarians may not like the increased involvement of research firms in the space, but the writing on the wall is clear: such guardrails are better for everyone involved, both consumers and crypto companies. The industry cannot be worth trillions of dollars and not catch the watchful eye of regulators.

This article was written by Kashyap Kompella and James Cooper.

This article does not contain investment advice or recommendations. Every investment and trading move carries risks, and readers should do their own research when making a decision.

The views, thoughts and opinions expressed herein are those of the authors only and do not necessarily reflect or represent the views and opinions of Coin-Crypto.

Kashyap Kompella, CFA, technology industry analyst, is CEO of RPA2AI, a global artificial intelligence consultancy. Kashyap holds a bachelor’s (honours) in electrical engineering, an MBA and a master’s degree in corporate law. He is also a CFA Charter holder. Kashyap is the co-author of Practical Artificial Intelligence: An Enterprise Playbook.

James Cooper is a law professor at the California Western School of Law in San Diego and a research fellow at the Singapore University of Social Sciences. He has advised governments in Asia, Latin America and North America for more than two and a half decades on legal reform and disruptive technologies. As a former contractor for the US Department of Justice and State, he advises blockchain and other technology companies.

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