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Risk Fraud & Compliance

Crypto-crime & caveats

Paul Marrinan  Head of Investigations / Inca Digital

Paul Marrinan  Head of Investigations / Inca Digital

Is cryptocurrency a hot mess of scams and frauds or a new frontier of decentralized finance? What do the numbers actually say?

Cryptocurrency is a scam used by criminals to launder money. And it is hardly used for illicit activity at all.

Depending on who you listen to, both statements are considered to be true. If you were to believe government officials like Janet Yellen and Christine Lagarde, this new financial ecosystem is used extensively by money launderers and other financial criminals. Yet, this view is contradicted by those in the cryptocurrency industry, and starkly so by the major blockchain forensics companies in that space that claim that crypto-crime is less than 0.5% of cryptocurrency transactions in the market.

“In 2020, the illicit share of all cryptocurrency activity fell to just 0.34%,” reported Chainalysis in their second annual crypto-crime report; CipherTrace also estimated that figure to be “less than 0.5%.” Importantly, Chainalysis and CipherTrace — both industry-leading blockchain forensics companies — hold some of the largest datasets on crypto-crime and blockchain metadata in the world.

What is most surprising about this figure is that there seems to be no caveat or disclaimer to indicate that this is not the full picture of criminal activity with a cryptocurrency element. Unfortunately for Citigroup, its recent Bitcoin report did not escape such analysis, which The Financial Times described as “one of the most execrable pieces of propaganda masquerading as ‘research.’”

Looking behind the crypto-crime data

Without going as far as that, it is important to question where this 0.34% figure came from. It is effectively a summary of all activity which has been positively identified as being linked to an opaque category of transactions referred to as illicit. Importantly, crypto-crime reports give very useful insight into blockchain forensic companies’ activities over the last calendar year. From a law enforcement and compliance officer perspective, however, there are a number of concerns arising from such reports.

First, the “less than 0.5%” figure does not help anyone looking for funding for blockchain forensics software licenses, as the best in the business have already claimed that there is nothing to see here. Second, these reports include a number of often ignored caveats in their analysis, showing that figures are likely to increase when retrospectively analyzed through a more holistic lens. Lastly, they do not clearly indicate how limited is the scope of their analysis. These reports reference crimes like money laundering, but acknowledge they cannot accurately identify this crime type if it doesn’t originate online. To be clear, if a crime originates off-chain and it’s proceeds are layered through cryptocurrency transactions, this is undoubtedly money laundering involving cryptocurrency — which may explain the perspective of Yellen and Lagarde.

The point here is that these figures should be understood in a larger context. Industry-led crypto-crime reports may well be the most accurate attempt at quantifying crypto-crime that we have today. However, the infinitesimal size of illicit activity which these reports can reliably identify is simply an indicator of analysis based on non-random events, as was recently cited in a peer-reviewed study. It is reasonable to assume that these reports do not account for a significant “dark figure of crime”, which has either not been detected or not been reported so far.

Developing immunity to blockchain forensics

International IT specialist Evgeny Dmitriev uses the analogy of pesticides to explain how cybercriminals develop immunity to tools like blockchain forensics. Criminals have demonstrated time and again that they are usually ahead of these solutions in their ability to adapt and evolve when faced with new challenges, including the movement of darknet markets to Telegram in the form of Bots like Televend, and the increased use of DeFi smart contracts to obfuscate the source and destination of funds.

Notably, Chainalysis and CipherTrace do not explicitly state that they have covered all forms of crime or that these figures are fully complete. They simply show that only approximately $10 billion in transactions can be reliably attributed to illicit activity, a figure supported by Coinfirm’s report. While most data shows a drop in the value of cryptocurrency being sent to high-risk exchanges, the use of nested services or Over the Counter (OTC) service providers offering services on exchanges which are not perceived as high risk is apparently on the rise. Significantly, these nested services do not provide sufficient insight into the activity of their clients or their client’s customers.

From a criminological perspective, 0.34% of all transactions is not the total amount of crypto-crime occurring in the world. It does, however, give a useful set of reference points to help identify illegal activity that involves cryptocurrency. In the peer-reviewed paper cited above, they estimated the likely amount of illegal activity was approximately four times what was observed at the time. Assuming this to be applicable to the observed figure it is reasonable to estimate that crypto-crime maybe a modest 1.4% to 2% of all activity, or representing $40 billion to $59 billion. There is a possibility that the real figure could be higher than this, but in absence of better data it is at least in line with the estimates in the traditional financial system, if not slightly lower.

Unfortunately, there is the practical aspect of crypto-investigations: Most law enforcement agencies are either novice at investigating cryptocurrencies or simply do not have the training or capacity needed to record crypto-crime. While groups like Interpol and Europol have started comprehensive training programs with support from blockchain forensic companies, most programs provide only a short-term license to participants for the allotted training period to develop their skills on specific private sector tools. The number of officers trained in these programs currently is still relatively small.

One thing to learn from the crypto-forensics industry is that bitcoin is one of the least likely methods of filtering funds. Nevertheless, we as a society clearly need a better means to measure criminal activity linked to the broader cryptocurrency markets. The concern is not for illegal activity already identified, but in the dark figure of crime being disguised as legitimate trading.

The key takeaway is that we appear to be underestimating the ability of criminals to obfuscate their activity, thus causing an inherent risk to the wider financial ecosystem. For now, we should consider cautiously accepting the current industry estimates — with the caveat that these figures are limited to what we already know, and not an estimate of all potential crime involving crypto.

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