Crypto crimewatch: a look into the fight against crypto crime

Though the last couple of years have been rocky for the wild, wild west of Web3, it’s undeniable that the space has expanded dramatically since its early days.

Despite today’s bear market, developer activity has continued on an upward trend. Blockchain has been used to bolster security and increase transparency, and cryptocurrencies can help make payments and investment opportunities more accessible.

Unfortunately, not all the attention has been good, as criminals have also seen opportunities in the space.

“Every technology provides you some degree of efficiency, and that can be used with good or bad intent,” says Mriganka Pattnaik, co-founder and chief executive of Merkle Science, a blockchain analytics platform for law enforcement, financial services and crypto services.

Crypto is employed across a variety of nefarious activities, like ransomware, money laundering, terrorism financing, and even straight-up kidnapping. This has resulted in lucrative paydays for criminals, who collectively raked in US$20.1 billion in 2022.

In the grander scheme of things, that amount may be a drop in the bucket – for example, a whopping US$800 billion to US$2 trillion is estimated to be laundered yearly. But US$20 billion is still a big deal.

What makes the technology so appealing to them? Let’s go a bit deeper into the criminal mind.

Behind the crime

If you’re up to no good, cryptocurrencies can have more appeal than, let’s say, banks. Banks have to look closely at the customers and businesses using their services to make sure nothing bad is going on. Think about the stringent processes and paperwork involved with opening up an account as part of “know your customer” (KYC) requirements – handing over that kind of personal data spells trouble for someone trying to avoid the law.

Cryptocurrencies, on the other hand, live on a decentralised system outside the control of any one authority, so you can instantly transfer money without bank accounts.

Historically, it has been much easier for criminals to hide behind fake identities on crypto platforms, making it challenging for authorities to find and freeze assets.

Non-fungible tokens have also presented great opportunities for money laundering because of how easy it is to transfer these digital assets and exchange them for cash.

But among all these options, decentralised finance (DeFi) has become an especially valuable vehicle for criminals because of how it leverages automation to run its protocols, making it hard for authorities to see the humans behind the machine.

As more regulation seeps into crypto exchanges, Pattnaik says that criminals will be tapping into DeFi platforms.

“In centralised exchanges, law enforcement can subpoena the KYC data held on criminals or give them legal notice to request that data. But for a lot of DeFi protocols, it is difficult to identify the human or entity behind it because the KYC process might be more lax,” he shares.

“These DeFi platforms may be deliberately turning a blind eye to bad actors or don’t bother with KYC as regulation and enforcement pathways are unclear in most geographies.”

For regulators, grappling with this new dimension of cybercrime comes with some big challenges, such as the rapid pace of evolution in the crypto space, says Pattnaik.

They’re often “one step behind” and need to work with technology vendors to keep up because they can’t change or adapt internal processes as quickly as criminals are finding loopholes.

A multi-pronged approach

As funding and interest flow into crypto, so will crime.

Some fear that the surge in bad actors will dampen the long-term prospects for crypto, which is why there is such a need for blockchain analytics and security solutions.

This is where Merkle Science comes into the picture, helping to build a safe environment for cryptocurrencies to flourish by enabling greater compliance and security.

The firm started out by supporting crypto companies in looking for ways to mitigate the risks posed by criminals. More recently, its scope has expanded to government agencies and regulators from all across the world, working to bridge the gap between the public and private sectors to collectively address this issue.

He adds that Merkle Science’s four main products were designed for a multi-pronged approach to managing crypto crime.

The first one, Compass, is a compliance operations tool to help companies monitor, assess, and score the risks associated with crypto transactions. Another product, Tracker, provides forensic capabilities that help enforcement agencies locate illicit funds.

“Say someone was a victim of a hack, and they lost US$1 billion in Bitcoin – the police investigator would use our Tracker tool to help them figure out where the money has gone,” he explains. “It’s also used by audit firms or companies like Kroll that are dealing with the FTX shutdown.”

Merkle Science’s Know Your Blockchain Business takes some of its cues from tried-and-tested practices from the financial industry, such as KYC and anti-money laundering (AML) checks. It provides risk scoring of crypto companies for regulators and financial institutions.

To do this, Merkle Science relies on data from a wide network of government agencies and cybersecurity firms to support real-time analytics and increase the likelihood of catching the criminals in the act, or shortly after.

Based on this data, Merkle Science can more effectively help law enforcement prevent crypto crime by identifying and reporting potential or suspicious criminal activity.

“Based on certain crypto wallet activity, we can tell if something is behaving like a ransomware or darknet address, like if a node is receiving US$100 multiple times a day,” says Pattnaik. This mimics the logic of KYC and AML processes, albeit with more complex crypto elements.

Finally, the fourth piece of the puzzle is Institute, which Merkle Science developed to train people on the nuances of blockchain analytics. This is key, as a “lack of knowledge” is one of the biggest problems in the Web3 space, he says.

A safer environment for growth

Pattnaik predicts that the industry will focus more on compliance issues, especially as more regulations come into the picture.

In fact, “the less regulatory ambiguity there is for crypto markets, the better it is for mainstream adoption,” he affirms, citing the entrance of established firms like BlackRock into the world of crypto.

For Merkle Science, having clear guidelines and regulations is essential to safely grow the cryptocurrency ecosystem and ensure its long-term viability.

“When risk-based compliance policies and controls are in place and enabled by blockchain analytics tools, it’s more likely for use to see legitimate players and sustainable growth,” he concludes.