Originally published in the NOWNodes blog.
Blockchain analysis has emerged as a big business over the past few years. The U.S. Government reportedly spent $6 million to carry out blockchain analysis activities. The companies providing blockchain analysis activities are also seeing a lot of traction today. Private blockchain analysis companies have raised total funding of $80 million till date. To understand the drivers of this capital inflow, we must understand what blockchain analysis is.
Majority of the global population knows that blockchain is the technology behind cryptocurrency transactions. The purpose of it is to create a distributed ledger which contains the details of all the online transactions on the various protocols. Apart from recordkeeping, blockchain technology also validates the transactions happening online. It also helps users to verify the transactions without the presence of a centralized authority.
The blockchain technology deals with cryptocurrency transactions. So, it is vulnerable to fraudulent activities as it happens to any other form of the currency exchange system. The analysis of blockchain helps to identify such frauds and suspicious activities. Analysing blockchain, one can detect in real-time the changes happening in the blockchain’s activities. Blockchain analysis also helps to take immediate actions if any of the changes seem suspicious.
The crypto exchanges are not in a compulsion to deploy blockchain analysts. Yet, most of them follow the requirements.
There are several benefits of allowing a blockchain analysis company to inspect an exchange’s data. It keeps the exchange protected for the potential threats of money-laundering and fraud. It helps to prepare customer intelligence reports, estimate revenue, and create new services. These firms are also known as blockchain forensics companies. Yes, it sounds quite interesting!
History of Blockchain Analysis
The history of blockchain analysis stems from the history of blockchain frauds and attacks. The first significant instance of bitcoin fraud dates back to 2011. This was the year when a bitcoin user lost $500,000 to hackers. In that same year, a wallet service entity named MyBitcoins vanished from the web. These incidents kept on continuing with several exchanges getting hacked and shut down in 2012.
In 2015 another exchange called BitStamp got hacked. In 2016, hackers stole a whopping $77 million from the Bitfinex exchange. Due to a rise in such scenarios, blockchain analysis or blockchain forensics firms were launched one after another. The increasing number of hacks clearly pointed to the fact that there was a demand for such services. Between 2013 and 2017, several blockchain analysis or blockchain forensic firms were established. Many of them are operating as top-tier companies of today.
Why is Blockchain Analysis Required?
Blockchain technology, the cryptocurrency exchanges, the crypto wallets, and the transactions on the exchange are all vulnerable to hacks and attacks. Such a risk-prone environment requires safeguards. That’s where blockchain analysis and blockchain forensics play a crucial role. Let’s try to understand this role in a bit more detail.
The basic functions of blockchain analysis involve transaction analysis and fund tracing. These analysis or forensic companies analyse each transaction on any blockchain protocol continuously. They also classify and group the addresses of the transactions on a regular basis. Selected addresses or address groups are then frequently monitored as well. Any suspicious activity happening through these addresses are then notified with an alert.
At a deeper level blockchain analysis also makes the flow of funds transparent. To understand the inflow and outflow of crypto funds is a difficult task. It is especially true when transactions are linked with thousands of addresses. Blockchain analysis helps to cut the clutter and extract the most important information. Analysing transactions also help to classify transaction behaviours. Any suspicious behaviour is followed up immediately. This helps to reach the bottom of any illicit act.
Blockchain analysis companies also verify information on their client’s behalf. They carry out necessary checks on its client’s potential partner’s claim. Blockchain analysis proves useful to prepare the transaction profile of selected addresses.
Finally, these blockchain analysis companies also come in handy to monitor stablecoins. They track the secondary market transactions and document the audit trails as well as the decision paths.
Blockchain analysis helps to visualize the entire scene of blockchain transactions and the movement of funds with transparency and traceability
Chainalysis — A Quick Intro
Chainalysis is one of the most reputed blockchain analysis companies. Established in 2014, the company has raised more than $45 millions of funding to date. It serves a host of government agencies as it’s clients. The list includes IRS, FBI, DEA, etc. It also works with crypto exchanges such as Binance.
The exchange Bitstamp, that was hacked in 2015, deployed Chainalysis as well. The company supports more than 87 leading cryptocurrencies. More than 350 companies have deployed it till date across 45 countries.
Lets then try to see how blockchain analysis works in the real world through the prism of Chainalysis.
The most popular product of Chainalysis is Know Your Transaction (KYT). Its also known as Chainalysis KYT. The fraudulent activities in the crypto world follow certain patterns. These include frauds related to the darknet, anomalous transactions, etc. Chainalysis detects all risk-prone activities. However, only the tracking and identification of potential frauds are not enough. This is why Chainalysis does even more for the clients.
Chainalysis provides alerts to make its clients aware. These alerts are sent in real-time and they are compliant with the anti-money laundering policies of most of the companies. Such alerts from blockchain analysis companies have lots of advantages. They can be used to freeze deposits as and when required. They can be used to stop withdrawals to fraudulent addresses. They can also be used to thwart the threats of ransomware.
Another successful product of Chainalysis is Chainalysis Reactor. Chainalysis Reactor is a software and it helps to identify the owner of the cryptocurrency and his address. The Chainalysis Reactor also equips the user with intelligence gathered and compiled from social media. It also creates understandable visuals showing the money trail. Additionally, it helps to present the case with annotations and graphs in case of fraud.
Chainalysis also has an offering known as Kryptos. It provides a portfolio of profiles of all the cryptocurrency businesses. There are more than 1800 such profiles available on Kryptos. The information that these profiles contain include details on these business’ KYC policies, latest news on these companies, their locations, etc. Apart from acting as an information repository, such products help to benchmark the services of one business against the industry standards.
Challenges to Blockchain Analysis
Experienced crypto holders often try to outwit blockchain analysis or blockchain forensics firms. There are several tricks and strategies that these companies deploy. One of the most common tricks is to use mixers. These mixers combine the inputs of multiple senders and hide their unique addresses. The mixed input is delivered from a single address making all the other addresses untraceable.
Another anonymity technique used to avoid traceability is creating multiple wallets. Creating multiple wallets and multiple transactions in between make the address the most difficult to trace back.
People often use exchanges that don’t comply with KYC regulations. They also take help of the non-custodial coin-exchangers to bypass blockchain analysis. Similar to non-compliant exchanges, people often use privacy conscious wallets as well to avoid the clutches of blockchain forensics.
Crypto trading is often unregulated and risky. Using untraceable addresses to launder money is a common threat. Willful non-compliance with KYC requirements frequently puts the stakeholders at risk. Therefore, all transactions and related addresses should be monitored. They should be monitored on a regular basis with the provisions of sending alerts as and when required.
Along with the transactions, the businesses and their stakeholders should also be studied carefully. Industry-wise data helps to assess the profile of the businesses. It also helps to judge the activity pattern of a specific address or business against that of the others.
Blockchain analysis or blockchain forensics is, therefore, a necessary tool. A tool for exchanges to protect themselves from hacks. A tool for businesses to choose and collaborate with the right types of partners. A tool to detect frauds beforehand.
Another advantage of blockchain analysis is that it does not stop at detection. It provides measures to protect. Blockchain analysis also provides measures to track and trace. It improves the entire environment by collecting intelligence and archiving it. With the advancement in blockchain technology and the expansion of crypto exchanges, the faculty of blockchain analysis is only going to get bigger.