Historically, crypto currencies have had a reputation for being widely used by criminals and terrorists because of their anonymity and the fact that they can be transferred without the need to use traditional financial markets and banks. However, according to analysis from a company called Chainalysis there are actually less than 1% of crypto transactions linked to illegal activities. Given the capitalisation of cryptos being over $500billion, 1% would equate to $5billion, which is a drop in the ocean compared to the $800billion to $2trillion of cash (2% to 5% of global GDP) that the United Nations estimates is money laundered worldwide p.a. One possible reason for cryptos not being used more extensively for nefarious activities is that they leave a ‘digital footprint’ which enables others to track and trace, and thus ascertain, where a digital payment has come from and gone to. Indeed, this is one of the reasons it is being alleged that the Chinese have introduced their own Central Bank Digital Currency. Notably in a report from Bloomberg, one of China’s central bankers has explained that, “user identities will likely be tied to individual wallets, giving authorities another window into people’s lives”.
The ability for cryptos to be tracked has proved very helpful, particularly when a crypto has been ‘forked’. One of the reasons cryptos may need to be tracked down is because their owners may have misplaced them when there is a ‘fork’ - a term used to explain when a Blockchain splits, often instigating the creation of a new crypto currency. Forks usually occur due to a significant change in a Blockchain’s protocol leading to splitting the Blockchain into an ‘old’ way of doing things and a ‘new’ way of doing things. It is claimed that between 2017-2019 there were 58 Bitcoin forks, resultant from which the original Bitcoin Blockchain has now spawned other versions, e.g. Bitcoin cash, Bitcoin Gold etc. In addition, forks can be categorised into either a ‘hard fork’ or a ‘soft fork’; a hard fork is when a Blockchain totally changes the way it functions so that those running the Blockchain need to change the software they use and, conversely, a soft fork means that although the rules of the network change the old software is still used to validate transactions.
Chart of Bitcoin Blockchain and Software Forks
Unsurprisingly, it can be a challenge to keep track on these different forks and the cryptos they create. However, there are websites to help one track and trace forks such as ForkDrop.io and Forks.net, and now there is a service called Reclaim Fork (from UK-based Coinfirm) which can also help. The crypto and blockchain analytics firm has looked into the digital wallet which was holding over $1.2 billion of Bitcoins (which the US government recently seized) that were allegedly linked to the infamous illegal Silk Road website. Coinfirm has discovered that there could be in excess of another $380,000 worth of different cryptos due to forks linked to the seized digital wallet that have, as yet, been taken under the control of the US government.
Another company active in tracking down cryptos is Chainanlysis which has just raised $100million, valuing itself at $1billion (up from only $266million in July 2020). Chainanlysis provides information and analysis to governments, exchanges and financial institutions using a range of compliance tools helping to track and trace the source of funds and lost cryptos. There are also other longer established firms such as Kroll (owned by Duff and Phelps) and Alaco, which this year launched Alaco analytics. These firms are employed by organisations such as banks, corporate brokers, accountants and law firms to help conduct background checks, due diligence and investigations on individuals and corporations including sources of funds. Henry Burrows at Alaco analytics has stated, “We are definitely seeing institutions warm to virtual assets. There is far greater regulatory clarity than there was in 2017, and a far better understanding of the risks. Services like ours provide clear and concise information on customers and customer’s funds – in more granular detail than traditional financial services. As that understanding grows, we will continue to chip away at the misplaced perception of crypto as a refuge for financial crime.”
The ability to track and trace cryptos ought to offer traditional financial institutions greater comfort as they continue to embrace this asset class, together with the increased transparency and independent due diligence which are now available. Furthermore, as people understand what their transactions do, indeed, create a digital footprint, this should lead to more trust in cryptos as an asset class and possibly deter cryptos being used for illegal purposes - unlike the preferable ‘suitcase of cash’ which has historically been used so often for shady deals….