Fiat currencies are highly regulated by government institutions while crypto users continue to enjoy a number of freedoms.
Quite obviously, global governments acknowledge the risks posed to banking institutions and financial regulators if virtual currencies continue to experience mass adoption. For this, they have presented a number of reasons and mechanisms for tracking crypto transactions.
Why Do Governments Track Crypto Transactions?
The government needs to oversee the cryptocurrency sector for a number of reasons, with main reasons for crypto tracking being:
Regulation to Prevent Insider Trading
Considering that cryptocurrencies are not fully regulated by governments, a number of issues arise as far as financial flows are concerned.
Digital assets operate without the firm grip of banking institutions witnessed in the traditional stock markets. For this, it becomes almost impossible for regulatory bodies to detect malpractices such as insider trading unless if the government agencies track invoke blockchain analysis to track transactions.
The attributes born in the crypto trade offer little possibilities for governments to enforce taxation laws. The fact that many people and institutions continue to engage in commerce using virtual currencies has prompted governments to track crypto transactions in pursuit of ensuring that people pay taxes off the proceeds of their commercial activities.
A host of dark web criminal cases have involved the use of cryptocurrency to protect the real identities of perpetrators. The only way for government agencies to crack cases like such is for them to track the chain of transactions that would lead to the actual masterminds of notable criminal operations.
The Money Laundering Concern
Governments aim to be very vigilant on matters money laundering, which mostly involves the unlawful practice where people use virtual currencies to stash their wealth in distant destinations.
Governments usually argue the case of money laundering under the lens of national security and the concealment of criminal proceeds. By tracking crypto transactions, governments can implement anti-money laundering (AML) laws effectively.
How Governments Track Crypto Transactions
The following section will explicate a number of mechanisms and stakeholders that continues to enable the governmental capacity to track crypto transactions.
Following the Money
This denotes a conventional practice that’s been used by the conventional banking system to crack down on financial malpractices since time immemorial.
In the context of cryptocurrencies, government agencies “follow the money” by tracing the flow of cryptocurrency to identify specific wallets and patterns of user cash outs. The process is then followed with the identification of IP addresses to expose target identities within the government’s interest.
Regulated Crypto Exchanges
The compliance of target crypto wallets to Know Your Customer / Anti-Money Laundering policies (KYC/AML) makes the governments’ task of tracking crypto transactions even more efficient. The mentioned policies require crypto exchanges to flag any suspicious transactions that occur on their platforms.
In fact, an increasing number of governments have used crypto regulation laws to prompt exchanges into adopting strict KYC/AML protocols at their registration.
So far, this method has proved to be pretty effective, with reports intimating that more than 500 illegal transactions were reported by Japanese exchanges in the year 2018 alone.
Hiring Blockchain-Focused Analytical Firms
Another method used by governments in tracking crypto transactions involves the hiring of technical talent within the blockchain sector, usually done through engagements with private contractors and already-existing blockchain analytical tool providers.
In fact, past reports have shown that the U.S. government has directed big funding into hiring private contractors to help its agencies (including the IRS, the DEA and the FBI) track crypto transactions (See below).
Chart showing the hierarchy in government funding received by blockchain firms to date (Source: Diar).
As it stands, governments have moved to exploit the pseudo anonymity of cryptocurrencies – a technique that has expanded the law enforcement capacities of intelligent bodies in hunting down crypto-centric criminals.
Considering that a long list of blockchain firms have specialized in decrypting the paper trail created by virtual assets, governments have found it convenient to invest in their talent to meet law enforcement targets.
Chainalysis is one such blockchain firm that leads the way in exposing crypto transactions that occur across various blockchains. The company has invented innovative tools that assist private entities, governments and crypto investors to conduct big blockchain data analyses for purposes of crypto tracing.
As early as the year 2017, the U.S. Internal Revenue Service (IRS) hired Chainalysis to expose anonymous crypto wallets that would enable law enforcement agencies to reveal real-world identities of actual holders – focusing on tax evading suspects.
Elliptic enterprises is another blockchain analytics firm that has created a number of sophisticated tools that can be used to flag and identify the origins of cryptocurrencies. Notably, the company is known for developing the Bitcoin Map that’s valuable to government agencies.
CipherTrace is also a major stakeholder in the blockchain industry, having innovated deanonymization tools used by governments and private sector players in tracking crypto transactions. According to the blockchain analytics firm, the CipherTrace portfolio has 700 crypto assets. In the past, the Maltese government hired the firm to help track money launderers and terrorist financiers.