What Are the Steps in a Cryptocurrency Investigation?

Steps in a Cryptocurrency Investigation

Cryptocurrencies like Bitcoin and Ethereum have exploded in popularity and adoption over the last few years. However, cryptocurrencies’ pseudo-anonymous and decentralized nature also makes them rife for potential criminal activity. As a result, cryptocurrency-related investigations are becoming increasingly common for law enforcement and financial regulators.

A cryptocurrency investigation is an official inquiry into suspicious or illegal cryptocurrency activity. This can include crimes like fraud, money laundering, tax evasion, and terrorist financing. The IRS has conducted over 10,000 cryptocurrency-related investigations since 2019. About 75% of them involve unreported crypto taxes. Cryptocurrency investigations require specialized skills and methods to track transactions on the blockchain and identify individuals behind crypto wallet addresses.

The basics of conducting a crypto investigation are similar to traditional financial investigations. However, given cryptocurrencies’ novelty and technical complexity, they also present unique challenges. Cryptocurrency investigators must leverage the right mix of human intelligence, blockchain analytics tools, and cryptocurrency forensics to track illicit crypto transactions successfully.


The Trigger for Cryptocurrency Investigations

Several red flags can trigger a formal investigation into potential cryptocurrency-related crimes, including:

  • Suspicious transactions: Certain transaction patterns, like frequent transfers between unknown wallets or transactions with entities in sanctioned countries, can raise alarms. Mixing services that obfuscate transaction trails are also deemed suspicious.
  • Tax reporting gaps: Discrepancies between an individual’s lifestyle and their reported income from cryptocurrency investments can prompt an audit from tax agencies.
  • Whistleblower tips: Inside information from employees, contractors or former associates can accuse a business or individual of crypto-related fraud.
  • Law enforcement intelligence: Ongoing surveillance of criminal networks may reveal the use of cryptocurrencies to enable money laundering, drug trafficking, or terrorism financing.
  • Exchange compliance: Cryptocurrency exchanges have KYC and transaction monitoring obligations to report suspicious account activity to regulators.
  • Public complaints: Investors reporting crypto investment scams or ponzi schemes can trigger probes into fraudulent schemes and market manipulation.

The Steps in a Crypto Investigation

Cryptocurrency investigations typically go through the following key stages:

1. Scoping the investigation

Investigators start by defining the scope and parameters of the inquiry. This involves identifying the timeline, transactions, entities and individuals that will be the focus of the investigation.

2. Issuing legal orders

Investigators use subpoenas, search warrants, and court orders to obtain transaction records and account information from exchanges, banks, businesses and other third parties.

3. Analyzing the blockchain

Public blockchain data is analyzed using analytics tools to chart transaction flows between different addresses and map linkages between entities.

4. Open source intelligence (OSINT)

Publicly available information, social media, news reports and forums are scoured for intelligence related to the investigated entities and activities.

5. Conducting interviews

Questioning of suspects, witnesses, informants and other parties can provide critical details beyond what’s contained in records.

6. Tracing cryptocurrency transfers

The flow of funds is traced through the blockchain using heuristics and clustering techniques to attribute transactions to real-world entities.

7. Identifying perpetrators

Investigators combine clues from blockchain analysis, documents and interviews to pinpoint the individuals behind suspicious cryptocurrency addresses and transactions.

8. Freezing assets

Law enforcement can freeze or seize crypto funds and wallets used for illicit activity through court orders served to exchanges.

9. Case resolution

The investigation concludes with exoneration or sanctions against the accused parties in the form of criminal charges, fines, or administrative penalties.


How Criminals Enhance Anonymity on the Blockchain

While the blockchain creates a permanent record of all transactions, cryptocurrencies allow for users’ pseudo-anonymity. Senders and recipients are represented by alphanumeric public keys rather than real-world identities. This relative anonymity on the blockchain can be exploited by criminals to cover their tracks. Here are some techniques used to enhance anonymity:

  • Using mixers or tumblers – These services merge funds from multiple sources and outputs to conceal the trail back to the original sender. The bitcoins are “mixed” before being sent to the final recipient address. However, advanced blockchain analysis can sometimes reveal connections between inputs and outputs.
  • Chain hopping – Funds are moved between different cryptocurrencies such as Bitcoin, Monero and Zcash to obscure audit trails. It becomes challenging to track funds across other blockchains with analysis alone.
  • Coinjoin transactions – Bitcoin transactions are merged with others in a single batch and signed off together. This prevents easy linkage between senders and recipients within the transaction.
  • Leveraging privacy coins – Coins like Monero and Dash use cryptographic techniques like ring signatures and stealth addresses to preserve transactional privacy. This makes tracking transaction origins near impossible.
  • Using decentralized platforms – Decentralized exchanges like Bisq allow trading directly between users without KYC. This provides another way to obtain “clean” coins with no links to the user’s identity.
  • Fake identification – Criminals falsify or steal identities to pass KYC and AML checks when opening exchange accounts to mask their real-world identity.
  • VPN and TOR – By masking their IP addresses using VPNs or The Onion Router, criminals prevent their geographic location from being traced when using cryptocurrency services.
  • Crypto laundering services – Hands-on laundering services are advertised on the dark web to scrub tainted coins for a fee, further disassociating transactions from illicit sources.
  • Offshore exchanges – Exchanges based in jurisdictions with weak KYC requirements are used to cash out criminal proceeds, avoiding scrutiny in regulated exchanges.

While complete anonymity is impossible to achieve for most criminals, these tactics make cryptocurrency investigations vastly more challenging. Law enforcement has to rely on advanced blockchain analytics, surveillance, and good old-fashioned detective work to connect the dots in crypto-related crimes. The cat-and-mouse game between criminals exploiting anonymity and investigators unmasking them is set to continue as crypto adoption grows.


Future of Cryptocurrency Investigations

As cryptocurrency adoption grows globally, we can expect to see increased regulatory scrutiny and crypto-focused investigations across jurisdictions. Here are some trends to watch for:

  • Specialized crypto investigation units in government agencies
  • Stricter Know-Your-Customer and Anti-Money Laundering protocols at exchanges
  • More advanced blockchain analytics tools and forensics for tracing transactions
  • Cross-border collaboration between national regulators for information sharing
  • The emergence of crypto-forensics as a niche area of financial investigation
  • Investigations related to smart contract hacking, DeFi protocols, and DAOs
  • The debate around investigator access to private wallet keys vs. user privacy rights

Cryptocurrency investigations will only grow in complexity and importance over time. Understanding the steps involved can help regulators, law enforcement, investors, and honest crypto users stay on the right side of the law. With vigilance and open collaboration, the crypto ecosystem can proactively self-police unlawful activity as it continues maturing into mainstream finance.

If you’ve been affected by a crypto scam, you are entitled to a case evaluation.

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