Navigating Crypto Crime in 2024

At the panel titled "Navigating Crypto Crime in 2024" on 18 September 2023 at TOKEN2049 Singapore, the panel consisting of Perianne Boring, Founder and CEO of The Digital Chamber who is moderating; Michael Gronager, Co-Founder and CEO of Chainalysis; Mauricio Beugelmans, Chief Legal Officer of OKX; and Sudhu Arumugam, CPO of M2; dives into how far crypto crime has come.

Crypto Crime in the Early Days & its Evolution

Crypto crime has been a central issue since the early days of crypto.

When Chainalysis launched, conversations around illicit activity dominated the narrative.

At the time, crypto was viewed as a major tool for criminals and a hotbed for illicit activity.

But today, less than 1% of crypto transactions are illicit.

How has this narrative evolve over the last decade?

Gronager said:

“… when Chainalysis started, we were probably looking at closer to 10%, if not more, of that illicit activity. One of the prime use cases in the early days, we saw Silk Road, we saw other things, and then crypto started to grow, and has been used for so many other use cases than criminal activity, and if you move forward to today, things have actually changed completely, and one of the reasons for this is really the growth of the industry, and the importance of the industry.”

The growth of the crypto industry, especially the rise of stablecoins, has expanded legitimate use cases.

Stablecoins are used across sectors which paradoxically allows for greater transparency and law enforcement opportunities.

Blockchain technology provides digital breadcrumbs that can solve crimes in ways that were impossible before, much like how DNA revolutionised forensic science.

He added:

“… because it means that now you have transparency into international crime to a level that's unprecedented. So, this is actually an opportunity to solve cases, local cases, that couldn't have been solved otherwise…our customers, many of them, are in the law enforcement space, in the intelligence space, and others, and they're saying the same to me, and they're basically saying, this is amazing. So, we believe that, like, solving financial crime by looking at the breadcrumbs of the blockchain will be similar to how DNA is changed, how you solve, like, physical crime on the streets and everything else, and that will be a huge shift.”

Blockchain analytics can give unprecedented insight into illicit finance, helping to trace the flow of funds in ways law enforcement could not previously imagine.

Boring concurred:

“..there's a lot more data about where they're sending the money, how they push it around, where it goes, and all that data is data that law enforcement has never had before, and so then that can also have a big influence on shaping policy and strengthening policy and strengthening law enforcement's understand of some of the most egregious criminal actors globally.”

The sophistication of crypto crime has increased over the years.

Exchanges have evolved from outsourcing key functions like custody to developing in-house solutions.

According to Arumugam, however, tackling financial crime requires highly specialised tools like KYT (Know Your Transaction), which they rely on experts like Chainalysis for.

The challenge for the industry is not just defending against crime but navigating policy and regulatory pressures.

Beugelmans elaborated:

“So one of the primary pieces that we've been looking at is from a regulatory and frankly law enforcement perspective. Regulators, law enforcement, they're looking at the numerator, not the denominator, right? So if it's X amount of crypto fraud that's identified, the fact that it may be a very small percentage relative to the volume that we see is a challenging argument to make to your regulators or to your law enforcement. You need to recognize that they're looking at the numerator, and then you have to study what they're seeing.”

We must recognise this and from a compliance perspective, we need toensure we are implementing strong risk-based Know Your Customer (KYC), transaction monitoring, and engaging with regulators proactively.

In the crypto industry, there has historically been hesitation to cooperate with law enforcement, often due to customer expectations of privacy regarding their information.

This attitude has evolved, but it is crucial for the industry to understand the perspective of law enforcement and regulators, particularly what is reported to them and the frameworks in which they operate.

Will Criminals Stop Using Crypto for Illicit Activity? Unlikely & Unrealistic

One key narrative we hope to eliminate is that cryptocurrency is primarily used by criminals.

According to Chainalysis' report, only 0.34% of transactions are linked to illicit activity.

However, policymakers and law enforcement will likely remain concerned until that number reaches zero, which is unrealistic.

As such, we must actively engage with these stakeholders to protect users and address crime in the space.

Scams' an Escalating Problem

In the 2023 update of Chainalysis’report, scams, especially targeting individuals over 60, remain a significant issue, which will likely attract further attention from lawmakers.

Although education and prevention efforts help, collaboration between the public and private sectors, such as the SpinCaster operation, has been crucial in generating leads and resolving cases more efficiently.

Nation-state actors also pose serious concerns, according to Gronager.

Russia has been linked to ransomware campaigns, and North Korea continues to engage in large-scale hacks, particularly targeting DeFi infrastructure.

As security has improved over time, these attacks have shifted towards centralised exchanges (CEX), which are now primary targets due to the concentration of assets.

North Korea's Hacks Linked to Missile Tests

North Korea's cyberattacks are alarmingly correlated with missile tests, highlighting the severity of this issue.

Gronager opined:

“And one funny thing, it's not funny, it's scary, but like around North Korean hacks is that there's direct correlation between the missile tests from North Korea and how much funding they get out of hacking projects.”

This threat is well-recognised by policymakers, and concerns about North Korea's use of cryptocurrency have influenced legislative proposals in the US, such as Senator Elizabeth Warren's bill to ban cryptocurrency.

Boring noted:

“It's legislation that was sponsored by Elizabeth Warren. We did a huge campaign this year to try to educate policymakers on why this was not the right approach. And so many of the members who had sponsored this bill and senators who had sponsored the bills, it's because of this North Korea piece. They were told that North Korea is using cryptocurrency to fund their efforts. Therefore, we've got to crack down on crypto. Banning it is not going to be a great way to go about it because we're just going to push the whole thing underground.”

Crypto Crimes Increase in Sophistication

With startup exchanges, smaller platforms typically face DDoS attacks and similar threats, which can be costly as hundreds of servers are being bounced around.

As these exchanges grow, attacks become more sophisticated, especially phishing campaigns.

Fortunately, advancements in technology have allowed for more sophisticated defenses, and it is essential that security teams remain vigilant and continuously update their systems.

Investments Scams: the Number One Way to Steal Digital Assets

To begin with, it is essential to identify the key areas of crypto crime.

Recently, the FBI released a report on crypto crime in 2023.

While somewhat US-centric, it had an international scope, largely driven by customer complaints and loss reports tied to crypto crimes.

These figures, if considered globally, would undoubtedly be higher.

One of the key issues is investment scams, which continue to be the leading method of stealing digital assets.

These scams include tactics like "pig butchering," where scammers build independent relationships with users, often outside the scope of exchanges.

The report also highlighted that losses amounted to around $5.6 billion, with individuals over 60 years old being the most frequent victims.

This demographic, regardless of the jurisdiction—whether it's the US, Singapore, the EU, the Middle East—is a key focus for regulators and law enforcement.

The severity of scams targeting seniors is recognised globally.

Hence user education is very important.

Users need tools to help them recognise potential scams, and they must feel comfortable contacting customer support if they have any suspicions.

The challenge, of course, is that scammers build direct relationships with users outside of our oversight.

On the back end, close collaboration with law enforcement is crucial, though it is a resource-intensive process.

Policymaker Education is Essential

It is vital that, as an industry, we do not simply react by shutting things down, but rather advocate for a regulatory framework that allows crypto to thrive safely.

When it comes to tackling crypto crimes, a key deterrent is the ability to seize proceeds.

If criminals cannot profit, it reduces the incentive for crime.

A world where exchanges are banned, driving activity underground, would be problematic.

Fortunately, we have regulated exchanges today, and many issuers, even if not fully regulated, work closely with governments.

This allows investigations to trace stolen funds and freeze them, which would not be possible in an underground market.

Gronager expressed:

“So you actually need these chokepoints and decentralized services that collaborate. Also, because today the industry is using a similar toolset, so if a hack happens, within minutes after, those funds will be marked as potentially stolen, and that means that they cannot be frozen. In a scenario where you make any of these things illegal, you will not have it. So I think that's the story we want to bring to policy makers, and people in law enforcement are saying exactly the same. So it's just a matter of getting policy makers to listen.”

Blockchain is a powerful tool for fighting crime; tracking funds on the blockchain can often be more straightforward than through traditional banking channels.

However, there is a gap in understanding how our industry combats crypto crime, and we need to bridge that by showing policymakers the strength of our systems and the industry’s commitment to compliance.

Decentralised finance (DeFi) presents both opportunities and challenges for crime prevention.

While DeFi allows innovation in product offerings, it also creates an environment where traditional compliance measures, like KYC, are harder to implement.

However, even in a decentralised ecosystem, there are still touchpoints where services and institutions can step in.

For example, institutions may use decentralised technology while providing secure interfaces for users, protecting their funds.

This balance between decentralisation and institutional control will be critical for the future of finance and combating crime.

Proof-of-Liabilities is the Balanced Solution

Proof of reserves is a step forward for exchanges, but on its own, it offers limited legal assurance.

While proof of assets essentially demonstrates the liabilities to customers—their deposits—it remains only a partial solution.

A more complete picture would require proof of liabilities from the entity's perspective.

For example, verifying that both assets and liabilities are accurately reflected is essential for ensuring transparency.

This would enable independent verification that the assets a company claims to hold are indeed there.

Now, integrating proof of reserves into traditional finance could be complex, especially in real-time.

While crypto exchanges can back customer assets 1:1, traditional banks lend out deposits, which changes the dynamic.

Regulatory backstops, like the FDIC, mitigate risks, but the challenge remains in real-time transparency, particularly with derivatives and complex financial products.

Bridging the gap between lagging audits and real-time proof of reserves is critical for the future of financial compliance.

Implementing this level of transparency in traditional banking would first require a clear definition of what proof of reserves would mean in that context.

Verifying customer assets on-chain might be more difficult due to the nature of traditional banking models, but blockchain technology holds the promise to address some of these challenges.

Law Enforcement & Private Sector Need to Partner Up to Combat Crypto Crime

In terms of fighting crypto crime, collaboration between law enforcement and the private sector is key.

We have seen successes in cases such as the recovery of funds donated to Hamas and tracing stolen assets from the Axie Infinity hack, highlighting how blockchain can aid law enforcement.

Even when funds are stolen, the transparent nature of blockchain can hinder attempts to launder them, making it harder for criminals to move assets undetected.

This type of success story underscores the potential of blockchain to track and recover illicit funds across borders.

Arumugam concluded:

“from a regulatory perspective and from the police and law enforcement, I think getting everyone up to the same level of knowledge is the next big leap forward for us because in some jurisdictions, they're much further along than others…And so I think getting everyone around the world to a certain base level will be the step forward over the next few years.”

The future of fighting crypto crime lies in strengthening global collaboration and leveraging technologies like blockchain.

As institutions adopt these systems, building a robust compliance framework that integrates both proof of reserves and active partnerships with law enforcement will be key to mitigating risks and ensuring long-term trust.