The reverse side of the fight against illegal operations on the blockchain

Imagine two banknotes in denominations of $ 1. One of them – crispy and snow-white, has just been printed by the US Mint. The other is sly and crumpled. But their cost is identical. It does not matter if they belonged to a street drug dealer or to a big politician. They pay equally well for the bus.

This is called interchangeability.

One of the main characteristics of money, which we take for granted. But when it comes to cryptocurrency, interchangeability is in jeopardy, which is partly due to the nature of the blockchain, which encourages transparency of transactions: purse addresses are pseudonymous, but money flows can be tracked by everyone.

Last week, we were all reminded of this threat when the Bitfury start-up company introduced Crystal, a set of software tools that helped track illegal activities on the detachment.

This platform is an attempt by Bitfury “to help bitcoin once and for all to break with its connections with transactions from the black market.”

Valery Vavilov, CEO of the start-up, explained that Crystal will allow users to “determine whether the bitcoin-address from which you are transferring money is involved in illegal operations.”

If we recall the past, then Bitfury, a company originally engaged in mining, is by no means the first company offering such “detective” services. Before it was Chainalysis, Elliptic and Skry (the latter is now part of the company Bloq).

And, of course, the capture of criminals, other things being equal, is a noble goal. For the sake of the purity of the experiment, let’s assume that all the “crimes” in question are real crimes, that is, those where there is some “sacrifice”.

The oversight services offered by these companies will bring to life another advantage of the blockchain, helping start-ups to settle in traditional financial structures.

Banks are reluctant to serve this sector because of its association with crime. If they could demonstrate that customer money is not “dirty”, banks would provide the industry with fairly comfortable conditions. But if you use blockchain in this way, it can have the opposite effect to what you expect.

Address blacklists

As Chris Berniske and Jack Tatar write in his book “Crypto assets”:

“The danger for bitcoin, especially for those accounts that accurately participated in illegal transactions, is that the exchange can simply blockchain this address, and then its content will become objectively less valuable than money at other addresses.”

So woe to that seller that he will sell woolen socks to a drug addict, and then he will not be able to spend compromised funds.

But this is not even half the threat. Berniske and Tatar continue:

“If the cryptocurrency is unstable, such a loss of interchangeability will lead to the death of the digital decentralized currency, since it deprives the share of the value of all the tokens and not only those that were used illegally.”

Developers of cryptocurrency are well aware of this danger and for many years are working to strengthen the protection of user data, which, in turn, will preserve (or restore lost) interchangeability.

Some technical methods, for example, zk-snarks or ring signatures, were first applied to the altcoins ZCash and Monero. (As the authors already known to us write, “the loss of the property of interchangeability is one of the problems that Monero decides”). For bitcoin, other algorithms that enhance privacy, for example, TumbleBit, are being developed.

“I think that in the end, the task of any analytical tool is to keep pace with the development of crypto-currency, for forks, paying special attention to those of them that are specially designed to ensure anonymity,” said Jason Weinstein, strategic adviser to Bitfury, who worked for 15 years in US Department of Justice, and now – a lawyer in LLP Steptoe & Johnson.

Such improvements, however, can exacerbate problems with the law.

“If you make anonymous crypto-currency accounting, as in ZCash, you can lose the whole market,” said Charles Hoskinson, founder, and CEO of IOHK, a company that is developing several blockchain businesses, including Cardano.

“For example, the Japanese financial services agency,” he adds, “approving any cryptocurrency before it appears on the country’s licensed trading floors will never miss a token with a high degree of confidentiality.”

On the other hand, if you do not provide for such functions, then after de-anonymization, the entire financial history of the user will be disclosed. And this, according to Hoskinson, “is even worse than the usual banking system.”

Double standards

In general, it seems that the cryptocurrency is still holding higher rates of “purity” of money than traditional currencies, at least their physical version. (But, to be honest, the comparison is not entirely correct, since it is impossible to transfer a suitcase full of bills in half the globe).

Satoshi created bitcoin, so that people who relate to each other with disbelief, could make transactions through the Internet. Disclosure of all transactions on the blockchain is the price that one has to pay for the credibility of the system, and he, the creator, (or she or they) felt that pseudonyms would soften the loss of confidentiality.

Radical transparency is often advertised as a feature of blockchain technology, which is understandable from the point of view of commercial firms and governments. And in the case of bitcoin, this transparency gives additional advantages to ordinary users. For example, if you track all wallet transactions on the exchange, you can notice the theft in time.

But if you use cryptocurrency as a means of payment, then the openness of the blockchain can play a cruel joke, even with law-abiding users.


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