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Crypto is less anonymous than you thought — and it might be a good thing

'Crypto is even less anonymous than traditional finance'

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Follow the crypto. That’s what the Federal Bureau of Investigation likely did after Colonial Pipeline Co., a U.S.-based refined oil pipeline operator, was forced to pay US$4.4 million in cryptocurrency after its systems were disabled by a ransomware attack in early May.

To track down the funds, authorities would have accessed the public blockchain ledger that recorded the payment and pulled out the mix of characters that indicated the digital addresses that received the money, according to Pamela Clegg, vice-president of financial investigations at U.S.-based blockchain forensics firm CipherTrace, which researches and works with federal authorities in these kinds of cases.

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Within a month, authorities had not only figured out where the funds were being held, but had identified the hackers and managed to recover 63.7 bitcoins, worth about US$2.3 million, from affiliates of the hacking group DarkSide.

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“It was really interesting because they actually got their hands on the private key,” Clegg told the Financial Post, referring to the unique cryptographic code used to access a cryptocurrency wallet. “So, that is really analogous to actually coming in and finding the cash under my mattress.”

While the incident brought greater attention to the threat of ransomware attacks, the recovery of the funds raised another important issue that is still reverberating through crypto world: bitcoin isn’t as anonymous and off-the-grid as many assume.

“It’s a common misconception that cryptocurrencies like bitcoin are totally anonymous and untraceable,” said Maddie Kennedy, senior director of communications at the blockchain analysis firm Chainalysis, told the Financial Post. “The reality is actually quite the opposite: cryptocurrencies are designed to be quite transparent.”

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Cryptocurrencies are designed to be quite transparent

Maddie Kennedy

A public blockchain ledger will outline a user’s ID in pseudonymous form, show their crypto balances and keep tabs on all of the transaction they’ve completed within that ledger. Kennedy added that anyone can access these transaction histories using public block explorers, though they might not be easy to read for the uninitiated.

“It’s really difficult to understand, it’s basically just like a bunch of numbers and letters transacting with another bunch of random numbers and letters, and that doesn’t really make sense to anyone when you just look at the ledger,” she said.

Companies like Chainalysis map out these difficult-to-decipher numbers and letters to extract a proper address and connect them to real world services, whether it’s an honest exchange or a wallet used for more nefarious purposes.

In this sense, they’re a lot less anonymous than regular banking structures.

“I would say that crypto is even less anonymous than traditional finance because blockchains, in their nature, are open and transparent,” said Arseny Reutov, head of the application security research team at Positive Technologies.

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“Crypto in general is what I refer to as pseudo anonymous,” Clegg said. “I can see all the transactions, I can see all the addresses, I can see everything that’s happening out there on the ledger. I just don’t know who’s behind those addresses. I don’t know who’s … pulling the levers.”

Clegg added that navigating the crypto world is a lot like the Wizard of Oz: it’s a matter of pulling the curtain back and seeing who is on the other side. That means labelling addresses on the blockchain ledger and categorizing them in terms of morality (good entities, bad entities, or neutral entities) or by the source of the address (an exchange or black-market entity).

These analysts can then build an intricate web of connected addresses using clustered algorithms. Consolidating these algorithms, or transactions, means that the team is able to trace multiple addresses back to a single entity. While firms like Chainalysis and CipherTrace track these connections, federal authorities are also catching up.

Crypto in general is what I refer to as pseudo anonymous

Pamela Clegg

For some early adopters attracted by the anarchic, “off the grid” origins of crypto, that may be an unwelcome development. But it really depends which part of the community you belong to.

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Justin Hartzman, the co-founder and chief executive officer of Canadian crypto trading platform CoinSmart, divides the community into two separate camps: the libertarian, “screw the man” camp that is protective of their money and wants to keep the sector decentralized; and the camp that sees the community growing and becoming more accessible and welcomes regulation to keep the bad actors out.

Hartzman added that in the early days of Silk Road crypto, being away from prying eyes and the authorities was a significant selling feature.

“Crypto kind of had its roots in this sort of libertarian sensibility,” Chainalysis’s Kennedy said. “But the fact of the matter is, I don’t think that global regulators would allow a totally anonymous cross-border technology to function without basic regulations in place to prevent some serious crimes like ransomware.”

As the tools to track transactions improve and authorities such as the U.S. Federal Reserve take on a greater oversight role — going so far as to consider their own central bank digital currency (CBDC) — questions of privacy may increasingly come to the fore.

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Regulators are pushing for more information, too. In March, the Canada Revenue Agency (CRA) demanded that exchanges such as Coinsquare hand over thousands of customers’ data on high-value accounts to ensure that these customers were meeting their tax obligations and properly reporting crypto assets. This came several months after regulators first went after Coinsquare in November 2020, requesting that they hand over customer data since the beginning of 2013 to comply with tax duties and obligations.

The question of how much granular data central banks and other regulators should have access to is one that will be hotly debated.

“At the end of day, we’re going to comply where we need to. But that’s not what I think is the best approach to it,” said Hartzman, adding that in his opinion, the responsibility should rest with individuals as the process for reporting transactions and data in the crypto space is becoming easier.

Ben Weiss, the chief executive officer of CoinFlip, a company specializing in a network on bitcoin ATMs, told the Financial Post that when it comes to how regulators and central banks should approach crypto holders, it should be about fairness.

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“Exchanges and (over-the-counter) desks should be treated like any other financial institution and shouldn’t be targeted just because they are involved in crypto,” Weiss said. “I think they need to be treated like other financial institutions.”

Even as regulators circle the industry, Weiss believes crypto users are still able to claim outsider status in the sense that they are not dealing with the traditional financial system.

“I think the crypto community has always been about taking control of your financial destiny and being your own bank, I don’t think it’s been … that much about the anonymity,” Weiss said.

If central banks get too deeply involved and launch their own digital currencies, that will only deepen the appeal — and outsider status — of cryptocurrencies such as bitcoin.

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“It’s like, ‘Oh, there’s Fedcoin, but I have Bitcoin,’” Weiss said. “I think in some ways, as long as that bitcoin option is there, it could actually help show the contrast.”

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For now, firms such as CipherTrace are left walking a fine line between the interests of the community and authorities looking for every scrap of information they can find.

Clegg said it’s important to root out the bad actors as they come up, but compromising basic privacy is not the answer.

“(Allowing the U.S. government to have all crypto addresses), that’s a step maybe a little too far for right now,” Clegg said.

“We want to respect the privacy and we want to respect the decentralized nature of crypto in general. As long as nobody’s doing anything illicit or nefarious, there’s no reason for us to really get involved in their activities.”

• Email: shughes@postmedia.com | Twitter:
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