Traditional Asset Tracing
Asset tracing has traditionally consisted of following the money. Investigators will search individuals' business assets, properties and vehicles; and for deeper investigations, forensic accountants will use bank statements to confirm funds and other transactional information to identify assets. There are many factors that can complicate the process of finding funds, particularly as an investigation relates to fraud and misappropriation. Challenges can range from location of the assets, third-party transfers and wires to sanctioned nations, just to name a few.
Asset Tracing Cryptocurrencies
Since the mining of digital assets began in 2009, added challenges have arisen in asset tracing. The challenges have come particularly from assets that can now be obtained through blockchains. The increase of digitalization of coins has made investigators think outside of the traditional asset tracing mechanisms. Adding a step to ensure digital assets are not missed in the investigation can help identify stolen or hidden cryptocurrencies.
Depending on the digital asset that is being traced, it is important to know the blockchain where the digital asset came from. Here are the key terms to understand before conducting cryptocurrency asset tracing:
- Blockchain – The digital asset will be stored and recorded into a digital ledger that is also known as the blockchain. According to IBM, “Blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network ... Virtually anything of value can be tracked and traded on a blockchain network.”1
- Crypto Wallet – A cryptocurrency wallet differs from a digital wallet, in the sense that it stores the key needed to access the cryptocurrency on the live blockchain. According to a cryptocurrency exchange platform, “Crypto wallets store your private keys, keeping your crypto safe and accessible. They also allow you to send, receive, and spend cryptocurrencies like Bitcoin and Ethereum.”2
- Centralized Exchange – Similar to ordinary stocks, individuals can buy digital coins and currencies through centralized exchanges. Centralized cryptocurrency exchanges “act as an intermediary between a buyer and a seller and make money through commissions and transaction fees.”3
- Decentralized Exchange – These types of exchanges allow users to buy and sell cryptocurrencies without an intermediary. These decentralized exchanges “rely on smart contracts, self-executing pieces of code on a blockchain. These smart contracts allow for more privacy and less slippage than a centralized cryptocurrency exchange.”4
Commonly Obtained Cryptocurrencies
During the pandemic, there was a rise of new digital currencies, such as NFTS and other digital coins. There are two that are the most common and highly traded on the exchanges.
- Bitcoin (BTC) – Well-known to be the original cryptocurrency that was mined in 2009. Bitcoin is purchased at a premium due to the amount mined and limited access to the coin.5
- Ethereum (ETH) – Often traded in the decentralized market, it is the second most popular coin next to bitcoin.6
Other Types of Digital Coins
- Non-fungible tokens (NFTs) – This type of digital asset has become more popular in the last 18 months. NFTs are digital objects that are verified on the blockchain. Most NFTs appear “in the form of art, music and as items in blockchain-based video games and video.”7
How is Cryptocurrency Traced?
Essentially, asset tracing for cryptocurrencies is not any different than traditional follow the money tracing. When comparing both, the major difference is the technology used to trace the assets. Additionally, digital coins can be traced in less time than traditional asset tracing investigations. If the tools are used correctly, the user is able to adequately find, analyze and graphically display transactions on the blockchain. The software tools are able to efficiently lead to the identification of the individual, or entities, behind the transaction and identify the location of the tokens.
Many of these tools are connected to centralized exchanges that have KYC (Know Your Client) information on their users. This information helps identify the owners of the wallets and the potential assets in question. The wallets get assigned a risk-based score with information on of the transaction, and it helps determine the safeness of the assets. An accumulation of information can help decide the feasibility of finding the owner of the digital asset.
There are setbacks that can take place when tracing cryptocurrencies. Fraudsters are creative in the ways they are able to hide their transactions through the blockchains. Additionally, not all exchanges obtain KYC information or respond to requests for information on the customer, making the investigation more difficult to conduct. Even if the wallet is traced, there is a possibility that that the jurisdiction may have data privacy rules or is unable to supply information of the final location of the asset.
Different Types of Crypto Asset Tracing
It is also important to note that there are different types of events that will lead into asset recovery in cryptocurrencies. Below are the most common occurrences.
- Hacks – The most common hack involves phishing attacks, in which a text or email is sent to the owner of the wallet to infiltrate a computer or phone in order to obtain digital keys or the digital wallet.
- Misappropriation of funds – Similar to other currencies, cryptocurrencies are used to hide funds, steal funds and embezzle funds.
Both instances could be equally difficult to trace, but there is a higher probably that the investigator will be able to show misappropriated funds, due to trails that are left for the purchase of the coins through the blockchain. Law enforcement is continuously learning different ways criminals are illegally obtaining access to the platforms that hold wallets and digital coins and are quicker to respond to requests to freeze funds to avoid further misappropriations.
As more regulations are put in place for digital coins, investigators will be able to better prepare for tracing digital assets and have access to more information on the blockchains. To supply a better view of the potential assets being traced, investigators should consider checking for digital assets across all platforms to see a holistic picture of the individual/entity in question. When looking for an investigative tool, keep in mind that most innovative tools will provide the information as long as the user is appropriately trained.
Footnotes
1 https://www.ibm.com/topics/what-is-blockchain
2 https://www.coinbase.com/learn/crypto-basics/what-is-a-crypto-wallet
3 https://corporatefinanceinstitute.com/resources/cryptocurrency/cryptocurrency-exchanges/
4 https://corporatefinanceinstitute.com/resources/cryptocurrency/cryptocurrency-exchanges/
5 https://freemanlaw.com/overview-of-the-most-common-cryptocurrencies/
6 https://freemanlaw.com/overview-of-the-most-common-cryptocurrencies/
7 https://cointelegraph.com/nonfungible-tokens-for-beginners/what-are-nfts-and-why-are-they-revolutionizing-the-art-world
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
