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Binance, the world’s largest cryptocurrency exchange and target of regulatory scrutiny and criminal investigations in Europe and the U.S., wants to counter the notion that virtual assets facilitate criminality on a large scale.

In April, the exchange cited findings by Chainalysis, a U.S. blockchain analytics firm, that less than 0.2 percent of all cryptocurrency payments in 2021 were illicit, as compared to a U.N. study’s estimate that 2 to 5 percent of global gross domestic product—the equivalent of $800 billion to $2 trillion—is laundered “in the traditional fiat space” every year.

“Criminals don’t like crypto because the fact that transactions are publicly and permanently recorded enables investigators,” Binance argued in an online statement. “In contrast with traditional financial investigations, the transparent nature of crypto makes it easier to identify bad actors.”

It is a common trope in the industry.

In April 2021, San Francisco-based Coinbase, which, like rival Binance, faces U.S. accusations of operating an unlicensed securities exchange, cited research by a second blockchain analytics firm, CipherTrace, to assert that “illicit activity accounts for less than 1 percent of cryptocurrency transactions.”

This narrative, analysts told ACAMS moneylaundering.com, belies gaps in the ability of analytics firms to measure the total volume of illicit transactions in the cryptocurrency sector and promotes the questionable notion that public blockchains—the shared, immutable, online ledgers that record all “on-chain” cryptocurrency transactions in real time—deter criminality.

“[Chainalysis reports] are the only ostensibly compliance artefact that captures so much public attention from non-compliance professionals,” said Luke Raven, a compliance officer in Melbourne, Australia who most recently worked at a now-defunct local exchange, Cabital. “That’s because they’re essentially a marketing exercise for the entire crypto industry.”

Ciphertrace did not respond to questions from moneylaundering.com by press time.

New York-headquartered Chainalysis noted in its latest annual “crypto crime report” in February that outflows of cryptocurrency from digital addresses linked to crime reached nearly $21 billion last year, up from $14 billion in 2021, largely because of a spike in online thefts from cryptocurrency platforms and a series of designations of exchanges by the U.S.

Chainalysis further noted that the value of illicit transactions as a proportion of “all cryptocurrency activity” rose for the first time since 2019, from a little more than one-tenth of 1 percent in 2021 to one-quarter of 1 percent in 2022, but at the same time concluded that crime as a share of total transactional volume is still “trending downwards.”

Chainalysis acknowledged that $21 billion represented a “lower bound estimate” based only on digital addresses linked to known ransomware attacks, blacklisted parties, fraud schemes, online theft, darknet market sales and other crimes.

Kim Grauer, the company’s director of research, told moneylaundering.com in an email that her firm is “transparent about the limitations of our analysis” and bases its crime estimates on “100 percent verifiable crime transactions.”

“We also put out estimates on potentially illicit activity, including quantifying money flowing through illicit OTC [over-the-counter] networks,” Grauer said. “These, however, cannot be verified as illicit with 100 percent accuracy given there is no corresponding investigation or court case.”

The firm’s findings still contrast strongly with those put forward by three Australia-based academics, who estimated in 2019 that based on transactional data from 2009 to 2017, one-quarter of all 106 million Bitcoin users engaged in crime, and that by 2018, illicit finance accounted for around $76 billion a year, or roughly half, of all transactions in bitcoins.

Cryptocurrencies have transformed drug trafficking by enabling crime syndicates to cut out street dealers and sell directly to customers around the world through darknet markets, as well as peddle higher-quality narcotics, said Sean Foley, a finance professor at Macquarie University in Sydney and one of the report’s authors.

“Chainalysis is trying to tell us about the total consumption of cocaine in Australia by telling us about how much cocaine has been seized,” Foley said. “It’s very difficult for me to meaningfully comment on the methodology because they don’t really tell you what they do.”

Like Chainalysis, Foley and his colleagues reviewed wallets linked to darknet activity, scams and hacks uncovered by law enforcement, but also incorporated other red flags, such as the use of mixers and tumblers, and used network analysis to identify Bitcoin users who mostly engaged in crime.

The three researchers also excluded deposits and withdrawals consistent with mere investments in cryptocurrency from their analysis.

“I’m interested in the peer-to-peer as opposed to just looking at all activity,” Foley said. “We removed that from our denominator, which will increase the total [proportion] of illicit transactions.”

Cash-for-crypto

Chainalysis also acknowledged in February that its estimate of $21 billion of illicit transactions in 2022 depends “solely on on-chain intelligence,” and does not capture proceeds from “non-crypto native” crimes such as drug and human trafficking in which cryptocurrency functioned only as a method of payment, or as part of a wider, cash-based laundering scheme.

In other words, while the sale of a few grams of cocaine to a recreational drug user from a vendor on the Tor2door darknet market would be included by Chainalysis, a multi-million-dollar payment in Bitcoin or USDT from a “clean” digital address, or wallet, controlled by an Albanian crime syndicate to a Colombian cartel for an entire shipment would not.

Cryptocurrency crime estimates therefore also fail to capture the growing illicit cash-for-cryptocurrency market in Europe and elsewhere, where professional money-laundering syndicates convert illicit banknotes into virtual assets to move value and settle transactions between disparate groups in different countries.

U.K. officials, for example, estimate that British crime syndicates every year convert more than £1 billion worth of illicit cash every year into cryptocurrency that they then move overseas.

In 2021, illicit cryptocurrency transactions “linked to the U.K.” equated to at least £1.2 billion—approximately 1 percent of the aggregate value of all cryptocurrency transactions in Britain—”with a realistic possibility” the true amount was “significantly higher,” the agency reported in March.

In December 2020, the U.S. Treasury’s Financial Crimes Enforcement Network disclosed that “despite significant underreporting” by virtual asset service platforms, the bureau received suspicious activity reports on $119 billion worth of transfers involving cryptocurrency.

FinCEN noted that the $119 billion amounted to roughly 12 percent of “total activity” in the U.S. cryptocurrency market that year, and described industry estimates that only 1 percent of all cryptocurrency transactions involve illicit funds as a probable underestimate.

“Chainalysis are probably the best in terms of their research capability, and it’s good to see them moving to caveat this stuff a little more strongly,” said Raven, the Melbourne-based compliance officer. “But they don’t go out of their way to correct people [misrepresenting their reports], and that’s a problem.”

Off-chain

Critics have also pointed out that the most widely cited estimates of cryptocurrency’s links to crime exclude the enormous volume of potentially illicit transactions that do not appear on the blockchain.

For example, a criminal with access to several wallets on the same exchange can conduct illicit activity entirely within the same platform—including layering funds by swapping one type of cryptocurrency for another—without generating a record on a public ledger.

Only platforms with sophisticated “off-chain” controls can flag the illicit activity in question, but either way, blockchain analytics firms do not incorporate those transactions in their estimates.

“The vast majority of crypto transactions—there are citations of around 90 per cent—occur within exchanges,” said Alison Jimenez, president of Dynamic Securities Analytics in Florida. “Just 10 percent is above the waterline, the rest is recorded on internal ledgers of crypto exchanges, which have in some cases been found to be sloppy or outright fraudulent.”

Reports by both Chainalysis and Ciphertrace also suggest that the firms only count the value of funds stolen in a hack or gained from other crimes, despite the fact that criminals commonly layer their proceeds through tens, if not hundreds, of digital wallets.

Chainalysis told moneylaundering.com that its research counts “both sending and receiving in the share of illicit activity percentage.”

Furthermore, that cryptocurrency platforms frequently allow traders to borrow huge amounts against the virtual assets they hold makes renders any firm conclusions as to the proportion of illicit transactions that comprise overall market activity all but impossible to make.

The U.S. Commodity Futures Trading Commission noted in a civil complaint against Binance in March that the exchange provided customers the ability to trade certain derivatives with leverage ratios of up to 125, meaning that a trader with one bitcoin in their wallet could assume a position 125 times greater than that amount.

“In crypto, you can have this extreme amount of leverage that makes the total transaction volume really big, while illicit activity like ransomware payments doesn’t involve leverage,” said Jimenez.

A common practice known as “wash trading,” whereby a firm or party trades with itself to artificially boost the price of a cryptocurrency or give the illusion of liquidity, further inflates the total value of market activity, both licit and illicit.

On June 5, the U.S. Securities and Exchange Commission accused Binance of as much, alleging that from at least September 2019 until June 2022, Sigma Chain, a Swiss entity owned by the platform’s founder Changpeng Zhao, served as a vehicle for artificially inflating trading volumes of newly listed tokens on the Binance.US platform.

“I applaud the effort to try and quantify [cryptocurrency crime], but the way it’s framed and the comparisons just aren’t valid,” Jimenez said. “They [blockchain analytics firms] are in the business of helping both law enforcement and the crypto industry, and perhaps if they were more alarmist, it would not be good for half the customer base.”

A spokesperson for Chainalysis rejected the notion that the company’s crime reports double as a sort of fig leaf for the cryptocurrency sector. They instead shine a light on specific phenomena, such as ransomware, and help law enforcement allocate resources against “the most insidious crimes,” the spokesperson said.

Contact Koos Couvée at kcouvee@acams.org