Chain Analysis: Everything to Know
By Beluga Research September 8, 2023
- Cryptocurrency chain analysis, also known as blockchain analysis, is the process of examining blockchain transactions to trace and analyze the flow of funds
- Chain analysis allows platforms and law enforcement officers to gather information about illicit activities like scams and hacks
- Techniques in chain analysis, including address clustering, transaction graph analysis and coin tagging, allow investigators to trace funds, detect suspicious behavior and prevent the circulation of tainted funds
- Chain analysis supports enforcement efforts, enhances transparency and assists in anti-money laundering (AML) compliance and asset recovery
Cryptocurrency chain analysis, also known as blockchain analysis, is the process of examining blockchain transactions to trace and analyze the flow of funds for investigative purposes. The term "chain analysis" typically refers to "on-chain analysis." This is defined as the analysis of data on the blockchain, like user transactions, that provides information about a specific cryptocurrency.
The correlate term of on-chain analysis is "off-chain analysis." This is defined as the analysis of data off the blockchain, like social media posts about a cryptocurrency, that affects the value of the cryptocurrency. The term "chain analysis" should not be confused with the company called Chainanalysis. This company develops an array of software products for platforms. One example is Address Screening, which helps a platform take actions to prevent high-risk users from connecting to the platform.
A Brief History
Chain analysis emerged with the launch of Bitcoin in January 2009. Initially, Bitcoin was seen as an anonymous digital currency. It attracted individuals who sought to exploit its pseudonymity for illicit purposes. Researchers soon realized that while Bitcoin transactions offered some privacy, they were not truly anonymous. The transparency of the blockchain allowed for tracking and analyzing transactional data. This led to the development of various chain analysis techniques.
As the cryptocurrency ecosystem expanded, chain analysis methods became more sophisticated. Companies specializing in blockchain forensics and analytics emerged. They offered tools and services to trace and analyze cryptocurrency transactions. These developments have strengthened the regulatory framework around cryptocurrencies. They have also enhanced the security of blockchain networks.
Chain Analysis: Everything to Know
- Address Clustering. Chain analysis starts with address clustering, which is defined as grouping addresses that are likely controlled by the same entity. The analysis of transactional patterns and other data typically makes it possible to link addresses to specific individuals and entities. Address clustering traces fund flow. It can spot potential money laundering and other illicit activities.
- Transaction Graph Analysis. Transaction graph analysis visualizes relationships between addresses and transactions on the blockchain. Mapping these connections helps analysts identify patterns, detect suspicious behavior and uncover hidden relationships in the cryptocurrency ecosystem.
- Coin Tagging. Coin tagging labels specific coins or tokens with attributes that provide valuable information. Coins associated with illicit activities or known scams can be tagged. This makes it easier to track their movement through transactions such as sales, purchases and exchanges. Coin tagging prevents the circulation of tainted funds in the crypto ecosystem.
- Darknet Market Analysis. Chain analysis combats illicit activities on darknet markets. These are online platforms where illegal goods and services are traded using cryptocurrencies. With chain analysis, investigators can track funds to and from these markets. They can identify vendors and gather evidence for law enforcement.
- Exchange and Custodian Monitoring. Chain analysis techniques monitor cryptocurrency exchanges and custodial services to ensure compliance with AML and know-your-customer (KYC) regulations. With transactional data, platforms and governments can audit exchanges. They can also flag suspicious activities and thwart threats.
- Privacy Coins and Mixing Services. Chain analysis has evolved to address privacy-enhancing measures like privacy coins and mixing services. It can be more challenging to trace transactions involving these methods. Advanced analytical methods like heuristics and statistical analysis provide valuable insights.
- Get access to relevant blockchain data. An entity such as a government, platform or law enforcement agency can gather information for chain analysis by collecting it from public blockchain explorers, Application Programming Interfaces (APIs) provided by blockchain networks and specialized chain analysis tools.
- Process and analyze the data . The data will yield meaningful insights that the entity can use to prevent or limit malicious activity.
- Share information with other entities. A platform may choose to share the results of chain analysis with other platforms. This will lessen the risk of activities like scams in the crypto ecosystem.
- Pseudonymous . Users are not directly identified by their real-world identities. Their activities can still be traced through their wallet addresses on the blockchain. This allows investigators to follow the flow of funds and establish connections.
- Transparent. All transactions are recorded and accessible to anyone. This transparency provides visibility into the movement of funds. It enables the analysis of transaction patterns and identification of potential risks and anomalies. The real-world identities behind addresses are not readily available unless users voluntarily disclose them.
- Involves examining transactional metadata, including timestamps, transaction sizes and inputs/outputs. The metadata provide insights into transaction nature, such as whether a transaction is a regular transfer with smart contracts. Analyzing these details helps identify patterns and trends in cryptocurrency usage.
- Requires studying transactional behavior . For example, chain analysis may involve tracing the movement of funds through mixing services or tumblers. These services aim to obscure the origin and destination of funds. They do this by mixing sets of funds. Sophisticated analysis techniques can be utilized to trace the flow of funds through these services. It can uncover a distinct set of one user's transactions.
- Involves identifying cryptocurrency addresses associated with illicit activities. Such activities may include money laundering, darknet marketplaces and ransomware attacks. Investigators can track and flag suspicious addresses using various tools and techniques. This contributes to the overall security and integrity of the crypto ecosystem.
- Enhanced Transparency . Cryptocurrency chain analysis allows anyone to view and analyze transaction data on the blockchain. The transparency promotes trust and accountability in the cryptocurrency ecosystem.
- Transaction Monitoring . Chain analysis tools enable real-time monitoring of transactions. They can identify suspicious activities like large transfers and transactions that involve known illicit entities. Flagging these transactions allows authorities to take appropriate actions to prevent and investigate potential illegal activities.
- AML Compliance . Cryptocurrency chain analysis tools assist financial institutions and cryptocurrency exchanges in complying with AML regulations. They provide insights into the source of funds and identify suspicious transactions.
- Law Enforcement Support . Chain analysis is an essential tool for law enforcement agencies to investigate and prosecute criminal activities that involve cryptocurrencies. Tracing transactions and identifying wallet addresses helps investigators follow the money trail and gather evidence.
- Asset Recovery . Chain analysis helps track and potentially recover stolen or illicitly obtained funds in cases involving cryptocurrencies. Identifying destination addresses and monitoring subsequent transactions allows investigators to increase the chances of recovering assets. The investigators can then help platforms return funds or assets to their rightful owners.
- Privacy Concerns . Chain analysis raises privacy concerns. The transparent nature of blockchain compromises user privacy. It deters some individuals from using cryptocurrencies. It can motivate them to adopt privacy-focused alternatives.
- False Positives and Negatives . Chain analysis tools can generate false positives or false negatives. False positives flag legitimate transactions as suspicious. This causes unnecessary scrutiny and inconvenience for users. False negatives allow illicit transactions to go undetected. They enable criminals to operate unnoticed. Too many false positives or negatives can contribute to a distrust of chain analysis, specific platforms and the crypto ecosystem.
- Limited Effectiveness with Privacy Coins . Chain analysis is significantly limited in its effectiveness to analyze transactions with privacy-focused cryptocurrencies like Monero and Zcash. These cryptocurrencies employ advanced cryptographic techniques to enhance user privacy.
- Complex Data Interpretation . Analyzing blockchain data requires deep understanding of cryptocurrency protocols, transaction structures and data analysis techniques. It is a challenging task that requires specialized knowledge and expertise. Continuous learning and adaptation are necessary to keep up with evolving trends and privacy-enhancing technologies.
- Potential for De-anonymization . Chain analysis techniques can sometimes be used to de-anonymize users by linking their activities to real-world identities. This raises concerns about the potential misuse of transaction data. It also motivates users to call for more robust measures to protect privacy.