Before a new generation of cryptocurrency customers helped bring him down, Ryan Felton sold his cryptocurrency scheme with big promise: he was building "Netflix on the blockchain."
He called the encrypted streaming service FLiK. For a small amount of the popular digital currency Ether, customers can buy the FLiK token, which gives them access to streaming shows and movies on the new platform. Felton described the project as an "entertainment revolution". Crypto enthusiasts have bought over $2 million worth of FLiK coins.
But the streaming business never materialized. Instead, Mr. Felton bought a home worth $1.5 million, along with $32,000 worth of diamonds. He spends an extra $180,000 on a red Ferrari.
As cryptocurrencies became popular in the 2000s, the technology was seen as an ideal vehicle for crime. A drug dealer or scammer can transfer large sums of money instantly without relying on a bank to confirm the transaction. For early adopters, cryptocurrency was attractive because it promised the privacy and anonymity of money without the drawbacks of face-to-face exchanges.
That secret was an illusion. Encrypted transactions are recorded on a public ledger called the blockchain. To an inexperienced observer, the records on the blockchain are incomprehensible - a meaningless jumble of letters and numbers. But there is a growing industry dedicated to cracking them.
At the center is Chainalysis, a New York-based analytics startup that was valued at $8.6 billion after a funding round last year. With tens of millions of dollars in federal contracts, Chainalysis has built a reputation as one of the cryptocurrency industry's leading investigators, a team of blockchain analysts that help the government track crypto transactions.
With federal agencies cracking down on cryptocurrency fraud, onchain analytics has become increasingly important to the industry. The firm presents itself to government and private companies as a positive force in a misbehaving industry, a firm whose business is to solve crime and work with government officials.
After FTX collapsed, his bankruptcy lawyers hired Chainalysis to dismantle the network of organizations at the heart of Sam Bankman-Fried's empire and track down $400 million worth of cryptocurrency the hacker had stolen from FTX accounts. Chainalysis has also done some light diplomacy: In April, it hosted a conference in Manhattan to bring together recently executed government officials and cryptocurrency executives in an effort to win back their trust. Guests received socks with the Chainalysis logo.
But this ambassadorial role has also put Chainalysis at odds with some of cryptocurrency's most ardent proponents, who have envisioned digital money as an anonymous private financial network. This confrontation is a battle for the future of cryptocurrencies and comes at a tumultuous time in the industry's short history.
From a government perspective, Chainalysis is perhaps the most trusted company in the industry, but only because it sells powerful tools meant to pierce the veil of secrecy that made cryptocurrencies so attractive in the first place.
Blockchain technology "is often the key to solving a problem," said Jonathan Levine, 32, co-founder of Chainalysis, 32. "It's more manageable and more addictive."
In late 2020, Mr. Felton is tasked with using investor money to finance his extravagant lifestyle. Tried it last summer in Atlanta. Beth Bisbee, an electrolysis researcher who once worked for the Drug Enforcement Administration, testified for the prosecution. In 2014, his analysis of blockchain records helped the Drug Enforcement Administration track down an online drug dealer in Arizona.
This investigation was relatively low-tech: Ms. Bisbee pasted Bitcoin transaction records into a spreadsheet where she searched for evidence. Crypto scams are much more sophisticated these days, involving multiple types of currencies, each with its own blockchain. Chainalysis creates software that can do time-consuming jobs for you automatically.
In the courtroom, Ms. Bisbee presented a color chart showing the movement of millions of dollars of ether spent by investors in Mr. Felton's tokens. The money has been funneled into a number of cryptocurrencies, digital vaults where people can keep their belongings. Using a forensic technique called bundling, Ms. Bisbee proved that all those wallet addresses belonged to just one person: Mr. Felton. From these accounts, he transferred his investors' ether to one exchange before transferring it to another. He then converted the ether into money.
"What was the source of much of this money before it was withdrawn?" one of the plaintiffs asked Ms. Bisbee.
“FLiK token sale,” he replied.
Prosecutors presented their case over four days in July. Mr. Felton pleaded guilty on the final day.
A new type of cryptocurrency business
About ten years ago, Mr. Levine, then an economics student at Oxford University, was in a pub with a friend when the conversation naturally turned to the topic of cryptocurrency arbitrage. Differences in bitcoin prices on the two exchanges have created a profit-making opportunity: buy bitcoin at a lower price, then sell it at a profit.
The arbitrage trade was time-consuming and logistically difficult for Mr. Levine to operate. "I should have had £100 to my name," he said. But the conversation ignited Levine's passion for bitcoin. Digital currency was invented in 2008 by a mysterious person named Satoshi Nakamoto, who envisioned a private, decentralized form of commerce that operates outside the oversight of any government or financial institution.
However, Levin was not a radical libertine. The 20-year-old from the UK was interested in the inner workings of technology and saw an opportunity for professional development – not many other people seemed to know about cryptocurrency. At the time, Bitcoin was still considered the domain of hackers and drug dealers. None of Mr. Levin's professors wanted to supervise his research.
Mr. Undeterred, Levine began attending cryptocurrency conferences and eventually wrote his master's thesis, "Building a Decentralized Payment System: A Bitcoin Case Study." But you still have questions.
“Nobody understood how or why people actually use encryption,” Levine said. "If you can collect this information and communicate it to all your key stakeholders, you can consistently build one of the most important companies."
While still at Oxford, Levine founded a blockchain analytics firm called Coinometrics, but it quickly petered out. (“Maybe it's not the best idea to meet your founders on Reddit,” he said.) Then, in early 2015, he was introduced to Michael Gronager and Jan Moller, two Danish entrepreneurs who worked at a similar company . Gronager used blockchain analytics to track down cryptocurrency missing from the collapse of Mount Gox, an early exchange. Together, the three founded Chainalysis.
As the cryptocurrency industry expands, blockchain monitoring becomes more and more important. These days, some of the biggest crypto firms hire blockchain analytics firms to monitor their clients' activities and comply with anti-money laundering laws. In the process of bankruptcy, analyst firms investigate the remnants of failed crypto companies, rummaging through public transaction records to find the missing funds.
The recent downturn in the cryptocurrency industry has affected the monitoring business. Elliptic, a competitor to Chainalysis, cut 10% of its staff in February. In the same month, Chainalysis laid off around 40 employees, a decrease of around 5%.
But blockchain analytics firms have been insulated from the worst effects of the market crash. Chainalysis declined to disclose exact sales figures, but Mr. Gronager said the company's revenue increased by 70% last year, despite the crisis in the cryptocurrency markets. That growth is in part a function of the company's business model: Two-thirds of its revenue comes from partnerships with government agencies, including law enforcement agencies, the company says, a revenue stream that remains relatively stable even as the market it collapses. .
The Justice Department paid Chainalysis $12,500 for its work on the Ryan Felton case, according to federal records. But this mission was a drop in the ocean. The Justice Department, Treasury Department, and other federal agencies are pushing to be able to use Chainalysis software to track blockchains, including a tool called Reactor that maps transactions. Chainalysis has about $65 million in active federal government contracts, according to an analysis of federal records by Jack Poulson, chief executive officer of Tech Inquiry, a nonprofit that tracks contracts.
Recently, however, Chainalysis has faced competition from smaller rivals, including TRM Labs, a monitoring company that has gained notoriety by selling software for new types of cryptocurrencies under names like Solana.
In 2021, a TRM official sent an email to the Treasury Department questioning its decision to award Chainalysis an exclusive contract, according to email records obtained through a public records request.
According to the emails, a TRM representative "requested explanations as to why this purchase was not made in accordance with the public offering process." “There are many vendors with similar capabilities that meet the requirements,” the rep wrote. According to the company's press officer, TRM signed its contract with the finance ministry before the start of last year. And TRM has been contracted by Chainalysis to work on the bankruptcy of FTX.
“We are moving from a Bitcoin world to a multi-chain world and people need tools to detect illegal activity no matter where it occurs in the cryptocurrency economy,” said TRM CEO Esteban Castaño. “There will be new assets, new blockchains coming out all the time.”
Fight for privacy
At times, the transparency of the blockchain has been a great help to law enforcement. In 2020, Chainalysis partnered with US investigators to take down the largest child pornography site on the dark web. By analyzing the blockchain, the agents discovered the digital addresses of customers who used bitcoins to buy illegal pornography. This path led to cryptocurrency exchanges where customers mainly bought bitcoins; The government can then call these companies to determine the identities of the wallet's owners.
Despite these police victories, the rapid growth of blockchain monitoring companies has caused some concern in the cryptocurrency world. One of Chainalysis's government clients is Immigration and Customs Enforcement, which has an ongoing contract with the company totaling about $12 million, according to federal filings. An ICE spokesperson did not respond to requests for comment; Mr. Groegger, the founder of Chainalysis, said the agency tracks blockchains to fight drug trafficking and that he was unaware of any instances where ICE used his company's tools to enforce drug laws. 'immigration.
For privacy advocates, the company's relationship with ICE looks like a slippery slope.
“It's very easy to use a blockchain analytics tool to see which transactions are sending money to El Salvador,” said Justin Ehrenhofer, head of crypto-privacy firm Cake Wallet. "It gives them a new perspective to specifically target immigrants."
Mr. Ehrenhofer discovered virtual currencies when he was a teenager. At the time, she was using private browsers to search for LGBTQ content online because she didn't have time to talk to her parents yet. His interest in technology stems from its potential use as a privacy tool. But this view is becoming increasingly outdated. In recent years, the radical and idealistic traditions of technology have largely given way to a more pragmatic approach, as Wall Street traders and Silicon Valley venture capitalists flock to the cryptocurrency world in search of new ways to create wealth. online.
“The initial driver for what we consider digital currency and money was privacy,” said Finn Brunton, author of a 2019 book on the history of cryptocurrencies. "It's all the other way around."
Cake Wallet is one of the few companies still developing tools to make cryptographic transactions less traceable, which is something of a contrast to the blockchain monitoring industry. One of the company's main products is a cryptocurrency wallet that supports Monero, a privacy coin that is harder to track than other cryptocurrencies. Each exchange of funds is publicly recorded, but transaction information is obscured, making it difficult to tell which wallet sent or received the money.
Investors who want to avoid blockchain tracking software can also move funds through services known as mixers, which receive multiple chains of transactions and then combine them to mask the origin and destination of the funds. In August, the Treasury Department banned Americans from using a popular mixer called Tornado Cash, saying it had been used to launder more than $7 billion in virtual currency, including hundreds of millions of dollars stolen by North Korean hackers.
The sanctions have sparked an outcry from cryptocurrency investors. A group of Tornado Cash customers is suing the Treasury Department to block the ban, arguing mixers are important to protect privacy. One of the plaintiffs said he used the service to donate to the Ukrainian war effort, hoping to remain anonymous for fear of reprisals from Russia.
Chainalysis has said little publicly about the methods it uses to fight technologies like Monero or another crypto-privacy service called Wasabi Wallet. But the company is trying to trace those transactions: Chainalysis has offered "wasabi removal services" to OFAC, the Treasury Department branch that oversees sanctions, according to documents obtained via a public records request.
The government's access to such tools has old-school cryptocurrency enthusiasts worried. said Max Hillebrand, CEO of zkSNACKs. Wasabi Wallet Company: "Bitcoin could be the worst tracking nightmare we've ever imagined - a world where everyone uses Bitcoin, but everyone's transaction history is completely available to everyone, and everyone knows how much money they have." "It's not a world I'd feel comfortable living in."
Mr. . A streak of bright orange lights hung in the sky.
"It's time to build things," said Mr. Groegger. "And we really do."
Once upon a time, blockchain analytics was just a nerdy subculture obsessed with the industry, but recently it has taken hold. On Twitter, researchers with hundreds of thousands of followers are using bots to detect cryptocurrencies. Chainalysis has hosted the Links Conference since 2019, but the latest edition was the largest ever, with 900 attendees packed into the venue that hosts the NFL Draft.
In November, tech journalist Andy Greenberg released Tracers in the Dark, a cinematic account of the rise of on-chain analytics, detailing several major preliminary investigations. Many of the law enforcement officers mentioned in the book have achieved celebrity status in the world of blockchain monitoring and have leveraged their knowledge of the inner workings of the technology into high-paying corporate jobs.
Tigran Gambarian, the former IRS agent who helped solve a child pornography case, attended the Links conference in his new role as director of compliance at Binance, a cryptocurrency exchange. "I think I've met a legend," said one fan, shaking Mr. Gambarian's hand.
Mr. Gambourian and other government investigators have used on-chain analytics technology to pursue terrorists and drug dealers on the dark web. But the worst behavior in today's digital currency industry is much harder to fight: fraudulent offshore companies run by secretive executives, companies that engage in sophisticated financial engineering techniques to hide holes in their accounts. In Levin Decaz, which Chainalysis introduced the new praduktyu functions, the previous client has become bizarre.
“Pazlya FTX you have a lot of power when you have a lot of money and a lot of money,” they say. "We're always, when you start growing your brain, how big you are when you start growing."
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