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IRS Challenged to Find Tech for Tracing Private Crypto Deals (1)

July 7, 2020, 4:30 PM; Updated: July 7, 2020, 8:37 PM

The IRS wants to know more about cryptocurrency assets and technologies that make it easier for users to remain anonymous when involved in illicit activities.

But the agency may be hard-pressed to find private companies with the technology to track all of those transactions.

The IRS Criminal Investigation division last week requested information about tools that will allow it to trace transactions involving “privacy coins"—like Monero, Zcash, and Dash—and technologies that help users hide their identities when transacting with more mainstream cryptocurrencies, such as Bitcoin, that aren’t anonymous in nature. The agency said acquiring this capability will make investigations more effective and deter potential criminals.

Cryptocurrency industry specialists say the IRS may have a tough time fulfilling this need.

“The development of technologies to enable the tracing of Monero transactions or of Zcash transactions between shielded addresses will be extremely technically challenging,” said Tom Robinson, chief scientist and co-founder of the blockchain analysis firm Elliptic.

“Even if such techniques are developed, they are unlikely to be effective for long, as either the exploits are patched, or criminals move to using other cryptoassets,” he told Bloomberg Tax in an email.

Companies like Elliptic and its competitor Chainalysis have recently announced that they’ve begun tracing and screening transactions involving some privacy coins. But at least in Elliptic’s case, the company can only provide more transparency into transactions that users have chosen to make visible, according to Robinson. He said there aren’t currently any solutions for coins, like Monero, where all transactions are private.

“While privacy coins make blockchain analysis more difficult, it is not impossible, and many are in research & development,” a spokesperson for Chainalysis said in an email. The company declined, however, to comment directly on the IRS solicitation.

Regulatory, rather than technological, solutions may make more sense for dealing with privacy-enhancing technologies like the lightning network, which can make transactions involving cryptocurrencies like Bitcoin more anonymous, according to Robinson. For example, the nodes that intermediate those transactions could be classified as “money transmitters,” requiring them to maintain transaction records, which could then be subpoenaed by law enforcement investigators, he said.

Criminal Activity

Peter Van Valkenburgh, director of research at the advocacy group Coin Center, agreed that current technology may have its limitations when it comes to the IRS’s request.

Even so, he said, it’s encouraging to see the agency digging into these more novel coins and technologies, beyond “plain vanilla Bitcoin,” especially when it has lagged behind other federal agencies in issuing regulations on cryptocurrencies.

“These things will be used by criminals, just like messaging apps are used by criminals, just like cash, U.S. dollar transactions are used by criminals,” Van Valkenburgh said.

“And so it’s important that law enforcement play a continuing game of keep-up with new technology so that they can keep doing investigations,” he added.

Robinson said the IRS is correct in singling out the tracing of privacy coins and technologies like the lightning network as a challenge for criminal investigators.

“Monero in particular has seen growing adoption by cybercriminals, due to the enhanced anonymity that it can provide,” he said.

(Adds comment from Chainalysis spokesperson in eighth paragraph. )

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Vandana Mathur at vmathur@bloombergtax.com

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