Within a few years of Bitcoin’s arrival, academic security researchers—and then companies like Chainalysis—began to tear gaping holes in the masks separating Bitcoin users’ addresses and their real-world identities. They could follow bitcoins on the blockchain as they moved from address to address until they reached one that could be tied to a known identity. In some cases, an investigator could learn someone’s Bitcoin addresses by transacting with them, the way an undercover narcotics agent might conduct a buy-and-bust. In other cases, they could trace a target’s coins to an account at a cryptocurrency exchange where financial regulations required users to prove their identity. A quick subpoena to the exchange from one of Chainalysis’ customers in law enforcement was then enough to strip away any illusion of Bitcoin’s anonymity.
Chainalysis had combined these techniques for de-anonymizing Bitcoin users with methods that allowed it to “cluster” addresses, showing that anywhere from dozens to millions of addresses sometimes belonged to a single person or organization. When coins from two or more addresses were spent in a single transaction, for instance, it revealed that whoever created that “multi-input” transaction must have control of both spender addresses, allowing Chainalysis to lump them into a single identity. In other cases, Chainalysis and its users could follow a “peel chain”—a process analogous to tracking a single wad of cash as a user repeatedly pulled it out, peeled off a few bills, and put it back in a different pocket. In those peel chains, bitcoins would be moved out of one address as a fraction was paid to a recipient and then the remainder returned to the spender at a “change” address. Distinguishing those change addresses could allow an investigator to follow a sum of money as it hopped from one address to the next, charting its path through the noise of Bitcoin’s blockchain.
Thanks to tricks like these, Bitcoin had turned out to be practically the opposite of untraceable: a kind of honeypot for crypto criminals that had, for years, dutifully and unerasably recorded evidence of their dirty deals. By 2017, agencies like the FBI, the Drug Enforcement Agency, and the IRS’s Criminal Investigation division (or IRS-CI) had traced Bitcoin transactions to carry out one investigative coup after another, very often with the help of Chainalysis.