Simplifying Criminal Detection with Ethereum’s Shanghai Upgrade

Staking rewards resulting from the Ethereum Shanghai upgrade has facilitated the identification of unconventional behavior among ETH holders. Ethereum has transitioned into a proof-of-stake blockchain through its groundbreaking Merge event in September.

This new transaction confirmation mechanism relies on validators staking their Ether. The Shanghai upgrade, implemented in March, allowed stakers to withdraw their previously locked Ether.

Notable investment themes within the Ethereum ecosystem include decentralized finance (DeFi), stablecoins, wrapped versions of Bitcoin (BTC), and nonfungible tokens (NFTs). Furthermore, the network now provides fixed-income assets after the upgrade.

Spotting Counterintuitive Behavior with Staking Rewards

Staking rewards resulting from Ethereum’s Shanghai upgrade have made it easier for investigators to identify unconventional behavior exhibited by ETH holders.

Ethereum’s Proof-of-Stake Transition & Investment Themes

Ethereum has successfully transitioned into a proof-of-stake blockchain with the historic Merge event in September. This new transaction confirmation mechanism relies on validators staking their Ether. Additionally, the Ethereum ecosystem’s notable investment themes include decentralized finance (DeFi), stablecoins, wrapped versions of Bitcoin (BTC), and nonfungible tokens (NFTs).

Risk-free rate

The Significance Of  Yield In Traditional Finance & its Implications For Crypto Forensics

Yield, a fundamental element in traditional finance (TradFi), is crucial in determining the perceived risk of financial assets. The fluctuations in creation, whether they rise or fall, directly impact investment decisions. In the context of benchmark rates set by the United States Federal Reserve, these movements are a rationale behind various investment choices.

Detecting Suspicious Fund Movements: Compliance professionals closely monitor trends at a risk-free rate to identify any irrational movement of funds within capital markets. Such movements may indicate potential attempts to launder money. Unlike regular investors, individuals involved in money laundering are not primarily focused on financial gains. Their main objective is to obscure the origins of illicit funds.

The Role Of Ethereum’s Staking Yield: The staking yield of Ethereum, which represents the “risk-free rate” within the crypto ecosystem, has gained significance. The introduction of the Shanghai upgrade has likely contributed to the advancement of crypto forensics. The staking yield of Ethereum serves as a valuable parameter for analyzing and investigating crypto-related financial activities.

Understanding the impact of yield is vital in traditional finance as it influences risk perceptions of financial assets. Compliance professionals leverage trends in risk-free rates to identify potential money laundering activities. In the realm of cryptocurrencies, Ethereum’s staking yield holds importance and can enhance the field of crypto forensics, especially after the implementation of the Shanghai upgrade.

Activity vs. Entities: Contrasting Focuses In TradFi & Crypto Forensics

Managing The Risk Of Financial Crime In Traditional Finance (TradFi)

TradFi institutions employ automatic systems to mitigate financial crime risk by detecting potential illicit utilization of financial assets. Data scientists are crucial in developing and implementing models that raise suspicions regarding suspicious transactions. However, investigating teams must still assess the leads collected and determine whether Suspicious Activity Reports (SARs) are required.

Contrasting Approaches: Traditional Finance vs. Cryptocurrency

An intriguing distinction arises regarding forensics in Traditional Finance (TradFi) and cryptocurrency. In the case of cryptocurrency, the focus is primarily on the criminal entity rather than the specific activity itself. Investigators analyze networks of crypto wallets to trace the movement of criminal assets.

Understanding The Three Stages Of Money Laundering

Money laundering usually has three steps: placement, layering, and integration. Firstly, the perpetrators introduce proceeds from criminal activities into the financial system (order). Then, funds are moved in complex ways to obscure the audit trail and sever the connection with the original crime (layering). The legal economy has finally fully integrated the criminal proceeds, enabling their utilization for any purpose.

Detecting Illicit Assets In Crypto: Placement Stage

In the realm of crypto assets, it is more convenient to develop solutions that identify the placement of illicit assets. This is mainly because much-laundered money originates from crypto-native crimes, including ransomware attacks, DeFi bridge hacks, smart contract exploits, and phishing schemes. In such offenses, the wallet addresses of the perpetrators are often readily available. As a result, They can monitor relevant wallets post-crime to analyze the flow of assets.

Challenges In Traditional Finance: Layering Detection

Conversely, forensic experts lack visibility into specific offenses in traditional financial institutions. Human trafficking, drug trafficking, cybercrime, and terrorism are such offenses. Criminal proceeds injected into the financial ecosystem pose challenges for detection.

This lack of information significantly complicates the detection process. Most Anti-Money Laundering (AML) solutions are primarily designed to identify the layering stage of money laundering, resulting in their effectiveness. These solutions detect and analyze complex transactions and patterns to uncover potential money laundering activities.

Forensic experts employed by banks lack knowledge of criminal activities involving offenses like human trafficking, cybercrime, and terrorism. They cannot detect illicit funds’ injection into the bank’s system. This lack of visibility poses challenges for uncovering and addressing financial crimes. Most Anti-Money Laundering (AML) solutions are designed to identify layering because detection becomes extremely difficult.

Uncovering Unusual Activity with Ethereum’s Staking Rewards

Designing effective solutions to identify layering requires adopting the mindset of criminals who strategically manipulate fund flows to obscure the money trail. One of the proven methods to uncover such activities is identifying irrational asset movements, as money laundering does not prioritize profit generation.

Thinking Like Criminals: Decoding Complex Fund Flows

Exploring the intricate strategies criminals employ to create convoluted pathways for funds, aiming to obfuscate the origin and destination of transactions.

Spotting Irrational Asset Movements: The Key To Detection

It highlights the significance of detecting irrational movements of assets to uncover suspicious financial behavior, as money laundering activities often exhibit unusual patterns that deviate from established benchmarks.

Leveraging Benchmark Rates: Enhancing Detection

Strategies Examining the utilization of Ether’s post-Shanghai staking yields as reference interest rates for cryptocurrencies, enabling the formulation of baseline risk-reward structures. This knowledge empowers investigators to systematically identify financial behaviors that contradict trends in the benchmark rate.

Case Study: Detecting NFT Wash Trading

We are exploring the application of transaction surveillance architecture to detect the manipulation of prices and layering of criminal assets through the coordinated efforts of multiple market participants in NFT trading. The absence of profit motives in these transactions becomes a red flag, signaling potential illicit activities.

Detection solutions can effectively expose layering activities by adopting a comprehensive approach that mimics the thinking of criminals, focusing on irrational asset movements, and leveraging benchmark rates. Such techniques serve as valuable tools for uncovering complex financial crimes and ensuring the integrity of economic systems.

Defi & The Menace Of Financial Crime

Individuals and organizations have covertly exploited traditional capital markets to move funds for evading sanctions and financing terrorist activities. Similarly, DeFi ecosystems have become attractive targets for financial crime due to their capability to transfer large amounts of assets across jurisdictions using blockchain technology.

Shifting Landscape & Increased Obscurity

The transition from Centralized to Decentralized Exchanges

• Recent incidents, such as the collapse of FTX, have led to a notable shift in activity from centralized to decentralized exchanges.
• This surge in DeFi volumes has facilitated the concealment of illicit flows.

Driving Factors For Criminals Seeking New Channels

Strengthened Compliance Controls by Centralized Crypto Service Providers

• Regulators are mandating stricter compliance controls for centralized crypto service providers.
• These enhanced measures may be prompting criminals to explore alternative avenues for money laundering.

Expanded Scope Of Illicit Flows In DeFi

Diversification of Criminal Activities

• Illicit flows entering the DeFi space may originate from a broader range of criminal activities.
• This paradigm shift necessitates improved capabilities of forensics teams to investigate complex fund flows across diverse protocols, even without prior knowledge of the source of criminal assets.

The Importance Of Layering Typologies & Systematic Surveillance

Focusing Compliance Efforts On Discovering Layering Typologies

• Compliance efforts should prioritize the identification of layering typologies within DeFi ecosystems.
• The rapid progress in blockchain interoperability highlights systematic surveillance’s significance in detecting illegal transfers.

Challenges In Detecting Suspicious Activity

• Crypto’s extreme price volatility hampers the effectiveness of static risk thresholds.
• Money laundering can go undetected in such an environment.

To address the emerging challenges in DeFi ecosystems, enhancing compliance efforts and developing improved methods for investigating complex fund flows is crucial. Establishing benchmark rates like Ethereum’s can establish baseline rationality for fund flows and detect anomalies that may indicate suspicious activity.