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Cryptocurrencies and DeFi

Academic research in cryptocurrencies was at first predominately in computer science but then gravitated to using finance tools and frameworks to understand financial activity. Cryptocurrencies provide an interesting framework to examine financial activity because the transactions are digitally recorded on blockchains, which are generally public ledgers designed to operate largely outside of the traditional financial system’s regulatory framework. These public ledgers can also be a source for a diligent researcher to use clustering techniques, attribution, and other big data techniques to understand crypto movements.
 

Overview

Clustering algorithms can be instrumental in tracing illicit transactions within the Bitcoin network, as demonstrated by Meiklejohn et al. (2013) in their study of the Silk Road, a notorious darknet marketplace. This marketplace, which operated between 2011 and 2013, facilitated the trade of illegal goods and services, including drugs, weapons, and forged documents. Building on this framework, Foley, Karlsen, and Putnin, (2019) explored the broader scope of illicit activities transacted through dark markets from 2009 to 2017. Their findings revealed that nearly 46% of non-exchange-related Bitcoin transactions were linked to illegal activities, although this percentage declined to below 25% by April 2017, partly due to the adoption of less traceable cryptocurrencies.

Makarov and Schoar (2022) provided a more conservative estimate of illegal activity within the Bitcoin market, attributing less than 3% of the total volume from 2015 to 2021 to illicit transactions, scams, and gambling. Their approach differed from Foley et al.'s by excluding within-cluster dark market volumes and taking a broader view by including total market volume. Despite these differences, they estimated substantial amounts of illicit activity, including $1.6 billion in dark market transactions and $1.4 billion linked to mixers, which obscure cryptocurrency origins. The study also highlighted the interactions between unregulated offshore exchanges and more regulated crypto exchanges, which follow Know-Your-Customer (KYC) and Anti-Money Laundering (AML) guidelines.

Investigating darknet marketplaces presents significant challenges due to their constantly evolving nature and the development of new technologies like tumblers, mixers, and advanced cryptographic protocols. Cong et al. (2023) provided an overview of various crypto-related crimes, including investment scams and ransomware. Companies like Chainalysis and TRM Labs are increasingly focusing on "attribution," aiming to uncover the identities and activities behind these illicit operations. However, reports such as the one produced by Chainalysis (2024) have been criticized for not fully detailing their methodologies, potentially underestimating the scope of illegal activity within the crypto space.

Further academic research is crucial in understanding the intricate dynamics of dark market activities involving cryptocurrencies. For instance, Cong, Harvey, Rabetti, and Wu (2023) documented the prevalence of ransomware attacks, identifying 43 distinct gangs responsible for nearly 2,700 attacks between May 2019 and July 2021. Griffin and Mei (2024) focused on tracking scam-related addresses on the Ethereum blockchain, revealing that most scamming activities involved the Tether Stablecoin and that on-chain fees for money laundering were minimal. Their findings underscore the significant role that legitimate crypto exchanges play in facilitating the entry and exit of illicit funds.

Finally, the manipulation and fraudulent practices within cryptocurrency markets have also been a subject of investigation. Griffin and Shams (2020) examined Tether's role in Bitcoin's price inflation, finding that unbacked Tether issuance likely contributed to significant price increases during the 2017-2018 Bitcoin boom. Their research sparked widespread controversy and led to legal actions against Tether, which admitted to not being fully backed by U.S. dollars at times. The study also highlighted the ongoing concerns about the lack of transparency and potential manipulation within the cryptocurrency market, raising questions about the safety and legitimacy of investments in this space.

Relevant Papers

Sex, Drugs, and Bitcoin: How Much Illegal Activity Is Financed Through Cryptocurrencies?

Foley Et Al.

(2018)

An Anatomy of Crypto-Enabled Cybercrimes

Cong Et Al. (2024)

How Do Crypto Flows Finance Slavery? The Economics of Pig Butchering

Griffin and Mei (2024)

Is Bitcoin Really Un-Tethered?

Griffin and Shams (2019)

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