When Chainalysis released its first crypto crime report covering 2018, the crypto community rejoiced. However, not everybody read beyond its 1% headline and they’ve gleefully parroted the figure for years.
“Illicit transactions are down to 1% in 2018,” posted one X (formerly Twitter) user, while another claimed, “the share of Bitcoin economic value sent to darknet markets has declined to less than 1% in 2018.”
And they’re not alone. Indeed, examples of similar quotes are almost endless. If you search for the 1% figure for any subsequent year, you will find the same refrain — always a figure of 1%, and always “proved” by either Chainalysis or its competitor, Elliptic.
However, when Chainalysis and Elliptic reference this figure, they do so alongside very precisely written claims with extensive footnotes and disclosures. Despite this, people still overlook those details. “Less than 1%” is what they want to — and do — believe.
The problem is, it isn’t true. The 1% estimate is completely misleading.
1% of a fake 100% might be 20% of a real 5%
To begin, wash trading, fake volume, and non-economic activities on crypto exchanges are rampant. Unfortunately, no one knows how much crypto actually transacts globally. Everyone — including Chainalysis and Elliptic — just guess. Past academic research has questioned up to 95% of volume as illegitimate.
Suddenly, 1% of the total — if 95% is fake — could become 20% of the real 5%.
Again, no one knows how much activity actually occurs in crypto because almost all activity occurs off-blockchain. Not even Chainalysis or Elliptic knows what occurs on these offshore platforms, and they cannot make any conclusions about these unknowable trades.
Crypto exchanges have every incentive to misreport data to leaderboards like CoinMarketCap and CoinGecko. Indeed, faking tremendous trading activity conveys leadership, liquidity, and strength.
Not only are they rewarded for lying by attracting customers who believe their fake stats, exchanges are further incentivized to enlist wash-trading and non-economic actors to pump up ‘real’ volume.
No-bid NFTs: Excluded from the ‘1%’ figure
There’s another way in which ‘1%’ misrepresents the loss of victims.
Rather than 99% of NFT investments not being illicit, in reality, up to 99% of NFTs have no bid.
Millions upon millions of NFTs now have no bid, however, almost no one talks about that, focusing instead on elite collections like CryptoPunks or Bored Ape Yacht Club.
One researcher found that 69,795 of the 73,257 NFT collections it studied — each of which contains thousands of individual NFTs — have a near-$0 market cap. Researchers from DappGamble also found that four-fifths of NFT collections fail to even sell all of their constituent NFTs, even during the minting period.
Conveniently for the pro-crypto ‘only 1% illicit activity’ lobby, Chainalysis and Elliptic’s ‘1%’ figures exclude all of these now-worthless NFTs.
Abandoned ICOs and IDOs: Excluded from the ‘1%’ figure
The vast majority of 2017-2019-era initial coin offerings (ICOs) are worth near-$0. As early as 2018, as many as 86% of the ICOs conducted in 2017 had cratered in value. The stats only got worse during subsequent years.
There were not tens of thousands but millions of coin offerings. Most launched directly on ostensibly decentralized exchanges like Uniswap, PancakeSwap, and SushiSwap. 99% of these initial DEX offerings (IDO) are worth near-$0.
‘Lack of liquidity’ after the IDO is another problem — a euphemism for worthlessness.
While Chainalysis might not be able to assert that these rug pulls, scams, and grifts are criminal as a controlled legal term, the destruction of victims’ investments is identical. Whether by crime or garden variety scam, the money is gone.
The SEC accused Changpeng Zhao’s market maker on Binance of wash trading 99% of the volume on certain newly listed tokens’ opening day of trading. More recently, someone theorized that FTX once helped Binance move assets between Binance.com and Binance.US for the purposes of wash trading.
It’s been reported that as much as 80% of trading volume on unregulated exchanges might be wash trading. Even more is non-economic.
After FTX collapsed, centralized exchanges started discussing how to regain users’ trust. Bitpanda CEO Eric Demuth especially suggested that exchanges should stop acting like con men. “We need to stop telling people to trust us and give them an actual reason to,” he said.
Digital asset exchanges can fake trading volume through shell companies that trade on their platforms. Binance became a target for authorities partly because some of Zhao’s proxy companies were trading on Binance and Binance.US. Binance also allegedly commingled company funds and customer funds, allowing it to divert customers’ deposits to ‘market makers’ like Sigma Chain and Merit Peak — both controlled by Binance’s CEO.
Without these proxy companies and a fair amount of wash and non-economic trading, volume on exchanges like Binance might be far less than CoinMarketCap shows. Of course, Binance itself bought CoinMarketCap in 2020, which might explain how it can keep its data atop the leaderboard even with its regulatory issues.
So the percentage of criminal activity in bitcoin might actually be higher than Chainalysis’ data shows. The vast majority of bitcoin transactions are not on-chain but rather off-chain, occurring on the books of a centralized exchange and disclosed via a corporate API.
Chainalysis and Elliptic can only analyze transactions that show up on blockchains, regardless of their purpose or whether the transactions are economically significant.
Not the first time Chainalysis called out
The lack of trust in Chainalysis dates back as far as 2015 when its CEO denied accusations that it allegedly committed a Sybil attack against the Bitcoin network. A Sybil attack consists of creating false nodes to target a peer-to-peer network. Bitcoin developers Wladimir van der Laan, Peter Todd, and Gregory Maxwell detected the attack.
According to van der Laan, the Sybil attack consisted of non-functional nodes that didn’t store or provide information. Other nodes connecting to them wouldn’t be able to sync with the rest of the legitimate network, leaving them waiting for information.
Chainalysis allegedly created 250 fake Bitcoin nodes to intercept data about transactions. It claimed it was intercepting IP-based location data for a study on bitcoin transactions between countries and blamed a vulnerability in lightweight nodes using a simplified payment verification (SPV) protocol.
When it failed to convince the Bitcoin community that nothing was out of the ordinary, it claimed to shut down nodes to remedy the situation.
How trustworthy is Chainalysis? In its latest Crypto Crimes Report, it admitted to adding to its 2022 figures due to newly discovered addresses used by sanctioned parties and the addition of the FTX creditor claims. It may have also lumped all CoinJoin transactions into a single unit – including perfectly legitimate transactions from parties that value privacy. Chainalysis also notably did not include bribery as an illicit category.
Yet the main problem always seems to be its headline figure. Always claims of around 1% of crypto activity being illicit. The problem is, it just isn’t true