detection and analysis
By Natacha Wagner & Clement Pavue
What are cross-chain transactions?
To execute a cross-chain transaction, users need to send funds through cross-chain protocols. These protocols act as bridges between different blockchains and use smart contracts to convert the assets. For example, users deposit assets from blockchain A in the smart contract and withdraw new assets compatible with blockchain B.
Cross-chain transactions and AML/CFT
Due to the fact that cross-chain transfers make it harder to follow the flow of funds on blockchains, Cross-chain transfers are often used in the case of illicit crypto activities precisely because they make it harder to follow the flow of funds on blockchains. And this represents higher risks in terms of money laundering and terrorism financing.
In 2020, the Financial Action Task Force (FATF) issued the “Virtual Assets Red Flag Indicators of Money Laundering and Terrorism Financing” report. In this report, FATF considers as a red flag the action of “Depositing VAs (virtual assets) at an exchange and then often immediately converting the VAs to multiple types of VAs, again incurring additional transaction fees, but without logical business explanation (e.g., portfolio diversification)”.
In its Targeted Update on Implementation of the FATF Standards on VAs and VASPs from June 2022, FATF has identified potential illicit finance risks in decentralized finance (DeFi), particularly in chain hopping or cross-chain transfers. The report states: “DeFi protocols can be used to perform ‘chain-hopping,’ which can make the transactions more difficult to trace.” Identifying cross-chain transactions should therefore be integrated into AML/CFT policies for efficient transaction monitoring and risk management.
Analyzing cross-chain transactions
Scorechain provides a blockchain analytics platform that facilitates crypto transaction monitoring and investigation processes. A cross-chain analysis feature has been developed as part of the Cut The Cord project. The goal of the feature is to give users the missing information between blockchains and help them reconstruct the money trail in case of cross-chain transfers.
With this feature, users can identify cross-chain transactions using the WBTC protocol and the exchange of BTC to ETH through the creation of WBTC. The feature will cover more protocols soon. It can flag a transaction if it has involved a cross-chain transfer and provide more information about the transfer (e.g., addresses, protocol, amounts, and twin transaction). With this information, users can seamlessly follow the funds across blockchains.
The cross-chain feature is also available in Scorechain’s Investigation Tool. It provides users with a clear visualization of cross-chain transactions and allows them to continue their investigation on the other blockchain.
Analyzing cross-chain transactions
Crypto assets have been around for more than 10 years with the aim of revolutionizing financial services and bringing enhanced financial inclusion. Over the last decade, there has been a significant expansion of crypto markets and broader adoption of crypto assets. In addition, blockchain technology also improved and developed new use cases, notably with blockchain interoperability and decentralized finance (DeFi).
However, all of this brings new challenges and threats in terms of AML/CFT compliance by creating new ways for illicit actors to enhance transaction anonymity for money laundering and terrorism financing. And this includes cross-chain transactions, which obfuscate the trail of funds across blockchains.
The Cut The Cord project aims to enhance AML tools’ capabilities in Europe. It puts a strong focus on crypto assets and the inherent challenges related to their development. Scorechain’s work in the Cut The Cord project aims to provide the right tools that can help overcome these challenges by facilitating AML/CFT compliance for crypto assets.
For more information about the project, please visit: https://ctc-project.eu/. You can also join the CTC Stakeholder Community by signing up in the following link: https://ctc-project.eu/community-signup/.