Blog Post

Tackling Next-Gen Financial Crime with IRS-CI Executive Director Jarod Koopman

March 6, 2024

‍Introduction

The rise of Web3 and Decentralized Finance (DeFi) is reshaping the digital asset landscape, but also presenting new challenges in combating financial crime. In a recent webinar, AnChain.AI brought together Jarod Koopman, Executive Director of Cyber and Forensics at the IRS Criminal Investigation, and Brennan Long, Head of Law Enforcement Relations at AnChain.AI share their insights on the emerging challenges and how public-private partnerships is essential in paving the way for a safer and more secure digital asset future.

Key Takeaways

Rapid Evolution in Financial Transactions: The digital asset landscape has transformed, creating new and complex obfuscation methods for laundering money. This demands a shift in strategies by using advanced tracking and tracing tools that assist law enforcement in investigating and monitoring illicit blockchain transactions.
Misconceptions and Realities of Cryptocurrency: Despite misconceptions linking cryptocurrencies directly to criminal activities, digital assets offer substantial legitimate potential. Law enforcement is focusing on adaptive strategies and robust regulatory guidelines to effectively monitor and combat the misuse of digital assets.
Emerging Challenges and Law Enforcement Response: The DeFi space faces increasing cyberattacks and security challenges, highlighting the need for enhanced defenses. U.S. law enforcement is countering these threats through strategic partnerships, advanced training, and capacity building, aiming to deepen their understanding of the DeFi ecosystem and address sophisticated obfuscation techniques.

The Shifting Battleground in Financial Crime

The digital asset landscape has experienced rapid growth, from the early days of digital currency exchanges to the proliferation of Initial Coin Offerings (ICOs) scams, dark web marketplaces, and now the advent of smart contracts and DeFi. These advancements have not only revolutionized financial transactions but also introduced novel methods for criminals to launder illicit proceeds. Law enforcement's strategy has evolved from “knowing the criminal and proving the crime to now knowing the crime and having to prove the criminal,” with the aim of tracing the flow of illicit funds through the blockchain, emphasizing the importance of "following the money trail" in a digital context.

Crypto: Beyond the Shadow of Crime

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Jarod Koopman emphasized the misleading nature of directly associating cryptocurrency with criminal activities. Acknowledging the vast potential of crypto and DeFi for legitimate uses, Koopman argued that cryptocurrencies should be viewed as “the new vehicle” that criminals may exploit, rather than the root cause of criminal activity itself.

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Even though digital assets are not as widely used in financial crimes as traditional fiat currencies, their role in facilitating serious offenses, such as state-sponsored terrorism financing, human trafficking, investment fraud and other criminal activities demands ongoing vigilance.

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Law enforcement must develop adaptive strategies to monitor and combat the misuse of digital assets in criminal endeavors. The dynamic nature of DeFi and the innovative criminal use of cryptocurrencies highlight the need for robust guidelines and compliance measures to effectively tackle the movement of illicit proceeds across the blockchain..

How Web3 and DeFi are Reshaping Financial Crime and Security

The DeFi space has become a hotspot for cyberattacks, underscoring the need for robust security measures. Smart contracts, while revolutionary, are a double-edged sword where their code-based foundation can be exploited for malicious activities. Additionally, the blending of Web3 gaming with financial systems introduces novel channels for money laundering, necessitating innovative regulatory approaches.

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Complexity in DeFi

‍Criminals are employing increasingly sophisticated methods to evade detection, taking advantage of the advancements in DeFi to hide their illicit fund trails. Techniques such as mixers, peel chains, multi-chain, and cross-chain transactions allow criminals to quickly and seamlessly transfer illicit proceeds across various blockchain networks, posing significant challenges for tracing and combating financial crimes in the modern era.

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DeFi as a Target

‍In 2023, DeFi protocols emerged as prime targets for cyberattacks, experiencing a variety of sophisticated threats. These included the exploitation of mixing networks via third-party services, manipulation of liquidity pools, compromised security keys, and issues related to double liquidity counting. A notable incident was the theft of $195 million from Euler Finance, a DeFi lending platform on the Ethereum blockchain, through flash loan attacks. Such incidents underscore the escalating security challenges and the critical need for stronger defenses against these vulnerabilities within the DeFi sector.

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Smart Contracts: A Double-Edged Sword

‍While smart contracts offer a broad range of applications, from supply chain management to banking, real estate, and healthcare, their code-based foundation also introduces risks. Malicious actors can insert harmful code into smart contracts, deceiving victims into authorizing transactions that could empty their digital wallets, for example, through crypto wallet drainers.

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The Emerging Role of Gaming

‍The growing interconnectivity between Web3 gaming and traditional financial systems is raising concerns among law enforcement. Gamers can buy in-game tokens with credit cards or via crypto-integrated payment platforms like CashApp and Venmo. These tokens can be moved across games, converted into cryptocurrency, and then transferred to exchanges worldwide, creating a novel and complex avenue that criminals may exploit. Moreover, the integration of secure, untraceable communications within Web3 gaming platforms adds another layer of complexity, significantly hindering oversight and creating a potent mix for high-threat scenarios.

Looking Forward

Recognizing the evolving threats and intricate nature of DeFi, U.S. law enforcement is emphasizing public-private partnerships, specialized training, and international collaboration with foreign law enforcement partners to effectively combat financial crime. Through this comprehensive approach, U.S. law enforcement is not only equipped to address current challenges but also poised to navigate the complexities of the future digital crime landscape.

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