To fully understand an ecosystem, you must dive deep into learning about its players. In Web3, one key player is Chainalysis, an industry backbone that many people haven’t heard of. I recently had the opportunity to talk to Caitlin Barnett, the director of regulation and compliance at Chainalysis, to understand why its work is vital in building the industry.
A Blockchain Phonebook
Chainalysis is a blockchain analytics company. “We’re kind of like a phonebook for the blockchain. We provide real-world identities to crypto addresses,” says Barnett.
More generally, it gathers data from the blockchain and builds powerful tools for businesses, governments, and exchanges to drive business results, fight cybercrime, manage risk, and comply with regulations surrounding digital assets like non-fungible tokens (NFTs) and crypto. Its data platform has helped solve some of the world’s most high-profile cybercriminal cases and helps grow consumer access to cryptocurrency safely.
In part, Chainalysis exists because blockchain is still a risky business, especially for newcomers and large institutions. Much of blockchain technology remains underregulated, misunderstood, and used for nefarious purposes like money laundering, dark market transactions, and tax evasion. A large part of Chainalysis’ work is to allow organizations and individuals to use the technology for good while avoiding exposure to bad actors and fraud.
Four Web3 Adoption Issues
In general, organizations face four key issues in adopting Web3 technologies. Chainalysis helps them face the last three in particular.
- Token and asset classification: It’s difficult to offer services and products when the government isn’t clear on how they should be treated, especially in terms of taxation of financial instruments. This is a key challenge in tokenization, where you package assets like equities, real estate, or commodities into tokens that live on a blockchain.
- Complying with regulations around criminal activities: Many organizations stay away from unregulated spaces like decentralized finance (DeFi) because of its connection to criminal activities and uncontrolled markets. Companies don’t want the public relations or legal nightmare of offering crypto services, which are then used for trafficking or money laundering. There is also financial risk in putting value into these systems, as we’ve seen with the Luna/UST crash and the large Ethereum hacks.
- Protection against financial risk, fraud, and criminal activity: In addition to the legal, public relations, and financial risk, stakeholders must also be considered by organizations. Stakeholders have investors, employees, users, and clients to protect against many of the same risks.
- Data-driven decision-making is difficult when you don’t have data: Organizations also need data from the blockchain, which is an open-source database, after all, to make more informed decisions. That can include market activity, protocol usage, transaction flows, and more.
Where Chainalysis Comes In
Chainalysis tackles these issues in a number of ways, but its main offerings are:
- Reactor: Reactor is software that connects crypto transactions to real-world entities. That can help track the movement of stolen funds, for example, but also provide legitimate activity data for businesses like loans and transfers.
- Address screening: Chainalysis builds tools that help organizations prevent high-risk users from connecting to their platforms and using their services. This is useful for DAOs (decentralized autonomous organizations), decentralized applications (dApps, which are protocols running on-chain), or marketplaces that don’t want criminal actors using their platforms. This helps those organizations comply with regulations and builds trust with their legitimate customers, who can use the services knowing that they’re clean and controlled. Building this trust is key in attracting newcomers to the Web3 space.
- Business data: It provides blockchain analytics to help businesses better understand customers, tailor product offerings, and identify new revenue streams.
- Kryptos: According to the company’s website, “Kryptos is the industry’s reference directory for cryptocurrency services’ on-chain activity. Search over a rapidly growing list of 6,500 services and monitor their activity over time.”
- Compliance screening tools. Chainalysis offers free tools to Web3 entities like data exchanges (DEXs), DeFi platforms, DAOs, and dApp developers to aid in their compliance efforts and adhere to sanctions policies.
Final Thoughts
In many ways, spotting criminal activity and generating data is much easier with blockchain than ever before. Despite the original cypherpunk ethos of anonymity and privacy that drove the creation of Bitcoin, “blockchain is completely transparent . . . It’s open-source code,” says Barnett. She goes on to explain her previous role in criminal investigations for traditional finance, where she would be doing Google searches and coming up only with shell companies and bureaucratic obscurities. But with blockchain, everyone has unfettered access to transaction history, making her job a lot easier.
Nonetheless, as in every emerging industry, regulation and control is a tradeoff with innovation. The lack of “regulatory clarity” has blocked many organizations from taking next steps. “I think what people struggle with is the fast pace of this technology, and how it’s outpacing the regulations. As new technology has been developed, a number of the traditional financial institutions have been hesitant to fully jump into the crypto space . . . It’s difficult to see how things are falling into place, we don’t have a classification for all these other assets [being created] . . . but as the industry continues to develop, we’ll also continue to develop and enhance our existing tools to support [in] any way we can.”
Web3 may work well on its own, but it doesn’t yet mesh well with Web2 and the existing financial infrastructure. As a data provider, Chainalysis is a core driver of that meshing process.
“A lot of the work Chainalysis and others are doing is really to legitimize this industry,” says Barnett. Unless you’re a criminal relying on the shadows to conduct your activities, you’re probably okay with that.
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