A team of researchers from UK university Cambridge have found a way to track stolen bitcoins even after they’re laundered, giving law enforcement an entirely new and powerful way to track the proceeds of cryptocurrency crime for the first time.
The algorithm, called Taintchain, is based on a 19th century UK law, which established the first in, first out (FIFO) principle, upon which many cryptocurrency launderings seem to operate.
Although the blockchain is a transparent ledger where every transaction can be seen and traced, the units themselves like Bitcoin for example are impossible to track as they have no serial numbers or other individual identifiers.
So how does this system work?
The research team, made up of Ross Anderson, Ilia Shumailov, and Mansoor Ahmed came up with a system that is based on the FIFO principle, which stipulates that when funds are divided from an account (like when a bank or other financial institution collapses), the first person to have paid in is the first person to be paid out.
The new Taintchain algorithm applies this principle to bitcoin wallets: if the first bitcoins paid into the wallet are stolen, then the first ones paid out are considered stolen too. Although malicious actors use several different patterns that are supposed to hide the funds, the algorithm is immune to them due to observing the FIFO principle. Of course, that insight immediately suggests a way for malicious actors to hide their activity from Taintchain analysis by randomizing the way they pay out from wallets.
Refer to the picture below for an example of how this theory will work: