IRS Offering Grants of Up to $625,000 for Cryptocurrency Tracking Solutions

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When one hears that the Internal Revenue Service (IRS) is incen­tiviz­ing devel­op­ers to pro­vide it with cryp­tocur­ren­cy track­ing meth­ods, one might assume that it’s look­ing to hunt down every last penny of tax money to ensure the gov­ern­ment is get­ting its due.

While there is likely some truth to that theory, it’s also true that the IRS Criminal Investigation depart­ment (IRS-CI) reg­u­lar­ly breaks up all sorts of under­ground crim­i­nal enter­pris­es from dark web mar­ket­places sell­ing illic­it goods to orga­nized fraud and money laun­der­ing rings.

Enterprising con­trac­tors can now submit pro­pos­als to the IRS; those that can demon­strate suc­cess­ful cryp­tocur­ren­cy track­ing tech could be eli­gi­ble for grant money up to $625,000.

The IRS and cryptocurrency tracking

The IRS is seek­ing to lift the veil of secre­cy that sur­rounds cryp­tocur­ren­cy trans­ac­tions. While Bitcoin trans­ac­tions and wallet address­es are made public, noth­ing else about the trans­ac­tion con­nects to per­son­al iden­ti­ties. As long as a cryp­tocur­ren­cy user doesn’t trans­mit infor­ma­tion that could link them to these trans­ac­tions or use a per­son­al email address to reg­is­ter at a coin exchange, it is vir­tu­al­ly impos­si­ble to iden­ti­fy them. Some “high secu­ri­ty” coin types (such as Monero) take it a step fur­ther by con­ceal­ing wallet IDs and trans­ac­tion amounts as well.

While there are no end of legit­i­mate uses for cryp­tocur­ren­cy, these pay­ment types are obvi­ous­ly attrac­tive to crim­i­nals. Crypto is typ­i­cal­ly demand­ed in ran­somware and black­mail sit­u­a­tions, is the coin of the realm on dark web mar­ket­places that sell illic­it drugs, and is a pop­u­lar target for hack­ers look­ing to steal a form of cur­ren­cy that is tough to track down. There is a legit­i­mate case to be made for law enforce­ment cryp­tocur­ren­cy track­ing capa­bil­i­ties, but it is very dif­fi­cult to square with pri­va­cy con­cerns.

The IRS is not alone in seek­ing cryp­tocur­ren­cy track­ing tech­nolo­gies to assist in all of the above sce­nar­ios. In August, secu­ri­ty firm CypherTrace announced that it had developed a means of expos­ing the wallet IDs of Monero users at the behest of the U.S. Department of Homeland Security. However, there is still no means of crack­ing the iden­ti­ty of cryp­tocur­ren­cy wallet hold­ers other than good old-fash­ioned detec­tive work and hoping the holder makes some sort of a public mis­take.

IRS-CI has asked con­trac­tors to pro­vide it with cryp­tocur­ren­cy track­ing abil­i­ties that go beyond what is cur­rent­ly avail­able. The agency has put out the call for “tools, soft­ware, data, and algo­rithms” that allow it to trace and attribute coins and Layer 2 off-chain trans­ac­tions. The Layer 2 net­work pro­to­col adds the extra layer of secu­ri­ty to coins like Monero by adding a final anony­mous trans­ac­tion step pro­tect­ed by a third party.

The amounts being offered make one wonder how many seri­ous takers the IRS will actu­al­ly have, how­ev­er. The agency is offer­ing an ini­tial $500,000 grant for a work­ing pro­to­type, fol­lowed by an addi­tion­al $125,000 grant for fur­ther devel­op­ment. If one were able to come up with some sort of ana­lyt­ics or other mea­sure that could reli­ably trace and iden­ti­fy crypto hold­ers, one would think it would be worth a great deal more than that to other sources. To be fair to the IRS, it appears to be focus­ing more on the abil­i­ty to lift anonymi­ty ele­ments specif­i­cal­ly from “pri­va­cy coins” such as Monero and BTC Lightning Network than the abil­i­ty to instant­ly iden­ti­fy a wallet holder. However, CipherTrace’s con­tracts for its sim­i­lar work on the Monero track­ing tool have appar­ent­ly totaled over $6 million to date.

Hackers moving to privacy coins

There has been a sharp increase in hack­ers moving to Monero in recent months, with a particularly big spike in August. While the con­tro­ver­sial cur­ren­cy has been delist­ed from a number of major exchanges (and even banned entire­ly in Japan), its added layer of anonymiza­tion is highly appeal­ing to ran­somware attack­ers and sim­i­lar threat actors that pro­vide a wallet address to vic­tims during the process of car­ry­ing out a crime.

However, cryp­to­coins (and an inter­est in strong trans­ac­tion pri­va­cy) is hardly just for crim­i­nals any­more. The coro­n­avirus crisis seems to have set off something of a boom in interest in crypto among the gen­er­al public, pos­si­bly fueled by con­cerns about the safety and anonymi­ty of dig­i­tal trans­ac­tions with more shop­ping moving online during lock­down mea­sures and travel restric­tions.

Is the IRS tracking taxpayers who use cryptocurrency?

The IRS almost cer­tain­ly wants to be able to account for crypto trans­ac­tions and is making plans to do so, but it is unclear how much of this cryp­tocur­ren­cy track­ing push is about tax eva­sion versus the stated aim of more effec­tive law enforce­ment.

This is the first year in which the IRS has revised its forms to specif­i­cal­ly ask tax filers if they have bought or sold any cryp­tocur­ren­cies. While the “I didn’t know crypto had to be report­ed” excuse prob­a­bly wouldn’t have worked prior to this during an audit, the blunt ques­tion now makes it abun­dant­ly clear to filers that the IRS wants an account­ing of any and all vir­tu­al cur­ren­cies for tax pur­pos­es.

There is a legit­i­mate case to be made for #lawen­force­ment #cryp­tocur­ren­cy track­ing capa­bil­i­ties, but it is very dif­fi­cult to square with #pri­va­cy con­cerns. #respect­da­ta Click to Tweet

This can create an inher­ent pri­va­cy con­flict even for those who want to be honest about their tax oblig­a­tions, how­ev­er. Documenting cryp­tocur­ren­cy trans­ac­tions could mean reveal­ing a wallet address to the IRS, which defeats the pur­pose of the system of anonymi­ty. There is prior evidence that the IRS has been using known address­es to track trans­ac­tions to other unknown address­es for the pur­pos­es of audit­ing. The IRS guidance on the sub­ject seems to sug­gest that crypto trans­ac­tions must be declared either by pro­vid­ing a record of each trans­ac­tion or pro­vid­ing all trans­ac­tions over the year for a par­tic­u­lar wallet address. Reason has doc­u­ment­ed the story of an early crypto-holding filer in just this situation, who wanted to fully resolve his tax oblig­a­tions with the IRS but insist­ed on block­ing out public address­es from all doc­u­men­ta­tion. This has led to a multi-year court battle in which the crypto holder is fight­ing sum­mons issued by the IRS that essen­tial­ly man­date ongo­ing sur­veil­lance of all of his trans­ac­tions.

CPO Magazine source|articles

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