Cryptocurrency trade surveillance and transaction monitoring firms are answering the call from regulators worldwide to prevent crypto crime and market manipulation. To do so, there is a need to analyze two different types of information: data that is recorded on the blockchain (on-chain) and data that is recorded off of it (off-chain).
In this article, we outline the differences between on- and off-chain analysis – and why both types are indispensable to compliance teams seeking to understand their full risk profile.
On-chain analysis is the study of cryptocurrency transactions that are executed on public blockchains. Its purpose is to determine the nature of these transactions, and – if they are deemed to be criminal – pass this information on to financial regulators or law enforcement investigators.
On-chain analysis is challenging not because cryptocurrency transactions are hard to access – block explorers and smart contracts offer unprecedented levels of transparency – but because blockchains are designed to prioritize privacy and security over readability. This means that even with the help of a block explorer, it can be difficult for a non-expert to determine the who, what, and why behind a transaction.
Off-chain analysis is the evaluation of trades and transfers that occur off of the blockchain, often within or between crypto exchanges and other market participants. Its purpose is the same as that of on-chain analysis: to monitor for illicit activity and, when identified, alert the parties concerned.
Off-chain compliance analysts regularly evaluate some combination of the following data:
- Know-your-customer submissions
- Due diligence evaluations
- Fiat-to-crypto onramps
- Crypto-to-fiat offramps
With so many different data sources involved, off-chain analysis requires a more comprehensive toolset than on-chain analysis. Analysts of off-chain data need detection models that can alert them to dozens of different suspicious activity types, from market manipulations and money laundering methods to onboarding fraud and sanctions evasion. They also need risk monitoring systems that can group and document alerts of all types for case management purposes.
Why is combining on- and off-chain analysis necessary?
Many situations call for analysts to synthesize on and off-chain data. Investigators at the U.S. Securities and Exchange Commission, for example, linked off-chain token listing announcements to on-chain DEX trades to convict a former Coinbase employee of crypto insider trading. Examiners at the New York Department of Financial Services (NYDFS) have also begun to perform this same type of monitoring.
Another example can be found in crypto investigations. When a criminal investigator identifies a pattern of suspicious crypto transactions, they can use on-chain analysis to determine whether the entities involved have later (or previously) transacted with a regulated exchange. If the agent finds an exchange connection, they can subpoena that organization to gather off-chain know-your-customer information. This same process also works in reverse; a compliance professional can use on-chain analytics to identify suspicious crypto transactions initiated by a customer on-chain, and then use official reporting mechanisms to provide off-chain information to their regulators.
Solidus HALO, our crypto market integrity platform, combines on- and off-chain analysis by design. By aggregating information from both on and off of the blockchain to create a universal risk view for every client on an exchange or suspect in an investigation, HALO makes case management simple.
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