Reversible blockchain transactions would improve cryptocurrency

Published at: Oct. 5, 2022

A proposal out of Stanford University to make crypto transactions reversible is adding a wrinkle to discussions of crime and fraud prevention. Researchers suggested that mutability — the ability to reverse blockchain transactions — would help prevent crime.

One of the advantages of cryptocurrency is that it is possible for the market — individuals, traders and banks — to decide if reversibility is wanted. Not only would a new (reversible) cryptocurrency be able to test the acceptance or desire for reversible transactions, it would help to test the idea that reversibility reduces crime.

Although cryptocurrency is not a tool of the dark web, it’s sometimes portrayed as such. Fraud, scams and other forms of crime do happen and are growing in proportion with the amount of money invested and the number of coins traded.

One of the main ways law enforcement addresses crime in crypto markets is with blockchain forensics. Blockchain forensics is a growing field in law enforcement where transactions are analyzed to follow and recover stolen or fraudulently obtained cryptocurrency assets. It first achieved prominence a few years ago when the United States Internal Revenue Service used it to successfully recover the ransom Colonial Pipeline paid to the hackers who took control of it. But in the highly decentralized and risky world of cryptocurrencies and nonfungible tokens, blockchain forensics is becoming an important tool for compliance as well as regulation, creating potential impacts on legitimate traders.

Investigators closely scrutinize the transactions recorded on blockchains, looking for signs people are trying to hide or disguise their tokens. Some of these include rapidly switching between ledgers, using tools that mask or fake IP addresses, multiple small transactions and using a tumbler or mixer service, where crypto from many sources is pooled together to disguise where it’s coming from.

Reversibility would make it much easier for law enforcement to recover stolen and fraudulently obtained funds, reducing the potential rewards from crime. That could reduce the risk for banks and other established financial institutions in offering cryptocurrency services to the general public as opposed to being special investments. It would also reduce any problems associated with human error, such as “fat finger” errors. This would help make cryptocurrency much more useful for exchange, investment and other mundane uses.

On the other hand, reversibility — or mutability — would also run up against the idea of the blockchain itself. Mutability could make the blockchain as vulnerable to manipulation as any other repository of information, which would stultify one of its key security features. And attempting to impose a standard for when the blockchain could be edited would seemingly violate another important feature: that of decentralization.

The anonymous, decentralized nature of cryptocurrency finance makes tension between regulators and cryptocurrency somewhat inevitable. For ideological or privacy reasons, many people are attracted to the promise of anonymity offered by the blockchain, but those features attract more scrutiny from regulators as that same anonymity can enable transactions that range from those where taxes aren’t collected to the sale of illegal drugs or weapons or enabling countries such as North Korea evade international sanctions.

As cryptocurrencies become more mainstream, financial institutions and investors will also push regulators and exchanges to adopt protections or weaken the anonymity to comply with securities and anti-money laundering laws.

Mutability would make blockchain forensics even more important to regulators and investors. As an analogy, various government agencies and financial institutions require that companies and individuals keep accurate financial records. Many fraud schemes require manipulation of these records — embezzlers have to cover their tracks, stock waterers try to convince people a company is doing better than it actually is in order to inflate the share price and on and on. When they get discovered, forensic accountants are called in to put together accurate financial statements.

Blockchain forensics firms would end up in charge of protecting the integrity of the blockchain, effectively becoming the de facto central authority — and leading to inevitable variations of Can we trust them?

But the final say on making the blockchain reversible or mutable should be the decentralized force of the market itself. The most unique thing about cryptocurrency is that there are and can be so many currencies competing against one another all at once. In early modern Europe, a stable currency emerged out of hundreds of unstable ones, backed by high-purity precious metals and managed by a central bank. This “astonishing achievement of men in tights,” as economist Nathan Lewis memorably put it, was driven not by power-hungry monarchs but by merchants in places such as London and Amsterdam who demanded stability, while ordinary people benefited because they could rely on their money being valuable.

Unless decentralized finance can come up with an alternative that improves security and stability while not compromising its principles, a similar process may be underway.

Brendan Cochrane is the blockchain and cryptocurrency partner at YK Law. He is also the principal and founder of CryptoCompli, a startup focused on the compliance needs of cryptocurrency businesses.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.