How can there exist businesses that "specialize in blockchain analysis looking for patterns of usage that reveal how money is being used"?

Question

I read this today in a SE comment for an unrelated question:

there are businesses that specialize in blockchain analysis looking for patterns of usage that reveal how money is being used.

To me, this is downright offensive, since I have spent 20 years trying to come up with something that I can do that will actually generate money.

And now somebody claims that there are entire actual businesses that do nothing but analyze the Bitcoin blockchain looking for patterns, and somehow make money from this?

Can somebody explain to me how this makes them money? And what, more precisely, do they do when they "look for patterns"? Surely this must involve more than just having a Bitcoin Core fullnode on a PC and looking at the blocks locally?

Answer 1

And now somebody claims that there are entire actual businesses that do nothing but analyze the Bitcoin blockchain looking for patterns, and somehow make money from this? .. Can somebody explain to me how this makes them money?

These chain analysis businesses make money by selling data to interested parties, such as regulators, other businesses, police/gov enforcement agencies, etc.

As example, in many jurisdictions, businesses that act as bitcoin exchanges (trading fiat <-> bitcoin) are required to comply with 'anti-money laundering' (AML) and 'know-your-customer' (KYC) rules and regulations. This ultimately means that these businesses will need to catalogue data about who is using their service, and for what reasons. So they will employ the services of a chain analysis firm that can supply data about what is happening on the bitcoin network, in an effort to appease regulators.

And what, more precisely, do they do when they "look for patterns"?

Chain analysis firms will work to obtain as much information about the economic activity happening on the bitcoin network as possible. This includes:

• The structure of transactions (number of inputs/outputs, value of inputs/outputs, address types, etc)
• The relation between different transactions / addresses (eg, attempting to group clusters of addresses to outline a user's wallet, etc)
• The messages exchanged P2P on the network (eg, where do new blocks/transactions originate from)
• Publicly available data (eg, when a user posts an address of theirs to a forum online)
• Privately available data (eg, buying or trading data about customers from private businesses)

By combining clues gained through the above methods, a chain analysis business can make guesses about which users own certain UTXOs, as well as the relationships and economic flows that exist between these users. Since this data is of value, these businesses can exist.

For a thorough explanation of these different types of attacks on privacy, the Bitcoin wiki has a great page: https://en.bitcoin.it/wiki/Privacy#Blockchain_attacks_on_privacy (as suggested by MCCCS in a comment)

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An important thing to note is that many of the metrics used by chain analysis firms rely on certain heuristics that do not always hold true. This means that in many cases the resulting analysis is false, or perhaps just nonsensical. Bitcoin privacy is a back-and-forth battle, with many developers working on tools and techniques that directly attack the validity of heuristics used by chain analysis (eg, coinjoin, payjoin, etc).

On the other hand, a chain analysis company would be expected to overstate the validity of their results, since their revenue is contingent upon this validity, and they want to convince customers and regulators that the fees they charge are worthwhile.

Ultimately, a user can interact with the bitcoin network in a way which grants them zero privacy against these businesses, or they can interact in a way which allows them extremely high levels of privacy. It really just depends on the user's habits, and the tools available to them.

So the true effectiveness of chain analysis is hard to discern, but in any case it is an attack on the privacy and security of bitcoin users worldwide. Note that even if the conclusion of a chain analysis firm is false, there is nothing to stop an overzealous regulator from persecuting an individual based on the result anyways. The stakes are apparently high, for everyone involved.

So I do agree that it is offensive, though perhaps for different reasons.