Problems with Cryptocurrency Tracing

Law enforcement agencies rely heavily on blockchain analysis tools, such as Chainalysis Reactor and TRM Forensics, to trace cryptocurrency transactions. These platforms can be helpful during an investigation, but they’re not infallible. Instead, these platforms are often misunderstood. When used without proper caution, they can easily lead to incorrect attributions, wrongful seizures, and flawed legal conclusions.

Both platforms use heuristic clustering to group wallet addresses that they believe belong to the same person or entity. The problem is that these assumptions are based on transaction patterns instead of confirmed identities.

If two people interact with a shared service or make a similar type of transaction, the software might incorrectly assume their wallets are linked. These clusters are not independently verifiable, and they often include addresses controlled by users who are completely unrelated.

Another significant issue is the use of omnibus wallets by exchanges. When a person deposits cryptocurrency into a platform like Coinbase or Binance, those funds go into a pooled wallet controlled by the exchange, not the individual. If an analyst stops tracing when funds hit the exchange, it’s incorrect to assume that the wallet belongs to the suspect. Any seizure based on that assumption could be challenged for lack of probable cause.

Chainalysis and TRM sometimes label addresses based on reports from third parties, law enforcement agencies, or scraped data from the dark web. These labels may be outdated, overly broad, or simply wrong. Yet, we often see agents rely on them as if they’re conclusive. A label saying “fraud” or “scam” is not a substitute for real evidence, especially if there’s no way to verify where the tag came from or how it was applied.

Blockchain analysis tells you where the money moved. It doesn’t tell you why. That means it can’t show whether the transaction was part of a scam, a legitimate purchase, or something completely unrelated. Without subpoena responses, chat logs, emails, or other off-chain context, you’re guessing. And guessing is not a basis for seizure.

Chainalysis and TRM are good for generating leads. But they do not — and cannot — prove ownership or criminal intent by themselves. Every case needs to be backed by corroborating evidence: KYC records, statements, on-chain patterns that match off-chain behavior, and so on. If you’re relying solely on what the software shows, you’re not building a strong case — you’re risking someone’s rights.

The Most Common Tracing Methodologies

When “dirty” (criminally derived) money is mixed with “clean” (legitimate) money in a single account, the government uses accounting “legal fictions” to determine which portion is traceable to the crime.

Courts often look to three primary rules when dealing with commingled bank accounts and other types of commingled property:

• Lowest Intermediate Balance Rule (LIBR) –
  • Assumes “clean” money is spent first, leaving the “dirty” money in the account.
  • This government-friendly method maximizes the amount of “traceable” criminal proceeds.
• Pro Rata (Averaging) Rule –
  • Withdrawals are split proportionally between clean and dirty funds based on the ratio at the time of withdrawal.
  • This middle ground shares the “loss” of withdrawals between the two types of funds.
• Drugs-In, First-Out (DIFO) –
  • Assumes “dirty” money is spent first. In other words, the tainted money leaves the account as soon as a withdrawal is made.
  • This defendant-friendly approach often results in finding that all criminal proceeds were already spent.

The three doctrines above — LIBR, Pro Rata, and DIFO — are the most commonly cited accounting rules when courts analyze commingled funds. But they are not the only tracing methodologies that appear in forfeiture litigation. In cryptocurrency cases, especially, it is important to distinguish between recognized accounting doctrines and investigative shortcuts that are sometimes presented as if they were legal standards.

• First-In, First-Out (FIFO) –
  • Under a FIFO approach, the earliest funds deposited into an account are presumed to be the first funds withdrawn.
  • Depending on the timing of deposits and withdrawals, FIFO can either preserve alleged criminal proceeds or exhaust them. Courts occasionally apply FIFO implicitly without labeling it as such.
• Last-In, First-Out (LIFO) –
  • LIFO assumes the most recent deposit is withdrawn first.
  • In accounts with rapid deposits and transfers — including cryptocurrency exchange accounts — this approach can materially change the remaining “traceable” balance. The timing of transactions becomes critical.
• Direct Tracing (Specific Identification) –
  • Direct tracing attempts to identify specific funds moving from deposit to withdrawal without relying on presumptions.
  • This method requires continuity of control and clear documentation. Once funds are commingled in pooled exchange wallets, direct tracing often becomes impossible without exchange-level records.
  • In cryptocurrency cases, direct tracing typically requires verified deposit records, exchange internal ledger data, confirmed ownership at each stage of custody. Without that documentation, courts are left with presumptions rather than proof.
• Netting or Aggregation Approach – 
  • In some cases, the government does not attempt transaction-level tracing at all. Instead, it argues the total alleged criminal deposits equal a certain amount and the total withdrawals equal another amount. Therefore, the remaining balance must include tainted funds.
  • This “netting” approach bypasses detailed tracing analysis. Courts differ on whether this satisfies the government’s burden in forfeiture proceedings.
• Total Commingling Theory – 
  • Occasionally, the government argues that once criminal and legitimate funds are sufficiently commingled, the entire account becomes forfeitable.
  • Courts are cautious with this theory. Forfeiture generally requires traceable proceeds or proof that the account itself functioned as an instrumentality of the offense.
  • Mere commingling does not automatically convert all funds into criminal proceeds.

Crypto-Specific Practices Violate Traditional Accounting Rules

In cryptocurrency seizure cases, investigators often rely on methods that are not rooted in traditional commingling doctrine. These practices should not be confused with recognized accounting principles. When you see these issues in the government’s tracing theory, you know that they are making an educated guess that probably

• Path-Based or “Any-Hop” Tracing –
  • This method identifies any transactional path between a source wallet and a target wallet. The existence of a path is then treated as proof of traceability.
  • This approach does not account for intervening ownership changes, exchange pooling, commingling across unrelated users, loss of custody continuity.
  • The existence of a path does not establish ownership or control.
• Clustering Heuristics –
  • Blockchain analytics platforms group wallet addresses into “clusters” based on shared inputs or behavioral assumptions. These clusters are based on heuristics. They are not verified ownership records.
  • Clustering can generate investigative leads. It does not establish legal ownership in a forfeiture proceeding.
• Probability-Based Attribution –
  • Some tracing reports rely on language suggesting that it is “more likely than not” that funds originated from a particular source.
  • Probability scoring, risk scoring, and software confidence metrics are not traditional accounting doctrines. They are analytical tools that must be supported by independent documentation.
  • Without corroboration, probability is not proof.

Courts have long recognized formal accounting doctrines such as LIBR, Pro Rata, and FIFO when analyzing commingled funds. But cryptocurrency tracing often introduces methods that look technical but are not grounded in established financial principles. In forfeiture cases, the government must do more than identify a possible connection. It must establish, by competent evidence, that the property at issue is traceable to unlawful activity.

When traditional accounting rules are replaced with software inference, the risk of overreach increases. Understanding which methodology is being applied — and whether it is legally recognized — is critical in defending against cryptocurrency seizure and forfeiture actions.

Other theories in crypto tracing:

• Clean-in, Clean-out
  • Sometimes the government will use a “clean-in, clean-out” theory that argues that at every step, the intermediate wallets had a $0.00 balance before receiving the tainted funds which eliminates any argument that the tainted funds were “commingled” with legitimate funds.
  • Laundering funds rarely uses this method.

What Courts Should Require Before Relying on Blockchain Tracing

In civil asset forfeiture cases, the government carries the burden of proof. That burden does not shift simply because a tracing platform generated a report. Before relying on a blockchain tracing report to justify seizure or forfeiture, courts should require:

• A clear explanation of the methodology used.
• Identification of any assumptions built into clustering or attribution.
• Independent documentation supporting wallet ownership.
• Exchange records confirming deposits and withdrawals.
• A clear explanation of where traceability ends.

If the government cannot explain how it moved from raw blockchain data to a conclusion about ownership or control, the court should not treat the output as proof. Judges need to understand why the blockchain data is objective, but the narrative built around it is not.

Red Flags in Government Cryptocurrency Tracing Reports

In defending crypto seizure cases, we routinely see the same problems. These issues matter because they go directly to reliability:

• Tracing that continues after funds enter pooled exchange wallets.
• Clustering assumptions presented as verified identity.
• Proprietary labels used without source disclosure.
• No exchange KYC or account records obtained.
• Multiple transaction “hops” treated as proof of continued ownership.
• No discussion of probability decay across transfers.
• No acknowledgment of where traceability becomes speculative.

When these issues appear in an affidavit, the tracing is inferential but not forensic. Courts should not accept inference where documentation is required.

Why does the state or government employees have such little training and experience? Cryptocurrency seizures are increasing dramatically as specialized crypto units have expanded. Agencies now use commercial blockchain analytics platforms to keep up. Exchanges and stablecoin issuers respond quickly to freeze requests, with nothing other than a seizure warrant signed by a judge.

Civil forfeiture procedures allow rapid seizure before full adversarial testing. The speed of seizure has increased. The rigor of analysis has not always kept pace. That gap is where experienced counsel and qualified forensic experts make a difference.

The Role of Forensic Accountants in Cryptocurrency Seizure Cases

Forensic accountants are uniquely positioned to evaluate cryptocurrency tracing when:

• Commingling in pooled wallets.
• Continuity of control.
• Breaks in traceability.
• Reconciliation between on-chain activity and off-chain records.
• Whether conclusions are supported by documentation or assumption.

Many seizure affidavits rely on software-generated graphics without independent financial analysis. That gap can determine the outcome of a case. In higher-value forfeiture cases, expert review is often decisive. When a forensic accountant evaluates the methodology, the weaknesses become apparent.

The Difference Between Investigative Tools and Courtroom Evidence

Blockchain analytics platforms are investigative tools. They are not adjudicative proof. These tools are designed to identify possible connections. They are not designed to establish ownership in a contested legal proceeding. In court, conclusions must be transparent, replicable, and supported by the records.

That “evidence” should not include an investigative lead, a chart, or software label. When investigative tools are treated as proof without scrutiny, the risk of wrongful seizure increases. Innocent owners are likely to see their life savings seized for forfeiture few ways to fight back.

Common Misunderstandings About Cryptocurrency Tracing

Several misconceptions frequently appear in seizure cases:

• “All blockchain transactions are public, so ownership is obvious.” Blockchain shows addresses. It does not show identity.
• “If funds move through a wallet, that wallet owns them.” Exchanges use pooled wallets. Deposits are commingled.
• “If software finds a path, that proves control.” A path shows movement. It does not prove common ownership.
• “Tracing never loses visibility.” Mixers, CoinJoin, and custodial pooling frequently end reliable traceability.

Understanding these limitations is essential before concluding that cryptocurrency is forfeitable.

What to Do If Your Cryptocurrency Has Been Seized

If your wallet or exchange account has been frozen or seized, you should not assume the tracing report is accurate. Your attorney must obtain the underlying methodology, and exchange account records. The cryptocurrency forfeiture defense attorneys at Sammis Law Firm can preserve all communications and transaction logs.

Consult counsel experienced in cryptocurrency forfeiture litigation at Sammis Law Firm. We understand why many seizures are based on incomplete or overstated analysis. We know how to challenge those weaknesses.

Additional Resources

Forensic Accounting Expert Witness on Cryptocurrency Tracing for Forfeiture – This article is written by Amanda Porupski, CPA, CVA, MAcc, a forensic accounting expert with extensive experience in tracing complex financial transactions, including cryptocurrency and digital assets. Amanda Porupski is qualified to testify as an expert witness on cryptocurrency tracing matters and is currently involved in active cases across the country. Amanda has taught continuing legal and professional education courses on cryptocurrency and asset tracing to attorneys, CPAs and financial professionals. The article explains the role of forensic accountants in cryptocurrency seizure proceedings when it comes to blockchain and asset tracing.

This article was last updated on Wednesday, February 11, 2026.