Crypto AML Tools Explained: How Compliance Works On-chain

Transparency Meets Surveillance

Crypto was supposed to be anonymous and free from government oversight. Instead, blockchain’s transparency has created the most powerful anti-money laundering tools in financial history.

Privacy and control are perhaps the biggest considerations that set the cryptocurrency world apart from traditional finance in its early days. Most people buy crypto and adopt crypto payments because of the anonymity of transactions it promises. However, the lines are closing in as governments across the world increasingly interfere with on-chain activity.

Their interference is often premised on the basis of national security and public interest. Hence, most crypto operators have been pressured into integrating Know Your Customer (KYC) and anti-money laundering (AML) standards, which only used to apply to traditional banking in the past.

Ironically, the same blockchain technology has been singled out as the catalyst for some of the most powerful anti-money laundering (AML) tools in the history of finance. This is because while cryptocurrency offers pseudonymity, that is, users are only identified through some alphanumeric codes, it does not offer true anonymity. All transactions made on a public blockchain like Bitcoin or Ethereum are recorded on a permanent, immutable public ledger.

Originally, it was difficult to interpret the ledger trail. However, some sophisticated data analytics firms have mapped the blockchain and can link pseudonymous transactions to existing entities. This step is particularly important as the industry hopes to attract institutional investments.

This article will demystify crypto AML tools, explaining what they are, how they work, what they can detect, and why they’re necessary for the industry’s survival. It will also explore how businesses implement compliance while preserving user privacy where possible.

What is AML and Why Does Crypto Need It?

AML (Anti-money laundering) refers to a collection of laws, regulations and procedures intended to prevent criminals from disguising illegally obtained funds as legitimate income. In traditional banking, banks are often tagged whistleblowers because of their legal duty to track customers’ deposits and flag suspicious activities such as money laundering, terrorism financing, or penalty evasion.

Over the years, the crypto market slowly became a hideout for such activities, specifically due to the anonymity of transactions and its borderless nature. Unsurprisingly, regulators across the globe felt threatened and began a nationwide crackdown on crypto exchanges. However, the narrative is gradually shifting as both parties come to an understanding. On the one hand, the regulators are beginning to appreciate the potential of blockchain technology, while crypto exchanges are settled on the need to improve their technology and integrate onboarding processes.

To operate legally, digital assets platforms must now collect more information that allows them to identify their customers, monitor transactions for suspicious behavior, report potential violations, and block transactions involving sanctioned individuals.

How On-Chain AML Tools Work

Transactions on public blockchain are recorded permanently; as such, it is easier to ingest this data and create software that tracks fund flow, behavioral patterns, connections between two or more wallet addresses, as well as illegal entities. This forms the basis of crypto AML.

While it is easier to detect the transfer of funds from one crypto address to another, the real value lies in interpreting who owns those addresses. Data analytics and forensics have adopted different methods, including:

• Address Clustering

Whereas users can create a new address for every transaction to protect their privacy, clustering algorithms help to determine when different addresses are connected to the same digital wallet or entity.

For example, in a Bitcoin transaction, which typically involves multiple inputs (spent coins), it is generally assumed that all those inputs belong to the same person. An AML tool simply analyzes these “common input spending” patterns to group millions of addresses into one single entity, such as a specific user, hot wallet or exchange.

• Taint Analysis

Where a suspicious entity has been identified, AML tools can be deployed to perform a taint analysis. An example is where a hacker sends stolen funds to a new address; the new address becomes tainted. Then, if the address moves the funds to an exchange, the exchange’s AML tool interprets the incoming deposit as “3 hops away from a hack” and shows a 100% taint score. Essentially, investigators are able to track illegal funds even when they’re split into multiple transactions.

Also, crypto exchanges are allowed to determine the threshold for rejecting tainted deposits.

• Risk Scoring

AML tools can also flag a suspicious transaction based on the risk assigned to it. Typically, funds originating from a regulated U.S exchange or crypto rewards earned from mining are considered low risk. On the other hand, deposits made from a tumbling service, a sanctioned jurisdiction, or a gambling website are flagged as high-risk. Some businesses reject any deposit above a risk score of 7.

Major AML Tools and Platforms

A handful of key players dominate the Anti-Money Laundering (AML) market, supplying the critical data, analytics, and monitoring infrastructure that powers compliance for some of the best crypto exchanges, banks, fintechs, and regulators worldwide.

These platforms provide real-time blockchain intelligence, risk scoring, transaction monitoring, sanctions screening, and investigative tools that help institutions detect suspicious activity and stay compliant with global regulations.

1. Chainalysis

Chainalysis is widely regarded as the leading name in crypto compliance and blockchain intelligence. Its tools are used by major government agencies, including the FBI, IRS, and Europol, to investigate sophisticated cybercrimes and trace illicit funds across multiple blockchain networks. The company has built a strong reputation for delivering accurate, real-time insights into wallet behavior and transactional flows.

Chainalysis’s list of product offerings. Source: Chainalysis

The platform offers a wide range of capabilities, including address clustering, on-chain forensics, transaction monitoring, risk scoring, and sanctions screening. These features make Chainalysis a go-to solution for regulators, law enforcement, and crypto businesses seeking to improve their AML frameworks and ensure transparent, compliant operations.

1. Elliptic

Conversely, Elliptic focuses on helping businesses assess wallet risk and maintain robust compliance standards. As one of the early pioneers in applying machine learning to blockchain analysis, the company gained prominence for its ability to detect patterns linked to illicit transactions with high accuracy.

List of Elliptic blockchain solutions. Source: Elliptic

The platform offers a wide suite of capabilities, including wallet screening, cross-chain analytics, transaction tracking, and risk scoring. These tools enable exchanges, fintechs, and financial institutions to identify suspicious activity early, mitigate exposure, and meet global AML requirements more effectively.

1. CipherTrace

CipherTrace, acquired by Mastercard in 2021, operates as an integrated AML and crypto risk-intelligence platform used by exchanges, financial institutions, and regulators. Its core strengths include fraud detection, DeFi risk analysis, darknet-market monitoring, and detailed attribution data that helps organizations spot threats early and strengthen compliance programs.

Historically, CipherTrace offered multiple flagship products, including Inspector for law-enforcement tracing, Sentry for automated AML risk scoring, and Armada for identifying VASPs within banking networks. However, several of these services were discontinued as of March 2024 as Mastercard began merging CipherTrace’s capabilities into its broader cybersecurity and digital-asset offerings.

Blockchain services offered by CipherTrace. Source: Ciphertracers.com

Despite the product sunset, Mastercard clarified that CipherTrace itself is not shutting down. Its technology now powers an updated, consolidated platform accessible through “ciphertracers.com”, continuing to support crypto intelligence, risk monitoring, and regulatory compliance across the evolving digital-asset ecosystem.

1. TRM Labs

TRM Labs has gained significant traction for its visually intuitive interface and robust cross-chain analytics. Its tools are designed to help Web3 companies operate effectively while meeting regulatory expectations, making it a preferred choice for startups and enterprises navigating fast-evolving compliance demands.

Blockchain solutions offered by TRM Labs. Source: TRM Labs

The platform specializes in NFT and DeFi analytics, on-chain investigations, and comprehensive cross-chain risk assessments. By offering clear visual mappings of wallet behavior and transaction flows, TRM Labs enables organizations to detect illicit activity early, strengthen their AML controls, and maintain compliance across complex blockchain environments.

The Compliance Workflow

How are these tools actually implemented by crypto businesses? In practice, most regulated exchanges and blockchain companies follow a structured four-step compliance workflow, a starter pack that ensures they meet regulatory standards while keeping users safe.

1. Know Your Customer (KYC)

It is nearly impossible to trace on-chain activity without verified user data. For this reason, crypto businesses are required to collect essential customer information, including government-issued IDs, facial verification, and in some cases, crypto wallet linkage to ensure activity can be attributed to a real individual or entity.

1. Transaction Monitoring

Once a client is fully onboarded, each transaction on the account is automatically scrutinized by the AML model in use. Usually, the AML tool traces the source of the funds and flags any suspicious activity.

Often, crypto exchanges set thresholds for automatic rejection of deposits. That is, if a particular deposit crosses the threshold limit, the transaction is instantly flagged.

1. Sanctions Screening

AML tools continuously screen transactions against global sanctions lists. Any transfers involving individuals, entities, or jurisdictions on these lists, such as sanctioned states like Russia, are automatically blocked, ensuring compliance with international regulations and preventing illicit activity.

1. Suspicious Activity Reports (SARs)

Any unusual withdrawals, deposits, wallet interactions, or address behavior can trigger a deeper review. If the risk appears credible, the exchange is required to file a Suspicious Activity Report (SAR) with relevant authorities. This applies to both crypto-native transactions and movement between digital assets and crypto to fiat off ramp channels.

1. Due Diligence

This is a continuous process. Crypto businesses must regularly reassess each user’s account, updating risk scores and reviewing any new activity or red flags. This ongoing scrutiny ensures that every customer’s risk profile remains accurate and compliant over time.

Privacy Concerns and Limitations

However, there has been a debate about where to draw the line with users’ privacy while implementing AML rules and procedures. Crypto exchanges owe it to their customers to protect their data. Particularly, those who entered the crypto market to escape the watchful eye of the state are now disappointed by the betrayal of the technology’s promise.

As a result, it is important for digital assets platforms to understand the limits of these obligations and major privacy concerns:

• False Positives

The first rule any crypto operator must understand is that AML tools are not perfect. Its actions can affect innocent users who unknowingly received tainted coins. Furthermore, malicious actors can perform dusting attacks. This involves sending tiny amounts of illicit crypto to thousands of innocent wallets to implicate them.

• Privacy coins and mixers

The rise of privacy coins like Monero and mixing tools like Tornado Cash further complicates AML monitoring. As a result, regulators have since added these platforms to the sanctions list or restricted their operations.

• Decentralized Protocols

DeFi sure has a lot of complexities when it comes to compliance. Due to its nature of operations and lack of a central authority, it is difficult to file SAR or collect IDs. This is still a grey area for the regulators.

The Future of Crypto AML

Nevertheless, compliance tools are consistently evolving with each challenge that threatens their functionality. The future of crypto AML looks like:

• AI and Machine Learning: This is expected to revolutionize how investigations are carried out by introducing new capabilities that can predict future illicit behaviour. Operators believe that this tool will be able to tell an innocent user seeking to protect their privacy, distinct from fraud.
• Cross-chain Analysis: Often, criminals “chain hop” to mask transaction trails. For instance, a criminal may move stolen Ethereum to Bitcoin, then to Solana, and on and on to lose trail. However, newer tools are becoming adept at tracking assets across multiple chains.
• Privacy-protecting Compliance: This is the holy grail of future AML compliance and is achieved through Zero Knowledge Proofs (ZKP). That is, users can prove their innocence without necessarily revealing their identity or transaction history. This essentially creates a balance between two extremes.
• Global Standardization (The Travel Rule)

Finally, the FAFT Travel Rule is currently being rolled out globally. It requires virtual assets service providers (VASPs) to share sender and receiver information with each other during transactions, similar to SWIFT messaging in banking.

Conclusion

Regulators worldwide were initially challenged by the difficulty of fitting blockchain technology into traditional legal frameworks. Interestingly, this very challenge became one of the strongest appeals of cryptocurrencies, especially for users frustrated with the complexity and limitations of the traditional banking system.

However, rising concerns over money laundering, terrorism financing, and cyberattacks made regulatory intervention inevitable. Interestingly, the same blockchain technology that once seemed ungovernable is now being leveraged to monitor transactions and enhance transparency. As a result, sophisticated AML tools have emerged, enabling crypto businesses to operate smoothly while staying compliant with global regulations.

While the era of transacting entirely beneath the radar may be ending, platforms like Digitap demonstrate that compliance doesn’t have to come at the expense of user experience. Our platform implements industry-leading AML measures, ensuring security, transparency, and regulatory adherence. Trade with confidence — join Digitap today.

FAQs (Frequently Asked Questions)

What does AML mean in crypto?

AML (Anti-Money Laundering) is used to describe the laws and procedures designed to prevent illegal funds from passing through the crypto market. For crypto businesses, this means they must test the veracity of each crypto transaction and flag suspicious activity.

Can crypto transactions really be traced?

Yes, Most blockchains are public ledgers where every transaction gets recorded permanently. While users remain pseudonymous, specialized analytics companies can use “clustering” and other forensic techniques to trace transactions to specific individuals or entities.

What happens if I receive tainted coins?

Tainted coins are often associated with crime. Thus, receiving a tainted coin can result in your accounts being frozen by your service provider. If the tainted coin is a small fraction, it may be treated as a dusting attack, although it is advisable not to touch the funds. If you unknowingly receive substantial tainted funds, contact your exchange’s support or legal counsel immediately.

Do all crypto platforms require KYC?

No, not all crypto platforms require KYC. The ones that require a KYC are centralized exchanges like Coinbase and Binance. However, decentralized exchanges (DEXs) and self-custody crypto wallets often do not require personal information. As the name implies, the exchange lacks a central authority that can collate and store the information.

Are privacy coins illegal?

Whereas the idea of privacy coins seems like the opposite of the law or what the regulators are trying to achieve, they are not illegal in most jurisdictions. Nonetheless, trading them is becoming difficult. Many countries like Japan and South Korea have banned them from exchanges, and the EU is implementing stricter rules that may effectively ban them from regulated platforms by 2027. As a result, many exchanges have delisted them.