This article is limited to transactions on exchanges only. The next entry will address remainder addresses in non-exchange scenarios.
For a better understanding what cryptocurrencies are, please read the first article in this series, available here: https://www.dallastxdivorce.com/2018/08/articles/articles/cryptocurrency-and-family-law-the-basics-part-1/
Everyone in the world can see when cryptocurrencies are transferred. Public addresses are wallets, and generally remain the same, and private addresses are similar to coins, and change upon transfer. When a private address (coin) moves from one public address (wallet) to another (from seller to buyer), one could simply follow the coin’s movement from public address to public address, by following the amount of cryptocurrency transferred between public addresses, similar to tracing cash amounts from bank account to bank account.
However, tracing assets is not as simple as following a trail, as the trail is in a constant state of transition, and it is difficult to determine who the buyer/recipient is. As discussed in the previous article, private addresses always change when transferred. Public addresses generally stay the same. However, while sales/transfers from a seller’s transmitting public addresses don’t change the transmitting public address, when only a portion of the cryptocurrency held in a transmitting public address is transferred to a single recipient, a third public address is created where the seller holds their remaining funds. A seller would then have the old public address where the seller could still receive funds, and a new one where the seller could keep the funds or enact a secondary transfer. Below is an example of how public addresses can be traced, and demonstrates how a remainder address is created.
Subdivisions would appear as follows:
(0.75 BTC) (0.25 BTC)
Seller (1uS) transfers a portion of her Bitcoin holdings (0.75 BTC) to Buyer (3Uk). Remember, the sale is a transmission of a private address, however, for purposes of this demonstration that private address (coin) is not shown, only the amount transferred is shown, as we are demonstrating how public addresses change in this example. That private address is transmitted and converted in secret. 3Uk receives 0.75 Bitcoin from Seller’s 1uS wallet, and it appears that Seller keeps the remaining 0.25 Bitcoin. However, that remaining 0.25 Bitcoin does not stay in Seller’s original, transmitting 1uS public address. Instead, it generates a new public address for Seller, called a remainder address, designated as 1Ru. Seller’s old public address (1uS) remains but has a zero balance. Seller can still receive funds and replenish the 1uS public address (wallet). Without access to exchange records, the remainder address, 1Ru, creates tracing issues, as a tracer would not know whether the remainder address (1Ru) is a second buyer (for example, if Seller put all 1.0 BTC up for sale, and the exchange sent 0.75 BTC to 3Uk and 0.25 BTC to a second buyer at 1Ru), or Seller’s remainder address (Seller only sold 0.75 BTC and kept 0.25 BTC in the newly created 1Ru remainder). It only appears as a new address in the blockchain, without clarification. A tracing party would know a transmission occurred, but they would not know to who, and unless it was a complete transfer, they would not know how much was retained.
Tracers need to pay attention when exchanges are used to sell cryptocurrency. In some cases the value of 1Ru could be a combination of multiple remainders and could appear to be a transfer larger than the original account balance, for example, 10 BTC. This could lead the tracer to believe that an error occurred, or the Seller had hidden funds. This 10 BTC scenario would occur when a second buyer puts in a buy order for 10 BTC, but no seller has 10 BTC to sell. The exchange then combines multiple remainder addresses to fill the order. Seller, unknowingly becomes part of this, and while Seller put 1.0 BTC up for sale, 0.25 BTC of that was combined with numerous other sell orders into one large 10 BTC sale order to the second buyer. Luckily for a tracer, if this were to occur, it would be clear that Seller sold both the entire share of 0.75 BTC from the 1uS public address, and the remaining 0.25 BTC (part of the large combination 1Ru public address). When no combination (i.e. combining multiple remainders to 10 BTC) occurs, the owner of the 0.25 Bitcoin in 1Ru is unknown. It could have been a second buyer who only wanted to purchase 0.25 BTC, or it could be Seller’s remainder address. To discover the holder of the 1Ru public address, Seller would need to subpoena the exchange. If no exchange was used, or the exchange is outside the reach of a subpoena (many are), the owner of 1Ru is truly anonymous. The best hope a tracer would have would be access exchange balance and transaction statements, but these may be impossible to obtain.
Exchanges are not the only time remainder addresses pose problems, and are not the only mechanism to sell cryptocurrency. Part three of this series will address cash-escrow services and privates sales, both of which compound the problems created for tracers by remainder addresses.
*Remainder addresses are also referred to as “change” addresses.