A mixer or exchange is the best bet, but then you're relying on a third party. A mixer may record it's transactions with people to say which coin was given out for which coin moved in.
At least this is my understanding of how the blockchain works. I may be wrong (likely!)
So if you move 20 coins from wallets A and B to wallet C, and then Wallet C moves those coins to wallets D and E, there's no concept of "whos" coins from A and B you moved into each wallet, it's just a count.
So in this case wallets A,B,C,D, and E are all suspect, and at some point they're going to try and buy something tangible or convert to real currency from one of those wallets.
That's why I asked - where is the stolen money, is it in X or in Y or in both?
The best we can do to reduce crime is to convince most of the exchanges not to take the stolen coins (or take them, but give them back to the real owners). But there are so many of them, and many of them are anonymous, I don't see how we can do that.
You could, theoretically, convince some providers of goods/services not to accept any tainted coins. It is doable, but most business owners don't care about that, as long as the money is not pure stolen (in both Bitcoin and physical world).
Consider that some money in your bank account has previously gone through being stolen, traded for drugs, guns, slaves, being laundered. Pretty much nobody but the Central Banks has clean money.
By using a set of different wallets where the control is shared but unknown outside of the mixer, you can end up with coins that are not traceable through wallets.
A bit like you giving money to a third party, who calls up his friend, and then his friend gives the same amount of money to your friend. 'Your money' then ends up being used for something else (unrelated to you).
So you are doing mixing. One of your users is a criminal, and that is apparent to you as you can trace where their coins came from. In your stash, you have 100BTC, 10 of which is the share from the criminal. He/she orders 1BTC to be transferred to a private wallet. You make a transfer to the private wallet from your stash, but you know exactly who gave the order. When the police comes to you, you will be forced to tell them who gave the order. Am I missing something? If I'm correct, then the attacker has to trust the mixer.
And then we have things like ZCash, which are designed to make tracing impossible.
Here's an approach to deter crime here: explicitly expose the implicit information about stolen coins. Wallets containing stolen coins are to be considered tainted to a specific amount of BTC. Receiving from them means your wallets gets that taint, proportionally to the amount received. The only way to un-taint a wallet is to return the stolen money.
This assumes certain infrastructure, of course.
How did you reach this conclusion?
Why not 0.1 in X and 0.9 in Y?
Why not 1 in X and 0 in Y?
> This assumes certain infrastructure, of course.
Will not happen any time soon. Just like it doesn't happen with the dollars / euros / etc.
Even if you somehow magically force this kind of filtering at the node level, people who desire freedom will move to some other cryptocurrency. Bitcoin is actually quite simple compared to more modern and more anonymous offerings.
Here's a more detailed proposal to show it can be done as a distributed system.
http://www.loper-os.org/?p=988
It's not about forcing nodes to do anything. It's about publishing data about what they're doing. Then people can make informed decisions. Some people won't like it, but precisely what freedom would be be trying to preserve, if they're fighting this? Freedom to foist off dirty money to people who don't want to receive it?
But you see, that's not the question I asked. I asked where the stolen money actually is. And the only truthful answer you can give is "I don't know".
I agree that we could create a system to track "tainted money" and use the proportional tracking in case of merge-splits (50-50 in our example). But you will quickly run out of untainted money (besides the freshly-mined coins), because
1) everything that touches the hot wallet in any exchange will be considered tainted
2) Even if #1 were not true, every time an exchange does a withdrawal, they don't do it in 1 transaction per address, they do it in batches, where they withdraw from the hot wallet into dozens/hundreds of addresses. They do it to massively save on the transaction fees.
Okay, let's go down that route. Here's where it is: nowhere. Not because it disappeared, but because it was never actually located IN a wallet. And this is true of all bitcoins! They're not really IN wallets. They're abstract entities, if they count as entities at all. The wallets are the more primary entities in the BTC platform, as I understand it. Wallets are associated with amounts of BTC.
The BTC platform has no concept of 'stolen' coins. That's why you'll need another parallel platform to deal with this issue. As a wholly hypothetical platform, we're free to propose the invention of new conventions here.