For years, blockchain analytics firms have sold regulators, exchanges, and banks on a simple promise: illicit money can be tracked.

Unlike cash, cryptocurrency transactions leave a permanent trail. Sophisticated compliance platforms built by firms such as Chainalysis, TRM Labs, and Elliptic map those trails, assign risk scores to wallets and help institutions identify suspicious activity before funds move further through the financial system.

But recent controversy surrounding UK sanctions against crypto exchange, HTX, highlights a growing problem in the industry: compliance systems may become less effective when they cast too wide a net.

The debate erupted after UK authorities sanctioned Huobi Global S.A.,…