How to make cryptocurrency easier for law enforcement? I am researching the topic of cryptocurrency and its impact on society. 

It's often said that cryptocurrency is equivalent to cash, but that is clearly not true since cash is very difficult to transport in large quantities over borders and usually requires physical presence to conduct a trade. It is also said that Bitcoin is not anonymous since the transactions can be tracked. However, in reality, its pseudo-anonymity can easily translate to true anonymity when a good laundry service is employed. Thus, cryptocurrency can and does open new avenues for criminals, such as making it much easier to transport and launder the proceeds of crime, facilitating bribery and blackmail by reducing their risks, and many of the bad things cash is associated with since money has always been a central element in crime.

Regardless of what you think of this from a political point of view (and I expect that many in this community don't see a problem with it), I think there is an interesting technical question here:

Is it possible to design a cryptocurrency that achieves a compromise between the relatively strong pseudo-anonymity of Bitcoin and the classic banking system that is disastrous to personal privacy?

Ideally, we should design a system that keeps as much as possible of Bitcoin's strong privacy protection and other desirable features such as decentralization, but at the same time, allows law enforcement to track anti-social actors like the classic banking system allows.

So, I'm asking for ideas of about how to get the best of both worlds. The network should work in a high privacy mode by default, and when the need arises, law enforcement should be able to reduce the privacy in a very visible way, for example by requesting the collaboration of other users. There should be no backdoor, no way to deanonymize the whole network in a surreptitious way like the NSA is doing by tapping all SWIFT traffic.
Therefore, the definition of "law enforcement" is not a magic attribute or key stored by the network, rather it's implicit: the party who can convince nodes to collaborate to deanonymize other nodes.

Additionally, it would be desirable to prevent anonymous laundry services while keeping the network open to join like Bitcoin, without the classic KYC routine of banks. This seems like a contradiction (Sybil attack) but maybe some compromise exists, so your thoughts are much appreciated.
It is possible to mitigate criminal elements in existing cryptocurrency networks within the current regulation framework. 


Addresses of results of criminal actions are well known. Think stolen Bitstamp funds. Eventually these are written to police reports somewhere.
Exchanges, and other respected corporations, should act as a gatekeepers in this community off their own interest. Authorities of financial institutions have a duty to report crime (Misprision of felony).
If any exchange process transaction that has gone through a blacklisted address, the transaction should be stopped and the actor should go through anti-money laundering process, because they have somehow got criminal assets in their hands. There should be a paper trail to follow. If exchanges do not do this then they should be themselves subject to money laundering investigation due to breaking local AML and KYC regulation.
Tracking back Bitcoin transactions to blacklisted addresses is technically very feasible, because all transactions are public and it is just matter of maintaining a tree of transactions in computer memory. It doesn't matter how many times you tumble your coins, because you simply can't eliminate the trace of transactions from blockchain.
This assumes there is a party (Interpol, FBI) who maintains and enforces a known black list of addresses. The list should be publicly available for anybody. The list contains addresses compiled from police reports world wide. Currently no no such party exist. All parties in global trusted police consortium should be able to add addresses on this list with reference back to a local police report.
Fungibility, as promoted by some Bitcoin advocates, does not exist. You simply can't say "I don't know where my money is coming from." to government officials. Banks and financial institutions like PayPal are already subject to this regulation.


This way the system would be opaque to every day transactions (think a transaction of hiring divorce lawyer, medical bills) but still having a mechanism to track down criminals.