Money Laundering In Cryptocurrency: Risks & Prevention

Identifying, monitoring, and preventing money laundering via cryptocurrencies are turning out to be a colossal nightmare for governments across the world. As per an estimate, approximately USD 2tn is laundered every year. Cryptocurrencies, if left unchecked, can take a significant share of this laundered money. 

Today, cryptocurrencies often get misused; cases range from activities such as purchasing illicit products off the dark web to moving unaccounted money (black money) from one person to another anywhere in the world. Governments across the world and regulators are still understanding/evaluating various implications of blockchain technologies that are often leading to poor governance and a fledgling money laundering business. 

What is Cryptocurrency? 

A digital or virtual currency secured by cryptography makes its ownership immutable. This solves the problem of counterfeit or double-spending. But, along with benefits, it brings certain challenges that need to be addressed. Most cryptocurrencies use a decentralized network of computers running on an underlying technology called blockchain. This network of decentralized computers maintains the distributed ledger. The currencies can either be purchased on a crypto exchange or mined by crypto miners (running on powerful computers) since most cryptocurrencies are not issued by governments or central banks. Therefore, they are theoretically immune to government intervention and interference making them a safe route for laundering money. As a digital asset and keeper of value, a lot of mainstream investors are now investing in cryptocurrencies. This makes it easier for wrongdoers to hide within the crowd and make oversight difficult.

What is Blockchain?

It involves a distributed database that is shared among a network of computers (nodes) spread across the world. It consists of tranches of immutable information held by it securely, known as ‘blocks’ that link together to form the blockchain. This network of computers maintains a secure, immutable, and decentralized record of cryptocurrencies. This network makes the system dependable and promises fidelity. It is this network that ensures that there is no external manipulation and that there is high fidelity within the system of record keeping it follows. The blockchain keeps on updating itself, in blocks, based on transactions/new data of the cryptocurrencies it is running. Given that each block is immutable, it records every transaction occurring on the network and connects with another block like a chain once the capacity to hold information of one block is full.

What is Money Laundering? 

The act of obtaining and moving illicit money, acquired from illegal activities in order to conceal the source of such money and legitimize its existence, is money laundering. The movement of funds has been the foundation of our economies and businesses since time immemorial.

Historically, as a society, lawmakers and governments have identified and legislated on activities that are deemed to be illicit and outlawed from time to time. Money generated from such activities is often considered black or illegally obtained, and is kept hidden from regulators, fearing identification and action. Earlier, couriers were used to move money or the Hawala network was used to handle these types of transactions. With access to more sophisticated technologies like cryptocurrencies, it has become simpler to move large tranches of money. Some reports claim that as much as USD 2.8bn was laundered using crypto exchanges in 2019. In 2021, a report said that approximately USD 8.6bn was laundered, and the number is only growing.  

Stages of Money Laundering

Money laundering involves significant sophistication and complexities. Launderers are very careful avoiding tax authorities and the government bodies to be able to pass through the system undetected. The process of washing dirty money and making it clean has certain standard steps. They can be performed via any vehicle, cryptocurrencies in this case. It requires a series of actions:

1. Collection: The process starts with collecting laundered money from illicit origins/organized crime.
2. Placement: Infusing illegitimate money into the financial system is done by procuring cryptocurrencies (multiple, usually) via crypto exchanges. Often, crypto exchanges with low compliance with anti-money laundering (AML) regulations are preferred. 
3. Layering: Hiding the true ownership of funds is at the heart of the process. This is done by routing the money via various offshore-onshore entities in structured transactions. In the crypto world, one currency can be exchanged for various other currencies or even an initial coin offering (ICO), often moving the destination countries as well. 
4. Integration: The final part is where the washed, clean money is put back into the system via a shadow network of dealer-brokers. This money is as good as any other and can now be used to make investments and purchase high-value items as a store of value. 

How do criminals use cryptocurrencies for money laundering

Even though the volume of cryptocurrency money laundering is nowhere as near as fiat currency, the increasing use of cryptocurrency has the world’s financial institutions on high alert. Many argue that using cryptocurrency to launder money is more complex and tough, however, there is a multitude of ways cryptocurrency can be used as a tool for money laundering. 

1. Mixing: The most common form of money laundering using cryptos. Mixing services mix users’ cryptos with other users’ cryptos, sending them through multiple different addresses, resulting in “clean” crypto coming out from the other end.
2. Online Gambling Platforms:  This is very popular among money launderers since the process of laundering money on online gambling platforms is very straightforward. Funds on the platform are paid through cryptocurrencies. After some transactions, these funds are then cashed out or placed in bets. 
3. Non-compliant exchanges: These are exchanges that do not follow any regulations. They have little to no user identity verification procedures set in place, making them very attractive to bad actors. 
4. Cryptocurrency ATMs: Cryptocurrency allows anyone to purchase cryptocurrencies with a credit/debit card. Inversely, it also allows anyone to exchange cryptocurrency for cash. 
5. Peer-to-peer networks: Using unsuspecting third parties, many criminals send funds. These decentralized peer-to-peer networks lower the risk and result in the “clean” cryptocurrency ending up in a country with little or no AML regulation where they can be cashed out for fiat money.

Cryptocurrency Money Laundering Risks

Since cryptocurrency is subjected to a higher level of anonymity, it is more susceptible to risks of money laundering and other criminal activities. Lack of identity makes it difficult to keep track of transaction source and destination, especially on platforms with weak AML and KYC measures.

A single crypto wallet might also be linked to many banks and credit cards, indicating that a group of people is utilising the wallet to divert funds around.

The lack of any central administrator makes it difficult for law enforcement to operate under different jurisdictions.Fradulent trading activities might therefore go unnoticed if there are no or weak AML measures in place.

AML Regulations related to cryptocurrency

Regulators throughout the world have introduced legislation and recommendations for enterprises trading in digital currencies to counteract the use of cryptocurrency in money laundering. In 2014, Canada became the first jurisdiction to authorise cryptocurrency legislation in the context of anti-money laundering, thanks to Bill C-31, which was passed by the Canadian Parliament.

The European Union (EU) recently passed the Fifth Anti-Money Laundering Directive (AMLD5), which requires crypto exchanges and custodial service providers to register with their local regulator and follow KYC and anti-money laundering AML standards.

The Payment Services Act of the Monetary Authority of Singapore (MAS) also requires crypto firms operating in the country to obtain a licence in order to comply with AML requirements.

In the United States, cryptocurrency exchanges are authorized and regulated under the Bank Secrecy Act (BSA). In essence, this means that cryptocurrency exchanges service providers must register with FinCEN, establish an anti-money laundering/counter-terrorist financing program, keep proper documentation, and submit reports to the authorities.

Some regulators have included cryptocurrency exchanges and wallet services in their existing anti-money laundering regulations, while others have created new ones.

Preventing Money Laundering in cryptocurrency

The inherently anonymous nature of cryptocurrencies, ease of cross-border transactions, and decentralized peer-to-peer payments make them an ideal choice for laundering money. Imagine this, you can buy any amount of bitcoin (or any other crypto) in one country via an exchange/casinos, online gambling, and encash it anywhere in the world. While many nations have introduced anti-money laundering acts and regulations, their implementation and on-ground compliance remain a challenge. Anti-money laundering compliance is crucial for preventing money laundering, and blockchain offers solutions. Some good practices can make life difficult for wrongdoers, like:

1. The blockchain ledgers are immutable. This means all transactions are recorded on it and cannot be changed. This opens up a great oversight opportunity. AI-backed technology solutions that can be deployed at scale can act as a great automated tool.
2. Complying with KYC requirements can be a massive deterrent to laundering money. A blockchain-based network can be engineered to record verified identification and can be attached to each transaction. Exchanges can run these ledgers, and technology firms can support this activity.
3. Ensuring compliance with AML can be achieved using blockchain-based smart contracts. The smart contracts can be programmed to add various parameters for the transactions to be successful, and ML-based algorithms can red-flag any anomaly. 
4. Blockchain analytics providers can help with regular updates on compliance and red-flag anomalies. This ensures a proper mechanism and audit trail for exchanges and enforces compliance with AML.

Check out our solutions here!