The Use of Cryptocurrency for Money Laundering
Money laundering is the process of disguising the proceeds of crime and integrating it into the legitimate financial system. Thanks to technology, criminals can use a new method to launder money: cryptocurrency. A cryptocurrency is a digital or virtual currency that uses cryptography for security. A defining feature of a cryptocurrency is its fundamental nature: it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.
To launder money via cryptocurrencies, criminals open online accounts with digital currency exchanges, which accept fiat currency from traditional bank accounts. Then, they start a ‘cleansing’ process (mixing and layering), i.e., moving money into the cryptocurrency system by using mixers, tumblers, and chain hopping (also called cross-currency). Money is moved from one cryptocurrency into another, across digital currency exchanges — the less-regulated the better — to create a money trail that is almost impossible to track. They can also use privacy coins, cryptocurrencies designed to enhance anonymity, such as Monero and Zcash. During the cleansing, criminals deploy various tumblers to spin addresses and make it increasingly harder for investigators to follow the transaction’s path. They obfuscate the origin and receipt of cryptocurrencies by mixing an initial amount of cryptocurrency with other cryptocurrencies, and then send smaller units of cryptocurrency to a chosen address, totaling the original amount minus one to three percent (taken as a profit by the coin mixing company). Once the money’s origin is properly murky, the funds are integrated into the legitimate financial system. According to the “Cryptocurrency Anti-Money Laundering Report,” criminals also use theft and gambling to launder cryptocurrencies.
Cryptocurrencies pose a significant challenge for financial institutions and anti-money laundering programs. While investors are currently active in this market, formal regulations are still evolving in many countries. Efforts to de-anonymize cryptocurrencies have led to the creation of new coins that are designed to be less anonymous and to the emergence of tools to analyze transaction records of existing coins to define user behavior and identities. In 2019, $4.26 billion have been stolen from exchanges and users by criminals. In addition, money laundered via cryptocurrencies was over $761 million in 2018, a number that includes only the laundering of stolen funds, not a complete estimate of all dark market transactions using cryptocurrencies. In 2013, the Financial Crimes Enforcement Network (FinCEN) published guidelines for Bitcoin suggesting that although using Bitcoin for purchasing legal goods and services was not illegal, the mining or trading of Bitcoin as well as the operation of exchanges on which Bitcoin is traded would fall under the label of ‘money service businesses’ and would, therefore, be subject to the same Anti-Money Laundering (AML) and Know Your Client (KYC) measures as other financial institutions. In October 2019, FinCEN Director Kenneth Blanco stressed that crypto-companies must comply with the “travel rule,” a US Bank Secrecy Act (BSA) requirement for money transmitters to record identification information on all parties in fund transfers between financial institutions.
The European Union has taken steps to guarantee that exchanges fall under KYC and AML requirements, with the European Commission adopting proposals that ensure that cryptocurrency exchanges and wallet providers fall within the EU’s anti-money laundering framework. The 5th Anti-Money Laundering Directive marks a critical development in cryptocurrency regulation, providing transparency to cryptocurrency businesses on their AML and counter-terrorism financing (CTF) obligations. Many countries are focusing on the regulation of exchanges, the primary entry points by which cryptocurrency traders and customers interact with blockchains, and thereby ensuring that they are required to apply KYC regulations to its customers at the point of registration or time of transaction. This includes a requirement to have verified accounts or an upper limit to which accounts may remain unverified.
For some governments, the regulation of cryptocurrency would add legitimacy to the industry, but for others, the regulation is not considered to be a pressing issue, especially considering the uncertainty among regulators on how to regulate the sector. A large-scale regulation could negatively affect the decentralization of cryptocurrency, but some regulation is necessary to legitimize the market. Regulations can protect not only the country but also the traders and can prevent market manipulation, possibly including the 51 percent attack. 51 percent attack refers to an attack on a blockchain by a group of miners controlling more than 50% of the network’s mining hash rate, or computing power. The attackers would be able to prevent new transactions from gaining confirmation, allowing them to halt payments between some or all users. They would also be able to reverse transactions that were completed while they were in control of the network, meaning they could double-spend coins.
Regardless of the level of anonymity, criminals must exchange their cryptocurrency for fiat currency at some point. The monitoring of such transactions, within and across blockchains, can lead to the de-anonymization of criminals. DCosta explained that “blockchain technology, by its very nature, lends itself to integrated decentralized monitoring efforts of financial transactions. A Blockchain-based platform will give regulators, auditors, and other stakeholders an effective and powerful set of tools to monitor complex transactions and immutably record the audit trail of suspicious transactions across the system.” Since all the information is stored in the blockchain and available to each node, suspicious activity can be detected by all the related participants.
Various solutions can be implemented to contrast money laundering involving cryptocurrencies: AML procedures can be strengthened at financial institutions; transaction monitoring can be enhanced and regulations can be improved; third-party ID providers can be placed under state supervision; cryptocurrency exchanges can be regulated, especially advanced digital exchanges and exchanges offering to purchase primary cryptocurrencies; blockchain can be used as a solution (a blockchain is maintained on an online public ledger, which enables the supervision, validation, and recording of the complete history of each transaction).
Less anonymous cryptocurrencies potentially address concerns about money laundering and criminal activity, and they may stand a better chance of entering the legitimate market compared to anonymous cryptocurrencies, especially if backed by national governments. It is also possible that a variety of coins will thrive while targeting different markets and traders. Regardless of the evolution of this sector, AML programs must ensure that their investigators have a profound understanding of this emerging market while using the right technology to effectively investigate suspicious activity.
Also Read: How Upbit hackers laundered millions using crypto exchanges?
