Anti-Money Laundering (AML) in the Cryptocurrency Industry
Bitcoin has been created to prevent future global financial turmoil caused by centralized financial institutions selling high-risk products. Bitcoin’s unique selling point, its decentralized, semi-private peer-to-peer transactions at the same time making it susceptible for criminals to launder money.
According to the United Nations Office of Drugs and Crime (UNODC), an estimated $715 Billion to $1.87 Trillion is laundered on a yearly basis. That equals between 2 to 5% of the global Gross Domestic Product (GDP).
The term Anti Money Laundering (AML) is often referenced in combination with Know Your Customer (KYC) and Combating Financial Terrorism (CFT).
AML is a legal framework that aims to prevent criminals from engaging in money laundering activities. KYC is verifying the identity of a customer in order to assess potential risks of illegal intentions. Basically, KYC is customer due diligence.
What is Money Laundering?
The definition of money laundering, according to Financial Action Task Force (FATF) is, the processing of criminal proceeds to disguise their illegal origin.
Money laundering typically is comprised of three phases:
1. Placement, the illegally obtained cash is entering the financial system
2. Layering, or structuring, in this phase the illicit money is separated from its source
3. Integration, the money is returned to the criminal from what seems to be legitimate sources
Money laundering is a criminal offence. In the European Union, for instance, violating the offense can get you imprisoned for four years or you can be obligated to pay an 82,000 EUR fine.
Overall, the main drawback, in regards to money laundering, for the entire cryptocurrency industry is the fact that it sets back the maturing of the market. Having ties to illegal activity, without the proper regulatory framework in place, hence, giving people the opportunity to conduct illegitimate business deals, without much risk of getting caught, isn’t beneficial to the industry as a whole.
Bitcoin has a long-standing reputation for being used to launder money, mostly related to the early days of Bitcoin circulation where it was used on the Dark Web. A study by the European Union expressed regulators’ concerns on criminals, turning to cryptocurrency for money laundering purposes more often. Whether it’s a fair assumption that cryptocurrency is associated with criminal activity, more so than fiat currency, is yet to be determined.
Along with the maturing of the cryptocurrency industry, comes regulation. Regulatory compliance should be a welcoming implementation for long-term viability and growth.
For many people, trading cryptocurrencies anonymous on digital asset exchanges is a positive thing, but at the same time, it poses difficulty for businesses as well as increases risk of criminal activity.
Nowadays, national and international security agency’s like Interpol, Europol and the FBI have working groups or specialized departments, dedicated to solving cryptocurrency related money laundering schemes.
Over-the-counter (OTC) trading of cryptocurrencies is usually done by institutional investors that do not want to manipulate the market by buying or selling crypto in bulk. OTC trading can also be an option for the trading of illiquid assets that do not have enough volume on exchanges. The OTC cryptocurrency market is estimated to be much higher in daily trading volume than the total 24-hour volume on digital asset exchanges.
Besides large institutional buyers, the OTC market is also used by criminals to launder money.
More and more OTC-desks are implementing KYC/AML regulations. The OTC-desks from reputable sources want to be compliant before they become scrutinized by authorities.
OTC platform LocalBitcoins removed the local cash buying and selling option, to comply with new Finnish crypto assets legislation that was introduced in the beginning of 2019.
Bitcoin mixing services
In essence a Bitcoin transaction can be traceable to a person as all the transactions are recorded and publicly available on the blockchain. To divert a transaction from being traced back to an individual a Bitcoin mixing or tumbling provider can be turned in.
As per the phases of money laundering, the three steps that money laundering is comprised of, also apply to Bitcoin mixing.
- Placement, a Bitcoin transaction enters the blockchain
- Layering, the transaction goes through the mixing service, the original transaction is no longer traceable
- Integration, the Bitcoin is returned to the criminal available to spend without the ability of getting traced back as illegal funds
Dutch financial security agency, Fiscal Intelligence and Investigation Department (FIOD), recently seized the website and servers of one of the three largest Bitcoin mixing providers, bestmixer.io.
Bitcoin mixing provider, Bitcoin Blender, stopped its activities after the takedown of Bestmixer.io.
Lately, cryptocurrency regulation news, in terms of AML and KYC laws, has emerged as many countries are taking active measures in combating money laundering through cryptocurrency.
Global authorities are researching and implementing AML regulations specifically for cryptocurrencies. One of the organizations that is appointed to research and suggest AML laws, is the Financial Action Task Force (FATF).
Founded by the G7 in 1989, the FATF aims to provide a global legal framework to combat money-laundering, terrorism financing and other threats towards the integrity of the international financial system. FATF has since included 31 additional members to the task force. The FATF currently is comprised of 38 members (36 member jurisdictions as well as 2 regional organizations).
G20 Summit Japan 2019
This month, the G20 was held in Japan. Each year, 20 countries meet to discuss global issues and try to come up with a universal solution.
This year the topic of cryptocurrency was discussed among the members. During the summit the FATF stated new standards for AML, in regards to cryptocurrency, are set to be finalized this month.
The new FATF standards are projected to be focused on tougher operating procedures for digital asset exchanges. Just like traditional financial institutions, for instance banks, asset exchanges should transfer customer information between exchanges, when a customer transfers funds between different entities. This new standard goes against the decentralized nature of cryptocurrencies.
Digital Asset exchanges
One of the first digital asset exchanges that were widely used by cryptocurrency enthusiasts, back in the day, was Magic The Gathering Online eXchange (July 2010). Mt Gox was established as an online playing card trading platform. It became the go-to exchange to buy and sell Bitcoin with over 70% of the daily trading volume, being traded there. In 2014 the exchange shut down, because it lost 850,000 BTC.
After Mt Gox, many new digital asset exchanges followed. A lot of them had issues that made them close shop after a while. Regulatory issues, hacks, vulnerabilities, malicious intended owners or just a lack of interest are reasons cited exchanges closed.
Some of the exchanges that are still up and running and have been around for a long time are: Kraken (2011), Bitfinex (2012), Coinbase (2012), OKCOIN (2013), Huobi (2013) and OKEx (2014).
A recent trend has been that exchanges change their head office to divert from jurisdictions that are unfriendly towards cryptocurrency. In September of 2017, China forced digital asset exchanges to close their operations, because of the nationwide cryptocurrency ban. Exchanges like Binance, OKEx and Bitfinex were forced to divert their head-offices to other jurisdictions.
Over time crypto-to-fiat and crypto-to-crypto asset exchanges have increased on their KYC/AML compliance level. In the graph below, an overview of exchanges and their AML measures. Courtesy of Cointelegraph.com.
Bitcoin is created as a peer to peer electronic cash system to avoid centralized authorities, messing up and creating financial turmoil. Its decentralization is admirable, but at the same time it can be a threat to financial regulators, because it is not manageable.
Regulation tends to lag behind innovative technologies like blockchain, making it susceptible for criminal activity. According to various industry professionals authorities are trying to catch up and set proper rules for individuals and professionals dealing with cryptocurrency
For a new technology to reach mass adoption, it goes through years of growing pains. The regulatory framework for the blockchain and cryptocurrency industry is being developed, with nations, like Malta, Switzerland and Singapore ahead on a global scale.
Official regulation is essential to support the surge in security token offerings as well as the potential of traditional assets, like stocks, eventually converting to blockchain-based tokens.
In order for the industry to reach mainstream adoption, an approval of a Bitcoin or Ethereum Exchange Traded Fund (ETF) would contribute to that. Back in November of 2018, Jay Clayton, Chairman of the SEC stated on CNBC, that he wants to see more regulations to extinct market manipulation, before approving a BTC or ETH ETF.
The cryptocurrency industry has some obstacles to overcome. Let’s see how the new AML standards by the FATF will affect digital asset exchanges. Will 2019 be the year of a Bitcoin or Ethereum ETF approval by the SEC? Are new regulations unfavorable for individual investors?
Time will tell how the new legal framework will affect the industry, but if I had to guess, I think it will be a good thing.
Full disclosure: This article is not intended as investment advice. It is just my personal opinion about AML. You should always do your own research, before investing in a project and never invest more than you are willing to lose.
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