Cryptocurrency Money Laundering using Virtual Currency Exchanges.
According to a 2022 report from the leading blockchain analytics company Chainalysis, criminals laundered $8.6 billion in cryptocurrency in 2021, a 30% increase over the previous year. The report says, “while billions of dollars’ worth of cryptocurrency are transferred annually from illicit addresses, the majority of it ends up at a surprisingly small number of services, many of which appear to be purpose-built for money laundering.”
Centralized exchanges are also still the favorite conduct for sending and receiving illicit cryptocurrency, accounting for 47% of transactions.
Cryptocurrencies are one of the most dynamic, fast-changing, and innovative parts of the financial services landscape. All innovation comes with risks, however, and many policymakers have identified anti-money laundering compliance and controls as one of the biggest crypto vulnerabilities.
There are numerous cryptocurrency exchanges that are regulated, that comply with applicable laws and regulations, and that cooperate with law enforcement authorities.
The majority of them also requires customer identification and conducts customer due diligence. However, there are still a few cryptocurrency exchanges that aligned their services towards the needs of criminal clients by enabling purchasing and selling virtual currencies without requiring a proper form of identification or verifying the provided identities.
How Do Criminals Use Cryptocurrencies for Money Laundering?
To conceal the illegitimate origin of payments, criminals use a variety of strategies involving cryptocurrency. All of these approaches rely on one or more of cryptocurrency’s flaws, such as their intrinsic pseudonymity, ease of cross-border transactions, and decentralized peer-to-peer payments. Money laundering with cryptos follows the same three-stage process as cash-based money laundering.
In this stage, illicit funds are brought into the financial system through intermediaries such as financial institutions, exchanges, shops, and casinos. One type of cryptocurrency can be bought with cash or other cryptocurrencies. It can be done through online cryptocurrency exchanges. Criminals often use exchanges with less levels of compliance with AML regulations for this purpose.
In this phase, criminals obscure the illegal source of funds through structured transactions. This makes the trail of illegal funds difficult to decode. Using crypto exchanges, criminals can convert one cryptocurrency into another or can take part in an Initial Coin Offering where payment for one type of digital currency is done with another type. Criminals can also move their crypto holdings to another country.
Here, illegal money is put back into the economy with a clean status. One of the most common techniques of criminals is the use of over the counter (OTC) brokers who act as intermediaries between buyers and sellers of cryptocurrencies. Many OTC brokers specialize in providing money-laundering services and they get very high commission rates for this.
- Crypto Mixing/ Tumblers
Mixing services, also known as tumblers, help cryptocurrency users to conduct transactions by mixing their cryptos with other users. A typical mixing service takes cryptos from a client, sends them through a series of various addresses and then recombines them, resulting in ‘clean’ cryptos.
- Peer-to-peer Crypto networks
Criminals use these decentralized networks to transmit funds to a different location, frequently in another country where there are crypto exchanges with lax anti-money laundering legislation. These exchanges assist individuals in converting cryptocurrency into fiat currency in order to purchase high-end items.
- Crypto ATMs
These ATMs allow people to purchase bitcoin via credit or debit cards and in some cases by depositing cash. Some ATMs offer the facility to trade cryptocurrencies for cash as well. In many countries, the KYC measures for the use of these machines are poorly enforced.
- Online Gambling
Many gambling sites accept payments in cryptocurrencies. Criminals can purchase chips with cryptos and cash them out after a few transactions.
Cryptocurrency Red Flags
To detect and prevent money laundering, cryptocurrency service providers should be vigilant for suspicious transactions and suspicious customer behavior. In 2020, the Financial Action Task Force (FATF) released a report into the methodologies of crypto laundering, which set out the following red flag indicators:
- Transactional behavior:
Certain transaction types and patterns of transaction are indicative of money laundering, including multiple transactions in small amounts, transactions that don’t fit a customer’s risk or wealth profile, regular transactions that result in frequent losses, or frequent transactions of fiat to crypto currencies with no obvious business explanation.
- Customer identity:
Issues arising from customer identification measures often indicate attempts to exploit the anonymity benefits of cryptocurrency. Examples of red flag behavior include multiple exchange accounts controlled from the same IP address, discrepancies in identifying documents during account creation, and frequent changes in identifying information.
- Money muling:
Money launderers may seek to get third parties (money mules) to conduct cryptocurrency transactions on their behalf in order to avoid AML controls. Customers that make deposits that are inconsistent with their wealth profile or that are not familiar with the financial products they are using may be being used as money mules.
- Funding sources:
Cryptocurrency exchange service providers should scrutinize the sources of cryptocurrency funds for indications that money laundering is taking place. Funds that come from sources linked to illegal activities, darknet sites, sites with inadequate AML controls, and from sites located in countries known to present a high AML risk, may be considered red flags.
AML Crypto Compliance
“Follow the money” – for generations it’s been the mantra of investigators looking for criminals.
In the cyber-realm, this battle between criminals and the authorities has been raging for years. Following FATF guidance firms should seek to implement a risk-based cryptocurrency AML compliance solution, featuring the following measures and controls:
- Customer due diligence:
Crypto service providers must establish and verify the identity of their customers accurately. In a cryptocurrency service context, it may be necessary to use digital identification methods, including scans of official documentation or biometric IDs such as fingerprints, face, or voice recognition.
- Transaction monitoring:
Firms must be able to monitor customers’ cryptocurrency transactions for suspicious activity and red flags. Given the considerable digital activity associated with crypto transactions, firms should seek to implement automated monitoring technology to capture the necessary data.
- PEP screening:
Politically exposed persons (PEP) pose a greater AML risk than other customers. Cryptocurrency firms should screen their customers regularly to establish their PEP status and inform their AML risk profiles.
- Sanctions screening:
Persons featured on international sanctions lists may use crypto laundering to avoid sanctions measures. Accordingly, crypto service providers must screen their customers against the relevant international sanction’s lists.
- Adverse media:
Customers that are involved in illegal activities may be the subject of adverse media. Cryptocurrency firms should screen for adverse media on traditional screen and print sources and digital outlets.
Money laundering is a huge problem worldwide. Unfortunately, while cryptocurrency means cheaper, faster international transactions, it also makes the crypto sector ripe for criminal activity, such as money laundering and terrorist funding.
To stay ahead of this, regulatory bodies are installing staunch anti-money laundering (AML) legislation. This helps to prevent money laundering through cryptocurrency exchanges and custodian services. Enforcing new technologies in criminal finance networks, adhering to FATF guidelines regarding cryptocurrency and bringing KYC norms into cryptocurrencies can prevent money laundering.
Alia Noor (FCMA, CIMA, MBA, GCC VAT Comp Dip, Oxford fintech programme, COSO Framework)Associate Partner
Ahmad Alagbari Chartered Accountants