Cryptocurrency investors often view regulation in a negative light, but regulation has proven to be very effective in preventing criminal activity on the blockchain and in the markets.
Unfortunately, money laundering is not limited to traditional financial markets; cryptocurrencies have also become a target for malicious individuals looking to generate cash illegally.
AML stands for Anti-Money Laundering and refers to the rules, policies, and laws put in place to prevent criminals from converting illegally obtained cryptocurrencies into real fiat currency.
Because cryptocurrencies are decentralized, allowing users' personal information to be hidden when executing transactions, cryptocurrencies have become an attractive arena for criminals.
This serves the main goal of AML protocols: to create a clean and responsible cryptocurrency landscape that is not filled with bad actors exploiting the system for their own selfish greed.
How prevalent is money laundering in cryptocurrencies?
The low cost of cryptocurrencies and direct transactions, as well as their ability to hide digital footprint, have unfortunately attracted many criminals to them for the purpose of money laundering.
In 2021, Chainlink reported losing nearly $9 billion worth of cryptocurrency to money laundering activities. However, that number has risen to $23.8 billion just one year later, according to Chainalysis, indicating that this is still one of the biggest issues in the crypto space.
When did it become a problem?
But money laundering in cryptocurrencies is not an entirely new phenomenon. In fact, it can be traced back to a government crackdown on the dark web site known as Silk Road in 2013.
When it was discovered that the illegal site was involved in money laundering using only Bitcoin (BTC) as a form of payment, it raised concerns among government agencies about the amount of cryptocurrency being used for such activities, leading to a wave of regulations that exist today.
How Criminals Launder Money in Cryptocurrencies
By exploiting blockchain technology and cryptocurrencies, criminals can obtain funds illegally through a wide range of devious tactics, and these are the most popular.
Smuggling: Dividing large amounts of money into smaller amounts that are then sent to the wallet through multiple transactions to hide the identity of the perpetrator.
Mixing: Services that mix cryptocurrencies of multiple users to hide transaction history.
Privacy-based cryptocurrencies: Privacy-based cryptocurrencies are designed to provide a greater level of anonymity to the person using them, making it difficult to trace their origin.
Offshore Accounts: Having an offshore account allows criminals to hide the initial source of their funds.
Currency exchange: Criminals may decide to transfer their funds across multiple exchange platforms, making it difficult for a third party to trace their actions.
How Criminals Launder Money in Cryptocurrencies
By exploiting blockchain technology and cryptocurrencies, criminals can obtain funds illegally through a wide range of devious tactics, and these are the most popular.
Smuggling: Dividing large amounts of money into smaller amounts that are then sent to the wallet through multiple transactions to hide the identity of the perpetrator.
Mixing: Services that mix cryptocurrencies of multiple users to hide transaction history.
Privacy-based cryptocurrencies: Privacy-based cryptocurrencies are designed to provide a greater level of anonymity to the person using them, making it difficult to trace their origin.
Offshore Accounts: Having an offshore account allows criminals to hide the initial source of their funds.
Currency exchange: Criminals may decide to transfer their funds across multiple exchange platforms, making it difficult for a third party to trace their actions.
How Anti-Money Laundering Works in Practice
As a cryptocurrency investor, you have surely encountered at least one of the many anti-money laundering practices that have been implemented in recent years.
Although they may seem unnecessary or a bit long in some cases, it is always worth keeping in mind that these measures are put in place to establish fair play within the crypto ecosystem, so they mean well, even if they seem like they are being difficult for the sake of it.
If you have ever signed up for a cryptocurrency exchange or centralized wallet, you have probably encountered the customer identity verification process. Simply put, this process involves collecting personal information about the customer from the user when they sign up to verify their authenticity.
Most often, the KYC process requires the person to present their passport, driver’s license, or birth certificate to verify their true identity and not someone who is intentionally trying to avoid identity verification. However, sometimes, it may also ask for a photo of the person in question or even their fingerprint.
If someone intends to launder money and does not need to follow KYC, they can easily create a fake account with random, unverifiable information that makes it almost impossible to identify them. Therefore, KYC has become mandatory for centralized exchanges to help correct this problem.
Wallet checking is a tool that allows anyone to instantly identify the owner of a wallet, and more importantly, the source and destination of their funds.
This is a more modern method that some exchanges have used to get a better view of individuals whose actions may seem suspicious.
If a broker finds that cryptocurrency transactions exceed a certain risk assessment threshold, they may block them if they suspect they are moving funds illegally.
Transaction monitoring
As the name suggests, transaction monitoring involves institutions scanning the exchange to identify any suspicious movement of funds.
The goal here is to look for any anomalies, that is, money that is out of the ordinary and unlike anything the rest of society has seen.
The role of regulatory bodies
As we mentioned earlier, as crypto investors, the idea of regulators constantly breathing down our shoulders and dictating rules from behind the scenes isn’t exactly appealing.
However, regulators have played a crucial role in setting the ground rules that must be followed in an attempt to eliminate money laundering from the cryptocurrency industry.
The exact rules and regulations for AML compliance may vary from jurisdiction to jurisdiction, but all laws and policies are designed for the same purpose. Here are the key AML policies to know, along with the region of the world to which they apply:
Financial Action Task Force (FATF): Provided a global anti-money laundering framework for virtual asset providers to follow, including Customer Due Diligence (CDC) and Suspicious Transaction Reporting (STR).
Markets for Crypto-Assets Regulation (MICA): A set of EU laws that sets out key provisions for issuance and trading. It encourages transparency and accountability by regulating crypto-assets that would not currently be regulated under existing financial legislation.
Fifth Anti-Money Laundering Directive (5MLD): This European protocol extended anti-money laundering measures to cryptocurrencies and introduced mandatory due diligence checks for individuals in “high-risk” countries. These checks include finding out the source of funds and conducting background checks.
Office of Foreign Assets Control (OFAC): A branch of the US Department of the Treasury, OFAC enforces compliance with US sanctions laws by requiring exchanges to comply with US sanctions laws while maintaining a list of banned individuals suspected of financial crimes.
Monetary Authority of Singapore (MAS): Policy aimed at strengthening compliance and oversight mechanisms within Singapore as a means of tackling criminal activities through the use of digital assets.
Australian Transaction Reporting and Analysis Centre (AUSTRAC): All Australian financial services, including those in cryptocurrencies, must comply with AUSTRAC regulations or face penalties.