Billions of dollars have been laundered through cryptocurrency exchanges — bitcoin businesses often find themselves on the front lines
Money laundering is a significant problem for the world economy. UN figures estimate that upwards of 2 trillion (yes, with a “t”) in U.S. dollar-equivalent is laundered through the global financial system every year.
While criminals use many methods to launder their funds, cryptocurrencies like bitcoin have emerged as a new potential tool for disguising ill-gotten gains.
According to a report from CiperTrace, up to $2.5 billion has been laundered on exchange using bitcoin. Since this report was last updated in 2018, that figure has undoubtedly increased.
Despite what some critics say, cryptocurrencies like bitcoin aren’t great tools for laundering money. Setting aside privacy coins like Monero, mainstream cryptos, particularly those with the most consumer interest and relative value, operate on transparent, open-source blockchain technology which makes investigating transactions pretty simple.
So why are cryptocurrencies attractive to criminals seeking to launder capital?
There are a handful of reasons, including the perception of anonymity and a potential technology knowledge gap among law enforcement, but the main reason is that the transnational nature of cryptocurrency makes it relatively simple to point a flow of funds toward underregulated or entirely unregulated jurisdictions.
To wit, CipherTrace’s analysis of over 45 million bitcoin transactions on the top 20 cryptocurrency exchanges found that the vast majority of the $2.5 billion (97 percent) ended up in countries with lenient or non-existent AML enforcement.
This is why it is absolutely critical for AML compliance to be widely adopted and practiced in the cryptocurrency industry.
Cryptocurrency businesses all the way down to single-entity traders and small bitcoin ATM or kiosk networks play a frontline role in combating money laundering.
Even as a small business, robust AML compliance is critical to your operations — not only to protect yourself from being exploited by financial criminals, but because it’s the law.
If you’re just entering the crypto space as an entrepreneur, are thinking about it, or you just want to know more about the topic of bitcoin money laundering, this post will help.
But the information here is for education only — if you’re a business owner doing research on AML bitcoin compliance requirements, contact us here to understand the scope of what you’ll need.
What is bitcoin money laundering?
The definition of money laundering also applies to bitcoin money laundering: It is generally defined as “engaging in acts designed to conceal or disguise the true origins of criminally derived proceeds so that the proceeds appear to have derived from legitimate origins or constitute legitimate assets.”
Money laundering is often grouped with terrorist financing (or bitcoin terrorism) in AML compliance circles. This is because while financing terrorism may not involve the proceeds of criminal conduct, it does mark an attempt to conceal either the origin of the funds or their intended use, which could be for criminal purposes.
There are other nuances to terrorist financing as well. Some terrorist groups may have “legitimate” financiers, meaning, they may have state sponsors or collect charitable donations that are not the result of criminal gains.
Regardless of the motivations involved or the source of funds, the methods used to fund terrorist operations can be the same as or similar to methods used by criminal money launderers.
How does bitcoin money laundering work?
There are three stages to bitcoin money laundering:
Placement refers to the moment criminal proceeds enter the financial system in an attempt to convert them into a monetary instrument, such as a money order or traveler’s check. Cryptocurrencies like bitcoin are not regarded as monetary instruments by regulators, but money service businesses/money transmitters have begun to adopt the use of Monetary Instrument Logs as a compliance best practice.
The next stage, layering, is when the converted funds are moved around into other assets, accounts, or financial institutions in an attempt to disguise the original source of funds.
At the integration stage, the funds are reintroduced to the financial system in order to purchase assets or fund other criminal activities or even legitimate businesses.
For the purposes of bitcoin compliance, placement is the critical stage we care the most about, because this is the time where a criminal may attempt to use your business to covert a sum of ill-gotten gains into bitcoin or some other cryptocurrency to help it “disappear” into the financial system.
Businesses may also unwittingly become part of a layering scheme where they are used “move money around” in an attempt to obscure the paper trail.
In any case, businesses have several AML tools they can (and by law, must) deploy to identify possible instances of bitcoin money laundering.
Though what follows is by no means an exhaustive list, here are some of the major tools in our arsenal against financial crime.
The role of businesses in combating bitcoin money laundering
Like we said above, businesses are required by law to set up an AML program and associated policies.
Every business model is different. Depending on services offered and areas of operation, an AML program and associated policies will end up being as unique as your operation.
Still, every AML program that satisfies regulatory compliance requirements will involve, among other things, the following:
A Know Your Customer (KYC) cryptocurrency policy
Know Your Customer (KYC) refers to a policy and associated set of practices designed to collect certain information about customers and their transactions. Included in these practices are the verification of customer identification, and potentially a cross-reference search of sanctions lists.
KYC helps in the fight against money laundering by enabling businesses to understand their customers and their financial dealings, and to prevent them from being used, even unintentionally, by criminals to launder their funds.
If you’re looking for additional resources on this topic, we wrote a simple explainer of KYC in the context of cryptocurrency here, and extensively about its utility in combating financial crime in the crypto space.
Enhanced Due Diligence (EDD) protocols
Sometimes KYC is not enough. Certain customers and their activity may trigger something referred to in compliance as “enhanced due diligence,” which you can think of as KYC-plus.
Basically, EDD is for higher-risk customers (as determined by certain criteria), and requires more information to be collected, as well as recurring review.
For more information on this topic, we wrote an explainer piece here.
A system for transaction screening (cryptocurrency red flags)
Multiple transactions occurring in a 24-hour period, a phone number associated with a prepaid or VOIP phone, or expired customer identification are just one of many potential red flags your business may have in place to catch potentially suspicious transactions.
Like we said above, each business is unique and will have its own set of red flags based on the makeup and circumstances of their institution. We wrote more extensively about transaction monitoring here, and about red flags here.
A system for reporting suspicious activity
When a customer trips a red flag, you may need to file a report for the suspicious activity you detected.
The filing of suspicious activity reports (SARs) requires its own policy and procedure. Certain criteria must be met for the filing of a SAR, and there are also filing deadlines and recordkeeping requirements.
We wrote more extensively about SAR filing here.
A dedicated BSA compliance officer
Your business also needs someone to lead the AML compliance strategy and enforce your company’s policies and procedures on a daily basis.
If you’re a sole proprietor or just starting out, that might be you. But it’s a critical role that must be designated formally within the AML program.
To learn more about the BSA compliance officer role, you can check out our article on the topic here.
Key takeaways for bitcoin compliance
This post introduces some of the core concepts of AML compliance in a cryptocurrency setting. But it is in no way intended to be an exhaustive look at the topic.
Each business model will have its own unique considerations when it comes to crafting AML policy. The best way to make sure that no stone is unturned is to work with an AML consulting firm like BitAML. You can reach out for a free consultation, or with any questions, here.