The cryptocurrency market is booming. With new technologies and new products launching on the market, the industry is seemingly going from strength to strength. With new technologies, however, come new challenges. How is the industry changing money laundering?
The rise of cryptocurrency is coming at a time of swelling digital usage and saw a particularly big uptake during the pandemic. As stated by PassFort head Alex Richter, cryptocurrency has become a hub for money laundering, with cybercriminals laundering a staggering $8.6 billion in cryptocurrency in 2021 alone – up 30% from 2020. Centralised exchanges are also still the favourite conduit for sending and receiving illicit cryptocurrency, accounting for 47% of transactions.
“Money laundering is always the same process at its core – it’s about turning illicitly obtained money into money that appears to have been legally obtained,” said Sentinels CEO Joost van Houten. “But what changes are the vectors for money laundering, cryptocurrency is a hot commodity for money launderers right now due to a lack of workable regulatory guidance from the Financial Action Task Force.”
Van Houten emphasised how crypto-related crime and money laundering used to be tightly tied to Iranian and North Korean illicit activity as a means of getting around sanctions. However, as cryptocurrencies move into the mainstream, this is ceasing to be the case.
“The use-cases have grown and become legitimised, with nations such as El Salvador adopting Bitcoin as legal tender as well as the investor boom in the past few years thanks to crypto exchanges offering easy to access cryptocurrency. Cryptocurrency has always had potential to be misused for money laundering, but this is no surprise, wherever there is value that potential will exist.”
One characteristic in cryptocurrencies’ favour, van Houten claims, is that every single transaction is recorded and publicly viewable. He added that crypto exchanges should be able to discern who owns a wallet on their services and verify the transactions associated with each one to track down the source of funds.
According to the Sentinels CEO, this is where the understanding the intersection between fiat money and cryptocurrency is key, “Without understanding how the two financial systems interact, AML efforts will become far more difficult to implement. Intelligent transaction monitoring rules and models that can identify dirty money before it ever enters the blockchain is the best way to prevent cryptocurrency from being used for money laundering.”
It is becoming ever more important for the industry to be vigilant to the threat of how the use of cryptocurrency can be manipulated. Europol recently revealed that professional money launders are offering specialised cryptocurrency services to other criminals.
Van Houten also remarked that the rise of privacy coins and the presence of tumblers are two key issues to be concerned about going forward – as well the need for crypto firms to get ahead of the curve on regulation. He said, “While cryptocurrencies do pose a threat as a money laundering vector, it is worth keeping a sense of proportion.”
“Regulation has already come for cryptocurrencies, FATF’s VASP guidance was updated in October 2021 and it stands to reason that this will see a slew of regulations imposed across the world on cryptocurrencies and associated businesses. Smart crypto companies will already be looking at improving their compliance processes and get ahead of the curve. These companies will set the standard for crypto compliance in their jurisdiction and form strong relationships with the regulator.”
New risks and regulations
While cryptocurrency as an industry itself has been dancing at the margins for over a decade now, the space has really come into its own over the last couple of years. However, with any industry that begins to grow in serious stature, new risks undoubtedly emerge.
Recent research by Thomson Reuters found that the growth of cryptos is now estimated to be near $3trn in total market capitalisation. Evgeny Likhoded – founder and CEO of Clausematch – said such fast growth in popularity and size means that crypto assets are now presenting new risks.
He said, “As criminals have always been early adopters of technology there are multiple AML risks associated with crypto as it is increasingly becoming mainstream and is involved in more activities. Losses from crypto-related crime rose 79% from 2021, driven by a spike in theft and scams.
“Organised criminal groups are perfecting the process of digital money laundering, firstly, due to its anonymity. Anonymous transfers between buyers and sellers enable transactions to take place under the criminal radar. A recent report by Chainalysis states that scammers took home a record $14 billion in cryptocurrency in 2021, mainly thanks to the rise of decentralised finance (DeFi) platforms.”
One of the biggest pressure points currently weighing down on the cryptocurrency industry is that of regulation – in earlier years, the market’s regulation was seen as nothing more than a pipe dream. However, with the sector’s growing presence and might, regulators are starting to get their teeth into it. Likhoded emphasised that a good sign of the industry growing is that regulators are now introducing more requirements for crypto firms to comply with, setting up working groups aimed at fighting crime in the crypto space.
IMTF CEO Gion-Andri Büsser added that cryptocurrency can offer a combination of anonymity, ease of use and the ability to bypass international borders and regulation that make the industry all the more appealing to money launderers.
Does Büsser believe regulation is coming? For this, the answer was two-pronged. He stated, “As cryptocurrencies have grown and reshaped the global financial network, the 5th and 6th Money Laundering Directives in Europe and the FinCEN’s Final Rule in the USA have made it clear that virtual currencies and the exchanges on which they trade are subject to anti-money laundering legislation.
“But in many other regions, regulations remain largely immature, allowing money launderers and terrorists to exploit loopholes, all the more as many institutions still have serious compliance gaps.”
With the cryptocurrency in the ascendant, how can the financial industry fight this? Büsser said that while banks are by nature risk-averse, with their traditional customers increasing turning to crypto, these firms can no longer be complacent in avoiding the culture choc.
He added, “Current AML regulations and processes essentially rely on identity and KYC checks at the intersection of the fiat and crypto world – screening and performing sanctions checks or terrorist watch list checks. When it comes to pure crypto-to-crypto transactions, the lack of identity information leaves banks struggling to determine whether the people involved in the transaction are trustworthy or not.
“When it comes to AML in cryptocurrency management, mitigating risk through a bundled approach to data seems the most effective approach. Regulations in the crypto world will follow the traditional regulations in a first step as shown by Singapore or Switzerland and hence the use of best-in-class technology in the KYC and Identity management space will generate value in reducing risks and fraudulent behaviour.”
While commentary around crypto can often end up going down the path of criticism and scepticism, there are some rays of light being uncovered by industry players. Mike Castiglione – director of regulatory affairs, digital assets at Eventus – believes that while cryptocurrency as a technology play opens up options for money laundering, this same technology provides law enforcement with opportunity as well.
He said, “In cryptocurrency, there is ‘bad guy tech’ and ‘good guy tech’ and right now we’re seeing a lot of success on the part of law enforcement in being able to monitor and crack down on money laundering that leverages crypto, with data analytics firms enabling law enforcement to do this.
Castiglione believes that many of the features that make cash attractive for money laundering also make crypto attractive for money laundering – it can be anonymous, it is portable, and it is fungible. However, the Eventus director underlined one vital distinction, which was that unlike cash, crypto has a digital record that enables law enforcement to trace as far back as they have the technology – and ability – to go. “That unbreakable link to ownership in crypto is a key part of fighting money laundering. The criminal can run and hide, but with digital assets the crime scene, that is the transaction record, is sealed in the blockchain permanently,” he remarked.
As many regulators and law enforcers are strengthening their hand in their dealings with cryptocurrency firms, there is a growing desire by those in the crypto industry to prove their metal and secure the trust of the wider financial market.
Castiglione said, “Already, many of the largest crypto exchanges have decided that security and trust are an important part of their brand. What the industry can do is adopt the right technologies and invest more in the ‘good guy tech’ part of the equation. That includes making sure they have sufficient surveillance systems in place.
“The industry can also continue to create the kind of public-private partnerships with governments so the industry can help shape better enforcement and better regulations. From my experience in government, regulators value intel from people in the trenches and those building the tech.”
Castiglione concluded by underlining what he believes to be one of the promises of crypto and digital assets – which is a ‘renaissance of ownership’. He added, “Throughout human history, people have wanted to steal things of value and evade prosecution. Cryptocurrency is another asset people want to acquire and it will be used by criminals just as all other currencies have been used by criminals. While these bad actors will try to retreat into the digital realm, the same technology that they use to hide assets can be used to help bring them to justice.”
Can crypto improve AML?
One of the key appeals of cryptocurrency for many is the decentralised nature of the currency. Remonda Kirketerp-Møller – CEO and founder of Muinmos – said, “Cryptocurrency, just like fiat money, is still an expression of trust; only the cryptocurrency holders do not put their trust in a third party like the government to enforce the value of their coins; but in a code enforced by each and every holder of the cryptocurrency simultaneously.”
Kirketerp-Møller explained that this particular feature makes cryptocurrency especially attractive to those who also have other reasons to either distrust their governments or avoid their suspicion – such as money launderers. This means from the get-go, cryptocurrency is more susceptible to money laundering due to it existing outside of the government’s domain and is ‘the biggest money laundering concern with cryptocurrency’, in the eyes of the Muinmos CEO.
However, Kirketerp-Møller emphasised that there was one specific trait that made cryptocurrency more convenient in the prevention of money laundering compared to fiat money – which is the ledger.
She said, “Up to 95% of all the money in the world, it is often said, is digital. This means most of our money does not have any physical existence and exists only as binary code in some computerised database. In the regular financial system, that database is being managed and kept secure by the banking system, which is supervised and given validity to by a central bank, meaning, by a government. In the crypto world, the money basically exists in a ledger. A ledger is, in fact, the record of the transactions made in a certain unit/s of the cryptocurrency (the ledger can be either partial, hence kept in ‘blocks’ on a chain, or kept fully by select ‘full nodes’, which act as sort of backup points of the system).”
Kirketerp-Møller said that even though ledgers keep the identity of the owners of cryptocurrency’s anonymous – they are ‘theoretically’ the perfect record-keeping system, thus allowing for easy transaction monitoring.
She concluded, “This, I believe, can turn out actually as a positive development in fighting financial crime. There are numerous new or in-the-making legislative acts, like the European MICA (Markets In Crypto Assets) – if they do use the unique traits of Crypto assets in order to create an effective AML regime, I believe all will benefit from it.”
Going forward, there are fledging signs that regulatory bodies are gearing up to ensure greater regulation across the cryptocurrency industry. PassFort’s Richter said , “The UK’s Chancellor recently announced that stablecoins would be brought under UK regulation to become a recognised form of payment. The UK seeks to follow the US and the EU paths and introduce a regulatory framework for cryptocurrency. Currently, the only measure in place is that all exchanges must be registered with the FCA.
“If the UK does implement regulations in line with its partners, businesses and financial institutions must be able to ensure they have the correct systems in place to stay compliant.”
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