
Money Laundering Through Cryptocurrency: Red Flags and AML Risks

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As the use of virtual assets becomes widespread, crypto firms have a major dilemma to deal with – increasing AML regulations and cryptocurrency frauds. These issues can cause businesses to halt their operations for days and can lead to millions in non-compliance fines. So what can cryptocurrency providers do to avoid breaching AML laws and stay one step ahead of crypto-related crimes at all times? Let’s take a deeper dive into this.
For cryptocurrency providers, AML and KYC procedures are a must for two reasons; the protection of an institution against financial crime and for complying with regulatory obligations. This means that cryptocurrency exchanges must collect the user’s identity information, implement customer due diligence and conduct ongoing monitoring of all transactions.
In October 2018, the Paris-based global financial watchdog, Financial Action Task Force (FATF), updated its Recommendation 15 and brought virtual assets, including cryptocurrencies, in the scope of Anti-Money Laundering (AML) regulations. As a result, all companies that deal with cryptocurrency transactions became obligated to comply with AML standards, as previously enforced on other financial institutions.
The efforts made by the FATF did not stop here. The global regulator conducted in-depth research to find out patterns and recurring red flags of money laundering in the cryptocurrency industry. Over 100 case studies contributed to this investigation and in 2020, a report was released on the findings. The FATF’s Virtual Assets Red Flag Indicators of Money Laundering and Terrorist Financing Report uncovered key details, enabling financial institutions and cryptocurrency exchanges to devise and implement effective AML programs.
Criminals are known to use various tactics to hide the origin of their illegally obtained funds. Generally, laundered cash passes through three stages, and crypto laundering mimics similar steps. This includes:
In the first step, criminals convert cash into cryptocurrency.
To layer the cryptocurrency and make it difficult to trace, it is channelled between wallets or through “tumbling/mixing services”.
The illegal cryptocurrencies are then converted back to cash or are used to purchase goods or services.
Now that you’re aware of the basic steps, let’s take a look at the five prevalent money laundering schemes that can be found in the crypto industry today.
Suggested Read: Dirty Funds & Tax Evasion – Can the Crypto Sector Be Safeguarded?
The FATF’s money laundering red flag indicator guidelines provide cryptocurrency exchanges with detailed information for minimizing crypto-related AML risks. The six indicators and red flags have been summarized below.
The FATF claims that in case any of the following activities occur, there may be a high likelihood of money laundering:
The following transaction patterns are highly indicative of money laundering through cryptocurrency:
Anonymity in the crypto sector is a major concern for authorities worldwide. Without verifying who the end-user is behind the wallet, suspicious transactions related to money laundering are difficult to detect and monitor. A major red flag is when a user fails to comply with Know Your Customer requirements.
Numerous red flag behaviours can be detected in end-users. For instance, an end-user that fails to provide sufficient personal information for verification might be concealing their identity to avoid getting caught. Other suspicious behaviours include accounts being opened under various names, users with domains registered in high-risk jurisdictions, and transactions made from suspicious IP addresses among others.
Funds that have unidentified or insufficient information about their origin serve as major red flags. A wallet linked with numerous credit cards, coins being transferred from mixing services, online gambling platforms, dark web marketplaces, etc. are all indicative of money laundering related activities.
Where some countries maintain a strict stance when it comes to AML/KYC regulation for crypto, others fail to follow suit. Criminals reap the benefits of such jurisdictions and use lax controls to their advantage. By moving funds across borders or transacting from high-risk areas with little AML procedures, laundered virtual assets can be easily layered.
Suggested Read: Crypto Regulations 2021 – The Updated Compliance Regime in France
In order to ensure that a cryptocurrency firm is not being exploited by criminals and being used to launder money, the following procedures must be effectively implemented.
Cryptocurrency platforms and virtual asset service providers must verify the identity of their customers during the initial stage of customer onboarding. To know your customer and ensure they are actually who they say they are, end-user names, date of birth, address and other Personally Identifiable Information (PII) must be collected and authenticated. Additionally, wallet addresses and transaction hashes must also be verified to prevent money laundering.
Compliance with the FATF’s regulation is not only necessary for the financial well-being of a company, but also mandatory. The Travel Rule requires crypto businesses to collect and share data on any entity whose transactions exceed the threshold of 1,000 USD/EUR. By complying with this rule, large sums of money can be prevented from being laundered.
Cryptocurrency businesses must implement ongoing transaction monitoring so that no suspicious activity is left undetected. This process involves the verification of each end-user, their transaction, the jurisdiction from where the transaction is being made, and much more. Additionally, a user-risk profile can be made, and fraudulent transaction patterns can be identified on time.
Anti-Money Laundering screening involves the verification of an end-user by screening them against watch lists compiled by regulatory authorities such as the FATF, UN, FINTRAC, AUSTRAC, and others. It involves authenticating the user information against criminal watch lists, global sanctions, and Politically Exposed Person (PEP) lists. As a result, fraudulent customers are detected and compliance targets are easily met.
To stay clear of money laundering and similar financial crimes, cryptocurrency exchanges must have adequate AML checks and KYC procedures in place. These practices have not only been endorsed by global regulatory authorities, but have shown encouraging results in the real world as well. As cryptocurrency adoption is showing no signs of slowing down, firms must invest in the right AML solutions to streamline compliance and fraud detection processes.
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