Money Laundering Through Cryptocurrency: Red Flags and AML Risks

  • Richard Marley
  • July 29, 2021
  • 8 minutes read
  • 208

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. 

The FATF’s Guidance On Virtual Assets 

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.  

How Do Money Launderers Use Cryptocurrency For Fraud?

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:

Stage 1: Placement 

In the first step, criminals convert cash into cryptocurrency. 

Stage 2: Layering

To layer the cryptocurrency and make it difficult to trace, it is channelled between wallets or through “tumbling/mixing services”. 

Stage 3: Integration

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. 

  1. Tumbling/Mixing Services: In this scheme, a service is offered to criminals whereby they are allowed to mix suspicious cryptocurrency funds with other funds, making the illegal coin trail hard to trace by auditors. 
  2. Unregulated Exchanges: To avoid coming into the spotlight while cleaning their dirty funds, criminals often opt to transact through unregulated cryptocurrency exchanges. Such platforms have inadequate AML procedures in place, making it easy for money launderers to cover their tracks. Without any transaction monitoring or background screening process, illegal funds are left unnoticed. This scheme was used in 2018 during the famous 2018 Coincheck money laundering scandal. 
  3. Online Casinos: Laundering cryptocurrency through an online casino is a fairly simple scheme. Criminals place their bets through stolen coins. Once the game is finished, the winning coins are withdrawn and changed for real money. While this does not allow them to launder huge amounts, legitimate money is received in the end. 
  4. Money Mules: Fraudsters often recruit money mules, i.e. individuals with clean transaction history, to launder illicitly earned cryptocurrencies. In some cases, criminals use Ponzi schemes to collect bitcoins from victims and money mules transfer the coins between accounts to hide the source of the illegal coins. According to Europol, 90% of all money mule transactions in Europe are connected to cybercrimes. 

Suggested Read: Dirty Funds & Tax Evasion – Can the Crypto Sector Be Safeguarded?

Money Laundering Red Flags to Look Out For

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.

Transaction Type

The FATF claims that in case any of the following activities occur, there may be a high likelihood of money laundering:

  • A user making numerous transactions in small amounts to avoid drawing attention
  • High-value cryptocurrency transactions made within a short amount of time
  • Transfer of virtual funds from regulated to unregulated exchanges 
  • Depositing previously identified stolen funds into crypto wallets

Transaction Pattern

The following transaction patterns are highly indicative of money laundering through cryptocurrency:

  • Opening of new accounts that do not match the user’s determined wealth
  • New accounts being regularly used for the transfer of large sums of funds 
  • Numerous accounts being used for the transfer of funds in a short amount of time
  • Minor amounts of coins being transacted from multiple virtual wallets that are instantly moved or transferred
  • Repeated exchange of fiat money to cryptocurrency without any apparent or credible reason

Anonymous Identity

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. 

Suspicious Individuals 

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. 

Source of Funds

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. 

Red Flag Locations

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

Practical Solutions For Minimizing Crypto AML Risks

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.

KYC Verification 

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 FATF’s Travel Rule 

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. 

Ongoing Monitoring of Customer Transactions 

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. 

AML Screening  

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. 

Final Thoughts

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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