Optimizing crypto anti-money laundering (AML) programs

Tags: AMLCrypto
Crypto laundering

Fairly or unfairly, Bitcoin and other cryptocurrencies have a reputation for being involved with money laundering. With the growth of cryptocurrency markets, the potential for enabling financial crimes is increasing scrutiny on the sector by regulators and lawmakers. Crypto exchanges and other industry players need to ensure their global Anti-Money Laundering (AML) compliance programs are robust, scalable and effective.

Bitcoin and money laundering

According to Chainalysis, there has been over $33 billion worth of cryptocurrency laundered since 2017. While that is an eye-opening statistic, note that the estimate for money laundering in total is $800 billion to $2 trillion per year. Even at the low end of that scale, Bitcoin and crypto money laundering accounts for less than 1% of all money laundering.

Regardless, the speed, potential anonymity and cross-border nature of crypto transactions present an enticing opportunity for criminals to launder their ill-gotten gains. Without counter-measures, the crypto industry risks increasing involvement with money laundering. The resulting reputational damage and regulatory restrictions could significantly affect industry growth and lead to fines, sanctions and even the potential of outright bans.

Bitcoin is the cryptocurrency most associated with money laundering, as it’s the most established and has the highest market capitalization. Some of the techniques deployed by launderers involving Bitcoin include using:

  • Unlicensed exchanges, which have weak or non-existent Know Your Customer (KYC) processes
  • Tumblers (or mixers), which split up funds amongst numerous accounts and transfers to hide the true source of funds
  • Peer-to-peer transfers, which transfer funds from one crypto wallet directly to another
  • Prepaid cards initially loaded by crypto payments
  • Crypto ATMs
  • Crypto gambling sites

It’s important to note that every Bitcoin transaction is recorded on its blockchain, as are the transaction addresses. Sophisticated blockchain tracing tools can map out activities for an address and, if a transaction address becomes identifiable, all the activities are exposable. Law enforcement has demonstrated they can uncover Bitcoin laundering schemes, most famously an attempt to legitimize a crypto theft of Bitcoin that’s now worth $5 billion.

Of course, Bitcoin is only one of thousands of virtual assets. While Bitcoin’s significant liquidity makes it easier to hide questionable transactions, there are many other virtual assets that can launder money. For example, the use of privacy coins, which by their nature hide the identity of users, is a growing concern. NFTs and DeFi tokens, with their rapid growth, are also potential targets for money laundering techniques.

Crypto regulations to prevent money laundering

There are numerous global initiatives to clearly define crypto regulations. While some jurisdictions already have provided legal clarity around crypto requirements, many others rely on existing regulations designed for other sectors or have simply offered rulings or guidelines to the industry. In general, the legal situation varies from country to country, and even within a specific country different regulators have different views.

To add to the confusion, the technology of cryptocurrencies is changing quickly, and criminals are constantly discovering new techniques. For example, the use of privacy coins, which as stated above hide the identity of users by their very nature, is a growing concern, and privacy coins have already been banned in some jurisdictions.

Even if a jurisdiction doesn’t currently mandate procedures for a circumstance, is avoiding due diligence just putting off the inevitable? For example, while crypto exchanges are now often required to perform KYC, crypto wallets generally do not. If money laundering controls are simply being bypassed by the use of crypto wallets, how long will regulators allow this to continue?

On March 31, an EU Parliament committee passed a provision that requires Virtual Asset Service Providers (VASPs) to verify identities for any transaction with a crypto wallet. In the U.S., Senator Warren is proposing AML legislation that will “make it easier to verify the identities of customers and transfers to private crypto wallets by requiring financial institutions to keep detailed records and submit reports to the Treasury Department.” While neither of these texts has become law, it does indicate an interest to put controls on this part of the industry.

Understanding the direction of regulatory demands, considering potential impacts and planning for various scenarios can help position an organization for long-term compliance and success. Having systems that are adaptable and can quickly implement new compliance measures reduces risk, saves time and is a competitive advantage.

Best practices to help ensure compliance

While waiting for laws and regulations to become better defined, industry players can take action now to prevent money laundering. By proactively working to protect transaction systems from financial crimes and abuse, you’re protecting your organization’s reputation and building trust with regulators and the public.

The Financial Action Task Force (FATF) Report on Virtual Assets Red Flag Indicators of Money Laundering and Terrorist Financing lists numerous suspicious patterns or activities to monitor or consider. While there may be legitimate reasons for any of the actions observed, taking due diligence measures to understand what is happening is advisable.

Joining industry coalitions can provide access to lawmakers and regulators to help create clear, fair and reasonable regulations. These industry groups can also work on common technologies or processes that will help all members. For example, the Travel Rule Information Sharing Alliance and the Travel Rule Protocol are focused on creating solutions for the FATF travel rule, which are “obligations to obtain, hold, and transmit required originator and beneficiary information in order to identify and report suspicious transactions.”

Having operations that can check, monitor and audit accounts and transactions effectively and efficiently is critical. In all markets where you currently operate or plan to in the future, robust AML/KYC systems that include the following will help you keep an eye on all compliance and performance indicators:

  • Identity verification
    Check and verify clients at the onboarding stage, or re-verification later, to ensure the legitimacy of the person
  • AML watchlist screening
    Check the person against sanction lists, which helps to ensure they are not connected to corruption or financial crime
  • Transaction monitoring
    Observe transactions and ensure they match expectations based on the customer’s profile

Bitcoin laundering, as with all forms of money laundering, is a serious issue that helps propagate criminal activity. With proper oversight, systems and dedication, VASPs and others in the crypto industry can protect their customers and their business from its damaging effects.

More crypto: ID Verification | KYC for crypto | Resources | Posts


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