Posted in Anti-Money Laundering (AML), Crypto Asset Compliance on May 16, 2024
Cryptocurrency laundering is a growing concern as more people turn to digital currencies for their financial transactions. Criminals often use cryptocurrencies like Bitcoin and Ethereum to launder money, making it difficult for law enforcement to track and trace their activities. Understanding the different stages of cryptocurrency laundering is essential to combat this growing problem.
There is no specific or single methodology for money laundering, and, as in many other subject areas, a theoretical model was built to conceptually cover as many money laundering methodologies as possible.
In the case of money laundering, this model was derived from money laundering methodologies that have been uncovered by law enforcement and government authorities. In practice, and despite the variety of methods employed, the laundering process is accomplished in three basic stages that this model comprises. These steps can be taken at the same time in the course of a single transaction, but they can also appear in well-separable forms one by one as well. These three stages are placement, integration, and layering. The same concepts that apply to money laundering using cash apply to money laundering using cryptocurrencies.
The Stages of Cryptocurrency Laundering
The first stage of the cryptocurrency money laundering process is the placement stage. During this stage, illicit funds are placed into the legitimate financial system. The illicit funds may be present in two different forms. First of all, the illicit funds can already exist in the form of cryptocurrencies, for example, if the criminal sells drugs and narcotics online and receives payment in cryptocurrencies right away.
Secondly, illicit cash can also exist in the form of fiat currency, which is then used to purchase cryptocurrencies. Either way, the placement stage establishes the circ*mstance that a criminal has cryptocurrencies of illegal origin available in a wallet.
The second stage of the cryptocurrency money laundering process is the layering or hiding stage. In this stage, the criminal facilitates crypto transactions to disguise the illegal origin of the funds. Money laundering with cryptocurrencies relies, by its nature, on the fact that transactions made in cryptocurrencies are pseudonymous. It is already at the placement stage when the criminal holds the illicit proceeds in the form of cryptocurrencies that they have a certain degree of anonymity.
However, criminals often use additional means of anonymizing to further disguise the funds’ illegal origin, breaking the links between different transactions. This is also related to the fact that, theoretically, crypto transactions can be traced back by following the blockchain. Each block, representing a transaction, contains information about the previous transaction.
There are many ways in which criminals can establish layers between different blockchain transactions. This can be accomplished both on regular crypto exchanges or by participating in an Initial Coin Offering, where criminals can use one type of coin to pay for another type. By doing so, they can further obfuscate the digital currency’s origin.
Why some exchanges, especially illicit exchanges, provide a good opportunity for criminals to layer the illicit origin of the crypto funds. Legitimate exchanges follow regulatory requirements for identification, verification, and sourcing of funds and are compliant with applicable laws and regulations. Other exchanges are not as compliant, not that they aren’t putting in the effort. It falls more to their ongoing struggle to meet compliance regulations with sub-par tools. This vulnerability is where most transactions related to Bitcoin money laundering take place.
When exchanges are regulated, they are required to apply so-called Know Your Customer policies and protocols. This allows for the matching of transaction data to the corresponding customer, thereby breaking the anonymity of each transaction. If exchanges are struggling to do so or are, by their nature, even completely unregulated and illicit exchanges, there is no way to establish the identity of the owner.
Final Thoughts
The stages of cryptocurrency laundering are placement, layering, and integration. Criminals use different methods at each stage to conceal the origin of the funds and make it difficult for law enforcement to track and trace their activities. The emergence of decentralized exchanges has made it easier for criminals to launder money, but governments and financial institutions are taking steps to combat this growing problem. Understanding the stages of cryptocurrency laundering is essential to protect against financial crimes and maintain the integrity of the financial system.
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