Cryptocurrency Viewed Through the Three Stages of Money Laundering

It’s not really necessary to rewrite the anti-money laundering manual for cryptocurrency, but a willingness to understand novels ways cryptocurrency can be used in the money laundering process will go a long way toward effective cryptocurrency AML practices. The same three stages used to describe the money laundering process involving cash (placement, layering and integration) can actually be used to analyze money laundering involving cryptocurrency. Obviously the attributes of cryptocurrency are quite different from cash, so what occurs in the placement, layering, and integration stages is not the same when cryptocurrency is involved. Let’s have a look at how cryptocurrency fits into the three stages of money laundering.

Placement

The placement stage of money laundering is where the money launderer first puts criminally derived proceeds into the financial system. According to George Forgang, who published a very informative capstone project on cryptocurrency money laundering, placing large amounts on illicit cash into the financial system for the first time is actually the most risky stage of money laundering for the money launderer. Such high risk makes the unique attributes of the cryptoeconomy more attractive. This 2018 Allen & Overy article tells us that cryptocurrency offers money launderers the opportunity to place money in anonymous cryptocurrency accounts which are a “low-risk” means of converting illicit money. Such anonymity is tolerated, according to Elliptic, by cryptocurrency exchanges with less than adequate KYC policies. Cryptocurrency, therefore, allows money launderers to take fewer risks in the placement stage of money laundering.

Layering

The second stage of money laundering is layering. The purpose of layering, Forgang writes, is to make “it difficult to [for investigators] to trace . . . money back to its original source”, by “mov[ing] [money] between accounts, products, financial institutions, and even to different countries and currencies.” The cryptoeconomy offers money launderers new opportunities for layering. One common method of layering involving cryptocurrencies is “chain hopping”, wherein the best-known cryptocurrencies are exchanged for “alt-coins”, or less well-known cryptocurrencies, which can only be purchased at advanced exchanges using other forms of cryptocurrency and not cash. Chain hopping can obfuscate the origins of a transaction and make it near impossible to track.

Initial Coin Offerings, or “ICOs” present other openings for layering. Elliptic explains that ICOs are when investors “purchas[e] a virtual product offered by [a] company with the hope that it will materialize and appreciate in value”. Allen & Overy notes that when the money launderers actually control the ICO, the launderers can offer a “fraudulent “capital raising” to convert their cryptodenominated illicit proceeds back into fiat currency.” Moreover, according to Elliptic, “investing in an ICO can be an anonymous transaction as both the issuer and the purchaser can shield their true identities through fictitious names”, and that “while the record of the transaction may be recorded in a public ledger, ‘there are now hundreds of blockchains on which criminals could transact. Concurrently, there’s been a proliferation of exchanges that may be less inclined to cooperate with authorities.” Clearly cryptocurrencies allow money launders to add complexity to the layering stage.

Integration

Forgang explains the integration stage as the point where “the cleaned, ‘laundered’ money is returned to the criminal with the funds now appearing to have been legitimately earned.” Here, Elliptic clarifies, the money can no longer be directly tied to a crime, but “[m]oney launders still need a way to explain how they came into possession of the currency.” Thus, money launderers find ways to “integrate” their proceeds in a way that makes it appear as if they money was legitimately earned. The volatility in value of cryptocurrency provides a ready excuse for a sudden influx of wealth. “A simple method of legitimizing the illicit income is to present it as the result of a profitable venture or other currency appreciation. This can be very hard to disprove in a market when the value of any given altcoin can change by the second” writes Elliptic. Allen & Overy adds that more and more goods can be purchased using cryptocurrencies, which expands integration opportunities.

Conclusion

Cryptocurrency has enormous potential to transform the financial system for the better, but it still presents considerable AML risks. In addition to known money laundering schemes, bad actors have developed novel schemes to take advantage of the cryptoeconomy’s vulnerabilities. Anti-money laundering and compliance professionals best bet is to familiarize themselves with the unique attributes of cryptocurrency, as well as the way in which it is known to be utilized by bad actors, so that they can effectively manage the risk of any business they conduct related to cryptocurrency.