Understanding Anti-Money Laundering

Anti-money Laundering (AML) consists of a series of regulations, laws, and procedures that help to combat the movement of illegal funds. AML regulation differs in different jurisdictions, but the formation of the Financial Action Task Force (FATF) in 1989 encouraged and developed an international standard for AML regulations.

AML measures usually target terrorist financing, tax fraud, international smuggling, and public corruption. Technology is constantly improving, and alongside it, so do money laundering methods. This makes it hard to create a criterion for determining illegal transactions. As a result, AML measures usually flag large transfers of money, repeated inflows of funds to an account, and regulators cross-check against the users on its watchlist for further investigation.

As you can see, AML regulation existed long before the development of cryptocurrencies. Hence it is also applicable to traditional assets and fiat currencies. Although the crypto ecosystem is constantly improving thus, it is challenging to apply AML regulation. Moreover, cryptocurrency and blockchain technology was built on the premise of anonymity and decentralization; thus, the imposition of KYC and CDD procedures to facilitate AML is usually contrary to the crypto-ethos.

What is money laundering?

Money laundering is the process of disguising illicitly or illegally acquired funds as legitimate money. The proceeds are usually made from criminal activities such as drug trafficking, human trafficking, or fraud. It usually involves three main stages.

1. Placement: Dirty money (illicit money) is introduced into the system through a cash business used as a front for the source of funds.

2. Layering: At this stage, money is moved around through multiple accounts, so that it becomes hard to track it. With cryptocurrencies, this process is made possible through coin mixers.

3. Integration: The final stage is reintroducing illegal money into the economy through investments or other financial channels.

Methods of money laundering

There are multiple ways of laundering money. Prior to the introduction of digital cash and currencies, money was laundered through fake businesses used as a front to launder cash. The digital age has introduced new money laundering methods, primarily through peer-to-peer networks such as PayPal, Venmo, and even peer-to-peer cryptocurrency networks.

Additionally, with the added benefit of user anonymity through cryptocurrencies, VPNs, and coin mixers, cryptocurrencies have become the perfect ecosystem for money launders to breed in because it becomes increasingly difficult to identify them.

How does AML work

To capture all forms of money laundering, regulators follow the general procedure listed below.

1. Flagging: The first step to capturing money laundering is flagging suspicious activities. There are a variety of activities that can be deemed as suspicious, of which regulators reserve the right to determine a suspicious act.

2. Investigation & Injunction: The regulators will then investigate the users. During or after the investigation, the user will be blocked from making any transactions.

3. Resolution: once the investigation is complete and there is a case for money laundering, the case will be reported to the relevant authorities to be dealt with.

AML, KYC & CDD

AML: As explained before, Anti-money Laundering is a series of regulations, laws, and procedures that help to combat the movement of illegal funds. AML is more of a reactive measure that seeks to prevent money laundering acts upon suspicion.

CDD: Customer Due Diligence refers to the measures of scrutiny that financial institutions must complete with all their customers. One of the central parts of CCD is completing the KYC procedure.

KYC: Know Your Customer is the regulatory obligation imposed on financial institutions as part of AML laws. KYC procedures require customers to submit personal identification documents to enable authorities to track and verify the user’s identity. In contrast to AML, KYC is a proactive measure for AML compliance that is aligned with customer due diligence.

Who is the FATF

The FATF is an inter-governmental policymaking body whose purpose is to establish international standards and policies for AML and Combating the Financing of Terrorism (CFT). They have issued 40 recommendations to fight money laundering and nine particular recommendations to fight terrorist financing.

The FATF membership comprises 32 countries and two regional organizations, including Asia and the Middle East.

The FATF’s streamlined standards against AML/CFT help governments and different jurisdictions share information, thus creating a more efficient and effective method against money laundering. Moreover, the FATF has created a criterion that tracks the performance of different jurisdictions in effecting AML/CFT regulations which motivate high-risk countries for money laundering to try and improve.

 AML & Crypto

 Below are a few reasons why cryptocurrencies are suitable for money launderers, which justify the need for regulation within the space.

• User anonymity: Creating a digital wallet to transact cryptocurrency requires no personal identification procedures, which helps to maintain the true identity of users. Moreover, privacy coins such as Monero and coins mixers (tumblers) are services that enable users to layer crypto transactions.

• Mechanism of cryptocurrencies: Blockchain transactions are irreversible because cryptocurrencies are built on decentralized technology. This makes it impossible for regulators to take action against custodial wallets, such as freezing wallets on suspicion of illicit transactions. Additionally, blockchain technology enables peer-to-peer transactions. Thus, there aren’t any regulated intermediaries to report suspicious activity.

• Lack of regulation: Blockchain technology is still relatively new and constantly evolving, which makes it hard to implement effective regulation. This makes it hard to impose even tax regulations.

With the added advantage of user anonymity through cryptocurrency transactions, it has become a common ground for money launderers. AML regulation would help to combat these criminal actions, which would overall improve the reputation of the space even though it takes more time and effort from both parties (users and service providers).