Cryptocurrency money laundering risk: the best explanation of a 3-step process.

Cryptocurrency money laundering risk- the best explanation of 3 step process with practical examples

It is not a secret that criminals are always looking for new ways how to “clean” the dirty money- cryptocurrency is not an exception and there is a high risk of cryptocurrency money laundering. As a novel type of value transfer, it prominently rose to be used for criminality. Nevertheless, those were the days of Silk Road when there was literally zero regulation, and no obligations were imposed on virtual asset service providers (a.k.a. VASPs- even the term itself did not exist). Fast forward to 2022, we already have FATF Recommendations, AMLD5 (now the 6th, but it was the 5th which placed cryptocurrencies in the ambit of supervision for AML/CTF purposes) and MiCA initiative in the EU, a requirement to register for AML supervision with the FCA in the UK, US Congress urging to put stablecoins under federal supervision, Bitcoin becoming a legal tender in El Salvador, India deciding to ban crypto as a payment method but regulating it as an asset, China creating its own central bank digital currency (CBDC), etc…  as you can see a lot is happening in the sector and changes have come from all sides.

Crypto is becoming “mainstream”, and its usage for different purposes, including illegal purposes, is growing. By current estimates, the use of cryptocurrencies for money laundering by cybercriminals is growing and has increased by 30% on a year-to-year basis, as reported by Chainanalysis. It is evident that crypto has gone already quite far in proving that it is here to stay in one or the other form, but still, there are some issues that need to be addressed. Henceforth, let’s dive into the discussion of cryptocurrency money laundering risk!

What is cryptocurrency money laundering and its risks?

The legalisation of proceeds of crime is a topic in its own right, and in order for everyone to be on the same page, I will give a bit of context. Money laundering is usually comprised of three steps- (1) placement, (2) layering, and (3) integration. Each step denotes a specific activity that could be undertaken and how usually money is “cleaned”. Below is an illustration of each step with a brief description:

Cryptocurrency money laundering risk process chart

Notably, different means of value transfer are better suited for one or the other part of the “equation”, but crypto scores equally well on all of them (of course, with their own drawbacks- since nobody is perfect :)). Now we will discuss each step in more detail and outline how one or the other could be undertaken.

P.S. this article will be mostly regarding simple transfers/exchanges in the context of cryptocurrency money laundering risk- stay tuned for more complex arrangements and how to counter them.

Step 1 – Placing the crypto for money laundering

In a traditional sense, placing concerns placement of the dirty money into the financial system. Since crypto is neither money nor is considered to be a part of the conventional financial system, this step itself is a bit different if we speak about cryptocurrencies. To start with money laundering, criminals typically place illegally obtained fiat currency into crypto by purchasing one. Alternatively, the fiat-to-crypto conversion can be circumvented by making random payments directly in crypto, those stolen from exchanges, obtained through scamming people, or any other cybercrime that you can imagine. What is important in this regard is that the original store of value was obtained from illegal activity. At this time, the crypto can be placed into, let’s call it, “cryptosystem” where further transfers/exchanges are possible.

It is noteworthy that if this step includes fiat currency, the person who facilitated placement will be still left with the dirty money. Hence, there will be a need to make alternative arrangements for cleaning it. In this article, we will focus solely on the crypto side of things and will not discuss the parallel process involving fiat currencies. Just keep in mind that these processes can be carried out simultaneously. You can read a summary of a case on this topic here– where ‘Doctor Bitcoin’ was helping lottery scammer to operate his “business” by making cash-to-crypto exchange. Doctor Bitcoin himself had his business posing as a front company engaged in marketing, so the cash that was received was positioned as an income from marketing campaigns.

Step 2 – Layering the cryptocurrencies

If placement allows criminals to introduce crypto arising from illicit activity into the cryptosystem, layering allows them to erase their traces and obfuscate their link to the initial crime/criminal proceeds. Conventionally, it was being carried out by making multiple transfers between different wallet addresses. However, since most of the blockchains are public, this approach does not really work as transactions can be easily monitored via the help of software (we’ll cover this in a subsequent article), and hence more novel ways are now being opted for. The criminals are quite often employing other services such as privacy wallets, coin mixers, dark markets, online casinos, decentralised exchanges, peer-to-peer exchanges, centralised exchanges with poor controls, decentralized protocols for private transactions (such as Tornado Cash), etc. Employment of the aforementioned services complicates tracking the trail revealing that the cryptocurrency originated from illegal activity.

Step 3 – Integration back into the economy

Following obfuscation of the origin of the cryptocurrencies, they can be introduced back into the economy. This can be done in a variety of ways, starting with converting crypto into fiat and ending with purchasing something for cryptocurrency on a dark market. The essence of the last step is that the perpetrator of the crime can obtain benefits from illegal activity. Some of them even go as far as to perform “transaction laundering” with cryptos by simply accepting them on their online store created specifically for such purposes. Regardless of the manner in which the funds are reintroduced into the economy, the criminals are receiving benefits and henceforth have more motivation to conduct new crimes, and the vicious circle begins!

After the integration is complete, the whole process of cryptocurrency money laundering is successfully accomplished.

How does cryptocurrency money laundering work in practice?

To illustrate how cryptocurrency money laundering works in practice, let’s look at one fictional case that could be very real. Let’s say that Carl Grimes has tricked people by promising 100x returns for providing him with the cryptocurrencies that he would reinvest in new and “hot” cryptocurrencies about which he has inside information (NB: insider dealing is not a crime with cryptos since they are not securities in most instances/jurisdictions). He was posting his lavish lifestyle on Instagram and was approaching his victims through this platform- having exposure on social media added more credibility to his persona. Nevertheless, it was later revealed that there is no such person and all people who were shouting “Why Carl? How could you do that, Carl?!?!” were referring to the fictional character from Walking Dead. Basically, our criminal collected cryptocurrencies from unscrupulous people who were being scammed by a person whose name was not even Carl but Rakesh.

Currently, Rakesh is facing a dilemma: he has collected 68 ETH from people but cannot enjoy them since he could be tracked. Fortunately for him, he knows a bit about how to cover his tracks and hence decides to start cryptocurrency money laundering. To do so, he transfers his funds from his unhosted wallet to numerous wallets opened with an exchange that has a lax KYC process (NB: according to CipherTrace study, 56% of 800 market maker exchanges have very minimal to no KYC at all) and does not require anything apart from email address to open a wallet for the transfers that are below 10,000 USD. After it is done, he continues with the endeavour and transfers it to 3 different privacy wallets that have integration with a mixer. Of course, he decides to employ the capability of the mixer and further obfuscates the origin of the ETH. Further, he does a payout in three different batches, one for 28 ETH, another 25 ETH and the last for 15 ETH to two different unhosted wallets- with 28 ETH going to one and 40 ETH to another. Finally, at this stage, he decides that he wishes to cash out some of the money and transfers 11 ETH to an exchange that has a link to fiat, where he has passed the KYC by supplying documents of his acquaintance whom he has paid 2,000 USD for providing his document and posing in front of the camera whilst the checks were being undertaken.

So now Rakesh makes a transfer of funds to his crypto-friendly service provider with whom he has an account opened in the name of another nominee and further uses a card to make some purchases without any worries that he will be caught.

What if you get caught while engaged in cryptocurrency money laundering?

Money laundering is a criminal offence by itself, not speaking that apart from DIY with this crime, Rakesh has defrauded people. In the event that he gets caught, he will face serious repercussions. To illustrate it, we will turn to some real-world examples.

For instance, in 2020, EUROPOL undertook an operation involving 16 different countries, as a consequence of which 20 QQAAZZ members were arrested. QQAAZZ was a criminal network that attempted to launder tens of millions of euros on behalf of the world’s foremost cybercriminals, and thanks to the enforcement, its members are currently facing quite lengthy jail time. Another example could be the arrest of Roman Sterlingov, the alleged founder of cryptocurrency mixing service Bitcoin Fog, who now faces at least a decade in prison if convicted. A similar story can be said of Larry Harmon, who pleaded guilty to a money laundering conspiracy arising from his operation of Helix, a Darknet-based cryptocurrency money laundering service, and now also faces jail time of up to 20 years.

The cases of convictions stemming from cryptocurrency money laundering are not solely on the other side of the Ocean and concern not only masterminds operating services allowing to obfuscate the origin of the funds. In the Netherlands, just recently, there were eight convictions related to cryptocurrency money laundering with the jail time from 3 to 51 months. In the UK, law enforcement seized a record-setting GBP 114 million in cryptocurrency in June 2021 and then, just a month later, in July 2021, there was another record with the seizure of GBP 180 million in cryptocurrency as part of ongoing money laundering investigations with probing of a woman on cryptocurrency money laundering charges who faces up to 14 years in prison. The same can be found even in India, where Naisar Kothari was arrested for alleged involvement in an online betting scam and international hawala transactions. Akin to the fictitious example offered above, Roger Nils-Jonas Karlsson pleaded guilty to securities fraud, wire fraud, and money laundering charges that defrauded more than 3,500 victims. Since this case is back in the US, he again faces up to 20 years and a hefty fine.

All of these are examples of what criminals can expect when they get caught (not if, as will be explained in the subsequent article, they will be most likely caught thanks to different solutions on the market).

How can PSP Lab help you to mitigate cryptocurrency money laundering risk?

Cryptocurrency money laundering is a serious issue and needs appropriate countermeasures to mitigate risks from materialising. Such measures themselves must be comprised of both appropriately trained staff members and software solutions that would enhance screening and monitoring of the customers and their activity. If you wish to learn more on the topic or looking for ways how to implement an anti-money laundering programme within your firm- feel free to reach out to us so we can assist you.