What is Cryptocurrency Money Laundering?

Money laundering is a financial crime defined as the process of taking a large amount of money that was acquired illegally, often by drug or human trafficking, and attempting to make it seem like it came from a legitimate source.

Cryptocurrency money laundering crimes are committed with similar intent. However, during the process, criminals take fiat money and convert it into cryptocurrency. They then route the cryptocurrency through several pathways to hide the trail and attempt to make its origins appear legitimate. 

Cryptocurrency is often the subject of potential money laundering crimes, largely due to the decentralized nature of blockchain financial operations and the anonymity often linked to crypto. Governmental and financial institutions take the volatility of the crypto market into consideration when discussing possible money laundering threats.

However, Bitcoin transactions can be traceable through the blockchain and are tied to specific cryptocurrency wallet addresses.

In 2021, hacker group DarkSide attempted to ransom the American oil pipeline system Colonial Pipeline. The FBI traced the transactions on the blockchain back to a wallet containing 63 Bitcoins (BTC) and proceeded to extract the coin with the wallet’s private key. This case emphasized the traceability of financial operations on the blockchain.

Money Laundering via Bitcoin

In the early days of blockchain-based digital currency, Bitcoin was used with criminal intent, including money laundering, by some malicious parties. One of the most notable cases was Silk Road, the darknet market used to purchase illegal goods, the majority of which were drugs.

While the platform was shut down, the US government seized more than $1 billion worth of Bitcoin from the Silk Road network in 2020. The operation was described as “the biggest cryptocurrency seizure in history”.

Cases of crypto money laundering led to many countries establishing anti-money laundering laws (AMLs) directed at cryptocurrencies. Obligatory compliance measures, such as Know Your Customer (KYC), have been implemented to promote transparency and prevent illicit operations.

Such regulations have been applied to crypto exchange platforms, as these virtual spaces are the main areas to purchase cryptocurrencies. The data provided by crypto exchange platforms like Coinbase can track suspicious transactions.

There have been criminal attempts to utilize Bitcoin to hide the tracks of illicit money by shuffling around funds. After converting fiat money into crypto, they swap and exchange between different cryptocurrencies several times. The process of swapping and exchanging was meant to make the funds harder to spot and follow along the chain.

At the end of the procedure, the crypto funds would be traded back into fiat currency. The money would then appear as legitimate funds acquired via crypto trading.

According to the United Nations, around $1.3 trillion is laundered yearly. This amount accounts for roughly 3% of global gross domestic product (GDP). It can be difficult to track and establish what share of global money laundering is made up of cryptocurrency-based crime. However, it is assumed to be a considerably small amount in comparison.

Privacy Coins

As of February 2022, there are around 10,000 cryptocurrencies in the world. Given this amount, some may be easier to utilize for money laundering than others. New cryptocurrencies have been developed to be more resistant to tracking and easier to utilize in criminal activities.

Roughly 90% of money laundering and other illicit criminal behavior on the darknet is done by bouncing assets between Bitcoin addresses, making it the most prominent option for cybercrime.

To counter the traceability of Bitcoin, privacy coins have been developed. Privacy coins are cryptocurrency assets that aim to provide a higher level of anonymity, security, and privacy. They are considerably more difficult to regulate. Monero, Zcash, and Grin are among the most popular privacy coins.

Monero

Monero is described as a secure, private, and untraceable cryptocurrency. Its standout feature is the anonymity provided to the users – observers are not able to decipher Monero addresses and the information they contain, such as transaction amounts, balances, or histories.

Monero is considered to be one of the best-known examples of privacy coins. It is listed for trading on most major cryptocurrency exchange platforms. It has the third-largest developer community in the crypto world, falling behind only Bitcoin and Ethereum.

Zcash

Zcash is a cryptocurrency based on Bitcoin’s codebase. It provides an inauditable platform for private transactions using zero-knowledge proof (ZKP) verifications. Thanks to ZKP, no information about the exchange parties or the transaction amount can be revealed.

Much like Bitcoin, Zcash has a fixed total supply, capped at 21 million units. Unlike some other privacy coins, Zcash offers selective disclosure, allowing users to prove payments for auditing purposes and comply with anti-money laundering or tax regulations.

Grin

Grin offers its users an open-source network with a range of privacy tools that can be used to erase all past transaction data from the blockchain without compromising the network security.

Grin’s Mimblewimble protocol helps create more compact blocks and ensures that the blockchain only contains the essential information, thus reducing the amount of computational resources required. Minblewimble blockchain does not contain identifiable or reusable addresses, and transaction data can only be seen by its participants.

Cryptocurrency Regulations

While Bitcoin was established in 2009, there are no globally unified cryptocurrency regulations as of yet. Many nations are working on laws and regulations, as well as developing new classification systems for cryptocurrencies.

The focus of many regulations is the taxation of assets coming from trading Bitcoin or other crypto assets. Due to the decentralization of digital currencies, they are often the subject of criticism in conversations about tax evasion.

With the increasing popularity of cryptocurrencies, taxation entities such as the IRS and SEC are working on establishing new tax regulations on crypto assets and crypto-denominated salaries.

There are also regulations for crypto mining and trading in the works, given their direct importance in the crypto market. Companies that opt to add Bitcoin or other cryptocurrencies to their balance sheets will be subject to regulations.

Cryptocurrency exchange platforms are also in consideration for new regulations. They are expected to provide better protection against tax avoidance and financial misconduct.

Regulated Centralized Cryptocurrency Exchanges

Centralized cryptocurrency exchange platforms (CEXs) are regulated. They comply with cryptocurrency laws within their jurisdiction and agree to formal regulatory oversights. The availability of centralized crypto exchanges may vary regionally, depending on the local laws and compliance.

Some of the regulated exchanges that have been approved by the SEC in the US are Binance.US, Coinbase, Gemini, and Kraken. Regulated crypto exchanges tend to hold a higher reputation among lawmakers and receive the bigger part of the market share in the US.

Centralized exchange platforms generally have the regulations they must follow established by the national government. As a way to assist in preventing illegal financial activities, centralized crypto exchanges must comply with anti-money laundering and Know Your Customer regulations.

Unregulated and Decentralized Cryptocurrency Exchanges

Some cryptocurrency exchange platforms do not require their users to follow regulations such as the KYC policies. However, these platforms may still be required to adhere to some governmental regulations. Bybit, Nominex, and Binance.com (not to be confused with Binance.US) do not require their users to submit information for KYC checks. 

Decentralized cryptocurrency exchange platforms (DEXs) are unregulated and do not possess a single centralized entity that may be held accountable for illicit activities. However, transaction information on these platforms may still be observed.