Digitization impacts every aspect of our lives and finance is no exception. Cryptocurrency – once a relatively niche area of finance and little understood – is now a topic of mainstream discussion and widespread investment. According to statistics shared in February 2022, the UK Government estimated that more than 10% of UK adults were already holding or had held some form of crypto asset.
The European Central Bank first outlined its plans for a Digital Euro back in 2021, after the start of a crypto-market crash. And, as part of its work on the future of money and payments, the UK Government is looking at the idea of a “digital pound”, although it has said this would be a digital complement to existing banknotes, not a replacement for cash.
With digital currencies having gained momentum, there is the promise of convenience, new investment, and opening up of financial markets. However, there are still concerns around the potential risks of money laundering associated with digital assets.
It's estimated $22.2 billion was laundered globally in 2023 leveraging cryptocurrencies. This is a reduction on the amount estimated to have been laundered using crypto in 2022 at $31.5 billion. While the numbers are high, they have decreased. This could point to organizations becoming better at identifying the risks associated with use of digital currencies thereby preventing money laundering. It could also point to criminals and sanctions evaders becoming more aware that their activities can be detected and pivoting. There is also the emergence of new forms of disintermediated financial transactions, particularly stablecoins, and sanctioned countries or entities may turn to alternative payment mechanisms to circumvent sanctions.
Cryptocurrency payments continue to be the primary source for ransomware payments following criminal cyberattacks. Criminal networks employ countermeasures against law enforcement, often using technologies like encrypted applications or devices to make detection of transactions in crypto or digital tokens harder.
Having said this, when put into context, around $3 trillion was laundered globally in 2023 and while the estimated £22.2 billion laundered through cryptocurrency undoubtedly contributes an unwelcome sum, it can’t necessarily be concluded that it presents a higher risk. Perhaps it’s better defined as representing a different set of risks that need to be identified and managed, particularly at the place where digital and fiat currencies meet.
Despite heightened regulatory scrutiny from governments globally over concerns relating to money laundering, tax evasion, and investor protection leading to some uncertainty and sell-offs in cryptocurrency markets, the appetite for digital currencies continues.
The European Union's ambitious plans for a Digital Euro signify a serious step towards mainstream adoption of a digital currency. The prospect of making public money available for digital payments promises greater convenience and accessibility for consumers in the Eurozone. It’s also been argued that a Digital Euro could make the Euro area more robust, helping competition in the payments landscape and opening the field to further innovation in payment provision.
However, concerns about trust and adoption rates remain. A recent report from BearingPoint found that while digital currency might well be taken up by some users in even the most cash-centric economies on the continent, concerns around trust mean it will “…likely remain a minority interest.”
Whether a digital pound or euro comes to fruition, or whether cryptocurrencies continue to grow via a different trajectory, organizations need to think about where they are exposed to crypto-related risk – be that direct or indirect risk – to prevent money laundering and other types of financial crime.
Preventing money being laundered through cryptocurrencies demands a multi-faceted approach that combines regulatory standards, data, workflow technology, and anti-financial crime best practices. Collaboration between government agencies, financial institutions, and technology providers is crucial when it comes to meeting the new threats posed by new opportunities.
Money laundering involving cryptocurrency involves disguising the origins of illegally obtained money through use of digital currencies, which provide a layer of anonymity to transactions. The process typically involves three steps: placement, layering, and integration.
This process exploits the relative anonymity of digital currencies and complicates the task of tracing the flow of funds and identifying the individuals involved.
Cryptocurrencies lend themselves to anonymity, due to the lack of centralized oversight. This anonymity makes them an attractive option for money launderers seeking to obscure the origins of ill-gotten gains. However, blockchain technology is designed to ensure every transaction is captured on an immutable ledger, in theory making transactions more transparent, if time consuming to trace.
This unique level of transparency provided by blockchain technology, and this “on-chain” data provides an opportunity for enhanced risk management, compliance, and AML efforts. While tricky and time-consuming, transactions can be meticulously traced and analyzed.
Off-chain data poses greater challenges. When digital assets are exchanged with fiat currencies or assets outside the blockchain, the trail becomes less accessible. Most cryptocurrency transactions are for legitimate investment, trading, and payment purpose, but the challenges posed by off-chain data and the pseudonymous nature of cryptocurrencies can’t be ignored.
One scheme employed to exploit vulnerabilities between digital and fiat currencies is using money mules as intermediaries. For example - an individual has crypto deposited into a wallet, which they convert into fiat currency, obscuring the trail of illicit funds and effectively washing the money.
To mitigate risks and prevent money laundering, it’s vital to implement robust due diligence before onboarding a client – whether you’re a bank, a real estate agent, a crypto exchange, or any other institution that might be leveraged in the process.
Ongoing checks to identify new risk and changes to an individual or entities risk status also help highlight red flags around those whom you don’t want to be doing business with. And transaction monitoring systems looking at unusual transaction patterns, large volumes of transactions involving high-risk jurisdictions, and attempts to obfuscate the true source of funds are essential.
Yes, digital currencies pose risks that cannot be ignored, but risks can’t be ignored in any area of the financial services industry. As with traditional finance, the dark side of digital currencies also encompasses a range of illicit activities including money laundering, terrorist financing, and cybercrime.
Red flags for crypto money laundering include unusual transaction patterns; large volumes of transactions involving high-risk jurisdictions; and attempts to obfuscate the source of funds, which probably also sounds familiar to those working in more traditional sectors.
A new source of risk emerges from the “crypto nexus” i.e. the space where crypto meets fiat, as many organizations could be vulnerable to gaps in visibility when data moves off-chain from on-chain. Closing this gap is going to be the work of regulators, financial institutions, exchanges, and regtech providers.
What digital currencies offer are opportunities for innovation and financial inclusion, with the potential to transform the world’s economies. They have lower transaction processing costs, faster transaction speeds, and can help eliminate some of the barriers to entry.
Risks need to be understood holistically so crypto can thrive safely, pushing investors to the fore and marginalizing criminals.
To discuss how Moody’s can support your anti-money laundering strategy, whatever area of financial services you work in, please get in touch – we would love to hear from you.