Money laundering is a global issue that affects both fiat currency and cryptocurrencies. To combat the financing of criminal activity, regulatory bodies have rushed to enact stringent anti-money laundering (AML) legislation to prevent money laundering via cryptocurrency exchanges and custodian services.
AML legislation has been passed with measurable differences in each jurisdiction. Because of the inherently global nature of crypto transactions, crypto companies that are now tasked with complying with AML legislation fear that crypto transactions will become more complex and thus cause end-user friction.
What does AML in crypto mean?
AML for cryptocurrencies refers to the laws, rules, and policies put in place to prevent criminals from turning unlawfully obtained cryptocurrency into cash.
What are the AML requirements for cryptocurrency?
The FATF establishes global standards for AML legislation. In 2014, the FATF published cryptocurrency AML guidance, and as a result, policymakers in FATF member jurisdictions acted rapidly. The United States Financial Crimes Enforcement Network (FinCEN), the European Commission, and dozens of other regulatory organizations have already legally codified most of FATF’s cryptocurrency AML recommendations.
The onus is then placed on cryptocurrency exchanges, stablecoin issuers, and, on a case-by-case basis, some DeFi protocols and NFT marketplaces, all of which the FATF defines as VASPs. Going forward, VASP’s Compliance Officers must mandate KYC checks and regularly monitor suspicious activity to thwart nefarious transactions that could be linked to money laundering and terrorist financing.
Additionally, VASPs must report suspicious activity to the relevant regulators and agencies who are responsible for analyzing the flow of funds and tracing unlawful activities to real-world identifiers using various tools, including blockchain analysis.
Do cryptocurrency transactions constitute a higher risk of money laundering?
In June 2014, the FATF released Virtual Currencies Key Definitions and Potential AML/CTF Risks, a report that highlights the following areas of concern with cryptocurrencies:
- A high degree of anonymity
Cryptocurrency transactions allow greater anonymity than traditional non-cash payment methods. Users can trade virtual currency on the internet, and transactions are generally characterized by non-face-to-face customer relationships, permitting anonymous funding (cash funding or third-party funding through virtual exchangers that do not adequately identify the funding source).
- Cross-border transactions
AML/CTF risks are exacerbated when you have worldwide reach because it makes surveillance and enforcement more difficult.
- Lack of centralized oversight
Law enforcement cannot conduct an investigation or seize assets against a single central location or entity (administrator) — although authorities can target individual exchangers to retrieve client information that the exchanger may collect. Thus, virtual currency transactions provide a level of anonymity that is not possible with traditional credit and debit cards or older online payment systems.
What is a KYC process in crypto?
KYC programs typically consist of three components: customer identification, due diligence, and ongoing monitoring.
- Customer identification
A customer identification program (CIP) verifies that the customer is who they claim to be by utilizing reliable and independent data. Verification information may include:
- The client’s legal name
- Date of birth
- Address
- Verification documentation, such as a driver’s license or passport
- Business licenses and articles of incorporation from enterprise customers
- Customer due diligence
Customer due diligence (CDD) is a new client or business relationship risk assessment. Financial service providers assign risk ratings to accounts based on background checks, customer surveys, and reviews of the client’s transaction history.
- Continuous monitoring
Continuous monitoring is performed by regularly reviewing transactions for signs of criminal activity. When suspicious activity is discovered, VASPs are required to file Suspicious Activity Reports with FinCEN or other appropriate law enforcement agencies.
Is there money laundering in crypto transactions?
According to a 2022 report from the leading blockchain analytics company Chainalysis, criminals laundered $8.6 billion in cryptocurrency in 2021, a 30% increase over the previous year. The report says that “while billions of dollars worth of cryptocurrency are transferred annually from illicit addresses, the majority of it ends up at a surprisingly small number of services, many of which appear to be purpose-built for money laundering.”
Since 2017, cybercriminals have laundered over $33 billion in cryptocurrency, most of which has since been moved to centralized exchanges. By comparison, the United Nations Office on Drugs and Crime estimates that between $800 billion and $2 trillion in fiat currency is laundered annually — up to 5% of global GDP.
How does the crypto Travel Rule relate to AML efforts?
Travel Rule compliance is an integral part of AML efforts.The Travel Rule for crypto assets mandates that VASPs to send, receive, and sanction screen customer personal information alongside a crypto transaction over a particular threshold.
Many exchanges now have AML/CTF processes in place that identify and screen their own customers for sanctions as part of onboarding and ongoing CDD. This prevents sanctioned users from directly initiating transactions.
However, FATF’s Crypto Travel Rule now requires institutions to receive and sanction screen the counterparty VASP’s customer information and perform due diligence on the counterparty VASP. With this information, VASPs can choose to accept or reject the transaction.
Unlike FIs, the crypto industry does not have a SWIFT network, which allows the safe transmission of standardized customer data. Thus, crypto exchanges today require a robust Travel Rule solution to perform proper counterparty risk mitigation and be able to identify or block a transaction with a sanctioned individual or entity.
As virtual currency transactions become more widespread, it has become even more critical to require VASPs go the extra mile to verify the beneficiary of transactions. Therefore, Travel Rule compliance has become a fundamental requirement as cryptocurrencies expand and reshape the global financial network.
Notabene’s next-generation crypto regulatory compliance software enables VASPs to pinpoint the counterparty VASP and beneficiary customer to a transaction, collect mandated customer identification information, and screen the beneficiary all pre-transaction, with minimal friction to the user and compliance team. Notabene then routes the compliant data transfer to any counterparty globally, no matter their compliance status.
Financial institutions and crypto exchanges using Notabene leverage our Rules Engine to set risk-based rules according to the mandates of their local jurisdictions and their risk appetite to automate compliance transfers to white-listed exchanges with proper AML procedures.
Our clients streamline compliance at scale, saving time and money to focus on the most suspicious transactions. Additionally, their end-users benefit from knowing that their transactions are safe, trusted, regulated, and compliant and will not be routed to sanctioned individuals.
The next article covers counter-terrorism financing (CTF), its requirements, and its relevance to the crypto Travel Rule.
