The rise of cryptocurrency
Cryptocurrency or ‘cryptos’ in short have gained immense popularity in the recent past owing to their anonymous nature, low transaction cost, decentralised nature, and ability to bypass the traditional financial system using blockchain technology. This replacement of long-standing and trusted financial institutions with a new decentralised system comes with a related risk of increased financial crimes.
Money Laundering 1.0
Money Laundering is the process of acquiring illegal money and “washing” it to appear legal. It is often done by crime experts running across geographies, which can eventually destabilise economies in the global financial system. It is done for a host of reasons including, but not restricted to, terror financing, human and drug trafficking, hiding illegal wealth, arms smuggling, bribery, fraud, etc. It can be divided into three phases which can happen at the same time or appear as separate transactions. ‘Placement’ is the first stage involving deposit of illegitimately gained funds into a legal financial system. During the second stage, ‘layering,’ so called to hide the source of funds by complicating the money trail, these funds are filtered through various banks to make the funds untraceable. The last phase, ‘integration,’ helps move the illegitimate money back into the mainstream economy.
Money Laundering 2.0 with cryptos- A nightmare for regulators
With the advent of technology, cryptocurrency has created a haven for money laundering, making the crime easy as it gets challenging for financial institutions and anti-money laundering agencies to relate transactions to criminal activities. Money launderers use copious ways to accomplish their tasks as they are becoming skilled in deploying state-of-the-art techniques to perform illegal activities.
Criminals are now increasingly switching to technology and herein lies the vital role of cryptocurrency in money laundering as it allows criminals to launder money without having to comply with “Know Your Customer” (KYC) requirements with fewer audit trails. Other advantages of cryptos over traditional money laundering modes include decentralised networks of users, untraceability, lack of adequate monitoring by agencies, absence of a centralised financial institution, etc. This has enabled cryptocurrency to emerge as a preferred payment method for illicitly obtained drugs and other goods online.
Techniques that may be deployed during money laundering
There are several techniques which may be used to launder money. However, it may be mentioned that some of these techniques are not always used for the sole purpose of money laundering. These include, but are not restricted to the following:
a. Cashing out: Can be done through a multitude of ways including through cryptocurrency exchanges, which is the predominant method. This can also be done by hiring ‘treasury men’ from Hydra, the largest marketplace of dark web to convert cryptos into hard cash and keeping this in the knowledge of certain restricted entities. This is also done by sending cryptos to less stringent jurisdictions for conversion to hard cash. ‘Cashing out’ can also be done by over-the-counter brokers and crypto ATMs, with little or no regulation.
b. Chain hopping and using privacy coins: Chain hopping involves jumping between different cryptocurrencies, often in rapid succession in order to avoid detection. ‘Privacy coins’ are cryptos with additional anonymity built into them. Both these may be used to avoid detection during money laundering.
c. Mixing: This involves third-party services called ‘mixers’ that mix up illicit funds with clean crypto before redistributing them. There are several mixer services available which can obfuscate the money trail. There are also some highly sophisticated ‘privacy wallets’ like Wasabi Wallet with inbuilt anonymisation techniques including mixing capabilities. These may again be deployed for money laundering activity.
Crypto laundering- Recent cases to point prevalence across continents
The use of cryptocurrencies for money laundering is rapidly gaining acceptance worldwide and is evident from the recent cases from UK involving the country’s largest ever cryptocurrency seizure worth £114 million (approximately Rs 1150 Cr) in a money laundering investigation, Hong Kong busting cryptocurrency money laundering scheme worth HK$1.2 billion (approximately Rs 1150 Cr) & the US sentencing cryptocurrency fraudster for money laundering and securities fraud. Details are as under:
1. UK: In June 2021, crypto assets worth £114 million were seized by London Metropolitan Police Economic Crime Command investigating money laundering offences. This is considered to be the largest cryptocurrency seizure in the country.
2. Hong Kong: ln July 2021, the Hong Kong Customs arrested four men for a suspected money-laundering syndicate involving HK$1.2 billion with the stable coin Tether. The men opened various local bank accounts and made transactions through a cryptocurrency exchange. The suspicious funds were processed via bank remittances and virtual currency from February 2020 through May 2021. Total sum involving cryptocurrency trading in around 40 e-wallets was about HK$880 million.
3. US: In July 2021, Roger Nils-Jonas Karlsson (a Swedish man) was sentenced to 15 years of imprisonment for securities fraud, wire fraud and money laundering charges that defrauded thousands of victims of more than US$16 million through an investment scam. Karlsson lured victims promising astronomical returns to purchase shares in an investment scheme using cryptocurrency such as Bitcoin and other online payment platforms and transferred the funds received to his personal bank accounts, and then used proceeds to purchase expensive homes, a racehorse, and a resort in Thailand.
4. US: In August 2022, the U.S. Treasury sanctioned currency mixer Tornado Cash, which the federal government claimed had been used to launder more than $7 billion of cryptocurrency since its creation. Shortly after the sanctions, Tornado developer Alexey Pertsev was arrested in Amsterdam for alleged involvement in concealing criminal financial flows and facilitating money laundering.
Cryptocurrency regulation as a tool to combat money-laundering
Governments, Regulators and Central Banks across the world increasingly feel the need to regulate this ‘new asset class’ which offers the advantage of money transfer using technology at a fraction of the cost but on the flip side poses serious threats like money laundering and destabilisation of the monetary system. The lack of regulation has at times served as a fertile ground for criminals inside and outside the country.
The recent move by the Government of India before the Winter Session to list ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’ can be seen as a step towards developing a regulatory mechanism for cryptocurrency in India. While the jury is still out on outrightly banning cryptocurrencies as has been done by China and less than a dozen other countries, the need for proactive regulation is certainly there.
Legislation can be seen as one of the ways to effectively deal with the ill effects of cryptocurrencies. Cryptocurrency legislation or regulation must mandate collection of customer information and sharing with other legitimate financial institutions for combating and minimising money laundering. On the other side, it must be emphasised that regulations should not be made so stringent that they stifle innovation and strangulate a nascent industry which has the potential to revolutionise the way the global financial system works.
Regulation of cryptos should effectively be through ‘loose’ regulation which permits virtual currencies to develop. A regulated space makes it easier for entrepreneurs and start-ups to implement and facilitate a quicker operation from anywhere in the world, enabling economic growth, protecting investors from liquidity issues while encouraging innovation and continuing the facilitation of entrepreneurial financing. This may involve issuance of official digital currency by the currency regulator which may eventually weed out private cryptocurrencies without the need to outrightly ban them.
Way forward
Cryptocurrency as a novel asset class with evolving technology has deep implications for our existing monetary system and thus a cautious and calibrated approach to regulation is the need of the hour. The landscape of the criminal underworld is changing with cryptocurrencies, and therefore it is paramount to work towards preventing virtual assets from becoming safe havens for illegal financial transactions.
It is therefore imperative to safeguard & protect citizens and the global economy from the abuse of cryptocurrencies and other virtual assets. This requires global coordination with vigorous and sustained action by governments, law enforcement agencies that work with the private sector under a clear, harmonised regulatory global framework that is well equipped to take on the challenge of crypto laundering.