Cryptocurrency Money Laundering

November 21, 2023 - Around 5 mins mins to read

The discussion surrounding the risks of cryptocurrency-enabled money laundering has become a common topic when it comes to Bitcoin and other cryptocurrencies. Money laundering is often brought up by governments and traditional financial institutions whenever the subject of cryptocurrency arises, along with concerns about the volatility of the crypto market and the sustainability issues associated with mining.

Politicians and mainstream economists often view cryptocurrencies as potential tools for money laundering, tax evasion, and other illicit activities. Regulatory bodies such as the United States Securities and Exchange Commission (SEC), Federal Reserve, and others criticize decentralized cryptocurrencies for their perceived lack of traceability and accountability. However, criminals have quickly discovered that using Bitcoin for money laundering is not a wise choice.

Contrary to popular belief, Bitcoin transactions are not anonymous or undetectable. In fact, transactions on the blockchain provide a clear and accurate record of where funds have been transferred, posing a significant problem for those who wish to remain untraceable. The hacker group DarkSide learned this the hard way after ransoming the Colonial Pipeline. The FBI was not only able to trace the transactions to wallets containing 63 Bitcoins, but they also managed to access the wallet and retrieve the coins using the private key. The exact method used by the FBI remains a controversial issue, but it is clear that cryptocurrency is not a safe haven, especially with the current level of scrutiny on the industry.

Bitcoin has indeed been used for money laundering in the past, particularly in its early days when governments and regulatory agencies were less knowledgeable about cryptocurrencies. In 2020, the U.S. government seized $1 billion worth of Bitcoin from the Silk Road network, where individuals had used Bitcoin to purchase illegal goods and launder millions of dollars.

These cases have prompted most countries to tighten their anti-money laundering (AML) regulations for cryptocurrencies. Governments have imposed mandatory compliance measures, such as Know Your Customer (KYC) rules, on many crypto-related organizations to prevent illicit activities. Since it is challenging to buy crypto outside of exchanges, governments can track crypto funds by monitoring the money that flows through popular brokerages like Coinbase.

Some individuals with criminal intent have attempted to use Bitcoin to shuffle funds and obscure the trail of illicit money. They acquire crypto and then exchange it between different cryptocurrencies multiple times to make it harder to trace their transactions. Once they convert their funds back into fiat currency, money launderers disguise their proceeds as capital gains or profits from trading on the crypto market. However, as cryptocurrencies gain wider acceptance as a means of payment, users, including money launderers, may not always need to convert their crypto back into fiat currency.

The United Nations estimates that $1.6 trillion is laundered globally each year, which accounts for nearly 3% of global GDP. It is unclear how much of this figure is attributed to Bitcoin and crypto-enabled laundering as a whole. Even if it were a few billion dollars per year, it would still be significantly less compared to other methods of money laundering.

Bitcoin is not the only cryptocurrency involved in money laundering activities. Some cryptocurrencies, known as privacy coins, are designed to provide more anonymity, security, and privacy, making them easier to use for illicit activities. However, these privacy coins are only slightly more problematic than Bitcoin from the perspective of AML regulators. Despite the existence of privacy coins, 90% of illicit activity and money laundering on the dark web still occurs using Bitcoin addresses.

One well-known privacy coin is Monero, which prides itself on being a secure and untraceable currency. It was created to establish a completely private network that gives users full control over who can see their activity. Monero is currently ranked as the 26th-largest coin by market capitalization and is listed on most major exchanges.

Zcash is another contender in the privacy coin space. It enables private transactions within an auditable platform. The Zcash blockchain verifies transactions using zero-knowledge proofs, allowing users to transact without revealing any information about the sender, receiver, or transaction amount.

Grin is a digital currency that aims to provide unrestricted electronic transactions without censorship. It is an open-source network that developers can use to implement new privacy tools, such as the signature “mimblewimble,” which can delete past transaction data from the blockchain without compromising the network’s security.

When it comes to taxation, many countries are still working to determine the best way to classify cryptocurrencies and the proceeds from trading them. Bitcoin is often associated with attempts at tax evasion. As cryptocurrencies gain wider adoption, agencies like the IRS and SEC are implementing capital gains taxes on crypto profits and subjecting crypto-denominated salaries to income tax.

Governments worldwide are also introducing new regulations for crypto miners and traders as the industry continues to grow. Both crypto and non-crypto companies are facing increased scrutiny from the SEC as more of them add Bitcoin and other cryptocurrencies to their balance sheets. Within the industry, crypto exchanges are under pressure to provide better safeguards against crypto tax avoidance.

Regulated crypto exchanges are those that comply with all crypto-related laws in their jurisdiction and are subject to formal regulatory oversight. Each country has its own laws regarding digital currencies, and some are more favorable towards decentralized finance than others. Regulated exchanges in the U.S. that have SEC approval include Coinbase, Binance.US, Gemini, and others.