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Explained: AML regulations and how they apply to the cryptosphere

Explained: AML regulations and how they apply to the cryptosphere

Explained: AML regulations and how they apply to the cryptosphere
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By CNBCTV18.com Nov 1, 2022 8:41:06 PM IST (Published)

In this article, we discuss the scale and rising instances of money laundering in the cryptoverse and the anti-money laundering regulations that are coming into place to avoid this malpractice.

Black money makes up a large portion of unaccounted funds across the world's economies. This money comes from not-so-legitimate sources like smuggling, drugs, illegal betting, and gambling. These funds cannot directly be brought into the actual economy, as they would become liable for taxation, raise suspicion of authorities, and could lead to raids from enforcement agencies.

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Instead, bad actors use various techniques to bring this money into the system without arousing the suspicion of authorities. This process is known as money laundering. In this article, we discuss the scale and rising instances of money laundering in the cryptoverse and the anti-money laundering regulations that are coming into place to avoid this malpractice.
What is money laundering?
As mentioned earlier, money laundering is the practice of converting black money into white through cash-rich businesses that make the garnered wealth look legitimate. Several popular Hollywood and Bollywood flicks provide an elaborate depiction of money laundering that comes very close to how it works in real life.
While these dramatized recreations are entertaining to watch, we must remember that money laundering is as illegal as illegal gets. You're cheating the government, and it is a severely punishable offence. With the popularity of cryptocurrency, blockchains became a breeding ground for money laundering because of the extreme anonymity that is possible with cryptos.
Money laundering in the Cryptoverse
Since 2017, more than $33 billion is estimated to have been laundered via blockchains by cyber criminals, and the number is only set to rise if strict regulations are not in place. While people might think that that is a whopping number, it is not even close to the figures with fiat currency.
According to the United Nations Office on Drugs & Crime, somewhere between $800 billion to $2 trillion are laundered annually across the globe, which is 5 percent of the global GDP. The number is much higher with fiat currencies, perhaps because of how long the practice has been ongoing and perfected.
Cryptos are new, but they are gaining ground soon. There are a few reasons why blockchains are the new breeding ground for money laundering. First, because of the anonymity that is possible with blockchains. You can have a pseudonymous public address - a meaningless string of letters and numbers - that allows you to transact in millions.
Second, cross-border transfer of funds is very much possible with cryptocurrencies, and governments can't entirely restrict the transfer of funds without cutting off all internet access. Third and most importantly, crypto is fast becoming a global currency, with people and businesses well aware and accepting of the popular tokens.
AML regulations in the crypto industry
While blockchains provide you with anonymity, they also have the ledger's permanence. Every transaction is permanently noted, and every trail can be followed back until the very end. Therefore, governments are trying to empower their enforcement agencies to follow the money trail back to its source or when it reaches an exchange. Why?
Governments instruct exchanges to do a complete KYC of their customers to ensure that their wallets are connected to their identity. So, when a suspicious transaction goes through a crypto exchange, the concerned departments can quickly catch the culprits or question them to get deeper into the matter.
Besides KYC, crypto firms also actively track transactions beyond a certain threshold. For instance, the data collection threshold in Singapore is around $1,100. Similarly, crypto exchanges and related platforms can pull up other suspicious transactions. This can include strange transaction patterns or crypto funds sent to sanctioned addresses. For instance, transactions to high-risk jurisdictions or multiple smaller transactions to several accounts with no connection to the recipient are also usually red-flagged and looked into.
Platforms can also red-flag users who exhibit suspicious behaviour. For instance, users that keep changing their personal information, including e-mail addresses, IP addresses, and other details, are usually red-flagged. Further, the use of a VPN to conceal IP addresses or a mismatch between a user's location and IP address should also raise flags.
Where it all fails
The current regulations work well when cybercriminals convert their crypto wealth into fiat currencies or other cryptocurrencies. This is because anyone who wants to convert their cryptocurrency needs to do so via a KYC-compliant crypto exchange. This ensures that transactions can be traced back to their origin.
However, what is impossible (at least with the way blockchains currently work) is catching cybercriminals who only deal within that particular crypto. They can keep sending crypto from one offline wallet to another without the funds ever touching KYC-compliant platforms. The authorities then become spectators of everything happening but are powerless to do anything about it. They can track wallet addresses but need help identifying the individuals behind these public keys.
Moreover, many anonymity services have cropped up that offer to obfuscate transaction details. For instance, several coin mixers take your coins and mix them with the tokens of others before sending them to your desired recipient. This creates a link between you and the mixing service but not to the eventual recipient. Therefore, creating a link back to you becomes almost impossible.
Unregulated exchanges are another way for cybercriminals to stay under the radar. Peer-to-peer exchanges or KYC-lax platforms allow crypto transactions to go through without any real-world identification. Cybercriminals are also known to use crypto mules. These individuals transfer funds on behalf of crypto criminals, making the transaction look normal.
There are many other ways to convert dirty crypto into clean funds. Therefore, AML regulations are always ongoing and need to be reworked to keep bad actors at bay.
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