Key Takeaways
- Crypto money laundering exploits blockchain pseudonymity to obscure the origins of illicit funds via mixers, privacy coins, and cross-chain swaps.
- Common techniques include crypto smurfing, layering, and fake ICOs. The idea is to fragment large amounts and disguise their movements until they are cashed out.
- Criminals often use crypto exchanges, particularly those with weak KYC (Know Your Customer) and AML (Anti-Money Laundering) policies, to launder funds.
- Regulatory agencies and blockchain analytics firms are strengthening AML measures to combat crypto money laundering, while law enforcement uses blockchain forensics to track illicit transactions.
Blockchain is a revolutionary tool because it offers an infrastructure for transferring money peer-to-peer, without a middle man or any onboarding proccess. There are no accounts or names – only blockchain addresses and public keys, giving users power over their data even as they transact.
However, there is also has a darker side to this faceless monetary system. Blockchain offers a multitude of opportunities for criminals looking to move money around without detection: according to the Chainalysis Report 2024, illicit addresses sent over $22 billion. Naturally, crypto money laundering is a hot topic for regulators. But how exactly does crypto money laundering work?
In this article, we will break down the mechanics of crypto money laundering, discuss the different techniques criminals use to do this, and explain why AML for crypto is crucial for a secure ecosystem.
What Is Crypto Money Laundering?
Crypto money laundering is the process of concealing the origins of illegally obtained funds through cryptocurrency transactions. Criminals can take advantage of blockchain pseudonimity, decentralized finance platforms, and crypto exchanges to obfuscate the source of their illicit money.
Unlike traditional money laundering, which involves multiple banks and offshore accounts, crypto money laundering happens on-chain. This makes it harder to trace, although blockchain forensics tools have improved significantly over the years to counter these activities.
How Does Crypto Money Laundering Work?
Crypto money laundering typically involves hiding the source of funds by passing them through multiple layers of transactions on the blockchain. The more transactions criminals do, the harder it gets to track them. Usually, the process consists of three key steps:
1. Deposit Funds
The first step in laundering crypto involves depositing illicitly obtained funds into the crypto ecosystem. They achieve this by purchasing cryptocurrencies on an exchange using stolen credit cards, transferring funds from darknet marketplaces, hacking crypto wallets, and more.
In addition, criminals often split large amounts into smaller deposits across multiple exchanges and wallets to avoid detection. This is known as crypto smurfing, which we will discuss later.
2. Pass the Crypto Through a Mixer
Once the funds are within the crypto ecosystem, they go through crypto mixers (tumblers). These services break down the transaction history by pooling funds from multiple users and redistributing them in small, randomized amounts to different wallets. As a result, it becomes difficult to track the original source of the funds.
Some well-known crypto mixing services include Tornado Cash (which was sanctioned by the US government) and Wasabi Wallet for Bitcoin transactions. With crypto mixers being an essential part of crypto money laundering, it’s no wonder that their legal status has yet to be determined. In November 2024, a court overturned the charges against Tornado Cash.
3. Convert Clean Funds Into a Stable Asset
Finally, after laundering the funds, criminals convert them into more stable assets such as stablecoins (USDT, USDC, or DAI) or simply fiat currency. This can be done through:
- Peer-to-peer (P2P) trading to cash out without alerting authorities.
- Off-ramping via centralized crypto exchanges that do not have strict Know Your Customer (KYC) procedures.
- Converting into NFTs or other digital assets before selling them on secondary markets.
At this point, the money is already laundered and can be spent freely without raising much suspicion.
4 Crypto Money Laundering Techniques
While mixers and tumblers are among the most popular methods, criminals use various money laundering crypto techniques to evade authorities. These include:
Crypto Smurfing
Crypto smurfing involves breaking down large amounts of illicit funds into smaller transactions, hence the name, across multiple wallets, making it harder to trace. Criminals often use a combination of bots and automated scripts to send transactions in a fragmented manner. This allows them to disguise the malicious transactions as normal trading activity.
Crypto Layering
Layering refers to the repeated movement of funds across different blockchains, decentralized exchanges (DEXs), and crypto wallets to obscure the transaction history. Commonly, criminals achieve this by utilizing:
- Cross-chain swaps, where they move crypto assets from one blockchain to another using bridges.
- Decentralized Finance (DeFi) platforms, which allow anonymous swaps between assets without KYC verification.
Privacy Coins
Privacy-focused cryptocurrencies such as Monero (XMR), Zcash (ZEC), and Dash (DASH) are designed to obscure transaction details. Unlike Bitcoin, which has a transparent blockchain, privacy coins use techniques like ring signatures and zero-knowledge proofs to hide sender and receiver information. As a result, critics of privacy coins are often concerned with their use in money laundering.
IPOs
Some criminals use fake Initial Coin Offerings (ICOs) or token sales as a front for money laundering. They create a fraudulent crypto project, attract investment, and then funnel illicit funds into the sale to make them appear legitimate. Once the ICO is completed, they cash out and abandon the project. Consequently, anyone who invested money into the project is left with worthless assets or nothing at all.
How To Spot Money Laundering
Money laundering is usually a complicated process, and tracking it from start to finish is sometimes impossible. While detecting cryptocurrency money laundering can be challenging, there are a couple of red flags to watch out for:
- Numerous cross-border transactions: Funds moving rapidly between different countries can indicate laundering.
- Use of multiple new wallets: Many newly created wallets receiving and sending large amounts of crypto could be a sign.
- High-volume transactions in small amounts: Smurfing and layering techniques often involve breaking large sums into smaller transactions.
- Interacting with known mixers or privacy coins: If users send funds repeatedly to Tornado Cash or Monero wallets, it may signal laundering attempts.
- Frequent liquidation of digital assets into cash: Although not inherently illegal, swiftly converting cryptocurrencies into fiat, particularly from lesser-known digital assets, may suggest an attempt to move funds away from the traceable blockchain environment.
- Consistent evasion of KYC procedures: Individuals with malicious intent often seek out platforms with minimal regulatory oversight. Therefore, repeated transactions routed through non-KYC-compliant exchanges can serve as a potential indicator of money laundering activities.
How Are Crypto Exchanges Used for Crypto Money Laundering?
Crypto exchanges play a crucial role in money laundering schemes. Bad actors often use:
- Exchanges with weak KYC/AML policies: Some platforms allow trading with minimal identity verification.
- P2P trading on centralized exchanges: Criminals use P2P features to buy and sell crypto without detection.
- Liquidity providers on DEXs: By adding liquidity to DEX pools, illicit funds can blend with legitimate trading volume.
To combat this, almost all of the major centralized exchanges implement strict anti-money laundering (AML) policies. As a result, they require users to verify their identities and report suspicious transactions.
Is Crypto Anonymous?
Some users consider cryptocurrency to be completely anonymous, but it is, in fact, pseudonymous. While Bitcoin and Ethereum do not require users to disclose their true identities, all transactions are available on public blockchains. These blockchains are freely accessible by anyone. As a result, law enforcement agencies can trace illicit funds by analyzing blockchain records.
Moreover, companies specializing in blockchain analytics, such as Chainalysis, work closely with governments to track illicit transactions and enforce regulations.
Why Is Crypto AML Important?
Implementing AML policies for crypto is essential to prevent financial crimes and ensure regulatory compliance. Without proper AML measures, crypto markets risk becoming a haven for illegal activities such as:
- Terrorist financing: Criminal groups can exploit crypto to fund illegal activities.
- Tax evasion: Governments rely on AML measures to track and tax crypto earnings.
- Market manipulation: Criminals can use illicit funds to manipulate prices and disrupt financial stability.
Governments worldwide have introduced crypto regulations requiring exchanges and businesses to follow KYC, AML, and transaction monitoring guidelines. With cryptocurrencies gaining more adoption over the past few years, governments will likely attempt to curb digital money laundering even further.
Closing Thoughts
Crypto and money laundering remain a major concern in the evolving crypto economy. While blockchain technology provides transparency, criminals will continue to find loopholes to launder funds. Nevertheless, with improved AML for crypto, blockchain analysis, and regulatory efforts, authorities are becoming more effective at detecting and preventing illicit activities.
Finally, for everyday crypto users, understanding how money laundering in crypto works is crucial for avoiding unintentional involvement in illegal activities. By staying informed and choosing compliant exchanges, users can ensure they navigate the crypto space safely and securely.
