Should you allow mixed coins on your crypto platform? Here, we examine the impact of crypto mixers on revenue, reputation and compliance.
For crypto firms, fighting against crypto mixer money laundering might feel like a never-ending battle.
On one hand, crypto mixers allow for increased security and privacy in blockchain transactions. But on the other hand, mixed bitcoin transactions have been linked to crypto money laundering, fraud and significant regulatory challenges.
In this piece, you’ll learn more about what crypto mixers are and exactly how they operate. By running through the advantages and disadvantages, we’re hoping to empower exchanges to make up their own mind on dealing with mixers.
What are crypto mixers?
Individuals and businesses use crypto mixers to hide the origin and destination of their cryptocurrency coins. These services provide significantly more privacy than standard blockchain transactions, which are built upon the idea of transparency.
Until recently, crypto companies were able to run without being bound by typical financial services regulations. Know Your Customer (KYC) was one such regulation, which meant that users who were using crypto platforms without KYC processes were doing so at immense risk.
Currency mixers lean into the idea of anonymity on the blockchain as it allows users to swap and “clean” coins without leaving traces on the blockchain, and without transaction history.
Due to the private nature of crypto mixers, they have been embraced by criminals as a new and secure way to turn ill-gotten gains into fresh coins.
And although crypto mixers weren’t directly created for criminal purposes, they are now predominantly used for this.
How do crypto mixers work?
Before diving into how crypto mixers work, it’s important to understand the basic steps of money laundering. That’s because mixers directly mirror what happens in cash money laundering, except coins are located on the blockchain instead.
For cash money laundering, there are three stages. Read more about the three steps of money laundering here:
- Placement: Hide the funds in real-world businesses
- Layering: Bounce the transactions from one account to another, making the original hard to trace
- Integration: Re-introduce funds into the everyday world for spending, saving or investing
Crypto money laundering follows a similar process:
- Users place their coins into the mixer alongside many other coins in what is essentially a communal washing machine of aggregated funds.
- The mixer uses an algorithmic technique to disguise who each of the coins belong to, where they came from and who they’ll be withdrawn by.
- The correct coins are redistributed back to each participant in a random manner and appear legitimate because they are not tainted by suspicious records.
Mixer platforms charge a small fee for their services, typically 1-3% of transactions, keeping the service sustainable to operate.
What are the two types of crypto mixers?
Users give their bitcoins to a centralized crypto mixer, which directly mixes the coins in one pot and spits back different bitcoins of the same value.
For account holders, this means placing a high level of trust in the crypto mixer (it is a third party after all). The centralized mixer still holds a record of the origin and recipient’s coins, which if exposed, defeats the privacy that mixing offers.
Moreover, if the mixer was subject to a hack or data breach, for example, all of the currency could be lost.
Decentralized mixers offer an alternative, taking advantage of the concept of a ‘zero knowledge proof’, which allows a statement to be proven without revealing its contents.
Users pool together in a coordinated effort and use smart contracts to secure their transactions. For example, imagine 100 users wanting to each mix one bitcoin – each user puts one in and the same user gets a different bitcoin back.
Because protocols are used to obscure the transactions in decentralized mixers, nobody knows who their original bitcoin now belongs to. These decentralized protocols are considered more secure than centralized mixers, as there are no possible records to expose.
What are privacy coins?
Although they are not a type of mixing platform, privacy coins have been specifically developed for the same purposes as mixers – increased security.
Monero and ZCash are two examples of privacy coins that can be bought directly and are very hard to trace. Therefore, they provide similar privileges as coin mixers.
Preparing for the known: Operating in a world of crypto regulation.
What are the benefits of crypto mixers?
While crypto mixers don’t have the best reputation, they weren’t created with money laundering in mind. Primarily, mixers offer anonymity for financial transactions.
Consider the decentralized nature of the blockchain: placing investments here leaves a public record and transactions are transparent. High-profile individuals in particular, along with those that are security-conscious are likely to prefer the anonymous nature of crypto mixers.
The service can offer a huge advantage to users that wish to hide their identity, or reduce their risk of becoming politically exposed, for example.
One key use case for crypto mixers is that they can facilitate fast cross-border transactions.
Microsoft and Tesla are two well-known examples of companies based in the United States that accept crypto payments for products.
And some corporations are now paying their staff in crypto too. But without using a mixer, companies are subject to hacking and phishing, since the blockchain’s ledger is publicly available.
Instead, crypto mixers can be beneficial for concealing the recipients by using anonymous addresses, and protecting payments. What’s more, these payments can be settled in as little as an hour, leading to fast international transactions with high security.
At a time where many international payments take days to settle, this could be an advantageous way to secure much-needed income quickly.
What are the risks of crypto mixers?
Unfortunately, many who seek to abuse cryptocurrency use mixers to do so.
As mentioned, crypto mixers work because of the afforded anonymity, meaning users could be unknowingly pooling their coins with money launderers, terrorist financiers or cybercriminals.
If crypto firms are revealed to be accepting these coins, it places them at risk of:
- Reputational damage
- Loss of funds
- Regulatory sanctions
Users of centralized cryptocurrency mixers are putting a whole lot of trust into a third party. This is where things can go wrong.
The service provider could be hacked, and be exposed to a data breach. Alternatively, if the regulators find evidence of money laundering within the mixer, it could freeze services and expose user identities.
When Europol seized ChipMixer earlier this year, the enforcement agency reported, “a large share of this is connected to darkweb markets, ransomware groups, illicit goods trafficking, procurement of child sexual exploitation material, and stolen crypto assets”.
Legitimate users were grouped with criminals,which would obviously tarnish their reputation. Likewise, it has shattered the trust for any exchange that was accepting ChipMixer coins, leading to inevitable customer churn.
Loss of funds
FTX is a well-known example of a crypto exchange that has recently collapsed. But, less known is the fact that $10 billion worth of customer coins were transferred through a ‘backdoor’, and approximately $1.7 billion of this still can’t be accounted for.
It’s unclear whether executives at FTX intended to hide these funds or whether they were simply lost. Either way, since the blockchain is typically so traceable, it’s likely a crypto mixer was used to offer privacy during their transactions.
A loss of funds can also happen accidentally through crypto mixers. As the second phase of mixing – to make coins untraceable – is incredibly complicated, the algorithmic process can go wrong, resulting in either:
- The wrong amount of coins making it to the recipient wallet
- No coins making it to the recipient wallets
Since users can often set the amount of time they allow coins to be mixed, this is more likely to happen as mixing time increases.
Regulatory compliance is likely to be one of the biggest concerns for cryptocurrency exchanges and ICOs, and while mixers aren’t inherently illegal in the UK and Europe, there’s enough noise around them to create a compliance headache.
- Institutions, such as wallets and exchanges, registering with the FCA
- Institutions practising customer due diligence and sending suspicious activity reports
- Sharing information with Financial Intelligence Agencies since they have the authority to obtain an owner’s address
Ensuring that an exchange follows 5AMLD might therefore be difficult if mixed coins are allowed.
There is also the consideration of future growth. If your exchange is hoping to operate in the US any time soon, it’s important to be aware that the US Deputy Assistant Attorney General recently stated that “seeking to obscure virtual currency transactions is a crime.”
Should your crypto firm allow mixed coins?
Despite less than 1% of crypto users relying on mixers to make their transactions more private, the total value of coins passing through mixers in 2023 was approximately $67 million.
As such, for many crypto firms, the risks may just not be worth it. However, at the end of the day, it depends on your organization’s jurisdiction, company values, and risk-aversiveness.
Performing due diligence.
KYC processes are an integral part in ensuring crypto exchanges can protect themselves and their customers from fraud and money laundering, even amid an evolving crypto regulatory landscape. Having these controls in place will protect investors from financial losses and add stability to a notoriously volatile market.
IDnow’s highly configurable identity verification solutions work across multiple regulations, industries and use cases, including crypto. Whether automated or expert-assisted, its online identity-proofing methods have been optimized to meet the strictest security standards and regulatory requirements without compromising on customer conversion or consumer experience.
Global Head of Crypto and Fintech at IDnow
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