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How criminals leverage non-compliant crypto exchanges for money laundering.

As the rise of crypto continues, so does the risk of criminal activity. What can crypto firms do to protect their business and customers from fraud?

Could Satoshi Nakamoto have predicted how profoundly Bitcoin would change the landscape of the traditional financial system when he released his Bitcoin White Paper on October 31, 2008? 

In that whitepaper, Nakamoto wrote of virtual currencies that use cryptography to secure and verify transactions. He explained that bitcoin miners (or nodes) support the network and provide a way to initially distribute coins into circulation. Since there is no central authority to issue coins the nature of the Bitcoin blockchain lends itself to decentralization. 

Within just a few years of the white paper, so-called cryptocurrencies had blossomed all over the internet. However, because there is no central authority, cryptocurrencies are operated independently and exchanged with a much more limited supervision, mostly through crypto exchange platforms. Since cryptocurrencies provide a high degree of anonymity that is often unattainable in the traditional financial system, it has attracted criminals looking to launder money from their illicit activities.  

From the 2010s to modern day, the steady increase in use of cryptocurrencies forced the hand of European lawmakers to devise a European legal framework. With the creation of countless crypto-related businesses and exchange companies, European institutions had to implement proper legislations for crypto activities.  

There are two important legislations that are relevant in the fight against money laundering in the crypto industry. The first is the Anti Money-Laundering Directive 5. Read our glossary entry on ‘What is money laundering’ for more information on the different stages of money laundering, how it works, and some of the latest techniques fraudsters are using to defraud victims.

The second legislation that will help regulate the crypto industry, thereby preventing money laundering, is the Markets in Crypto-Assets (MICA) Note: As the UK is no longer part of the European Union, UK lawmakers have started work on their own proposed crypto regime. In addition to defining clear rules for designated actors conducting crypto transactions, the EU and the UK has also established a set of rules and principles to safeguard against the misuse of crypto assets. Each country will however be required to enforce said requirements on a national level. Read more about one country’s journey toward compliance in our ‘Cryptocurrency in Germany: Is it regulated and safe?’ blog.

Newly adopted regulations now require crypto exchanges and custodian wallet providers to implement KYC/AML regulations to better deter money laundering. However, non-compliant crypto platforms are still out there, posing numerous risks to their businesses, and their customers. 

The long and bumpy road toward compliance. 

It’s safe to say that in the early days of crypto, crypto firms were perhaps not as ‘keen’ on transparency as they are now. These days, KYC and compliance measures are top of mind for crypto firms, as operations are now under heavy scrutiny by national and international authorities. Crypto firms must therefore enforce strict screening processes, by ensuring there is a robust KYC process in place to verify customers’ identities, addresses, and source of funds. Monitoring transactions and assessing risks are also part of their requirements. Implementing such measures means processes invariably need to be revamped, or new programs developed. 

Because of the arduous road to becoming regulation-ready, many exchanges decide to forgo improvements, and are still operating non-compliantly and without KYC measures in place. 

Criminal actors, whether traditional finance or crypto, are always on the look-out for platforms without proper KYC mechanisms, to gain access and engage in fraudulent activity. Even when crypto platforms comply to the highest KYC standards, some users are still able to circumvent those controls (see our previous article: ‘Buying crypto without a KYC check? Here’s why it’s risky for both users and platform operators.’). Using non-compliant crypto exchanges can be risky for customers, as they may lose their funds following a mandatory shutdown. On top of that, non-compliant exchanges may not have adequate security measures to protect user funds and personal information. This makes them vulnerable to a whole host of different attacks. 

History has shown that authorities have little patience with non-compliant crypto platforms. In 2017, BTC-e was shut down by law enforcement in the United States after it was accused of facilitating money laundering and other illegal activities.  

Alexander Vinnik, one of BTC-e’s founders, was alleged to have stolen identities, facilitated drug trafficking, and helped to launder criminal proceeds from syndicates around the world. He was later sentenced in France to a five-year jail sentence, after a long and complex legal battle with U.S. and Russian authorities amid an intelligence imbroglio.  

In 2020, crypto exchange platform BitMEX was charged with violating AML/KYC regulations by the U.S.  In October 2021, the Seychelles-based company agreed to pay as much as $100 million to resolve charges with CFTC and the Financial Crimes and Enforcement Network. 

Laundering crypto money 101. 

Thanks to weak AML and KYC policies, non-compliant crypto exchanges provide an accessible avenue to launder money, particularly when they offer on- and off-ramp facilities, which facilitate cryptocurrency being exchanged for fiat (government-issued currency). 

According to Chainalysis, illicit addresses sent nearly $23.8 billion’s worth of cryptocurrency in 2022, which was an increase of 68% compared to 2021.  

Dark net marketplaces offer money laundering services, but they are not the only means used by bad actors for laundering crypto. On-chain money laundering mixers help criminals convert crypto from illicit origins, by obfuscating blockchain transactions with a view to masking the proceeds of crime. More traditional intermediaries can also be used to hide the origin of funds for crypto trading, such as offshore accounts and shell companies. Click here to discover how money laundering is threatening the stability and integrity of online casinos.

How money laundering in crypto works.

Criminals employ various techniques and services to channel funds through multiple addresses or businesses, concealing their origins. Subsequently, these assets are transferred from an ostensibly legitimate source to a destination address or exchange for conversion into cash. This intricate process greatly hinders efforts to trace laundered funds back to illicit activities.

Below are popular crypto scams and common methods criminals use to launder blockchain funds:

  • Smurfing: Large sums of money are split into smaller amounts that are sent through via multiple transactions.  
  • Mixing: These services are used to obscure the transaction history of a cryptocurrency by blending cryptos of multiple users. 
  • Offshore Transactions: Offshore accounts are used by criminals to obscure the origin of funds. 
  • Services based in high-risk jurisdictions: Those services are located in areas flagged for deficiencies in their Anti-Money Laundering (AML) or Combating the Financing of Terrorism (CFT) systems.
  • Fiat exchanges: Fiat exchanges convert crypto to cash, varying from mainstream to peer-to-peer (P2P) or non-compliant platforms, and after cash conversion, traditional financial investigation methods are necessary.
  • Nested Services: Nested services within exchanges leverage hosted addresses to access liquidity, enabling potential misuse by bad actors for money laundering in exchanges with lax compliance standards.
  • Exchange Hopping: Criminals also use multiple crypto exchanges to transfer funds across different platforms, making tracing the money trail difficult. 
  • Privacy-Oriented Cryptocurrencies: Some blockchains employ advanced cryptographic techniques to hide transaction amounts, addresses, and other information. 
  • Gambling Platforms: Cryptocurrency money launderers favor gambling platforms, using a mix of identifiable and anonymous accounts to deposit funds, which are then either cashed out or used in coordinated bets with affiliates.

Preventing money laundering through dedicated regulations and mechanisms. 

In recent years, regulators have stepped up to enforce sanctions toward non-compliant operators in the crypto industry. Between criminal charges and sanctions lists, crypto entities operating either knowingly or unknowingly for illegal actors are now facing increased regulatory pressure and scrutiny. In fact, in 2023 and beyond, taking steps to become compliant with AML regulations should be the top priority for all crypto exchanges. 

Crypto operators must implement strong KYC/AML mechanisms to ensure they are in full compliance with local legislation. This can also help regulators by identifying any red flags associated with certain transactions. For example, by adopting a layered approach through geofencing, account profiling and identity screening, crypto exchanges can drastically improve their AML/KYC programs. Recent developments in artificial intelligence mean the implementation of such detection tools can help to significantly deter criminals looking to launder money, whilst improving compliance levels.  

The implementation of these robust controls will enable exchanges to participate in the fight against money laundering and contribute to the democratization of crypto currencies, which will ultimately lead to further mass adoption.

Read our latest blog to discover money laundering red flag indicators.

KYC to power crypto adoption. 

Although enforcing KYC measures was a controversial decision for some crypto purists as it appears to go against many of the principles outlined by Nakamoto, they are an important tool for cryptocurrency platforms to prevent money laundering. As cryptocurrency adoption continues to increase, KYC processes have become an essential step in safeguarding the community.  

Non-compliant exchanges will remain a target for money laundering specialists as they offer an opportunity to exploit gaps in controls. Non-compliant exchanges are also at risk from the authorities, which could not only impose major financial sanctions and business closures, but also criminal charges for mismanagement. In short, the existence of non-compliant exchanges poses a threat to crypto firms, crypto customers and the crypto industry itself.

Read more about the the novel, and potentially problematic approach by new crypto platform, Worldcoin to eschew traditional customer onbroading in favour of iris scans.

Putting the KYC into crypto. 

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.  

For more information on why using crypto platforms without KYC processes is a risk, check out our ‘Buying crypto without a KYC check? Here’s why it’s risky for both users and platform operators.’ blog

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.

For more insights into the events that have affected financial services, crypto, and gambling in 2023, and what trends will shape 2024, check out our blog, ‘Unlocking the benefits of an identity-first 2024.’


How criminals leverage non-compliant crypto exchanges for money laundering. 1

Jason Tucker-Feltham
Head of Crypto Sales at IDnow
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