The process of money laundering using cryptocurrencies typically involves three stages: placement, layering, and integration. In the placement stage, the illegal funds are introduced into the cryptocurrency system through various means, such as buying them from an exchange, mining, or receiving them as payment for illicit activities.
The layering stage involves a series of transactions aimed at concealing the source and ownership of the funds, such as converting them into different cryptocurrencies, transferring them to multiple accounts, or using mixing services that pool multiple transactions to obscure the origin of the funds. Finally, in the integration stage, the laundered funds are returned to the legitimate financial system as apparently legal funds, either by selling the cryptocurrencies for fiat currency or by using them to purchase goods or services.
There are three predominant dimensions that make cryptocurrencies interesting for money launderers and therefore from our money laundering perspective. These dimensions are Anonymity and Scalability, and both, currently, and in the future, and due to the ease of use, criminals must be able to handle them without having to acquire too much time-consuming knowledge. In terms of scalability, it makes intuitive sense to look at the cryptocurrencies with the highest market capitalization, because money launderers such and terrorists need a certain transaction volume to facilitate their activities.
Money Laundering Using Cryptocurrencies
Having knowledge about different cryptocurrencies and being able to differentiate between their characteristics, is essential for crypto financial crime prevention and crypto compliance. This skill, the skill to be able to navigate between different cryptocurrencies, is something that currently only a very few people in the field of financial crime compliance can do. Under consideration of the most important money laundering cryptocurrencies dimensions, we will look at Bitcoin, Monero, Dash, ZCash, and Verge.
Let’s first talk about Bitcoin. Bitcoin is currently the most well-known cryptocurrency on the planet and is usually described as a virtual, decentralized, and, at the first glance, anonymous currency. Bitcoin is not government-backed or backed by any other legal entity. Bitcoin is based on the proof-of-work consensus mechanism. The issuance of Bitcoins takes place via mining. To reiterate, mining is the process of voluntarily making computers available to the Bitcoin network to solve complex mathematical problems. Computers that can solve such problems and, as a consequence, can create transaction «blocks» are rewarded with Bitcoins.
Bitcoin can be bought with and directly converted into fiat currency on a wide array of cryptocurrency exchanges. Examples of exchanges that currently accept Bitcoin are Coinbase, Kraken, Anycoin Direct, and Lunco. Out of all cryptocurrencies currently in circulation, Bitcoin is the easiest to convert into fiat currency. Bitcoin is often characterized as an anonymous currency. Although everyone can verify the chain of transactions based on the public ledger, at first glance nothing in the system connects Bitcoins to individuals. However, this anonymous character is far from absolute.
Even though it can be complex, it is technically feasible to identify the parties behind a Bitcoin transaction by bringing together factors that accompany such transaction. In other words, Bitcoin is not a fully anonymous currency, but rather a pseudo-anonymous coin.
However, Bitcoin is very interesting for criminal organizations, because the market volume is quite large, the infrastructure around it has been built, and it is well recognized and almost even reputable.
Secondly, there is Monero. Monero is an open-source P2P cryptocurrency with a focus on private and censorship-resistant transactions. It was launched in April 2014 and is based on what is known as the CryptoNote Proof-of-work algorithm. Monero has been specifically developed to allow its users to execute transactions in full anonymity. It is said to be cryptographically private by default. In particular, it uses cryptography to shield both sending and receiving addresses as well as the transacted amounts.
Monero is characterized as being fully fungible. This means that two units of XMR can always be mutually substituted and there can be no blacklisting of certain units of XMR by vendors or exchanges due to their association with previous transactions.
Non-fungible cryptocurrencies, like Bitcoin and Litecoin, are theoretically susceptible to blacklisting; if they have been used for illegal activity in the past, then such history will be contained in the blockchain forever.
The ring confidential transactions combine the technique of ring signatures and what is referred to in the crypto-community as the concept of the confidential transaction. Ring signatures combine or ‘mix’ a user’s account keys with public keys obtained from Monero’s blockchain to create, what could be called a ‘ring’ of signers, meaning outside observers cannot link a signature to a specific user.
Combined with stealth addresses they allow to fully obscure the identity of both senders and recipients of Monero. Confidential transactions add another layer of privacy to the ‘mix’ by also concealing the amount of each transaction. Without revealing the actual numbers, they include cryptographic proof that the sum of the input amounts is the same as the sum of the output amounts.
In addition to ring confidential transactions, Monero also makes use of stealth addresses. Stealth addresses are randomly generated, one-time addresses created for each transaction made by the sender on behalf of the recipient. All payments sent to the recipient are routed through these addresses, ensuring there are no links on the blockchain between the sender’s and the recipient’s address. In other words, stealth addresses prevent linkability on the blockchain.
These mechanisms make Monero incredibly interesting for criminals all over the world. In addition, its market capitalization was at almost 7 billion US-Dollar at the beginning of 2018. It was the best performing cryptocurrency of 2016 in terms of market cap. Unsurprisingly, Monero has been attributed to its popular use in criminal activity in the past over and over again.
Latly, there is Dash. Dash was formerly known as Darkcoin and is an open-source P2P privacy-centric cryptocurrency. It was first launched in January 2014 and is based on what is known as the X11 Proof-of-work algorithm. What is specific to Dash, and makes it different from most other coins, is that it has a two-tier network. Dash’s blockchain is secured via so-called “master nodes” in addition to the Proof-of-work done by miners.
A masternode is a server connected to the Dash network which guarantees a certain minimum level of performance and functionality to perform certain tasks related to PrivateSend and InstantSend, which are Dash’s anonymity and instant transaction features. Transactions with traditional cryptocurrencies can be very time-consuming, which means that they can take anywhere between a few minutes and more than one hour. This is because enough blocks have to pass to ensure that a transaction is irreversible and at the same time not an attempt to double-spend money that has already been spent.
Dash tackles this issue utilizing its masternode network. Masternodes can be called upon to form voting quorums to check whether or not a submitted transaction is valid and if it is, “the masternodes ‘lock’ the inputs for the transaction and broadcast this information to the network, effectively promising that the transaction will be included in subsequently mined blocks and not allowing any other spending of these inputs during the confirmation period”. As a result, Dash is said to be able to compete with nearly instantaneous transaction systems, such as credit cards.
Like Bitcoin’s blockchain, Dash’s blockchain is transparent by default, which means that generally speaking transactions are always openly verifiable and traceable on the blockchain. To give its users true financial privacy, Dash offers the option to use a feature called PrivateSend. PrivateSend obscures the origins of a user’s funds through a process known as “mixing”. A cryptocurrency mixing service is a service offered to mix potentially identifiable or tainted cryptocurrency funds with others, to obscure the trail back to the fund’s source. Dash is regarded as a privacy coin by many due to this very feature.
All of these features, make it very attractive for money launderers.
Instead of relying on cryptographic techniques, Verge banks on the existing and tested technology of The Onion Router TOR and the Invisible Internet Project I2P to protect users’ identities. Verge made headlines when a popular adult website adopted it to start accepting cryptocurrency payments. The primary reason for the development was Verge’s privacy features. As of May 2020, Verge ranked 85th by market cap with a total value of 63.3 million US-Dollar. While this market capitalization is not that big yet, Verge must certainly be watched and in case market capitalization skyrockets, it is like becoming more interesting for money launderers.
Money laundering using cryptocurrencies is a significant challenge for law enforcement agencies, financial institutions, and regulators. The anonymity and lack of regulation associated with cryptocurrencies make them an attractive option for individuals seeking to launder illegally obtained funds. However, through the implementation of regulatory frameworks, technological solutions, and strict due diligence procedures, it is possible to mitigate the risk of money laundering using cryptocurrencies and preserve the integrity of the financial system.