What is Anti-Money Laundering (AML)?
AML (Anti-Money Laundering) regulations aim to prevent illicit funds from being disguised as legal income (in other words, being laundered). Money laundering is the process of converting “dirty” money into “clean” cash. This can be accomplished by concealing the funds’ origins, mixing them with genuine transactions, or investing them in legal assets.
Cryptocurrency is a popular means to launder money because of its anonymity and regulatory gaps. Large-scale crypto seizures reveal that criminals often utilize it to launder large sums of money, which makes monitoring unusual activity an inevitable part of security measures for cryptocurrency exchanges.
Individual nations and international bodies such as the FATF (Financial Action Task Force) have passed legislation to prohibit money laundering. To stay AML compliant, crypto exchanges should monitor suspicious activity and report it to respective authorities.
First, let’s explore how money laundering works, and then we’ll move the practices used to prevent illegal financial activities.
How does money laundering work?
Criminals use money laundering to disguise illicit funds as legitimate income. The money comes from illegal activities like drug trafficking, terrorism, and fraud.
The process of laundering money goes in three stages:
- Criminals are incorporating “dirty” money into a financial system. This process is called placement.
- They move their funds around to make it more challenging to track their transactions. One of the techniques used to conceal the source of “dirty” money is cryptography. This process is called layering.
- Finally, they reintroduce “dirty” money into the economy through investments or other financial operations that look legitimate. This process is called integration.
What exactly is AML?
Anti-Money Laundering (AML) regulations aid in the prevention of illegal funds being laundered. AML compliance is applicable to any financial businesses, cryptocurrency exchanges in particular, and helps protect their customers and fight financial crime. However, cryptocurrency regulation is challenging due to its anonymous nature and revolves around tracking customer behavior.
AML is a set of rules and laws designed to prevent the transfer of unlawful funds. The introduction of AML policies is linked to the Financial Action Task Force (FATF). Let’s see how those policies work.
What is the FATF?
The FATF (Financial Action Task Force) is an intergovernmental regulatory body established by the G7 in 1989 to combat terrorism financing and money laundering. Terrorist financing, tax fraud, and transnational smuggling are all targets of AML regulations overseen by the FATF and other bodies. Although AML requirements vary by country, there is a global attempt to unify them.
Cooperation between different governments and jurisdictions also promotes information exchange and more efficient money launderer tracking. Over 200 jurisdictions have agreed to abide by the FATF’s rules, and the number is growing. The FATF conducts monthly evaluations to ensure that all participants are adhering to the regulations.
How do AML practices work and why should the world of crypto be concerned about them?
Money laundering tactics have been evolving along with technological advancements. Different types of AML software are introduced to make compliance easier and alert about potentially suspicious behavior. Large money transactions and recurrent account transfers are examples of activities that might be flagged as suspicious. AML measures also include cross-checking against people added to watchlists.
Anti-money laundering legislation applies to any asset and currency, including crypto. But with the latter, it’s harder to regulate financial activities. Given that the blockchain technology (crypto is based on) is continually evolving and the world of cryptocurrencies is expanding, AML procedures and measures are regularly updated. However, the regulation of crypto isn’t necessarily seen as a good thing. Anonymity and decentralization are essential to many cryptocurrency holders, and increasing regulation that implies documenting user identities is frequently perceived as going against the spirit of crypto.
How are AML measures applied?
The processes of regulating cryptocurrency exchanges can be broken down into three major steps:
- Suspicious actions, such as massive inflows or outflows of funds, are automatically recognized and reported. Another example is inconsistent behavior within an account.
- The user’s ability to deposit or withdraw funds is suspended during or after an investigation. This measure eliminates any further laundering opportunities. Following that, the investigator creates a Suspicious Activity Report (SAR) on a user.
- If there’s proof of illegal activity, the appropriate authorities are notified. If discovered, the stolen money will be returned to its rightful owners.
AML requirements are usually taken very seriously by cryptocurrency exchanges. The two most essential tools in combating money laundering schemes are transaction monitoring and better due diligence.
What is the difference between anti-money laundering (AML) and know-your-customer (KYC) policies?
AML laws require financial institutions and service providers to conduct Know Your Customer (KYC) checks. Users are required to submit personal information to verify their identity and therefore establish accountability for their financial transactions. While other AML practices only track suspicious activities, KYC is what requires due diligence checks.
Why do we need anti-money laundering (AML) in crypto?
The numbers speak for themselves: criminals used cryptocurrency to launder an estimated $1.3 billion in “dirty” money in 2020. For various reasons, cryptocurrency is well-suited to money laundering:
- Transactions are final and cannot be reversed. You can’t get your money back once you’ve passed it across the blockchain until the new owner transfers it back to you. You will not be able to recover funds through the police or regulatory bodies.
- Anonymity is a feature of cryptocurrency often seen as its major benefit.
- Its regulation and taxation remain fragmented. Criminals take advantage of the fact that authorities worldwide are still struggling to tax cryptocurrency in a unified and comprehensible manner.
While criminals utilize cryptocurrencies to launder illicit funds and commit tax evasion because of their anonymous nature, cryptocurrency regulation boosts its general reputation while also ensuring proper taxation. Improvements in anti-money laundering (AML) policies help legal crypto users feel safe. However, they do require additional effort and time from all businesses involved with crypto, as well as many regulatory bodies.
While AML regulation makes the process of cryptocurrency trading a bit slower, it is important to keep everyone secure. Technology in detecting potential money laundering is improving, and cryptocurrency exchanges take their role in combating financial crime. Unfortunately, governments and organizations can hardly ever eliminate all money laundering activities, but legislation can help minimize them, and different jurisdictions are putting a lot of effort into solidifying their regulatory tactics.