by Micah Kindred, Associate Member, University of Cincinnati Law Review Vol. 91
Cryptocurrency is becoming mainstream, and, because of this, criminal activity associated with cryptocurrency is on the rise as well. Money laundering is one of the more prevalent criminal threats that is already taking place through cryptocurrency. Some U.S. government entities have released regulations to help curb the use of cryptocurrency to launder money. This article will explore the current United States anti-money laundering regulations relating to cryptocurrency and will suggest potential changes. Part II will provide a brief description of the current crypto money laundering landscape. Part III will examine the regulation of crypto exchanges, traditional banking regulations, and how both may be used to further prevent crypto money laundering. Part IV concludes with a possible approach to future cryptocurrency money laundering regulations.
The amount of money laundered through crypto increased thirty percent from 2020 to 2021, equating to $8.6 billion in 2021 alone.1Gertrude Chavez-Dreyfuss, Crypto Money Laundering Rises 30% in 2021, Chainalysis Reuters (Jan. 26, 2022), https://www.reuters.com/technology/crypto-money-laundering-rises-30-2021-chainalysis-2022-01-26/. Crypto’s appeal for money laundering is most likely due to its very purpose––crypto was created as “a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.”2Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, Bitcoin (2008), https://bitcoin.org/bitcoin.pdf. The exclusion of financial institutions is likely the primary reason criminals are turning to crypto to launder money. Removing central authorities like financial institutions from financial transactions allows criminals to circumvent traditional anti-money laundering regulations.
Another major appeal for money launderers is the availability of “mixers.” A mixer is a centralized or decentralized service that “increases the anonymity of certain crypto transactions.”3Sean Stein Smith, Crypto Mixers Are Making Headlines, But What Are They?, Forbes (Aug. 14, 2022), https://www.forbes.com/sites/seansteinsmith/2022/08/14/crypto-mixers-are-making-headlines-but-what-are-they/?sh=58499986492c. Some mixers are noncustodial, meaning the cryptocurrency is never held by another entity or third party.4Id. These types of mixers handle the crypto by using smart contracts, which are “digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met.”5Id.; What are Smart Contracts on Blockchain?, IBM, https://www.ibm.com/topics/smart-contracts (last visited Oct 6, 2022). Each mixer uses a different method to mix crypto, but essentially users deposit dirty crypto, or crypto associated with illegal activity, into a smart contract that “mixes” the crypto so that users can then withdraw the same amount of clean crypto they put in after a certain period of time.6Smith, supra note 3. These services are appealing for money launderers because the services increase both anonymity and privacy of transactions.7Id. Due to the level of anonymity crypto provides, and its exclusion of central authorities, money laundering through crypto is a natural progression for money laundering schemes.
Money laundering via cryptocurrency is a major concern.8Chavez-Dreyfuss, supra note 1. Some of the criminal groups that utilize cryptocurrency for money laundering are “ransomware attackers, malware operators, scammers, human traffickers, dark net market operators, and terrorist groups.”9Id. To combat this threat, the U.S. government has provided some regulations. Most notably, Congress has released the Bank Secrecy Act, the Anti-Money Laundering Act of 2020, and additional regulations.10Katherine A. Lemire, Cryptocurrency and Anti-Money Laundering Enforcement, Reuters (Sept. 26, 2022), https://www.reuters.com/legal/transactional/cryptocurrency-anti-money-laundering-enforcement-2022-09-26/. These regulations apply to “money services businesses,” which now include “administers or exchangers” of virtual currency.11Id. The Bank Secrecy Act requires all money services businesses, including those that exchange or transmit virtual currencies, to register with the Financial Crimes Enforcement Network of the U.S. Treasury (“FinCEN”).12Id. This requirement also applies to mixer service providers.13Id.
A. Crypto Exchange Regulation
To understand the current anti-money laundering regulations in the crypto space, an understanding of crypto exchangers and administrators is important. A crypto exchanger is “a person or entity engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.”14Id. A crypto administrator is a “person or entity engaged as a business in issuing a virtual currency and who has the authority to redeem such currency.”15Id.
In 2013, FinCEN declared that these exchangers and administrators “qualify as money services businesses under the Bank Secrecy Act (“BSA”) and FinCEN regulations.”16Id. Two of FinCEN’s requirements placed on money services businesses are that they register with FinCEN and develop, implement, and maintain an anti-money laundering compliance program.17Id. In the years following, FinCEN made clear that mixer service providers are regulated through the BSA and “businesses that exchange or transmit virtual currencies” are also regulated through the BSA and FinCEN.18Id. Beyond this, in 2020, FinCEN explained that the anti-money laundering requirements placed on other money services businesses applied to “decentralized finance,” which is blockchain-based finance that removes central authorities like banks and exchanges.19Id.
To comply with the varying anti-money laundering regulations, many crypto exchangers and administrators are “conducting KYC on new customers, monitoring transactions, and investigating suspicious transactions.”20Id. KYC stands for “know your customer,” which essentially requires financial institutions to verify the identity of their customers and understand the risk that each customer may be involved in suspicious activity like money laundering.21James Chen, Know Your Client (KYC): What it Means, Compliance Requirements, Investopedia, https://www.investopedia.com/terms/k/knowyourclient.asp (last visited Oct 6, 2022).
While these regulations are a good starting point for crypto anti-money laundering regulation, they present some major issues. Most significantly, criminals interested in money laundering are not likely to go through an exchanger or administrator that complies with U.S. government anti-money laundering regulations.22Daehan Kim, Mehmet Huseyin Bilgin & Doojin Ryu, Are Suspicious Activity Reporting Requirements of Cryptocurrency Exchanges Effective?, 7 fin. innovation SpringerOpen 78 (2021), https://jfin-swufe.springeropen.com/articles/10.1186/s40854-021-00294-6. Many exchanges do not require customer verification.23Barbara Thompson, Buy Bitcoin (BTC) Anonymously Without Verification or ID, Guru99 (Oct. 1, 2022), https://www.guru99.com/buy-bitcoin-without-verification-id.html. Moreover, many peer-to-peer crypto exchanges allow users to exchange crypto without a central authority, and crypto ATMs allow users to purchase crypto with cash.24Barbara Thompson, Buy Bitcoin with Cash or Deposit (Convert Cash to BTC), Guru99 (Oct. 1, 2022), https://www.guru99.com/buy-bitcoins-with-cash.html. The ability to buy crypto with cash may negate any regulatory ability the U.S. government might have since criminals will simply move away from central crypto exchanges and administrators in favor of the still available, easily accessible, and significantly more private alternatives.25Kim, Bilgin & Ryu, supra note 22. Peer-to-peer exchanges or networks present a different issue in that money launderers “can often use unsuspecting third parties to send funds on their way to the next destination” on these networks.26Bitcoin Money Laundering: How Criminals Use Crypto, Elliptic (Sept. 18, 2019), https://www.elliptic.co/blog/bitcoin-money-laundering. These peer-to-peer networks are one of the primary ways for money launderers to circumvent anti-money laundering regulations since they completely remove central authorities from transactions.27Id.
Further, the regulatory entities face another issue requiring crypto exchangers and administrators to comply with anti-money laundering requirements. The most probable exchanges to be used for money laundering are the decentralized exchanges, which are mostly in the early stages of development.28Kim, Bilgin & Ryu, supra note 22. Even if anti-money laundering regulations are put on these exchanges, whether exchanges will successfully implement the necessary requirements is questionable.29Id. One of the main reasons for this is crypto is still an incredibly new and tumultuous space, so these companies are focused on survival rather than compliance.30Id. Even if a decentralized exchanger wanted to comply, the pure lack of precedent for what money laundering looks like in crypto transactions makes it unrealistic that the exchanger would consistently successfully identify suspicious transactions regardless of effort.31Id.
B. Potential Improvements
Although current anti-money laundering regulations are necessary for crypto businesses, improvements can still be made. One possible improvement is to create a tiered system of regulation for crypto exchangers and administrators that accounts for the maturity of the exchanger or administrator based on the current regulations. Instead of requiring all exchanges and administrators to comply with expensive and confusing anti-money laundering regulations, have the regulations be based on the size of the company. This would allow new companies in the crypto space to grow without forcing them to decide between complying with anti-money laundering laws or keeping the company afloat. By removing the burden of implementing robust anti-money laundering programs, the government would incentive innovation among crypto companies. Smaller companies would be able to focus on furthering the crypto space rather than fearing of government action against them for the company’s lack of compliance. The potential for creating a working relationship between the U.S. government and crypto businesses because the government would be showing its willingness to work with the industry as it grows is an additional positive to this structure. One important caveat to this would be basing the tiers on the parent company of the exchanger or administrator as to avoid companies regularly creating new, small exchanges so they do not have to comply with anti-money laundering regulations. A tiered regulation system would have to be temporary though. Once crypto exchangers and administrators are normalized, the regulation would need to be restructured and become much more robust, but for now, a tiered regulation system could be useful to encourage innovation while still preventing extensive money laundering.
Since regulating crypto exchangers and administrators is likely insufficient, utilizing the anti-money laundering structures already in place at more traditional central authorities––like banks––could aid crypto anti-money laundering regulations. Banks already have the infrastructure to comply with anti-money laundering regulations like KYC.32Chen, supra note 21. Currently, banks must “identify their customers, beneficial owners of businesses, and the nature and purpose of customer relationships.”33Id. Additionally, banks must “review customer accounts for suspicious and illegal activity and maintain and ensure the accuracy of the customer accounts.”34Id. This includes reporting when someone:
(1) transports, is about to transport, or has transported, monetary instruments of more than $10,000 at one time— (A) from a place in the United States to or through a place outside the United States; or (B) to a place in the United States from or through a place outside the United States; or (2) receives monetary instruments of more than $10,000 at one time transported into the United States from or through a place outside the United States.3531 U.S.C.S. § 5316(a) (LexisNexis 2022).
These foreign reporting requirements could be revised to include transport to crypto exchangers or administrators. Additionally, the definition of suspicious transactions could be expanded to include transactions like frequently buying crypto at abnormal times when compared to the market (since crypto is primarily used as an investment) and other seemingly suspicious behavior relating to crypto.36Kevin Voigt & Andy Rosen, Cryptocurrency: Definition and Current Prices, NerdWallet (Nov. 14, 2022), https://www.nerdwallet.com/article/investing/cryptocurrency. A plethora of possibilities are available when it comes to utilizing banks’ anti-money laundering infrastructure to further prevent crypto money laundering.
These additional regulations could provide an alternative approach to preventing crypto money laundering and aid the regulations in place for crypto exchangers and administrators. Since banks have the infrastructure to implement new anti-money laundering regulations, they should also be a central part of crypto anti-money laundering regulations.
Anti-money laundering regulations are needed in the cryptocurrency space. However, the current regulations on their own are likely insufficient because they may inhibit cryptocurrency innovation if they are imposed on all crypto exchanges in the same way. To combat this issue, a tiered system for anti-money laundering regulation of crypto exchanges based on the maturity of the parent company could be created. To further prevent money laundering through cryptocurrency, traditional banks could be utilized by taking the current anti-money laundering infrastructure they have and applying the same to traditional currency to cryptocurrency transactions and vice versa. While these regulations will not be all-encompassing, as clear by the ability to purchase crypto with cash or other unverified means, crypto exchange and traditional bank regulations may provide a sound starting point for future cryptocurrency anti-money laundering laws.
- 1Gertrude Chavez-Dreyfuss, Crypto Money Laundering Rises 30% in 2021, Chainalysis Reuters (Jan. 26, 2022), https://www.reuters.com/technology/crypto-money-laundering-rises-30-2021-chainalysis-2022-01-26/.
- 2Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, Bitcoin (2008), https://bitcoin.org/bitcoin.pdf.
- 3Sean Stein Smith, Crypto Mixers Are Making Headlines, But What Are They?, Forbes (Aug. 14, 2022), https://www.forbes.com/sites/seansteinsmith/2022/08/14/crypto-mixers-are-making-headlines-but-what-are-they/?sh=58499986492c.
- 5Id.; What are Smart Contracts on Blockchain?, IBM, https://www.ibm.com/topics/smart-contracts (last visited Oct 6, 2022).
- 6Smith, supra note 3.
- 8Chavez-Dreyfuss, supra note 1.
- 10Katherine A. Lemire, Cryptocurrency and Anti-Money Laundering Enforcement, Reuters (Sept. 26, 2022), https://www.reuters.com/legal/transactional/cryptocurrency-anti-money-laundering-enforcement-2022-09-26/.
- 21James Chen, Know Your Client (KYC): What it Means, Compliance Requirements, Investopedia, https://www.investopedia.com/terms/k/knowyourclient.asp (last visited Oct 6, 2022).
- 22Daehan Kim, Mehmet Huseyin Bilgin & Doojin Ryu, Are Suspicious Activity Reporting Requirements of Cryptocurrency Exchanges Effective?, 7 fin. innovation SpringerOpen 78 (2021), https://jfin-swufe.springeropen.com/articles/10.1186/s40854-021-00294-6.
- 23Barbara Thompson, Buy Bitcoin (BTC) Anonymously Without Verification or ID, Guru99 (Oct. 1, 2022), https://www.guru99.com/buy-bitcoin-without-verification-id.html.
- 24Barbara Thompson, Buy Bitcoin with Cash or Deposit (Convert Cash to BTC), Guru99 (Oct. 1, 2022), https://www.guru99.com/buy-bitcoins-with-cash.html.
- 25Kim, Bilgin & Ryu, supra note 22.
- 26Bitcoin Money Laundering: How Criminals Use Crypto, Elliptic (Sept. 18, 2019), https://www.elliptic.co/blog/bitcoin-money-laundering.
- 28Kim, Bilgin & Ryu, supra note 22.
- 32Chen, supra note 21.
- 3531 U.S.C.S. § 5316(a) (LexisNexis 2022).
- 36Kevin Voigt & Andy Rosen, Cryptocurrency: Definition and Current Prices, NerdWallet (Nov. 14, 2022), https://www.nerdwallet.com/article/investing/cryptocurrency.