Do digital currencies and cryptocurrencies pose a higher risk of money laundering?

Cryptocurrency, once a niche area of finance, is now mainstream.

The opinions expressed here are those of the authors. They do not necessarily reflect the views or positions of UK Finance or its members.

In its report issued in February 2022, the UK Government estimated more than 10% of UK adults owned or had owned some form of crypto asset. The European Central Bank has widely discussed digital currencies and outlined its plans for a digital euro in 2021, and the UK is considering a digital pound as a complement to existing banknotes.

Crypto and digital currencies offer convenience and new investment opportunities, but concerns remain about the risk of money laundering and other types of financial crime. Criminals can exploit the relative anonymity of digital currencies to disguise the origins of illicit funds, complicating tracing efforts. Cryptocurrency payments can also often be used for ransomware payments following cyberattacks, with criminals using encrypted technologies to evade law enforcement.

An estimated $22.2 billion was laundered globally using cryptocurrencies in 2023, which is a decrease on the 2022 estimate of $31.5 billion. This could indicate improved risk detection, or that criminals are adapting to avoid being caught.

Despite the $22.2 billion thought to have been laundered through crypto in 2023, it is only a fraction of the $3 trillion believed to have been laundered globally last year. Nevertheless, it represents a significant risk that needs to be managed carefully and effectively.

Financial institutions need to consider where they are exposed to crypto-related risk – be that direct or indirect risk – and particularly conscious of where digital and fiat transactions meet.

Crypto provides a layer of relative anonymity in transactions due to the lack of centralised oversight, which makes it an attractive option for money launder processes. It also complicates the task of tracing the flow of funds and identifying the individuals involved. However, blockchain technology is designed to ensure every transaction is captured on an immutable ledger, in theory making transactions more transparent, if not time consuming, to trace.

The unique level of insight provided by blockchain technology, and “on-chain” data provides an opportunity for enhanced risk management and AML efforts. While tricky and time consuming, transactions can be meticulously analysed and tracked.

Off-chain data poses different challenges. When digital assets are exchanged with fiat currencies or assets outside the blockchain, the trail becomes less accessible. One scheme employed to exploit vulnerabilities between digital and fiat currencies is the use of money mules as intermediaries. For example - an individual has crypto deposited into a wallet, which they convert into fiat currency, obscuring the trail of funds and effectively washing the money.

Preventing money being laundered through cryptocurrencies demands a multi-faceted approach that combines regulatory standards, data, workflow technology, and anti-financial crime best practices. Collaboration between government agencies, financial institutions, and technology providers is crucial to meeting new threats posed by new opportunities.

Red flags for crypto money laundering may include unusual transaction patterns, large volumes of transactions involving high-risk jurisdictions, and attempts to obfuscate the source of funds, which probably sound familiar to those in traditional sectors.

To mitigate risks, robust due diligence is essential before onboarding clients, and ongoing checks help identify emerging threats. Transaction monitoring systems are also crucial for detecting unusual patterns or attempts to obscure the source of funds.

Digital currencies pose risks, but they offer opportunities for innovation and financial inclusion. Understanding risk exposure holistically is crucial for the safe growth of the crypto industry, pushing investors forward while marginalising criminals.