The emergence of innovative technologies like decentralized exchanges (DEXs) and cross-chain bridges has significantly reduced obstacles to the unrestricted movement of capital between different blockchains.
However, in addition to their application in retail payments and various financial transactions, the Financial Action Task Force (FATF) has identified crypto assets being employed in a diverse array of criminal activities. These include money laundering, the illicit trade of controlled substances and prohibited items like firearms, fraud, tax evasion, circumvention of sanctions, computer-related crimes such as cyber-attacks resulting in theft or ransomware, exploitation of children, human trafficking, and financing of terrorist activities.
Criminals exploit the anonymity provided by these tools to transfer billions of dollars in cryptocurrency across various assets and blockchains, effectively obscuring their illicit financial transactions.
Virtual or crypto assets possess various characteristics that make them enticing to individuals and businesses. Unfortunately, these same attributes make them equally attractive to criminals and terrorists. The broad spectrum of illicit uses highlights the need for robust measures to address and mitigate the risks associated with crypto assets.
It is therefore imperative for countries to establish stringent regulations or prohibitions regarding crypto assets. At the same time, the financial industry must comprehend its responsibilities and diligently adhere to obligations aimed at curbing the risks of money laundering and terrorist financing.
Money laundering has a precise legal definition that must be adapted to the cryptocurrency context. The U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) defines money laundering as the three-step process of making “illegally-gained proceeds (i.e. ‘dirty money’) appear legal (i.e. ‘clean’),” by 1) placing dirty money in the legitimate financial system, 2) layering it within additional transactions to obfuscate its origins, and 3) integrating it into the financial system with more transactions so that funds appear licit.
Stated below are a few protocols extensively used for leveraging money laundering objectives and obfuscating trails of illegally acquired funds.
Cross-chain bridges are advanced protocols or mechanisms designed to facilitate effortless transfers of digital assets between diverse blockchain networks. They allow users to interact with assets on one blockchain while maintaining their value and functionality on another. By obviating the necessity for centralized exchanges, these bridges enhance liquidity across multiple chains, fostering a more interconnected and inclusive decentralized finance (DeFi) ecosystem.
Layering through Multiple Chains: Money launderers exploit cross-chain bridges to execute complex layering techniques. By leveraging the interoperability offered by these bridges, they move funds between different blockchains, obfuscating the source of the assets. This layering process involves transferring funds through multiple chains, making it extremely difficult to trace the origin and destination of the illicitly obtained funds.
For example, a money launderer could convert their ill-gotten gains into a privacy-focused cryptocurrency like Monero, known for its enhanced anonymity features. They can then use a cross-chain bridge to transfer the Monero to another blockchain, such as Ethereum or Binance Smart Chain, further complicating the tracing process. By repeating this process across multiple chains, they create a convoluted trail that makes it challenging for investigators to follow the flow of funds.
Example: Ren Protocol is a cross-chain liquidity protocol that facilitates the transfer of assets between blockchains, including Bitcoin, Ethereum, and other networks. While the Ren Protocol serves legitimate purposes, it can also be utilized for money laundering. Criminals can leverage Ren Protocol's interoperability to move funds across different chains, effectively disguising the origin and destination of the laundered assets.
Mixers and tumblers refer to cryptographic tools or services that blend various streams of funds, potentially eliminating the ability to trace the original source of those funds. Their primary purpose is to safeguard the privacy of crypto asset holders by allowing them to combine their coins with others in order to maintain anonymity.
These are specialized services that aim to enhance privacy and fungibility in cryptocurrency transactions. The primary objective of a coin mixer is to break the link between the sender and the recipient of the cryptocurrency, thereby creating a layer of anonymity and making it challenging to associate specific funds with their original source.
Money launderers exploit coin mixers to obscure the illicit origins of their stolen funds and create an illusion of legitimacy. Through a series of intricate steps designed to confound transaction trails, they effectively launder money, making it almost impossible to trace the flow:
