What Is AML (Anti-Money Laundering)?

The “2022 Crypto Crime Report” by Chainalysis, stated that in 2021, the total amount of money laundered via crypto was $8.6 billion which was a 30% increase from 2020. The report went on to mention that the total amount of money laundered via crypto exchanges since 2017 is $33 billion.

It is perhaps no surprise that the growth of the crypto industry also saw a corresponding rise in illegal crypto activities such as money laundering. These activities can put a stain on the industry thus it is important to have rules and laws in place to regulate the industry. Crypto regulations, such as crypto anti-money laundering (AML) regulations, are not there just to maintain the industry's image but more importantly to ensure the safety and transparency of its users.

In this article, we take a look at what AML is and why is it important for crypto exchanges.

What Is AML

Money laundering is the process whereby criminals use to disguise the origins of their illegally obtained money and it has become a global issue that affects not just cryptocurrencies but also fiat currencies. Thus there is a need for rules to be in place to regulate and combat money laundering. This is where crypto AML and its laws come in. They aim to prevent criminals from exchanging their unlawfully obtained crypto funds for cash.

Since the introduction of Bitcoin back in 2009 and other cryptocurrencies thereafter, there have been numerous high-profile financial crimes that involved crypto. Perhaps one of the most infamous examples was the Silk Road case. The black market platform utilized anonymization technology to obfuscate users’ IP addresses and mask transactions that were conducted using Bitcoin. The FBI shut down the site in 2013 and they managed to seize more than 144,000 bitcoins which were valued at $34 million back then.

The Financial Action Task Force (FATF), also known as the Groupe d’action financiere, “sets international standards that aim to prevent these illegal activities and the harm they cause to society” and “is the global money laundering and terrorist financing watchdog”. As money laundering has no geographical boundaries, the FATF has developed the FATF standards which ensure that there is a coordinated global response to combat the financing of criminal activity. The reports and guidance published by the FATF are highly respected by policymakers. In fact, the FinCen (US), European Commission and the regulatory bodies of many other countries in the FATF’s member jurisdictions have made FATF’s crypto AML recommendations law and have started enforcing them.

Why AML Is Important For Crypto Exchanges

The FATF produced a report in 2014 highlighting three main areas of concern with cryptocurrencies:

High degree of anonymity

As crypto transactions are generally conducted on the internet with ways for anonymous funding, transactions conducted with crypto may allow for a higher degree of anonymity compared to traditional fiat currency transactions.

Global and segmented reach

Crypto transactions can span across many different borders and jurisdictions which makes surveillance and enforcement more difficult as it might require the involvement of different entities from different countries.

Lack of a central authority

The high degree of anonymity in crypto transactions means that it can sometimes be difficult to identify the specific country to impose the necessary rules on them.

As financial services providers, crypto exchanges have a duty to combat illegal crypto activities and transactions. According to Gemini, 95% of all crypto trades are conducted using centralized exchanges, which serves to further highlight the importance of the role that crypto exchanges play in enforcing AML regulations.

The FATF sets the guidelines and standards for crypto AML regulations. It is then up to the Virtual Asset Service Providers (VASPs) as defined by the FATF which includes crypto exchanges, stablecoin issuers, certain DeFi protocols and NFT marketplaces, to actively monitor crypto transactions for suspicious activity and whether they infringe on AML rules.

Travel Rule And AML

The FATF introduced the Travel Rule in 2019 which requires VASPs “to send, receive and sanction screen customer personal information alongside a crypto transaction over a particular threshold.” However, countries have different interpretations and implementations of the Travel Rule. For example, the Travel Rule stipulates that VASPs must apply the Travel Rule to any transaction over $1000 involving another VASP. However, the current US rules state that $3000 is the amount to be used instead.

Even though countries differ in their approach to the Travel Rule, the underlying principle of the sharing of customers' information between VASPs remains. Both the Originator and Beneficiary VASPs must collect, verify and transmit customers’ information on their end.

While the Travel Rule requires VASPs including crypto exchanges to take extra steps and measures, having the Travel Rule in place ensures that due diligence and proper counterparty risk mitigation are done in the screening of crypto transactions to prevent sanctioned individuals or entities from laundering money.

KYC

KYC, also known as “Know Your Customer”, is the procedure that VASPs use to confirm the identification of their platform users. Crypto KYC helps “connect pseudonymous cryptocurrency addresses to real-world entities in the event that the addresses are connected to the crime” thus ensuring robust identity verification checks during the customer onboarding process which can help with the traceability of funds and people involved in the money laundering process.

Both KYC and AML have the same goal of preventing the use of crypto transactions to launder money. Therefore, it is easy to see how KYC goes hand in hand with AML.

As the crypto industry continues to grow and reshape the global financial network, the industry will undoubtedly be subjected to increased scrutiny. AML regulations provide regulators around the world with guidelines and frameworks to enforce these practices into law to prevent money laundering. This will help build trust and further the growth of the crypto industry.

Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service. Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.