AML: Structuring and Layering Techniques in Crypto Tokenisation for Money Laundering and How to Detect Them

Structuring (Smurfing)

Structuring, also known as smurfing, involves breaking down large amounts of illicit funds into smaller, less conspicuous amounts to avoid detection. This is typically done to stay below reporting thresholds that would trigger red flags with financial institutions.

Example Scenario:

1. Initial Funds: A money launderer has a large sum of illicit money.
2. Smurfing Process: The launderer distributes this money to multiple individuals (smurfs). Each smurf deposits small amounts of money into various accounts across different banks and cryptocurrency exchanges.
3. Conversion to Crypto: These small amounts are used to purchase cryptocurrencies, often through different exchanges to avoid detection.
4. Further Transfers: The cryptocurrencies are then transferred through several wallets, adding layers to the transactions and making it harder to trace the funds back to their original source.

Layering

Layering is the next step after placement, aimed at further distancing the illicit money from its origins. It involves a series of complex transactions designed to obscure the audit trail and make the funds appear legitimate.

Example Scenario:

1. Initial Conversion: The launderer converts fiat currency into cryptocurrencies using the structured amounts from the smurfs.
2. Cross-Blockchain Transfers: The launderer moves the cryptocurrencies between multiple blockchains (e.g., converting Bitcoin to Ethereum and then to other altcoins), making the funds harder to trace.
3. Investments and Purchases: The launderer invests in tokenised assets, such as digital art or real estate, using smart contracts to automate and obscure transactions.
4. Integration: The launderer sells these assets or uses them to purchase legitimate goods and services, reintegrating the laundered money into the financial system as seemingly legitimate funds.

Detection and Prevention Strategies

1. Enhanced Due Diligence (EDD) and KYC:

• Robust Onboarding: Implement thorough KYC procedures to verify the identities of users and assess their risk profiles.
• Ongoing Monitoring: Continuously monitor user transactions for suspicious activity, including multiple small deposits, rapid transactions between different cryptocurrencies, and frequent cross-border transfers.

2. Transaction Monitoring Tools:

• Blockchain Analytics: Use advanced blockchain analytics tools to trace the flow of funds across different blockchains and detect patterns indicative of structuring and layering.
• Machine Learning: Employ machine learning algorithms to identify anomalies and suspicious transaction patterns that might suggest money laundering.
• In a nutshell you can integrate RegTech or automated AML solution to address both KYC/EDD and Blockchain analysis and AI/ML tools using solutions from SumSub or

3. Smart Contract Audits:

• Regular Audits: Conduct regular audits of smart contracts to ensure they do not contain vulnerabilities that could be exploited for money laundering.
• Automated Compliance: Develop smart contracts that enforce compliance rules, such as transaction limits and mandatory KYC, automatically.

4. Regulatory Reporting:

• Suspicious Activity Reports (SARs): Ensure that all suspicious activities are promptly reported to the relevant authorities, including detailed blockchain evidence to support investigations.
• Compliance Frameworks: Implement comprehensive compliance frameworks that align with international AML standards, such as those from the Financial Action Task Force (FATF).