CRYPTO CRIME DEBUNKED: Preventing Abuse of Virtual Assets: Combating Financial Crime and Money Laundering

Mubashir Malik; Tuesday 1st October 2024

Another Crypto-sceptic article I hear you cry? Not at all - Some of you may even seem overwhelmed with the amount of information or marketing being shovelled down your social media feed regarding cryptocurrencies -? including how you can become a billionaire overnight by just following that one crypto influencer on Instagram. Sound familiar?

Hear me out; there is absolutely no doubt that the rise of virtual assets using blockchain technologies, particularly cryptocurrencies, has revolutionised the financial landscape - which in my opinion - is a good thing that comes with many benefits and advantages.?

However, it is precisely these benefits and innovations that bring the risk of financial crime where criminals have started exploiting the sector for money laundering and financing terrorism.?

The criminals preference towards cryptocurrency and non-fungible tokens (also known as NFTs- I will explain what these are later) is owing to the nature of the products themselves– offering far greater opacity than traditional fiat currencies, much faster to transfer globally within a few seconds and finally keeping it all anonymous - a money launderer’s dream.

Let me give you some numbers for context:

• The Digital Assets market worldwide is projected to generate a revenue of US$57.7 billion by end of 2024 with an annual growth rate of -19.82% (CAGR 2024-2025)
• The number of users in the Digital Assets market is forecasted to reach 861million users by 2025.

(Source: Statistica)

According to Chainanalysis, since 2019, almost $100 billion in funds have been transferred from known illicit wallets to conversion services – where crypto is converted to fiat currency. The highest amount identified was $30 billion in 2022.

Almost $2 billion was wiped out by crypto hackers and fraudsters in H1 2024.

Hacks caused almost as much damage as attacks targeting retail investors like phishing scams. According to Nefture Security and Coinmonks, more than $1 billion was lost to various exploits, whilst in excess of $932 million were lost to scams through 278 crypto crimes totalling $1.9 billion. Approximately $188 million was recovered, bringing down the loss accrued during the first half of 2024 to around $1.7 billion. This year we also saw the biggest crypto heist recorded since the November 2022 FTX hack and the sixth biggest crypto heist ever: the $308 million DMM Bitcoin exploit.

There was a very refined, distinguished retired gentleman sitting next to me at the Cambridge Economic Crime Symposium last month who, during one of the workshops, said if these VAs are the source of so much criminal activity and is in fact making it seemingly work in their favour- then they should all just be banned globally - like class A drugs.

This drew some chuckles from the audience - however some countries such as China and others have indeed done just that.

So do we ban the industry altogether or manage the risks? How do we manage??

As I alluded to earlier, VAs offer a lot of legitimate business activities and uses.

This then means that all firms who deal and/or provide a platform to trade in these digital assets, referred to as - Virtual Asset Service Providers (VASPs), must stay on top of their game and remain alert to detect unusual trends or suspicious virtual asset transactions indicating the use of criminal proceeds for financial crime purposes.

As digital currencies become more mainstream, it is crucial to implement effective strategies to prevent their abuse.

I am going to explore the regulatory landscape as well as key measures that can be taken to safeguard ourselves against financial crime in the realm of virtual assets.

On a more ‘closer to home level’, the last thing we want is for somebody’s grandparent to be scammed into losing their life savings or pension fund through a crypto scam,? Okay, let’s face it - it can happen to ANYBODY - including you and me - and guess what -? it happens more often than you think!

But let’s back to basics if you are scratching your head thinking what on earth I am going on about.

Bitcoin, Stablecoin, Dogecoin, Ether, NFTs - Some of you may seem overwhelmed at what they all are? They are all Virtual Assets (VAs)

Best way to describe VAs is using the the definition of “Virtual Asset” as prescribed by the Financial Action task Force or FATF, which reads as under:?

“ a digital representation of value that can be digitally traded or transferred and used for payment or investment purposes.”?

The important elements of a Virtual Asset are:?

• VAs must be digital?
• It should have the ability to be traded digitally and transferred so?
• Should carry some value, as to be used for payment or investment

Whilst some people are increasingly familiar with cryptocurrencies such as Bitcoin and Ether, NFTs and VASPs are lesser known or understood.

An NFT is a unique virtual asset. Therefore, whilst you may purchase a lot of bitcoin, there is only one of each NFT in existence. They often come in the form of a digital artwork, another digital asset, or a representation of a real property. Do not worry - I will be doing a video on this soon to explain better.

A VASP as explained earlier is a business that provides one or more of the following services: the transfer or exchange between virtual assets and fiat currencies, or between different virtual assets; the safekeeping and administration of virtual assets; and providing financial services related to virtual asset issuance. It can also act as a virtual currency wallet for holding, storing and transferring virtual assets.

So - How do criminals launder money using Virtual Assets ?

A number of ways is the answer. (Don't try this at home)!

Money launderers will ask for a fee to provide money laundering services for other criminals who have sold illegal goods through the dark web for virtual currency.? Basically commission in return for cashing out or exchanging the funds, keeping the criminals' identities anonymous.

This often involves launderers taking ownership of the criminal’s digital wallets (this is where the virtual currency is stored) followed by ‘layering’, which involves multiple transactions converting from one virtual asset into another to remove all links to the original crime.

Furthermore in 2017 the Wannacry ransomware attack held thousands of computer systems hostage until the victims paid hackers a ransom in bitcoin. The cost of the attack went far beyond the ransom payments, it resulted in an estimated USD 8 billion in damages to hospitals, banks and businesses across the world. Other ransomware attacks have happened since and appear to be on the rise.

Understanding the key 3 Risks

1. Anonymity and Pseudonymity

Cryptocurrencies offer a level of anonymity that can be exploited by criminals. While transactions are recorded on a blockchain, the identities of the parties involved can be obscured, making it challenging for law enforcement to trace illicit activities.

2. Decentralization

The decentralized nature of many cryptocurrencies means there is no central authority to oversee transactions, complicating regulatory efforts. This can create a safe haven for money launderers and other criminals who seek to evade detection.

3. Cross-Border Transactions

The global reach of virtual assets allows for swift, cross-border transactions that can bypass traditional banking systems. This can facilitate the movement of illicit funds across jurisdictions, complicating enforcement and regulatory actions.

?How to create and implement strategies for Prevention?

1. Robust Regulatory Frameworks

Developing comprehensive regulations for virtual assets is essential - much like we already do for banks and financial services. Governments should work towards creating standardised rules that govern cryptocurrency exchanges, wallet providers, and other related entities. This includes:

- Licensing Requirements: Mandating that exchanges obtain licences to operate, ensuring they meet specific compliance standards.

- Transparency Regulations: Requiring businesses to disclose their ownership structures and operational practices to prevent shell companies and other deceptive practices.

2. Know Your Customer (KYC) Protocols & Anti-Money Laundering (AML) Measures

Implementing strict KYC procedures can help verify the identities of users engaging in cryptocurrency transactions and adopt robust AML practices to detect and prevent money laundering activities. Key elements include:

- Transaction Monitoring: Utilizing advanced analytics and machine learning to identify unusual patterns in transactions that may indicate criminal activity.

- Reporting Obligations: Establishing protocols for reporting suspicious transactions to relevant authorities promptly.

4. Collaboration with Law Enforcement

Building strong partnerships between the cryptocurrency industry and law enforcement agencies is vital. This can include:

- Information Sharing: Facilitating the exchange of intelligence between private sector players and law enforcement to enhance the detection of financial crimes.

- Training Programs: Offering training sessions (which I specialise in) for VASPs, their staff, law enforcement officers and the regulators themselves on the intricacies of blockchain technology and cryptocurrency to improve their investigative capabilities.

?5. Public Awareness and Education

Raising awareness about the risks associated with virtual assets and informing the public about how to recognize potential scams is crucial. Educational initiatives should focus on:

- Consumer Protection: Providing resources to help individuals understand how to protect themselves from fraud and scams especially via social media where many of them originate and lure their victims.

- Responsible Practices: Encouraging responsible investment and usage of cryptocurrencies to foster a safer environment for all users.

?6. Enhanced Technology Solutions

Investing in advanced technologies can significantly enhance the ability to detect and prevent fraudulent activities. Solutions may include:

- Blockchain Analytics Tools: Employing software to analyze blockchain transactions and identify patterns associated with criminal behaviour using blockchain intelligence.

- Artificial Intelligence: Utilizing AI to improve the accuracy of transaction monitoring and risk assessment processes.

FATF

The Financial Action Task Force (FATF) has been closely monitoring developments in the 'cryptosphere' and has issued global, binding standards to prevent the misuse of virtual assets for money laundering and terrorist financing. In recent years, some countries have started to regulate the sector, while others as mentioned earlier have prohibited virtual assets altogether. However, the majority of countries are yet to implement effective regulations. These gaps in the global regulatory system have created significant loopholes that can be exploited by criminals, terrorists and rogue regimes.

How do the FATF Standards apply to virtual assets ?

In Summary Countries need to:

1. Understand the money laundering and terrorist financing risks the sector faces
2. Licence or register virtual asset service providers
3. Supervise the sector, in the same way it supervises other financial institutions.

Virtual Asset providers need to:

1. Implement the same preventive measures as financial institutions, including customer due diligence, record keeping and reporting of suspicious transactions
2. Obtain, hold and security transmit originator and beneficiary information when making transfers.

The United Arab Emirates (UAE), following its successful exit from the FATF Grey list,? has shown proactive initiatives in this area by the Executive Office of Anti Money Laundering and CTF. Recently the Emirate of Dubai created the Virtual Assets Regulatory Authority [VARA] known as VARA.

VARA issued its Virtual Assets and Related Activities Regulations in 2023. The Regulations set out a comprehensive Virtual Assets (VA) Framework built on principles of economic sustainability and cross-border financial security along with various Rulebooks which are thoroughly comprehensive.

VARA is the world’s first, tailor-made Virtual Asset regime, and as such, its VARA Regulations are designed to specifically cater for the provision of permissible activities and services to customers and investors, from the emirate of Dubai as per their website.?

Last week they announced an update to their marketing regulations, aimed at strengthening the regulatory framework for virtual asset service providers (VASPs) operating in the emirate.

Alongside these updates, Virtual Assets Regulatory Authority [VARA] has introduced a comprehensive marketing guidance document to provide clear and actionable insights for VASPs engaging in marketing activities within the region. The new regulations will come into effect today (October 1st).

Abu Dhabi's ADGM (Abu Dhabi Global Market) has also developed their own Virtual Assets Framework.

Indeed virtual assets, including cryptocurrencies, are increasingly subject to regulation, although the extent and nature of regulation can vary significantly by country and region.?

As virtual assets continue to gain popularity, it is imperative to develop and implement strategies to prevent their abuse for financial crime and money laundering. By establishing robust regulatory frameworks, enforcing KYC and AML measures, fostering collaboration with law enforcement, and increasing public awareness, we can create a safer financial environment.

The goal is to strike a balance between innovation and security, ensuring that the benefits of Virtual Assets & cryptocurrencies can be enjoyed without compromising the integrity of the financial system.

References:

FATF.org

AML-UAE

Vara.ae

UNODC

Statistica

Chainanalysis

CNBC.com