Cryptocurrency typologies and red flags

Cryptocurrencies, with their pseudonymous nature and ease of international transfer, pose unique challenges for Anti-Money Laundering (AML) compliance in financial institutions. Last article, we broke down some of the myths regarding these types of transactions. This time we are breaking down cryptocurrency typologies and red flags to consider for transaction monitoring systems. Here are some of the most common.

Typologies:

• Money Laundering: Criminals exploit cryptocurrencies to launder illicit funds through various methods:

o Smurfing: Splitting large sums into smaller transactions to avoid reporting thresholds.

o Mixing Services: Anonymizing transactions by mixing funds from various sources.

o Peer-to-Peer (P2P) Exchanges: Utilizing unregulated platforms to bypass AML measures.

• Terrorist Financing: Terrorist organizations can use cryptocurrencies to fund their activities due to the difficulty in tracking transactions.
• Sanctions Evasion: Sanctioned individuals or entities may use cryptocurrencies to circumvent financial restrictions.
• Market manipulation: Market manipulation: misleading (or attempting to mislead) the market by actions or omissions that give a false appearance of trading activity, supply, demand or the value of cryptocurrencies. The proceeds can be used for illicit activities.

With the use of cryptocurrency exchanges increasing in popularity and regarding some of cryptocurrency transactions traits we explored in previous articles, it is important for financial institution to understand what constitutes an unusual/potentially suspicious transaction.

Red Flags:

• Transaction Patterns:

o Unusual Activity: Frequent high-value transfers, rapid deposits followed by withdrawals, or transactions inconsistent with customer profiles. Further, multiple cryptocurrencies bought with no apparent reason.

o Structuring: Breaking down transactions into smaller amounts to avoid reporting requirements.

o Geographic Risks: Transfers to/from high-risk jurisdictions with weak AML regulations.

• Source of Funds: Deposits with unclear origins or from wallets/accounts linked to illegal activities.
• Customer Profiles: Inconsistencies between user information and transaction activity (e.g., low-risk customer with high-risk transactions).
• Anonymity-Enhanced Cryptocurrencies: Usage of privacy-focused coins specifically designed to hinder transaction tracing.
• Mixing Services: Transactions involving known mixing services that obfuscate the origin of funds.

In short, red flags can be found in transaction types, pattern, anonymity, senders or recipients, source of funds and geographical risk. Further information can be found in FATF’s 2020 Virtual Assets Red Flag Indicators of Money Laundering and Terrorist Financing, which was published to help financial intuitions further develop their AML strategy.

By understanding cryptocurrency typologies and red flags, CASPs can strengthen their AML compliance efforts. Integrating effective transaction monitoring systems with blockchain analytics tools is crucial to mitigate the risks associated with cryptocurrency transactions. Remember, staying informed and adapting your AML procedures are key to a robust defence against financial crime in the ever-evolving world of cryptocurrency. Let the professionals at Compliance Champs know if we can level up your AML procedures!

Next week on our final article on transaction monitoring and cryptocurrency we will look at some best practices that CASPs can implement to safeguard their organization.