Crypto Transactions have AML Capabilities that are Almost Impossible to Replicate in Traditional Investigations: CipherTrace

Blockchain security firm CipherTrace notes that during her confirmation hearing on January 19, Dr. Janet Yellen, US President Joe Biden’s pick for Secretary of the Treasury, had said that “many” virtual currencies remain “a particular concern” when it comes to terrorism and criminal financing (and other illicit activities).

This statement from Dr. Yellen was in response to a question asked regarding how the United States can prevent the use of emerging technologies (Emtech), like crypto-assets, in financing illicit activities.

On January 21, 2021, Dr. Yellen had issued written statements to additional questions from the Finance Committee, noting that although digital currencies may potentially be used to finance terrorism or carry out money laundering activities, “it [is] important we consider the benefits of cryptocurrencies and other digital assets, and the potential they have to improve the efficiency of the financial system.”

Yellen had also mentioned that she thinks “the United States must be a leader in the digital asset and financial technology areas.”

As noted by CipherTrace:

“The newness of the crypto space lends itself to a lot of misunderstanding. This isn’t the first-time government officials have inadvertently spread the common misconception that crypto = criminal. However, blockchain analysis has proven time and time again that this equation is far from true.” 

As confirmed by CipherTrace, even traditional anti-money laundering (AML) research is now “beginning to rebuke this misconception.” According to a 2020 joint report on money laundering by BAE Systems and the Society for Worldwide Interbank Financial Telecommunication (SWIFT), “cases of laundering through cryptocurrencies remain relatively small compared to the volumes of cash laundered through traditional methods.”

Cryptocurrency and blockchain or distributed ledger technology (DLT) appear to have many strengths or advantages “when it comes to AML that are nearly impossible to replicate in traditional AML investigations,” CipherTrace revealed. For example, the “ability to quickly risk rate a cryptocurrency addresses based not only on its transactional history but the transactional history of the addresses it interacts with, as well.” Crypto exchanges are able to “easily freeze accounts and block outgoing suspicious transactions based on this data,” CipherTrace explained.

The blockchain security firm also pointed out that during 2019 the global average of “direct criminal funds received by exchanges dropped 47% from the year prior,” according to data from our 2020 Spring Cryptocurrency Crime and Anti-Money Laundering Report.

As noted by CipherTrace, this particular trend has marked a 3-year low for virtual currency exchanges across the globe, with just 0.17% of funds received by crypto exchanges in 2019 “coming directly from criminal sources.”

CipherTrace writes in a blog post:

“As more crypto AML regulations are implemented around the world, many criminals are finding it harder to offload their illicit funds directly to cryptocurrency exchanges—the most common crypto-to-fiat offramp.”

But a decline in the world average does “not necessarily mean exchanges are actually receiving fewer criminal funds,” CipherTrace clarified. The blockchain firm added that as “exchanges begin to develop stronger KYC and AML protocols, it becomes harder for criminals to directly deposit tainted funds into an exchange.”

The company also mentioned that “instead, savvy criminals layer funds through multiple private wallets before cashing out via regulated fiat off-ramps such as exchanges.” According to CipherTrace, this “evolving reality means exchanges must remain diligent to not only their direct (one-hop) exposure risk to criminal funds but should be looking at their multi-hop risk to best understand their risk exposure.”

By using CipherTrace’s AML tools to look at the weekly “interactions” for one “prominent” darknet marketplace, the researchers were able to determine that although just 9.8% of the dark market’s one-hop interactions were “directly with exchanges,” 30.7% of its two-hop interactions were with crypto exchanges which is “more than triple the one-hop risk to exchanges.”

As explained by CipherTrace:

“Anytime money changes hands and criminals stand to gain, there’s a risk of money laundering; however, with proper AML protections, the risks posed by cryptocurrency are actually much lower than those posed by cash. Blockchain analytics tools allow financial investigators to ‘follow the money’ in ways inconceivable in traditional financial crime. Throwing out cryptocurrency due to AML risks would be short-sighted in an era where many countries are embracing central bank digital currencies as the future of money.”

Dr. Yellen’s confirmation hearing may be accessed here, with the question regarding cryptocurrency at 3:22:33: 

A transcript of the exchange has been shared below:

Senator Maggie Hassan (D-NH):

“I wanted to change topics for a bit to the issue of terrorism financing. In previous finance hearings with outgoing Secretary Mnuchin I’ve raised the importance of Treasury programs that combat the financing of terrorist and criminal organizations. The bipartisan National Defense Authorization Act passed earlier this month and it included a provision led by Senator Warner that established an advisory group with Treasury to counter new ways that terrorist use emerging financial technology. One area of growing concern, for example, is the potential for terrorists and criminals to use cryptocurrency to finance their activities. So, Dr. Yellen, can you outline these emerging technological concerns and how Treasury should combat new forms of terrorism and criminal financing.” 

Dr. Yellen:

“Senator, I think you are absolutely right that the technologies to accomplish this change over time and we need to make sure that our methods for dealing with these matters with terrorism financing change along with changing technology. Cryptocurrencies are a particular concern. I think many are used, at least in a transaction sense, mainly for illicit financing and I think we really need to examine ways in which we can curtail their use and make sure that anti-money laundering [sic] doesn’t occur through those channels.”  

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