Crypto Currency and Money-Laundering

[Commissioner CESTATHyderabad]

By L. Venkateswara Rao

Money Launderers across the world aim at disguising illegally their earned money and attempt to make it appear untainted.  The amount of money laundered per annum is estimated to be about 0.5% of the world GDP.  In the modern times, usage of Crypto-Currency in money-laundering is increasing exponentially.  In this article, it is proposed to examine and analyse the money laundering activities adopted by the criminals using crypto currency and its impact on the economy. 

2. The proceeds generated out of commission of crime are “crime proceeds” and these are also known as “Proceeds of Crime” (POC).  The criminals after generation of the “Proceeds of Crime” will disguise its true origin and attempt to project it as untainted.  This process is known as money-laundering.

(i) The process money laundering generally involves the following three stages: -

2. 1. Placement: - In this stage the money launderer, introduces the illegal funds into the financial systems by breaking up large amount of cash into less conspicuous smaller sums which are directly deposited into a bank account.
   2. Layering: - The money launderer engages in a series of continuous conversions or movement of funds within the financial system by way of numerous accounts, so as to hide their true origin and to distance them from their criminal source.  The Money Launderer may use various channels for movement of funds, like a series of Bank Accounts, sometimes spread across the globe.
   3. Integration: - In this stage, the launderer ensures that the funds reached the legitimate economy after getting mixed with the legitimate money earned though legal sources of income.  The launderer may invest the funds into several activities like - real estate, business ventures etc.

3. The objective of Prevention of Money Laundering Act, 2002 which came into effect from 01.07.2005, is to prevent money laundering and to provide for confiscation of property derived from, or involved in, money laundering and for matters connected there with and incidental thereto.  Section 3 of the PMLA defines the offence of Money-Laundering as – “Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the [1][“Proceeds of Crime”] including its concealment, possession, acquisition or use and projecting or claiming] it as untainted property shall be guilty of offence of money-laundering.  An explanation to the above section has been inserted vide amendment dated 01.08.2019 clarifying that a person involved in one or more of the following processes or activities connected with “Proceeds of Crime” namely: - (a) concealment; or (b) possession; or (c) acquisition; (d) use; or (e) projecting as untainted property; or (f) claiming as untainted property is also guilty of the offence of money-laundering.  “Proceeds of Crime” (POC) is defined under section 2(1)(U) of PMLA as – any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property [2][or where such property is taken or held outside the country, then the property equivalent in value held within the country [3][or abroad]. 

4. Virtual currencies like Bitcoin, Ethereum have emerged as popular payment methods and gained acceptance globally.  Virtual currencies offer an innovative, cheap and flexible payment methods.  The unique and unfamiliar business models of virtual currencies threw a stiff challenge to the regulators.  The anonymity associated with these transactions naturally will encourage the criminals, to use virtual currencies to launder “Proceeds of Crime” derived out of commission of offences like smuggling, drug related offences, cyber-crimes, human trafficking etc.  Many criminals use Crypto Currencies to complete their operations and Bitcoin is a popular choice.  Criminals use various methods to take advantage of the anonymity crypto currencies to cover up the origin of illicit funds.

5. Money laundering using crypto currencies and Non-Fungible Tokens (NFTS) – (which are block chain based digital items whose units are designed to be unique, unlike traditional crypto currencies) are considered to be easier for criminals to launder crypto currencies like Bitcoin via online exchanges and convert to cash, through online transactions across the world.  This process will eliminate the requirement of moving money physically from one place.  Further, it also provides for risk-free transfer of illicit funds.  Above all, crypto currencies provide a great degree of anonymity, as public addresses used in these transactions are not registered in any individual’s name.  Even though, all the transactions completed using crypto currencies are recorded publicly on the block chain, only the person who conducted the transactions can access the account and wallet.  This modus operandi therefore makes it difficult for the investigators to link crypto currencies transactions to a single entity/person.

6. Methods adopted by criminals to launder money: - Criminals adopt various strategies to hoodwink the authorities and to avoid detection of money laundering using Crypto Currencies.  Some of the methods used by them are as follows: -

(a) Crypto mixing: - Crypto mixing is also known as tumbling.  In this modus operandi, the criminals will mix illicit and clean digital assets from several addresses together before re-distributing them to new destination wallets or addresses.  The process of mixing different digital assets increases anonymity, and help criminals to hide their identity before transferring funds to legitimate businesses.

(b) Peer-to-Peer Crypto Networks: - Criminals use these de-centralised networks to transmit funds to a different Crypto ATM.  These ATM’s allow people to purchase Bitcoin via debit cards.  Some ATM’s offer the facility to trade crypto currencies for cash as well.  In many cases, KYCs are poorly enforced.  These ATM’s frequently change their locations and addresses to other country’s crypto exchanges where the KYCs are poorly enforced or not enforced at all.  These exchanges help individuals in converting crypto currency into fiat currencies in order to purchase high-end items.

(c) Dark Exchanges: - These are unregulated cryptocurrency exchanges which does not implement KYC (Know Your Client) and will not enforce anti-money laundering Laws.  They operate without identity checks of the customers.  In these exchanges, one type of cryptocurrency is repeatedly exchanged for another as a dark exchange and it can slowly clean the chain.  The process helps the criminals to transfer it to an external crypto currency wallet without using a mixing service.

(d) Gambling websites: - Gambling platforms often accept payment in crypto currencies.  Money-launderers use cryptocurrency to buy Credit, Virtual Chips, or In-Game Currency on these platforms and cash out after a few transactions on the websites.  Once the website pays out the money in an account, it becomes legally earned or it becomes untainted.

(e) Virtual Currency Payment Products and Services: - The money launderers offer a variety of services including the use of virtual currency in order to anonymise the illicit transactions of criminals.  The virtual currency exchanges are used as un-licensed or un registered Money Value Transfer Service Providers to exchange criminals proceeds in the form of Virtual currency to fiat currency.  Complicit Virtual Currency Providers also utilise shell companies to electronically transfer fiat currency into, out of, these exchanges. 

(f) Nested Services: - This service operates within one or more exchanges.  Some exchanges have tax compliance standards for nested services and these are exploited by criminals to launder money.  When nested services complete a transaction, it appears on the block chain ledger under the exchanges address instead of the nested services or individual address.  Over-The-Counter (OTC) brokers are the most common type of examples for nested services.

(g) When criminals use OTC, they can anonymously trade large sums of cryptocurrency with the OTC’s facilitating direct trades which are secure and quick.  The OTC brokers are paid a commission for finding counter parties for a transaction.  Once the parties agree on the terms of transfer, the assets are transferred through the OTC broker.

(h) Anonymizing Service: - As the transactions of crypto currencies are recorded on the block chain, they can be generally traded on the original source.  To overcome this problem, criminals use anonymizing services to hide the source of their funds, thereby disrupting the link between crypto currencies transactions.  Participating in an initial coin offering using one coin to buy a different coin (buying Ethereum with Bitcoin) is one way to hide the origin of a digital currency using a major crypto exchange.

(i) Integration: - When Bitcoin or another cryptocurrency has been successfully laundered and it has reached the integration stage, it becomes difficult to connect it with criminal activity.  While the money is no longer directly related to a crime, money launderers still need a way to explain how they had obtained it.  To legitimize dirty cryptocurrency, criminals create on online company that accepts Bitcoins as payment to justify the income.  They can transform dirty Bitcoin into clean, legal money by doing this.

(j) Wash Trading: - Wash trading, means executing a transaction in which the seller is on both sides of the trade in order to present a misleading picture of an asset’s value and liquidity, is another area of concern for NFT’s.  In the case of wash trading, the aim of the criminals would be to make one’s NFT appear more valuable than it really is by “selling it” to a new wallet which is controlled by the original owner.  As many NFT trading platforms allow users to trade by simply connecting their wallet to the platform, with no identification checks, wash trading would be easy with NFT’s.

7. The characteristics of virtual currencies and the potential Anti Money Laundering / Countering the Financial Terrorism (AML/CFT) risks perceived by the FATF are as follows: -

1. the anonymity provided by the trade in virtual currencies on the internet and the limited identification and verification of participants.
2. the lack of clarity regarding the responsibility for AML/CFT compliance.

8. The 2022 Crypto Crime Report, [4]stated that the crypto currency-based crime hit a new all-time high in 2021, with illicit addresses receiving $14 billion over the course of the year, up from $7.8 billion in 2020.  The report also stated that crypto currency usage is growing faster than ever before.  The crypto currency chainalysis indicated that total transaction volume grew $15.8 trillion in 2021, up 567% from 2020 totals.  Overall, going by the amount of the crypto currency sent from illicit addresses to addresses hosted by services, cyber criminals laundered $8.6 billion worth crypto currency in 2021.  This represents 30% increase in money laundering activity over 2020.  These numbers only count for funds derived from “Crypto-Currency-Native” crime, meaning cyber-criminal activity such as dark-net market sales, or ransomware attacks in which profits are virtually always derived in crypto currency rather than fiat currency.  Overall, cyber criminals have laundered $33 billion worth of crypto currency since 2017.  It is difficult to measure how much fiat currency is derived from offline traditional crimes like drug trafficking and the extent converted into crypto currency and laundered.

9. As regards the usage of crypto currency in India, the Internet and Mobile Association challenged the legality of RBI circular dt. 05.04.2018 in the Hon’ble Supreme Court.  In the said circular, the RBI directed that the entities regulated by the RBI not to deal with or provide services to any individual or business entity dealing with or selling Virtual Currencies and to exit relationship, if they already had one, with such individuals.  The Hon’ble Supreme Court in decision dt. 4^th March, 2020 in the matter of INTERNET AND MOBILE ASSOCIATION OF INDIA VERSUS RESERVE BANK OF INDIA - 2020 (3) TMI 364 - SUPREME COURT allowed the writ petition and set aside the impugned RBI circular.  Accordingly, “the Crypto Currency and Regulation of official Digital Currency” Bill 2021 was introduced seeking to create a facilitative frame work for creation of official Digital Currency in the Lok Sabha.  The bill is yet to be passed.

10. As regards the cases booked, on alleged money laundering through crypto currency, [5]the Enforcement Directorate issued show cause notice to an exchange which failed to trace the real beneficiary who had laundered more than Rs. 2800 crores using crypto currency in two transactions.  The agency found receipt of Rs. 880 crores and transfer of Rs. 1400 crores worth crypto currencies but none of the transactions had the details of beneficiary.  In the above case, the criminals have converted the ‘Proceedings of Crime’ stashed in India in rupees into crypto currency ‘Tether’ and then transferred the same to ‘Binance Wallets’, a crypto wallet service provider where the illegal money was converted into dollars with ease for being laundered back into the legal banking system using Shell Company.  The Enforcement Directorate sleuths claimed that this exchange had provided the conversation of Indian rupees into crypto currency and kept all these transactions in secrecy and none of these transactions are available on the block chain for any investigation. 

11. In a paper released on “crypto currencies”, recently, the Financial Action Task Force (FATF) mentioned that many of these exchanges are so designed to avoid regulatory law enforcement scrutiny and help the criminals to distribute, store and launder the proceeds.  In one such case mentioned by the FATF in its study, an entity “Liberty Reserve”, having its own crypto currency called “Liberty Dollars”, was busted by the U.S. Enforcement agencies.  The money transferer in this case operated on massive scale with over a million users worldwide and made 5.5 crore transactions which were found to be illegal.  In 13^th December last year, the Enforcement Directorate officials arrested one person from Bhavnagar, Gujarat, who was found to be transferring a large amount of ‘Proceeds of Crime’ from illegal online betting to Chinese national out of the country converting Indian rupees into crypto currency.  Further, on 5^th August, 2022 the [6]Enforcement Directorate stated that it has frozen Rs. 64.67 Crore worth bank deposits of one of India’s prominent crypto currency exchanges “WazirX” as a part of an ongoing money laundering probe against some fraud smart phone-based loan dishing apps backed Chinese funds.

12. On a detailed analysis of the facts relating to the money laundering activities through crypto currencies and the modus operandi adopted by the criminals to accomplish the same, it would appear that the menace which is considered to be a country specific may turn out to be one having global ramifications since illegally acquired funds are being moved from one country to the other and so on.  It is therefore felt that stringent laws in the lines of Anti Money Laundering Law (AML) should be framed to regulate the entities involved in crypto currency dealings.  The president of Financial Action Task Force (FATF), which develops and promotes policies to protect the global financial systems against money laundering, terrorist financing has stated that ensuring citizens to remain safe from the harm caused by criminal activity including money laundering and terrorist financing should remain a priority for all Governments around the world.  The FATF has already stepped into towards exploring the challenges and opportunities of new technology to make the fight against money laundering and terrorist financing more effective.

13. The U.S. President already signed an Executive Order on 9^th March, 2022 outlining the first ever, whole-of-government approach to address the risks and harnessing the potential benefits of digital assets and their underlying technology.  The order lays out a national policy for digital assets across six key properties; consumer and investor protection; financial stability; illicit finance; U.S. leadership in the global financial system and economic competitiveness; financial inclusion; and responsible innovation.  The National Policy calls for two pronged approach (i) that the Department of the Treasury and other agency partners to assess and develop policy recommendations to address the implications of the growing digital asset sector ad changes in financial markets for consumers, investors, businesses and equitable economic growth and (ii) by encouraging the Financial Oversight Council to identify and mitigate economy-wide (i.e. systemic) financial risks posed by digital assets and to develop appropriate policy recommendations to address any regulatory gaps.

14. By taking a cue out of the global experience, we may mull the idea of taking concerted action to prevent the money laundering offence using crypto currency by making suitable regulatory laws stipulating utmost adherence to KYC norms and providing for stern action against offenders.  This can be achieved by gearing up our investigating agencies like Enforcement Directorate, Customs, Income Tax etc. by imparting appropriate training to the officials, coordinating with other countries by exchanging intelligence, information and modus operandi adopted by the criminals, formulation of stringent laws to regulate money laundering using crypto currency and stern enforcement of the AML Laws including initiating prosecution against offenders in deserving cases.

[The author is an Additional Commissioner in CESTAT, Hyderabad and the views expressed are strictly personal.]

[1] Substituted for “Proceeds of Crime and project projecting” by the prevention of Money-Laundering (Amdt.) Act, 2012 (2 of 2013), dt. 03.01.2013 w.e.f. 15.02.2013, vide S.O. 343 (E) at 08.02.2013.

[2] Inserted by Finance Act 2015 w.e.f. 14.05.2015.

[3] Inserted by Finance Act, 2018 (Act of 13 of 2018) dt. 29.03.2018 w.e.f. 19.04.2018 vide USR 383(E) dt. 19.04.2018.

[4] https://go.chainalysis.com

[5] [5] https://timesofindia.indiatimes.com

[6] www.thehindubusinessline.com