AML stands for Anti-Money Laundering. It is an umbrella term that covers every pertinent law, regulation, and juridical procedure that tries to unveil efforts of disguising ill-gotten or illicit funds as legitimate income.
Money Laundering, at its core, is a grave financial crime where white-collar and street-level criminals alike make large amounts of money through criminal activities, such as drug trafficking or terrorism.
The impact that money laundering has or might have on the World Economy is phenomenal. According to a report published by the United Nations in September 2020, the volume of money laundered was around US$1.6 trillion per year, equal to 2.7% of the global GDP. Over and above, there are cases of private wealth hidden in tax-haven countries, which amounts to US$7 trillion or 10% of the world GDP. Also, governments lose nearly US$500 billion each year from profit-sharing enterprises.
The Genesis of AML in Brief
The Bank Secrecy Act of the 1970s is primarily considered the route of all AML regulations in the United States. While it put deposits worth more than US$10,000 to scrutiny, it also gave power to banks to conduct due diligence and report transactions that were deemed suspicious.
Banks and similar financial institutions expanded on this regulatory framework of the Bank Secrecy Act and moved into other compliance processes such as the KYC or Know Your Customer, and CDD or Customer Due Diligence.
Money Laundering – as considered by the paradigms of KYC or CDD – looked into a range of aspects. The KYC process, for instance, aimed to nip three malpractices at their buds, including depositing illicit funds into the financial system, transactions that conceal their origin of funds and using laundered funds in acquiring real estate, financial instruments, and commercial investments.
Similarly, the purview of the Customer Due Diligence process, as laid out by the Financial Crimes Enforcement Network, stressed on the identification and verification of the customer’s identity and that of the beneficial owners with a stake of 25% or more in a company opening an account. It also focused on developing customer risk profiles and monitoring allegedly suspicious transactions.
The Anti-Money Laundering Act of 2020
With the above information serving as a context, the first concrete and probably the most comprehensive step towards AML came in as the Anti-Money Laundering Act of 2020. The priorities of this AML regulation, as stated in the official release, was to “predicate crimes that generate illicit proceeds that illicit actors may launder through the financial system.” Although the official declaration acknowledged that “money laundering” was essentially “linked to all of the Priorities.”
As its priorities, the Act decided to look into corruption, cybercrime, and terrorist financing activities – including international and domestic terrorism, fraud, Transnational Criminal Organization (TCO) Activity, Drug Trafficking Organization Activity, Human Trafficking and Human Smuggling, and Proliferation Financing.
One of the most crucial points to note here is the inclusion of Virtual Currency in cybercrime. Let us now shift our focus towards Virtual Currencies as a consideration within the paradigm of cybercrime.
Concerns Around Virtual Currency
As virtual currencies continue to grow in popularity, lawmakers are beginning to take notice and express concerns about their potential impact on the economy. While some are concerned about their impact on financial stability, others are worried about their potential to be used for illegal activities.
One of the biggest concerns for regulators around virtual currencies is their anonymity. They contend that the anonymity offered by these financial instruments makes them an attractive vehicle for money laundering.
Virtual currencies are attractive to criminals because they can be used to anonymously buy and sell illicit goods and services and move funds around the world without the need for a bank account. This makes it very difficult for law enforcement to trace the flow of money and track down the people behind the transactions.
But this is not the reality
While lawmakers argue that digital currencies are used predominantly for illicit activity, this can’t be much further from the truth.
According to blockchain analysis firm Chainalysis’s “Crypto Crime Trends for 2022” report, while illicit transaction activity reached an all-time high of $14 billion in the year 2021, its share of all cryptocurrency activity fell to an all-time low.
As a matter of fact, transactions involving illicit addresses represented a mere 0.15% of cryptocurrency transaction volume in 2021 despite the raw value of illicit transaction volume rising 79% from the previous year.
“Given that roaring adoption, it’s no surprise that more cybercriminals are using cryptocurrency,” stated Chainlysis noting total transaction volume growing to $15.8 trillion in 2021, up 567% from 2020.
Looking into the illegal use of crypto, Chainalysis found that two categories were possible for this growth: stolen funds ($3.2 billion) and scams ($7.8 billion), with DeFi playing a big part in both.
However, governments are still struggling to decide how to regulate Bitcoin and its ilk. Many of these policymakers are not well-versed in digital assets and either completely misunderstand them or are knowingly blowing the concerns around them out of proportion.
As such, concerns over the use of crypto to facilitate money laundering and terrorist financing are frequently used by lawmakers to highlight the need for more robust regulation of the digital asset industry. And this is what has brought forth a new bipartisan bill.
Digital Asset Anti-Money Laundering Act of 2022
On Wednesday, US Senator Elizabeth Warren (D-Mass.) and Roger Marshall (R-Kan.) introduced a bill to crack down on money laundering and terrorist financing via cryptocurrency.
The Digital Asset Anti-Money Laundering Act is designed to “mitigate the risks that cryptocurrency and other digital assets pose to the United States's national security by closing loopholes” in the current system.
If it becomes law, the bill will expand certain Bank Secrecy Act responsibilities to cryptocurrencies, such as KYC rules which will be applied to crypto participants, including wallet providers, miners, and validators. Moreover, it will also prohibit financial institutions from transacting with crypto mixers, which are tools designed to obscure the origin of funds, as well as privacy coins and other anonymity-enhancing technologies.
The Act will further allow the Financial Crimes Enforcement Network (FinCEN) to implement a proposed rule under which institutions are required to report certain transactions involving unhosted wallets where the user is in complete control of the contents rather than relying on an exchange or other third party.
According to Warren, the cryptocurrency industry should be governed by the same type of rules as other financial institutions.
“Rogue nations, oligarchs, drug lords, and human traffickers are using digital assets to launder billions in stolen funds, evade sanctions, and finance terrorism,” Warren said in a statement. “The crypto industry should follow common-sense rules like banks, brokers and Western Union, and this legislation would ensure the same standards apply across similar financial transactions.”
Putting Users at Risk
Senator Warren’s announcement of the bill comes in the aftermath of cryptocurrency exchange FTX’s collapse, which was misusing customer funds, and the subsequent arrest of its former CEO Sam Banman-Fried, who faces charges of wire fraud, security fraud, and money laundering, among other things.
While the lawmakers propagate this bill as a way to prevent the next FTX, it would only be able to achieve the opposite. Focused on financial surveillance, the bill does nothing to address the corporate control issues that led to the collapse of FTX and only puts users more at risk.
This bill aims to effectively outlaw self-custody of digital assets, which can prevent consumers from the kind of counterparty risks they were exposed to in the FTX collapse. It basically forbids cryptocurrency users from having control over their own assets.
The cryptocurrency industry heavily opposes this bill, which would effectively make it illegal for Americans to participate in public blockchains.
“If her (Warren) ill-conceived and certainly unconstitutional bill were to pass, it would forever set the US behind the rest of the world in the race for technological supremacy. She seeks to sell out our future because she does not trust Americans to make their own decisions and based on a demonstrably false position that crypto is only used for terrorism and money laundering,” wrote one crypto user.
Does KYC actually protect customers?
KYC or Know Your Customer process is used by financial institutions globally to verify the identity of their customers and to assess the risks associated with providing them with financial services. The KYC process is to help to prevent money laundering, fraud, and other financial crimes.
In order to comply with KYC regulations, financial institutions must collect certain information from their customers. This information includes the customer's name, address, date of birth, and identification documents. On top of that, financial institutions may also collect other information, such as the customer's employment and financial history.
A critical part of ensuring the safety and security of financial transactions, KYC is basically centralized siloes of sensitive information that have become a treasure trove for hackers.
KYC creates a massive database of sensitive customer information, making it very attractive to hackers. In fact, several high-profile data breaches in recent years have involved the theft of KYC data, including the 2017 Equifax breach that affected tens of millions of people.
Instead of actually protecting customers, it often does the opposite. In another way, KYC requirements are often used by financial institutions to screen customers and weed out those who may be high-risk. This can result in legitimate customers being denied access to financial services or being subjected to higher fees and stricter conditions. In some cases, KYC requirements can also be used to discriminate against certain groups of people.
The $885 billion crypto sector is still subject to patchy regulation worldwide. However, as the industry continues to outgrow rapidly, regulators are growing concerned about Bitcoin and its peers' impact on financial stability and its usage for criminal purposes.
And in an attempt to keep up, lawmakers are scrambling to force ill-fitting regulations onto the industry. However, while crypto assets and blockchain technology show great promise, many lawmakers still struggle to wrap their heads around them. That is why they are resorting to heavy-handed tactics that could stifle innovation.
But the cryptocurrency industry is still in its infancy, and it is vital that regulators take a measured approach. Over-regulation could stifle innovation and adoption. Too little regulation, on the other hand, could open the door to fraud and abuse. So, it is crucial that lawmakers take the time to understand this technology and its implications before rushing to force damaging regulations onto it. As such, they need to strike the right balance in order to allow the industry to grow and flourish.