Crypto and the "money laundering" trope

Money laundering

Crypto in general and, more recently, NFTs are pointed as "ideal tools for money laundering".

I am not an expert in "money laundering" so I'll rely on publicly available information of reputable quality. And to this effect, the United Nations Office on Drugs and Crime seems like a pretty reputable source.

The United Nations defines money laundering as:

“the conversion or transfer of property, knowing that such property is derived from any offense(s), for the purpose of concealing or disguising the illicit origin of the property or of assisting any person who is involved in such offense(s) to evade the legal consequences of his actions”.

It estimates that "between 2 and 5% of the global GDP, or $800 billion to $2 trillion in current US dollars" are laundered every year!

It then proceeds to explain what "money laundering" is "made of", what is the typical process.

As you can see in the screenshot above, the first stage of money laundering, "placement" leads to dirty money integrated into the financial system.

Crypto "placement"

So let's stop for a moment and ask: does crypto facilitate "placement" in comparison to existing means? The UNODC site explains for instance that in the case of drug money, cash is often split in small quantities and used to either make bank deposits or to "buy products / services" from a company controlled by the launderers.

Crypto is a pure electronic product / service and its connection to the financial system is through centralized exchanges which have a banking relationship. Thus at the "gate" between "dirty money" and "the financial system" we find that crypto doesn't "broaden" the passage way, doesn't create new avenues for dirty money to enter the financial system: the same "gatekeepers" - the classical, AML-regulated banks control the entry.

If one has money from an illicit activity, it cannot turn those directly into crypto, it will still need to start by putting them in a bank account before being able to convert them into crypto. There are no outlets selling crypto for cash with no AML measures, that I know of, and at any rate that wouldn't be allowed in any significant quantities.

Thus crypto doesn't seem to facilitate placement in any way. If authorities want to mitigate "money laundering" risk in connection to crypto, they will discover that all the measures are already in place at the level of the "gatekeepers" (the regulated banks) and no additional new measures are specifically needed because of crypto.

Crypto "layering"

After the dirty money was "placed", the "layering" step is destined to obfuscate the fact that the initial money is "tainted" by association to illicit activities. In this respect, doing the "layering" through the "crypto" financial plumbing displays different characteristics than doing it through the classical banking system.

Interfaces

In the classical system "the interfaces" are often friendly bankers or classical "web banking" websites. It seems reasonable to assume that the overwhelming majority of money launderers or not especially "computer literate" and rely more than the average financial services consumer on the "friendly bank counselor".

In contrast, there's no human to talk to when dealing with crypto: everything is, to this day at least, designed by geeks, for geeks. This is all the more the case since crypto comes from an ethos of "libertarianism" and "self sovereignty": people are expected to fend for themselves and not rely on others. You have an issue? You are supposed to go look directly on the blockchain where things might have gotten stuck. Centralized exchanges offer abysmal customer service. There's no one to talk to, you are generally guided to write tickets only after having read pages and pages of "faq" and you are lucky if you get an answer after weeks of waiting. The most advanced exchanges offer a "live chat" where you can waste some time "talking" to a chatbot. Needless to say, none of this is particularly appealing to anyone, let alone to the less-than computer-savvy.

Not only that, but the crypto systems in themselves are complex and fiddly. Cybersecurity is supposed to be everyone's concern, and that is not necessarily something even computer hackers excel at (let alone drug traffickers). Witness the "epic failure" of the Colonial Pipeline hackers who maanged to extract a cryptocurrency ransom only to see it seized back by the FBI because ... password management is not trivial to get right!

^{Would you rely on your friendly banker or rather risk having your password hacked by the FBI?}

What you put in and what you get

In the classical financial system, while you "layer" and "launder" money by performing financial operations aiming at making the money emerge with a "legitimate" lacker, one thing you don't have to care about is exchange risk. You put in dollars or euros or whatever, you move them among banks in seemingly legitimate operations and at the end you end up with the same currency as you started (unless you wanted from the beginning to end up with a different one).

In contrast, if you decide to take a detour through the "crypto" plumbing instead, things are very, very different: you are stepping outside the classical, relatively slow-moving currencies system and into a world where valuations can swing wildly from one day to another. You use a sum of money to buy cryptocurrencies and after you moved them around to "layer" them and want to extract the "laundered" money you realize the crypto valuation has cratered and you can only get back half or even less of what you've put in! This "exchange risk" is all too real which should act as a serious deterrent for any money launderer.

^{When the money you've put in crypto were ill-gotten, you can't even sue anyone to recoup losses!}

Volume

As I said before, the UNODC estimates that between $800 billion and $2 trillion dollars are laundered annually. Compare that with the total market capitalization of the whole "cryptoverse", which had hit $2 trillion briefly at the top but has hovered in the $150 billion - $800 billion for the longest part of the past five years. Besides, the volumes are spread over a large number of centralized crypto exchanges. To launder any significant amount of money one would have to work with several big exchanges (which are also under the brightest spotlights and are the heaviest regulated).

To illustrate that estimate, one only has to look for newsworthy stories in the mainstream media. There's barely 2 months passing between yet another "money laundering scandal" involving one of the big banking names hits the headlines.

^{December 2021, HSBC hit with a serious fine for AML failings}

^{February 2022, it's Credit Suisse's turn to occupy the headlines}

^{Another 2 months pass, another money laundering scandal at one of the biggest banks in Europe}

By comparison, the volumes in the classical world are so many orders of magnitude bigger than even a smallish bank can move significant amounts without raising a "blip" on anyone's radar.

Erasing traces

This is where the biggest differences lay. Existing regulation ensures that, in the classical financial world, each intermediary "knows their customer" so in theory the authorities can expect to be able to follow the trace of the money. This makes layering more arduous in the classical financial world, at least in theory.

In practice, everything happens inside opaque, proprietary IT systems. If the authorities come knocking on "bank's B" door because the sending "bank A" indicates this where they've sent the money it sometimes happen that "bank B" is unable to show what happened with the money because of "an IT error in which all records were deleted"

^{Errors happen!}

In contrast, in the crypto world, transfers are between pseudonymous addresses, of which only those managed by cryptoexchanges are associated with an identifiable customer. But even after they've left that address, transfers happen on blockchains, these IT systems which are open to anyone's prying eyes and are nigh-impossible to tamper with. That means that they remain there, available and usable for sophisticated data analyses techniques for decades.

These have already been successfully applied to show that the best known and most reputable blockchains (those who offer the highest security and the highest available volumes) are actually not "anonymous".

^{If it's not anonymous and not erasable, then perhaps it's not that good for money laundering?}

Specialized firms exist which track all blockchain transactions and perform advanced data anlysis with the aim of detecting suspicious activity. What they report is that, contrary to what interested actors would have you believe, the percentage of crypto transactions which can be linked with "tainted" addresses is low and getting lower every year

^{Source: Chainalysis - The 2022 Crypto Crime Report}

^{These sums are 1% or less than what the UNODC estimates is laundered yearly through the classical financial system}

^{Illicit activity is low and trends lower}

Crypto "integration"

Because purchases are naturally made with classical, fiat money, integration is generally easy for illicit money which has been placed and then layered competently.

In contrast, because of its complexity and volatility, crypto is still seldom accepted as means of payment. Thus using it in money laundering would involve an additional step of converting from crypto to fiat money - which again uses a regulated bank as a "gatekeeper". This fact ellicits similar reflections as were made in the placement step above.

Conclusion

I couldn't conclude without reminding of a marking fact: the biggest money laundering affair uncovered in the past years was the $200 billion "Danske Bank" scandal from 2017 - 2018. It happened in the regulated banking sector, where all the involved actors were supervised.

^{Read more here}

In contrast, tt can be thus said that "money laundering using crypto" appears to be a non-story: volumes are puny in absolute terms; they are proportionnally lower than in the classical finance world and trending lower; moreover, the intrinsic characteristics of crypto such as:

1. the need to integrate with the fiat world (on-ramp / off-ramp) through regulated banks
2. its inherent complexity and lack of user-friendliness
3. its volatility
4. the low volumes and the fragmented market
5. the transparency and traceability of blockchain transactions

make cryptocurrencies an unsuitable vector for money laundering. This has been indirectly confirmed by, among others, a former CIA director in a particularly candid piece from last year

^Source

Given all that, why the opposite message seems to regularly come up of the media channels? The first hypothesis which comes to mind is that while we keep stalling innovation and pointing fingers to "potential" money laundering through new technologies, old banking giants are happily laundering trillions every year through their opaque systems. We are faced here with a "red herring", a common tactic to deflect attention and try to smear a potential or perceived competitor.