1. Introduction

Market volatility is not the only issue facing virtual or cryptocurrency markets. Over and above the fact that almost $2 billion worth of cryptocurrency was stolen in hacks during the first seven months of 2022, a 60% increase from the same period last year, according to data from blockchain researcher Chainalysis, globally governments are grappling with how to regulate as well as criminalise Virtual or  Cryptocurrency activities that may or do tantamount to money laundering.

2. What is money laundering?

Money laundering refers to a financial transaction scheme that aims to conceal the identity, source, and destination of illicitly obtained money.

Money laundering process can be broken down into four stages:

• First a crime or an illegal activity must happen.
  • Although money laundering is a crime in and of itself, it can act as a catalyst for other crimes if not detected. The crime that generates the earnings leading to money laundering is called a predicate offence. Examples of predicate offences are drug trafficking, human trafficking, bribery, embezzlement, insider trading, fraud schemes and other money generating crimes.[1]
• Second, this crime or illegal activity should generate funds. These funds are called “funds generated from the proceeds of crime” therefore the funds become legally tainted.
• Third a person now called the Launderer passes the tainted money through a complex scheme of transactions to obscure the source of the funds and the crime itself.
• Fourth, through the complex scheme of transactions process, the money then enters a legitimate financial system and returns to the Launderer and or the person who initially committed the crime or the illegal activity or any other person no longer as tainted money but as clean money that can be used legitimately on the global financial system.

3. The connection between Money Laundering and Virtual or Cryptocurrency

When discussing the legal realities around Virtual Currencies or Crypto currencies. The first thing that comes to mind by many readers is how Virtue or Crypto currency transactions can be used as a conduit for money laundering. This is because the  virtual currency transactions are usually carried out on a Decentralised Block Chain and its therefore difficult to tell  whether those transactions are legitimate or not.

Example:

Tabitha sells illegal drugs and makes a substantial amount of profit from the sales. If Tabitha put the cash directly into her bank account, the transactions will attract the attention of the Financial Intelligence Authority of her country who may follow up the transaction to verify the source of the money. Tabitha knows this and decides to use Virtual Currency Transaction to hide and/or move the money.

In money laundering terms this activity by Tabitha is called Layering. Which is the technique of separating illicit money from its source through a sequence of financial transactions that makes it difficult to trace the origin. Once the money is now in the Blockchain, Tabitha will find a country whose Central Banking System allows deposits of funds from Virtual or Cryptocurrency Transactions. Once that Money enters the Banking system of that country it becomes legitimate. It is no longer tainted.

This activity, in anti-money laundering terms is called placement which entails physically introducing unlawfully acquired funds into the banking system.

Then Tabitha uses the funds in her account to integrate the funds into the financial system by buying real estate in that country as well as other countries globally. She can transfer the said money to those countries legitimately.

This activity is called integration. Tabitha can undertake all the cited transactions because once funds are moved into the Blockchain, ownership of funds is invisibilised. What is visible is the Hash Key until the owner decides to cash it as Tabitha has done. It is at this cashpoint that laundering is most likely to happen.  

4. Regulating The Virtual or Cryptocurrency Industry from An Anti-Money Laundering Drive Perspective

Many countries are putting measures in place aimed creating or strengthening anti-money laundering laws and regulations targeting virtual or digital currency transactions. However, the conversation is not one sided. There is also a conversation for creating space for the growth of the virtual currency industry whilst ensuring that it does not become  a safe haven for criminals to move their illicitly obtained money.

I will provide examples from two countries namely Canada and Israel which have taken steps to regulate the Virtual or Cryptocurrency industry from an anti-money laundering drive perspective.

In Canada, The Financial Transactions and Reports Analysis Centre (FINTRAC) is Canada's financial intelligence unit. FINTRAC administers the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) and its associated regulations, and assists in the detection, prevention and deterrence of money laundering and terrorist financing activities. Effective 1 June 2020, the PCMLTFA was amended to expressly regulate businesses dealing in virtual currencies. To mitigate the money laundering and terrorist activity financing vulnerabilities of virtual currencies, while not excessively obstructing innovation, the final amendments did not target virtual currencies themselves, but the persons or entities engaged in the business of dealing in virtual currencies.[2]

In Israel the Bank of Israel has published its draft amendment to the Proper Conduct of Banking Business Directive. Contrary to the current state of play, in which Israeli banks are not allowed even in miniscule terms to accept any funds which source would be crypto currency activity, the draft amendment explicitly prohibits banks from refusing to accept funds into a client's bank account for the sole reason that such funds originated from a cryptocurrency activity, provided that the funds are being transferred from a licensed cryptocurrency service provider. Israeli banks will be required to conduct a risk assessment and establish policies and procedures for remittances of funds originating or linked to cryptocurrencies, taking into account a risk-based approach and the identity of the cryptocurrency service provider.

5. Conclusion

Globally governments are trying to figure out how to deal with the virtual/cryptocurrency industry from so many perspectives. The perspectives include whether to recognize them as part of the Domestic Financial Systems and if such would be the case, how should they be recognized as a form? Should they be recognized as securities, commodities or both or a simple payment for goods and services methods? Then there is the issue of Crypto mining.  At this point, it appears that many countries have not regulated mining of cryptocurrencies despite its possible negative impact on the global environment.

In this Blog I have focused on another emerging challenge within the virtual/cryptocurrency space; and that is how by their nature cryptocurrency transactions can become a haven for money laundering. I have given two examples of how Cananda and Israel are regulating this space whilst promoting Virtual/Crypto currencies as a viable industry. Both countries target Crypto service providers by requiring registration of their businesses. This helps governments to trace transactions and hold accountable Virtual/ Cryptocurrency services owners who aid and abet money laundering activities on their platforms.

[1] In Chapeyama Salome (2021) To Tell or Not to Tell: Lawyers’ Reporting Obligation as a Tool to Combat Corruption Vis-à-vis Lawyer Client Privilege. Publication which is an adaptation of the master’s thesis submitted to fulfil the requirements for the Master in Anti-Corruption Studies degree at theInternational Anti-Corruption Academy

[2] https://www.lexology.com/indepth/the-virtual-currency-regulation-review/canada 3 accessed on 21/8/2022 at 3.00 pm CAT

By Seodi White

Keywords: Legal and IP