Although there is currently no common and established EU classification of crypto assets, I dare to say that the taxonomy used by the Swiss Financial Market Supervisory Authority is the best and probably the most widely used one (FINMA)[1]. FINMA defines the following three types of tokens: payment, utility, and asset: 1) Payment tokens – often referred to as cryptocurrencies or virtual currencies are means of payment or money or value transfer;
2) Asset tokens – assets, such as a debt or equity claim on the issuer; and 3) Utility tokens – tokens intended to provide access to a product or service. Please note that individual categories of crypto assets are not mutually exclusive, and they indeed exist also in hybrid forms.
Crypto assets pose an increased risk not only to investors and market integrity as such but especially in the prevention of money laundering and terrorist financing (AML/CFT). Fraud, cyber-attacks, money laundering, and market manipulation are currently the most significant crypto assets related risks. Understanding these risks and modus operandi of those who abuse them to commit a crime is crucial not only for obliged entities[2] that provide services related to crypto-assets but also for other stakeholders (accountants, auditors, supervisory bodies, law enforcement bodies, etc.).
Virtually anyone can perpetrate money laundering, but often it is a person who is aware of the origin of the money concerned, a person acting in conspiracy with such person or associated with them, or an individual having knowledge of the origin of the funds and acting in the benefit of the perpetrator. Perpetrators relatively often have a solid legal or economic background.
In principle, perpetrators are mostly individuals using virtual currency to buy or sell illegal goods on Darknet [3] (e.g. Silk Road) [4]
large and/or sophisticated organizations such as groups of “money launders” catering to smaller criminal gangs in exchange for fiat currency [5].
Crypto assets can be involved in any stage of money laundering. The money laundering process typically breaks down into the following three stages [6]:
Placement: Converting crypto assets into fiat currencies within a traditional financial system
Layering: Converting fiat assets into crypto-assets, exchanging crypto-assets (through “mixers”) [7], conversion between crypto-assets, and converting crypto-assets into fiat currencies. Large amounts of crypto assets may be split into less conspicuous, smaller sums stored in many custodian wallets. These sums are then converted into fiat through cryptocurrency exchange platforms, or alternatively through ‘clean’ wallets in return for a commission.
Integration: Integration of the laundered funds into the legitimate economy. The launderer might choose to invest the funds into real estate, luxury assets, or business ventures.
Despite crypto assets often being described as highly disruptive and risky, when considering the AML risks associated with them it is important to remember that there are many similarities with traditional assets, e.g. cash (each potential client holding crypto assets must be evaluated on their merit, i.e. it is necessary to duly analyse the origin of their assets and financial means). Basic risk assessment questions remain the same regardless of the presence or otherwise of crypto assets in a transaction or business relationship. Whilst crypto-assets may allow greater anonymity than traditional payment methods they are, because of DLT [8], often inherently more transparent than cash. Although crypto assets are viewed as high risk, not all those associated with them are involved in criminality.
In one of the following articles in the series of texts on crypto assets, we will take a closer look at some significant cases of abuse of virtual currency for money laundering purposes.
[1] FINMA [2018-2-16], [cit. 2020-05-04], Guidelines for inquiries regarding the regulatory framework for initial coin offerings (ICOs), available here.
[2] According to Section 2l) of Act No. 253/2008 Coll., on selected measures against the legitimisation of proceeds from crime and terrorist financing, the obliged entity is understood to be „a person providing services related to virtual currency, which for the purposes of this Act means an electronically stored unit, whether or not it has an issuer, and which is not cash under the Payment System Act, but is accepted as payment for goods or services by another person other than its issuer“.
[3] The Darknet means a private or hidden network that allows participants to remain anonymous by operating on the principle of encrypted, randomly generated connections between individual users.
[4] Silk Road was one of the first darknet markets. Darknet markets are anonymous, commercial websites, similar to classic e-shops, which are located on the Darknet out of reach of governments, where goods of a generally illegal nature are sold, such as drugs, stolen credit cards, fake documents, weapons, and the like.
[5] The term fiat currency originated from the Latin word fiat, which means regulation or order. It is basically a legal currency created in each state by the legislature.
[6] LIŠKA, Petr. Praní špinavých peněz v České republice/ Money laundering in the Czech Republic. 1st edition, Praha: RADIX, spol. s r.o, 1997, page 8. ISBN 80-86031-09-8.
[7] Mixers (also known as ‘tumblers’ or ‘laundry service’) are a solution (software or service) that allows the users to mix their money with other users to obscure the trail of value.
[8] DLT technology (Distributed Ledger Technology). The most common type of DLT is the blockchain technology. Its name is derived from the fact that transactions are grouped into blocks that are chronologically linked to form a chain. The entire chain is protected by complex mathematical algorithms designed to ensure data integrity and security. This chain forms a comprehensive record of all transactions in the database.
Filip Novák specializes in capital markets, fintech, compliance and money laundering prevention. In the area of capital markets, it focuses on the legal and regulatory aspects of the provision of financial services and collective investment, the supply of securities and admission to trading on public markets. In the area of fintech, compliance and money laundering prevention, it focuses primarily on crowdfunding, wealthtech, financial institution compliance and AML threats associated with cryptoactive activities and the use of new technologies. He currently works at the CNB as an expert in the field of financial market regulation and international cooperation. Prior to joining the CNB, he held the position of Head of Compliance and Legal Department of a Licensed Securities Dealer and previously at the law firm HAVEL & PARTNERS.