Introduction
In the global financial environment, with the popularity of cryptocurrencies such as Bitcoin and Ethereum, money laundering activities have taken on new characteristics and trends. To address these challenges, international organizations, regional institutions, and governments are strengthening and improving anti-money laundering (AML) systems to combat money laundering and related criminal activities, ensuring the security of the financial system. This article will summarize and analyze the basic concepts, challenges, international rules, and regulatory practices of the European Union and the United States in the AML system for crypto assets.
1.Overview of Anti-Money Laundering Systems:
1.1 Anti-Money Laundering Systems
Money laundering refers to the process of making illegally obtained funds or assets appear legitimate through financial or commercial means. The purpose of this is to legitimize these illegal proceeds in appearance, allowing criminals to use these funds without restriction. Money laundering is not only related to criminal activities such as drug trafficking, fraud, and corruption but is also closely linked to terrorist financing, money laundering, corruption, and tax evasion. It causes serious damage to the economy and society, undermines the stability of the financial system, encourages criminal activities, and weakens the government’s control over the economy. Therefore, governments are implementing strict AML measures to combat this behavior.
1.2 AML System Framework
1.2.1 International Standards and Organizations
The Financial Action Task Force on Money Laundering (FATF), established in 1989, is currently the most influential and authoritative standard-setting body in the world for anti-money laundering and counter-terrorist financing. FATF provides a framework for anti-money laundering and counter-terrorist financing through its “Forty Recommendations” and “Nine Special Recommendations.” Its recommendations cover financial institutions and non-financial institutions, from national legislation, law enforcement, and supervision to international cooperation and financial sanctions, putting forward specific requirements for relevant departments, including customer identity verification, recording and reporting of suspicious transactions, and maintaining transaction records. At the same time, FATF promotes the development of anti-money laundering systems in various countries by setting high assessment standards and strict mutual evaluation procedures.
1.2.2 Regional Organizations
The European Union (EU), the Asia-Pacific Group on Money Laundering (APG), and the Middle East and North Africa Financial Action Task Force (MENAFATF) are currently anti-money laundering cooperation organizations established in various regions. At present, China is one of the 41 member jurisdictions of the APG, and the organization also includes observer jurisdictions such as the United Kingdom and Germany, as well as observer international organizations such as the World Bank, Asia-Pacific Economic Cooperation, and the European Commission. MENAFATF is similar to APG in structure, a FATF-style regional organization with 21 member countries, 6 observer regions, and 12 observer international organizations. The anti-money laundering actions of EU member states are based on their original structure to formulate new regulatory regulations.
1.2.3 National Systems
Countries control the flow of funds through laws and regulations, financial intelligence units, and supervision and law enforcement at the execution level, and combat money laundering crimes through various administrative departments. For example, in China, money laundering is included in the criminal legal system, and individuals who commit money laundering crimes may be sentenced to fixed-term imprisonment and fines. The United States has strict requirements for the due diligence procedures of financial institutions and the sharing of information with the government through acts such as the Bank Secrecy Act, allowing the government to pay attention to any suspicious transactions in a timely manner and take relevant measures.
2.Challenges Brought by Crypto Assets to AML Systems:
2.1 Anonymity of Crypto Assets
Cryptocurrency transactions have anonymity. Although every transaction is recorded on the blockchain, it is difficult to determine the real identity of the transaction parties. Account information is identified by encrypted digital codes. When virtual assets are transferred between different addresses, it is difficult to associate one address with other addresses, and it is also difficult to associate the code with the characteristics of the person behind it. This anonymity makes it easier for money launderers to hide their identity and source of funds, therefore, virtual assets have a high possibility of being used as a tool for money laundering. In particular, technologies such as mixers can mix the transactions of multiple users, making it difficult to track the specific flow of funds, and money launderers can more easily hide the source and purpose of funds, bringing higher money laundering risks to crypto assets. Relevant cases will be specifically presented later.
2.2 Fast Liquidity and Borderless Nature of Crypto Assets
Through the network or virtual trading platforms, virtual assets can be transferred arbitrarily between different accounts worldwide and can be used for payment or purchase of services anytime, anywhere, and these transfers and payments can usually be completed in a very short time. Therefore, monitoring and freezing money laundering funds have become more complex and difficult. At the same time, virtual assets can rely on financial infrastructure distributed across multiple countries to complete cross-border transfers. Since different countries have different anti-money laundering laws for virtual assets, if the components of the virtual asset system are in a jurisdiction with weak anti-money laundering laws, it will bring great convenience to money laundering activities.
2.3 Convertibility of Crypto Assets
In most countries and regions, virtual assets can be exchanged with legal currency in the real world. For example, funds can be transferred into or out of the virtual asset network system through various payment methods, including cash, fund remittance companies, bank wire transfers, credit cards, etc. At this time, different assets can be converted through cryptocurrencies, making unregulated fund transfers convenient and feasible. Although the exchange of virtual assets may be strictly regulated in some countries, this only increases the cost of the exchange behavior and does not fundamentally restrict the exchange behavior in the gray area.
2.4 Decentralized Management
Transactions of virtual assets are mostly conducted through decentralized exchanges (DEX). In a decentralized model, there is no single entity that can be required to implement “Know Your Customer” (KYC) or report suspicious transactions. Therefore, users can transfer funds between different jurisdictions to evade regulation, making regulation difficult.
2.5 Irreversibility of Crypto Asset Transactions
Once a virtual asset transaction is completed, the triggered contract will be automatically executed and written into the blockchain. The immutability of blockchain technology gives virtual asset transactions the characteristics of irreversibility or reversibility. Electronic currency systems managed by governments and other officials can provide customers with the function of revoking transfers when disputes occur in transactions. In contrast, the irreversibility of virtual asset transactions has caused trouble for the investigation and recovery of virtual criminal assets.
3.International Crypto Asset AML Rules:
3.1 Main International Organizations
3.1.1 Financial Action Task Force (FATF)
Internationally, several organizations regulate money laundering in crypto assets, with the main one being the Financial Action Task Force (FATF). As the most important international organization for anti-money laundering and counter-terrorism, FATF is constantly revising and developing, amending Article 15 of the “Forty Recommendations” to include a clear definition of “virtual assets” (VA) and “virtual asset service providers” (VASPs), forming internationally unified terminology. Based on this, it has published the “VA and VASPs Guide” (also known as Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers), requiring member countries to effectively supervise the field related to virtual assets, ensuring compliance with anti-money laundering (AML) and combating the financing of terrorism (CFT) standards.
3.1.2 International Monetary Fund (IMF)
The International Monetary Fund (IMF) assists in the development of anti-money laundering (AML), combating the financing of terrorism (CFT), and proliferation financing policies within the international community and the legal systems of its member countries.
The IMF expanded its anti-money laundering efforts in 2000 and, following the terrorist attacks on September 11, 2001, extended its focus to include countering the financing of terrorism. In 2004, the IMF’s Executive Board agreed to incorporate AML/CFT assessments and capacity building as a regular part of the IMF’s work. In 2018, as part of its five-year policy review cycle, the Executive Board reviewed the IMF’s AML/CFT strategy and provided strategic guidance for future endeavors.
The IMF engages in bilateral (or multilateral) surveillance by conducting visits to member countries, analyzing the impact of their policies on neighboring countries and the global economy, and regularly publishing reports on these trends and analyses. This process is designed to assess countries’ compliance with international AML/CFT standards and help them devise plans to address any deficiencies. The IMF also considers AML/CFT in other areas of its work, including the Financial Sector Assessment Program (FSAP). In certain cases, it may integrate AML/CFT into IMF lending programs and collaborate with member countries on AML/CFT assessments and capacity-building activities.
3.2 Interpretation of International AML Rules and Measures
3.2.1 FATF Rules Interpretation
FATF’s recommendations for the regulation of money laundering in crypto assets are seen as a benchmark for the development of crypto asset AML laws in various countries. After establishing international standards for virtual assets and virtual asset service providers, countries have successively introduced new legal systems and developed relevant technologies to address the lack of regulation over virtual currencies. The organization has adopted traditional AML rules and transformed them for application to virtual assets.
FATF has extended the traditional AML laws to virtual assets. Virtual assets are subject to current laws and systems related to anti-money laundering. To prevent the misuse of virtual assets in money laundering, terrorist financing, and proliferation financing, FATF suggests that money laundering crimes should be expanded to cover any type of property. Countries should extend their anti-money laundering measures to cover criminal proceeds involving virtual assets; confiscation and provisional measures, freezing measures, economic sanctions, etc., all apply to virtual assets; countries should also maintain data on virtual assets seized, detected, and confiscated by statistical authorities, regardless of how they classify virtual assets under their property laws; countries should also impose a series of effective, appropriate, and deterrent civil, administrative, or criminal sanctions on VASPs or their directors and senior management who fail to comply with their AML/CFT requirements.
In FATF’s “Guidance,” FATF states that almost all of its recommendations are directly or indirectly related to the money laundering risks of virtual asset service providers, which means that “virtual asset service providers” (VASPs) should comply with the same AML and counter-terrorism financing obligations as “financial institutions” and “designated non-financial businesses and professions” (DNFBPs).
At the same time, FATF has also updated the traditional system for the situation of virtual assets. In the AML measures, some content is an update to the “Forty Recommendations.” One of the articles most valued by FATF is the “Travel Rule.” Its content is: the initiating and beneficiary parties of all virtual asset transfers must exchange identification information, and the accuracy of their information must be ensured. This rule will apply to all VASPs, financial institutions, and obligated entities. This rule is derived from Article 16 of the “Forty Recommendations,” the “Wire Transfer Rule,” which stipulates the integrity of the information chain in the wire transfer process, requiring financial institutions to supervise and have the right to take freezing measures. After the review in 2021, the application of the Travel Rule was extended to a series of new cryptocurrencies and products, including private crypto wallets, non-fungible tokens (NFTs), and decentralized finance (DeFi) fields.
3.2.2 IMF Measures Interpretation
The IMF’s mission is to promote international monetary cooperation, promote the development of international trade, promote sustainable economic growth, and provide assistance to members facing balance of payments difficulties. Based on this, the IMF, with the macro perspective of an international organization, has played a role in clarifying international standards, promoting international cooperation through bilateral (or multilateral) supervision, and developing emerging technological means for anti-money laundering in crypto assets.
The IMF supports FATF’s standards for anti-money laundering in crypto assets and can combine the Financial Sector Assessment Program (FSAP) to assess the AML/CFT compliance of various countries. Its rules do not involve crypto asset anti-money laundering policies but focus on ensuring that international standards are implemented through supervisory means, assessing the anti-money laundering risks of countries, and proposing improvement suggestions, and publicly disclosing the compliance risks of countries in assessment reports, strengthening the sharing of risk information between countries and transparency, and promoting healthier international cooperation. These measures, starting from the side, can also reduce the money laundering risks brought by crypto assets to a certain extent.
At the same time, with the development of crypto assets and decentralized finance (DeFi), anti-money laundering technology also needs corresponding progress and improvement. The IMF identifies new money laundering risks in a timely manner from a macro level, conducts research reports on various risks, and provides strategic guidance and technical support for future anti-money laundering actions.
4.EU and U.S. Crypto Asset AML Rules:
4.1 EU
4.1.1 Overview of the EU Crypto Asset Market Regulatory Act (MiCA)
In recent years, Europe has been gradually promoting the legislation of anti-money laundering in crypto assets, and its achievements are mainly reflected in the “Markets in Crypto Assets Regulation bill” (Markets in Crypto Assets Regulation, MiCA) officially implemented this year (2024). The regulation requires companies issuing and trading crypto assets, tokenized assets, and stablecoins in the 27 EU countries to obtain the corresponding licenses, and requires stablecoin issuers to hold appropriate reserves. At the EU level, the regulatory authorities for this regulation are the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA), while member states designate their own responsible agencies. This regulation makes the EU the first major jurisdiction in the world to have a crypto licensing system, and its implementation of related measures makes the trading of crypto assets more traceable, in order to combat tax evasion and money laundering. In the context of the successive bankruptcies of top cryptocurrency exchanges such as FTX, cryptocurrency hedge funds such as Alameda Research, and cryptocurrency lending platforms such as BlockFi, and frequent explosions in the crypto market, the EU hopes to stabilize financial risks and protect the market and consumers through strict rules and supervision.
4.1.2 Types of Regulated Tokens under MiCA
According to whether the crypto assets need to anchor the value of other assets, MiCA classifies crypto assets into electronic money tokens (Electronic Money tokens,简称 EMT), asset-reference tokens (asset-reference tokens,简称 ART), and other tokens: a. EMT, that is, electronic money, is designed to anchor its value by referring only to one official currency, and is an electronic alternative to coins or paper money. b. ART is designed to anchor its value by referring to any other value or rights or a combination of them, including one or several official currencies. ART covers all other crypto assets supported by assets other than electronic money, such as stablecoins USDT, USDC supported by the US dollar, government bonds, etc.
Electronic money (EMT) and asset-reference tokens (ART) are the main objects of EU regulation at present; while due to the information structure of decentralized finance (DeFi) being different from traditional finance, NFTs have uniqueness and non-fungibility, MiCA has not yet included them in the regulatory regulations.
4.1.3 Crypto Asset Classification Regulatory Requirements
For electronic money (EMT) issuers, MiCA has the following requirements: electronic money issuers must 1) obtain official permission; 2) publicly publish white papers and marketing information on their websites, and be responsible for any false propaganda; 3) comply with the market rules for issuance and redemption; 4) issue tokens at par value upon receipt of funds, and allow holders to redeem tokens at par value at any time; 5) open separate accounts in credit institutions and invest the received funds in high safety and low-risk assets of the same currency.
As for asset-reference tokens (ART), their issuers must be 1) a legal person or entity authorized by the EU or its country, or an EU entity; 2) a credit institution holding a white paper of crypto assets permitted by the national authority; 3) holders can redeem ART at market value at any time; 4) publicly publish white papers and marketing information on their websites, and be responsible for any false content and false propaganda; 5) establish and maintain effective and transparent procedures; 6) always maintain sufficient asset reserves to cover liabilities to token holders.
4.1.4 European Banking Authority (EBA)
When the holder of the token, the value or transaction quantity reaches a certain level, and when the transaction has a high risk of money laundering, terrorism, etc., or involves technologies such as private wallets, mixers, etc., the transaction will be taken over by the European Banking Authority (EBA), which will then carry out additional supervision, such as detecting the source and destination information of crypto assets through distributed ledger technology (DLT).
In July 2024, the European Banking Authority (EBA) issued the “Travel Rules Guidelines,” which are expected to come into effect on December 30, 2024. The “Travel Rules Guidelines” specify the information that must be carried with funds and crypto asset transfers, requiring payment service providers (PSP), intermediate payment service providers (IPSP), crypto asset service providers (CASP), and intermediate crypto asset service providers (ICASP) to collect and verify the information of the sender and beneficiary of the crypto asset transfers they execute, through specific procedures, to detect and manage missing or incomplete information, and always pay attention to risks related to money laundering (ML) or terrorist financing (TF).
4.1.5 Transfer of Funds Regulation (TFR)
The Transfer of Funds Regulation (TFR) provides more targeted requirements for anti-money laundering (AML) actions in the field of crypto assets compared to the Markets in Crypto-Assets (MiCA) regulation. On May 7, 2020, the European Union (EU) communicated in its action plan that it should expand regulatory oversight to the crypto asset service provider sector. The specific measures include establishing a coherent regulatory framework for the system within the EU to achieve more detailed and coordinated rules. This is particularly aimed at addressing the impact of technological innovation and the evolution of international standards, as well as avoiding discrepancies in the implementation of existing rules. The TFR stipulates that crypto asset service providers must include information about the originator and beneficiary when transferring crypto assets to ensure the transmission of information throughout the crypto asset payment chain.
In line with the Financial Action Task Force’s (FATF) Recommendation 16 on wire transfers, the TFR within the EU’s crypto asset AML policy mandates that no amount of cryptocurrency can be transferred between accounts of crypto asset service providers (CASPs) without personal identification information. This is an adaptation of the FATF’s “Travel Rule” in its “Guidance on a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (VASPs)”: when a customer of an exchange transfers funds to a non-custodial crypto wallet, and the transfer amount exceeds 1,000 euros, the wallet must be verified to belong to the customer.
The revision of the TFR imposes the “Travel Rule” requirements on crypto asset service providers (CASPs), requiring them to be able to track the transfer of crypto assets. However, public opinion on this legislation is mixed, with concerns that collecting personal identity data may not necessarily help in combating money laundering activities, and that the TFR violates the EU’s charter on privacy.
4.2 U.S.
4.2.1 U.S. Crypto Asset AML Case - Helix Mixer Case
The US crypto asset market also faces “anti-money laundering” challenges. In 2021, the Helix Bitcoin mixer operated by Gary Harmon and Larry Harmon was accused of serving users of darknet markets (such as Alpha Bay), providing them with anonymity to help cover up the flow of funds from illegal transactions. These illegal transactions included the trade of drugs, firearms, and other illegal goods. According to the investigation, Helix laundered over $354 million worth of Bitcoin, and Larry Harmon was arrested as a result, with 4,400 Bitcoins worth about $200 million confiscated. His operation of an unlicensed money transfer business also attracted charges from the US Department of Justice; the Financial Crimes Enforcement Network (FinCEN) accused Larry Harmon of violating the Bank Secrecy Act, facing a high penalty of up to $60 million. In 2021, Larry pleaded guilty to the charge of “conspiracy to launder money tools,” and other charges were dropped in exchange for his cooperation. He is currently cooperating with the government and is only allowed to use the Internet under direct supervision.
Larry’s brother, Gary Harmon, discovered that the government was trying to seize and confiscate the Bitcoins stored on the device. He tried to recreate the Bitcoin wallet stored on the device using Larry’s credentials and secretly transferred more than 712 Bitcoins (worth about $4.8 million at the time) to his own wallet. He then further laundered the money by transferring it through two online Bitcoin mixing services and used the laundered Bitcoins to make large purchases. After this action was detected, Gary agreed to forfeit the cryptocurrency and other properties obtained from the fraudulent behavior, with the total value of the forfeitable properties exceeding $20 million.
In this case, the “mixer,” which emerged with the birth of virtual assets, is an important tool for illegal money laundering and brings new challenges to law enforcement agencies. A mixer is a service that provides anonymity by disrupting the chain of fund flows. Its principle is to mix the cryptocurrencies of different users and then redistribute the mixed cryptocurrencies to the respective users, making it difficult for external observers to track the source and destination of the cryptocurrencies, enhancing the “anonymity” characteristic of crypto assets and increasing the difficulty for regulatory agencies to supervise crypto assets.
4.2.2 U.S. Crypto Asset AML Regulatory Measures
The US crypto asset anti-money laundering regulation is mainly implemented by the Financial Crimes Enforcement Network (FinCEN) to ensure the security and compliance of its financial system. The US has passed a number of laws and regulations related to cryptocurrencies, the most important of which is the Bank Secrecy Act (BSA) cited in the case above when sentencing Larry. The BSA requires financial institutions, casinos, and other businesses to monitor customer behavior, report large transactions, and record specific transactions. For example, when a cash transaction exceeds $10,000, it must be reported and recorded (known as a Currency Transaction Report, CTR). However, for crypto assets, the threshold is stricter, and any mixing transaction should be reported immediately, regardless of the amount. In addition, banks should also keep records of any suspected violations of federal law (Suspicious Activity Report, SAR) and supervise customer behavior at any time. At the same time, banks also have the responsibility to keep customers’ private information confidential to prevent identity theft and fund loss.
At the same time, the regulation of crypto asset trading platforms is also one of the means of anti-money laundering. In the Helix mixer case, Larry Harmon’s trading platform was not legally registered, which violated relevant regulations, thus constituting another charge against Larry Harmon. In the US, crypto asset trading platforms are generally regarded as Money Services Business (MSB) and are regulated by the Financial Crimes Enforcement Network (FinCEN). According to FinCEN’s regulations, these platforms must comply with anti-money laundering (AML) and Know Your Customer (KYC) legal requirements. At the same time, the US Department of Justice pointed out that Helix mixer was suspected of “operating an unlicensed money transfer business,” which implies how the regulation of crypto asset trading platforms legally restricts illegal money laundering activities. According to FinCEN’s regulations, cryptocurrency trading platforms are considered Money Service Businesses (MSB) and must register with FinCEN, complying with AML and KYC regulations, including customer identity verification, record keeping, and suspicious activity reporting; if the cryptocurrency provided by the platform is considered a security, then the platform may need to register with the Securities and Exchange Commission (SEC) and comply with federal securities law regulations, with the SEC focusing on protecting investors and ensuring the transparency and fairness of the trading platform; for platforms that provide trading of cryptocurrency derivatives, such as futures and options, they need to register with the Commodity Futures Trading Commission (CFTC) and comply with the Commodity Exchange Act regulations. In some states, crypto asset trading platforms have even stricter regulations. These compliance checks further promote anti-money laundering actions.
4.2.3 U.S. Crypto Asset AML Risks
However, there are still some risks and issues in the anti-money laundering regulation of crypto assets.
On the one hand, there is the risk of peer-to-peer conversion: peer-to-peer transactions are different from conversions facilitated by crypto asset service providers, and are conversions from cryptocurrencies to fiat currency. In this process, individuals or entities directly exchange cryptocurrencies for fiat currency, exchange cryptocurrencies by sharing wallet information, and exchange the corresponding fiat currency through traditional bank transfers (for example, cash exchanges, wire transfers, ACH transfers, etc.). The fiat currency transfer itself looks no different from other forms of transactions between the two parties, and the connection with cryptocurrencies can only be discovered by querying or monitoring abnormal transaction patterns. In addition, crypto asset holders will use crypto wallets for transactions, and this process completely bypasses financial institution supervision, and the risk of falsifying registration information is high (as in the case of Gary Harmon using his brother’s credentials to register a wallet and transfer Bitcoin).
On the other hand, the KYC system also has difficulties in implementation. The rule requires crypto asset service providers to send customer data, including names and account numbers, to financial institutions when transferring funds. However, the existing infrastructure of crypto asset service providers is not sufficient to provide adequate information, and there is a lack of consensus on the governance of the information sharing process between institutions, making the implementation of KYC rules difficult. For financial institutions, in order to obtain KYC information, they need to understand the business content of crypto asset service providers, customer groups, and sources of funds, and require crypto asset service providers to collect and provide customer information. However, it is relatively difficult to identify which customers have a deposit relationship with crypto asset service providers - they may have multiple transactions in fiat currency, while crypto asset transactions are not frequent, thus, from the very beginning, it is difficult for financial institutions to identify the identity of their crypto asset service providers. This also further leads to the fact that mixers such as Helix can still carry out unlicensed money transfer businesses under regulation.
5.Summary and Outlook of Crypto Asset AML System
The anti-money laundering system for crypto assets is still in its infancy and will be gradually improved in the future. Its improvement mainly depends on the expansion and updating of the anti-money laundering legal system in traditional finance. However, the technical barriers brought by crypto assets may not be effectively addressed through traditional anti-money laundering means. The anti-money laundering system for crypto assets is a field that is constantly developing and adapting to new challenges. It needs to rely on regulatory agencies to take more effective measures to combat money laundering activities using crypto assets as the technology evolves and global cooperation is strengthened. In the future, it is expected that more international standards and cooperation mechanisms will be introduced to promote anti-money laundering efforts worldwide. At the same time, regulatory agencies also need to find a balance between protecting consumer rights, promoting financial innovation, and preventing financial risks. With a deeper understanding of the nature and risks of crypto assets, the anti-money laundering system will become more precise and efficient, contributing to the maintenance of global financial stability.
