Spotting AML/CTF Challenges
Limitations & Way Forward
December 2023
Hellenic Police Team
Money is the engine behind every unlawful activity. Terrorists can maintain their leverage and activities as long as they have financial power. The fact that terrorists have as primary target to remain unidentified and untargeted, in combination with the rising of technology, rapidly led them to have an immediate orientation to online sphere for their agenda. With their inherently anonymous features, cryptocurrencies and decentralized finance (DeFi) increase the potentiality of being the central tool in the arsenal of Organized Criminal groups (OCGs) and terrorist organizations for either their operational capacities or lucrative activities.
In this digital era, the critical rise of cryptocurrencies and DeFi has posed new challenges for LEAs in their endeavors to detect and prevent illegal financial activities. Cryptocurrencies and DeFi systems are designed to be anonymous and decentralized, which makes it easier for OCGs and terrorists actors to launder money and finance their illicit activities. DeFi challenges the centralized financial system by disempowering middlemen and gatekeepers and empowering everyday people via peer-2-peer exchanges.
One of the major challenges faced by LEAs is the lack of transparency in cryptocurrency and DeFi transactions. Unlike traditional financial systems, where transactions can be easily monitored and traced, cryptocurrencies and DeFi transactions are often conducted pseudonymously, making it difficult for LEAs to identify the parties involved and track the flow of funds. This lack of transparency makes it easier for OCGs and terrorists to launder money and hide their financial activities from the authorities. This happens due to the fact that there is absence of middlemen managing the system, thus transactions are verified and recorded by parties who use the same blockchain, through a process of solving complex math problems and adding new blocks of transactions to the chain.
Another challenge for LEAs is the difficulty in accessing and analyzing data from decentralized financial systems. Unlike traditional financial ecosystem, where LEAs can access transaction data directly from banks and other financial institutions on the ground of their due diligence, decentralized financial systems are designed to be independent and self-governing, which makes it difficult for LEAs to obtain the data they need to identify and track criminal activities. This lack of access to data is further complicated by the fact that cryptocurrencies and DeFi systems are often global in nature, making it difficult for LEAs to coordinate their efforts across multiple jurisdictions.
The lack of regulation and standardization in the cryptocurrency and DeFi industries also poses a major challenge for LEAs in their efforts to combat money laundering and CTF. In many countries, the regulatory framework for cryptocurrencies and DeFi is still in its infancy, and many countries have yet to enact laws or create agencies specifically designed to tackle money laundering and CTF in this space.Unlike traditional financial systems, which are subject to strict regulation and standards, the cryptocurrency and DeFi industries are largely unregulated and unstandardized, making it difficult for LEAs to apply existing laws and regulations to these financial systems. This lack of regulation and standardization also makes it easier for OCGs and terrorists actorsnot only to evade the authorities but also safeguarding their money in this financial architecture, from being seized or confiscated.
The speed and efficiency of transactions in DeFi systems is another critical challenge, on the grounds that they could be conducted in real-time,moving funds in a expeditious way and thus LEAs might face obstacles to identify, trace and finally disrupt them.
In this complex financial ecosystem, LEAs might face significant obstacles, specifically in their preventive efforts embedded with the implementation of the golden rule “following the money”. Being as it may, it is paramount priority for LEAs to work hand-in-hand in a multidisciplinary way with all stakeholders, including but not limited to, international partners, regulators, and the private sector, so as to develop new solutions and enhance existing ones.
And here comes again the loop of the digital era. In particular, despite the fact that either blockchain analysis or other advanced technologies might not be the silverbullet proof, inevitably showing the way ahead. These technologies can be used to track and trace the flow of funds in DeFiecosystems and assist LEAs identify the parties involved in unlawful activities. It should be stressed that the use of these technologies must be done in compliance with privacy and data protection legal frameworks, as well as ethical considerations.
Without doubt leading role in this enhancement, plays the engagement of the private sector in terms of multidisciplinary cooperation and information sharing with LEAs. The evolution of new ML/TF typologies requires public-private partnerships to be adaptable and responsive to changing circumstances, and to continuously improve their processes and methods. Cryptocurrency exchange platforms, Financial Technologies (FinTechs), as well as other financial institutions or entitiescould contribute by sharing information about suspicious transactions and their involvedparties. This information sharing coupled with the respective software tools (such as AI and data analytics) would help LEAs to identify among others,patterns and anomalies within the online ecosystem and make more effective the disruption of such criminal activities.Needless to highlight that such an exchange must be done in a secure and controlled manner to avoid any unauthorized access and the potential misuse of sensitive information.
The implementation of effective regulations and standards for the cryptocurrency and DeFi industries is also crucial in the fight against money laundering and countering terrorism financing. These regulations and standards should be designed to balance the competing interests of the need for privacy and security, and should be consistently enforced across all jurisdictions. This will help to create a level playing field for all stakeholders in the cryptocurrency and DeFi space and reduce the risk of criminal activities.
Cryptocurrencies and DeFi are complex and technical in nature, and thus LEAs standing in front of this new facet, may lack the necessary expertise and resources to effectively tackle these issues. For this reason, supplementary to the aforementioned package of measures, is the need of investment in training and education to enhance their knowledge and understanding of the whole architecture of cryptocurrencies and DeFi systems. This will help LEAs to effectively identify and track illegal activities and develop more effective strategies to combat money laundering and CTF.Ongoing education and training for law enforcement officials is necessary to ensure they have the necessary knowledge and skills to effectively regulate and monitor these activities.
In conclusion, the challenges and limitations that LEAs face in their efforts to combat money laundering and CTF in the context of cryptocurrencies and DeFi are significant. However, by working closely with international partners, regulators, and the private sector, and by developing new solutions and enhancing existing ones, LEAs can effectively combat these unlawful activities and ensure the integrity of the financial system. The implementation of effective regulations and standards, the use of advanced technologies, the establishment of secure information sharing systems, and the investment in training and education are all critical components in the fight against money laundering and CTF in the cryptocurrency and DeFi space.
- U.S. Department of the Treasury, Illicit Finance Risk Assessment of Decentralized Finance (DeFi) Ecosystem, https://www.fincen.gov/.
- Financial Action Task Force (FATF), Money Laundering in Cryptocurrencies and DeFi: Emerging Trends, Challenges and Recommendations, https://geciclaw.com/.
- Global Financial Integrity, Global Financial Integrity Report 2022: Illicit Capital Flows and Their Impact on Sustainable Development, https://gfintegrity.org/issue/illicit-financial-flows/.
- McKinsey & Company, The Road Ahead for Crypto Regulation, https://blog.mexc.com/crypto-regulations-navigating-the-evolving-regulatory-landscape-creator-mckingston/.
- Chainalysis, “Criminal Activity in DeFi”, https://www.chainalysis.com/blog/2022-crypto-crime-report-preview-cryptocurrency-money-laundering/.
- CipherTrace, Cryptocurrency Anti-Money Laundering Report 2022, https://ciphertrace.com/wp-content/uploads/2021/05/CipherTrace-Cryptocurrency-Crime-and-Anti-Money-Laundering-Report-May-2021-051221b.pdf.
- Financial Action Task Force (FATF), Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers, https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Guidance-rba-virtual-assets-2021.html.
- International Monetary Fund (IMF), Addressing the Challenges of Money Laundering and Terrorism Financing (ML/FT) in the Context of Cryptocurrencies, https://www.imf.org/en/Publications/fandd/issues/2022/09/Digital-Money-101-explainer.
- World Economic Forum, Managing the Risks of Cryptocurrencies in the Future of Finance, https://www.weforum.org/press/2023/05/new-report-identifies-top-barriers-and-potential-solutions-in-global-crypto-asset-regulation/.
We invite you to delve deeper into the CTC project, exploring its website and engaging with our vibrant social media channels. Discover the remarkable work being done by dedicated individuals and organizations, united in a common purpose – to safeguard our digital world and protect it from the threats of terrorism financing. Together, we can continue to advance the fight against these illicit activities, ensuring that the digital realm remains a safe and secure space for all, now and in the future.
For more information about the project, please visit: https://ctc-project.eu/. You can also join the CTC Stakeholder Community by signing up in the following link: https://ctc-project.eu/community-signup/.
