Bitcoin and the ongoing money laundering risk

Written by Jason Morris on Friday June 8, 2018

Many more people will be using cryptocurrencies in the future. Users, particularly bitcoin users, are growing exponentially, with analysts expecting the number of bitcoin users to reach 200 million by 2024. This suggests that bitcoin and other cryptocurrencies will continue to challenge, and conceivably become more of a challenge, to the established ways of conducting financial transactions.




It's perhaps no secret that criminals, often early adopters of new technologies, have long since appreciated the properties in bitcoin that could enable them to evade law enforcement scrutiny. After all, one of the key advantages of bitcoin is that it can be transferred across international borders without having to use third parties, almost as easy as it is to send an email, not to mention the fact that this can also be done anonymously. So, is bitcoin being used for money laundering purposes?


A recent study was carried out by the Foundation for Defense of Democracies’ Center on Sanctions and Illicit Finance, alongside Elliptic, a cryptocurrency analytics provider, which looked at Blockchain data relating to bitcoin and the illicit inflows into digital currency services.


By looking at a small sample of bitcoin transactions that took place between 2013 and 2016, the study identified illicit transactional activity made to platforms where users would convert the bitcoin to a fiat currency, or another cryptocurrency, or to another bitcoin address accessible to the user, the result of which produced a flow of funds that could not be traced or viewed directly on the public Blockchain.


Darknet marketplaces like AlphaBay (and its predecessor Silk Road), were the source of almost all of the illicit transactions traced, and online gambling sites were often used to convert the bitcoin. A large proportion of conversion services concealed their jurisdictional location, although the study did find that European-based services were used far more often than any US-based services, around five times as much.


So, how did the study know that these were illicit transactions?


There appears to be some assumptions, albeit educated, but assumptions all the same, made in the study. It took the recognised legal definition of money laundering from the US Treasury’s Financial Crimes Enforcement Network (FinCEN) – this was, afterall, a US study – which states:


Money laundering is the process of making illegally-gained proceeds (i.e. "dirty money") appear legal (i.e. "clean"). Typically, it involves three steps: placement, layering and integration. First, the illegitimate funds are furtively introduced into the legitimate financial system. Then, the money is moved around to create confusion, sometimes by wiring or transferring through numerous accounts. Finally, it is integrated into the financial system through additional transactions until the "dirty money" appears "clean."


The study appears to have aligned this definition as best as it could to cryptocurrency transactions, by assuming that when an individual moves bitcoin from an address associated with illicit activity to a new address, or transfers it to a fiat currency, in a way the conceals the original source, then the intent must be to ‘cleanse’ the bitcoins. This became known as ‘bitcoin laundering’.


Financial institutions, particularly those providing banking services to cryptocurrency businesses, need to be aware of the risk of bitcoin laundering. Compliance departments within these institutions could embed procedures to assess the flow of funds into and out of the cryptocurrency accounts, and look for patterns where customers may be trying to obscure the original source. Being able to demonstrate that you are actively trying to mitigate this type of financial crime risk is an important one for firms to make, particularly when the regulator comes knocking.


It will come as no surprise to know that bitcoin exchanges were found to account for the largest share of the total amount of bitcoin laundered during the relevant period, at 45%. The next largest, at 25%, was the gambling service.


Of course, perspective is everything though, and it is really important to point out that the overall percentage of transactions looked at during the relevant period that were found to originate from illicit entities was only 0.61%. The fact that this is so low may lead you to wonder why we should be concerned about it as a risk at all. My worry though, is that as the number of cryptocurrency users grows, so will the opportunity for criminals to use digital currency systems to move their proceeds of crime.


I wrote recently about how some countries are moving towards a cashless society, and that one of the advantages of this is that it could help to tackle the predominantly cash-based, global money laundering problem. Criminals will still need an outlet to move their illicit funds, and perhaps cryptocurrencies will become a preferred option. By tackling this issue before it gets too big, the hope is that we can further reduce global money laundering in the future.



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