Anti-money laundering (AML) includes procedures, laws, and regulations designed to stop the practice of illegally obtaining money. Money laundering is one of the problems faced by the world’s financial sector. Criminals often seek to hide their illicit proceeds in the guise of legitimate transactions.
What Is the AML Mechanism in the Banking Industry?
The generic AML measures for all payment transactions include:
Authentication (KYC): Authentication is the process of verifying a customer’s identity through a knowledge factor (something they know) and a possession factor (something they have), such as passwords or tokens.
Customer Due Diligence (CDD): This is the process of verifying the identity of a customer through various databases. Understanding your customers is a critical AML measure in digital currency and all digital transactions in general.
Monitoring Transactions: Financial institutions can monitor their customers’ transfer activity to detect suspicious patterns such as unusually large cash transfers or completely unrelated transaction histories. This enables financial institutions to flag potentially illicit activities for further investigation by the relevant authorities.
Suspicious Activity Reporting (SAR): SAR reports enable financial institutions to pass on any suspected illicit transactions they become aware of directly to the Financial Intelligence Unit. The FIU will then relay the information to other regulatory and enforcement agencies, including law enforcement and tax authorities, as appropriate.
Why is AML Vital in the Crypto Industry?
It’s evident that crypto is changing the financial sector, but the extent of this change is still up for debate. However, digital currencies make it harder for regulators to enforce anti-money laundering laws in the financial sector.
They have been highlighted as a potential tool for money launderers, as they can be used to transfer wealth anonymously. As a result, crypto exchanges are increasingly required to comply with AML requirements, just like traditional financial institutions.
This means that the exchanges must implement policies and procedures to identify and report any suspicious activity, including transactions associated with money laundering. By doing so, crypto exchanges can help reduce the risk of digital currencies becoming a tool for money laundering.
Regulators seem to be catching up to digital currencies and finding ways to enforce compliance, as evident with some recent regulations passed globally.
Central banks are also exploring the possibility of issuing CBDCs as digital replacements for paper-based money to improve payment efficiency, combat counterfeiting, and reduce money laundering risks in the financial sector.
From the banks’ perspective, CBDC could help to reduce AML risks as central bank digital currencies are more easily traceable than cash. For example, if a criminal tries to launder money through digital currency, the bank would be able to track and identify the source of the funds more easily. In addition, CBDC could help improve transparency in the financial system as all transactions would be recorded on a public ledger. This would make it difficult for criminals to hide their illicit activities.
On a Final Note
Although money laundering in the cryptocurrency industry hasn’t been proven yet, there are high risks that it may be a point in the future. However, with the development of CBCDs, financial institutions can also implement banking industry best practices for cryptocurrencies beyond the generic AML measures mentioned above. These best practices could include things such as:
- adopting transparent governance structures;
- having well-defined and enforced anti-money laundering and counter-terrorist financing policies;
- conducting regular risk assessments; and
- having reporting procedures in place for suspicious activities.