Ultimate Guide to AML for Cryptocurrency

Crypto and digital payment companies paid $5.8 billion in fines last year for failures to enforce customer controls, anti-money laundering  (AML) compliance, and other financial crime issues, according to the report. As can be seen, companies in the crypto sector must now comply with changing global and local regulatory requirements in the fight against AML and terrorist financing, as well as collaborate with the Regtech sector, which provides solutions such as AI and machine learning.

What is AML in Crypto?

AML in the cryptocurrency sector refers to the regulations and practices designed to detect and prevent illegal activities like money laundering, tax evasion, and terrorist financing through digital currencies. While AML laws have traditionally applied to fiat currencies, their relevance in crypto has grown as the anonymity and global reach of blockchain transactions present new challenges for law enforcement. AML processes, such as Know Your Customer (KYC) checks, are now crucial for crypto exchanges and wallet providers, ensuring that individuals and institutions comply with regulatory requirements. As crypto adoption expands, AML compliance plays a key role in maintaining trust, transparency, and security within the ecosystem.

Why is AML Important for Crypto?

One of the biggest problems with the crypto industry is that it has become a global umbrella for financial crime. AML practices are vital to the crypto industry and the overall economy for a few key reasons: 

• Preventing Illegal Activities: AML measures are vital to combating illicit activities such as money laundering and terrorist financing. For example, in 2020, cryptocurrency exchanges were linked to over $2.3 billion in laundered funds, highlighting the need for effective AML controls. 
• Protecting Market Integrity: These regulations increase the stability and reliability of the cryptocurrency market, which creates greater trust among users and investors. The BitMEX case is a prime example of how regulatory failures can lead to significant financial and reputational damage. 
• Avoiding Regulatory Penalties: Failure to comply with AML regulations can lead to serious legal and financial consequences. Cryptocurrency platforms that fail to implement AML measures may be penalized by regulators with heavy fines and operational restrictions. 

AML Requirements for Cryptocurrency 

Given cryptocurrencies' unique risks and challenges, the industry's need for effective AML measures grows every year. Global regulators have recognized the importance of regulating crypto companies like traditional financial institutions to prevent cryptocurrencies, which are the latest target of financial criminals. However, these regulations vary by region, with some jurisdictions offering comprehensive guidance while others still need more thorough laws on cryptocurrencies. 

FATF plays a crucial role in setting global AML standards for the crypto industry, ensuring that money laundering and terrorist financing are minimized. Given the rapid evolution of digital assets, these regulations are constantly being updated to prevent the exploitation of vulnerabilities in bitcoin exchanges, wallet providers, and other virtual asset service providers. The major AML Requirements that are accepted globally are: 

Risk-Based Approach: Conducting thorough cryptocurrency risk assessments is essential for identifying vulnerabilities and preventing financial crimes. The crypto sector has distinct risks, including secure storage of private keys, transaction transparency, geographical parameters, and delivery channels such as digital platforms and crypto ATMs. Effective assessments help companies plan resources, guide development strategies, and ensure robust controls. Ongoing dialogue with stakeholders ensures that the assessment process remains comprehensive and valuable. 
• Know Your Customer (KYC): KYC procedures are essential in the crypto space, as anonymity of transactions is a significant concern. KYC procedures involve collecting and verifying customer data, such as full name, date of birth, proof of identity, and address, to set up an account. This way, crypto companies can verify their customers' profiles and track them in case of suspicious activity. 
• Customer Due Diligence (CDD): CDD means evaluating each customer's risk and applying appropriate risk-mitigation procedures. CDD methods involve ongoing monitoring of customer accounts and transactions to address monitoring issues caused by the decentralization of the crypto market. Regularly inspecting customer details is also essential to detect criminals using methods such as IP changes. 

• Transaction Monitoring: Cryptocurrency companies must monitor their platforms for large, unusual, or suspicious transactions, especially those involving high-risk jurisdictions. Cryptocurrency transaction monitoring is challenging due to the need for more regulation and anonymity of blockchain transactions. However, with techniques such as blockchain analytics, behavioral-based monitoring, and artificial intelligence, financial institutions and regulators can manage better and reduce the risk of financial crime. 
• Embrace Technological Solutions: Authorities recommend the adoption of AI-powered compliance tools such as Sanction Scanner to streamline AML compliance processes in the cryptocurrency sector and improve the detection and prevention of financial crimes. 
• Seek Compliance Expertise: Hiring compliance officers with experience in DeFi, regulatory, and FinTech can help to professionalize the compliance process. These specialists can navigate the complicated regulatory landscape and have previous expertise with compliance needs. 
• Comply with Country-Specific Regulations: Different jurisdictions may have varying viewpoints on cryptocurrency regulations. Crypto enterprises should be aware of the unique details and considerations of operating in various areas. 

Crypto AML Regulations Around the World

Every country and region in the world have different laws to combat money laundering. But there are also laws to combat money laundering in the cryptocurrency sector globally, such as the FATF's Travel Rule. 

FATF Crypto Travel Rule

In 2013, the FATF created a set of rules to combat money laundering. As of the first period of 2024, 35 out of 135 FATF member jurisdictions have enacted Travel Rule legislation, and 27 jurisdictions have started enforcement measures. The FATF Travel Rule requires financial institutions and Virtual Asset Service Providers to collect and exchange personal information on senders and receivers of virtual asset transfers. The essential requirements of the regulation are: 

• Information Collection: VASPs must gather and distribute details about the transaction's source and recipient. When a transfer exceeds a threshold of $1,000 USD/EUR, VASPs are required to gather additional identifying data, such as names, wallet addresses, and physical addresses. 
• Thresholds: Basic information such as names and wallet addresses are required for transfers below the threshold but does not need verification unless suspicious activity is detected. 

The Travel Rule represents a significant regulatory shift for the cryptocurrency industry, creating challenges in terms of implementation and compliance. It necessitates developing new systems for securely sharing personal data across different platforms, which is a novel requirement for the crypto sector compared to traditional financial institutions. 

AML Crypto Regulations in the US 

Cryptocurrency exchanges operating in the United States must abide by KYC and AML legislation since failure to do so may result in closure. The Financial Crimes Enforcement Network (FinCEN) aims to safeguard the financial system against illicit activity by requiring these exchanges to carry out KYC checks and put in place efficient AML systems. 

The US Treasury has also proposed new tax reporting obligations for cryptocurrency brokers. They will need to report detailed transaction information to the IRS using a new form, Form 1099-DA, designed to simplify reporting cryptocurrency gains and losses. These rules are expected to take effect in 2025. 

The regulatory environment for cryptocurrencies in the US is complex, with Bitcoin being classified differently depending on the context: as a currency by the Treasury, a security by the SEC, and a commodity by the CFTC. This variation, along with differing federal and state regulations, creates a multifaceted legal landscape. For tax purposes, cryptocurrencies are treated as property, requiring users to report transactions and comply with capital gains tax regulations. 

AML Crypto Regulations in the European Union 

The European Union strengthened the regulation of cryptocurrency assets in May 2023 by introducing important legislation that aims to stop their abuse of money laundering and terrorism financing. As part of the EU's larger digital finance plan, The Markets in Crypto Assets (MiCA) Regulation offers extensive guidelines to protect investors and preserve financial stability. To protect customers against fraudulent schemes, the MiCA places stringent rules on crypto asset services, requiring them to keep adequate liquid reserves and take responsibility for lost assets. Notably, non-fungible tokens (NFTs) are only included in the MiCA's scope if they belong to pre-existing categories of digital assets. 

Regulation 2023/1113 was developed in addition to MiCA to ensure transparency in the transfer of cryptocurrency assets. Regardless of the amount involved in a transfer, this rule mandates that crypto asset service providers collect comprehensive information about the sender and recipient. This action is intended to comply with international regulations developed for the worldwide campaign against money laundering. It is planned for both regulations to go into effect on December 30, 2024. 

AML Crypto Regulations in the UK 

With the goal of becoming a global center for crypto-asset technology, the UK have taken vital steps to regulate cryptocurrencies. Despite leaving the EU, the UK complied with directives and adopted the regulations of the EU's 5th and 6th Anti-Money Laundering Directives into national legislation. The principal regulatory body that monitors cryptocurrency organizations is the Financial Conduct Authority (FCA).  

The UK government has also introduced new measures to enhance regulatory clarity, including a consultation on the Future Financial Services Regime for Crypto Assets released by HM Treasury in February 2023, and new financial promotions restrictions launched by the FCA in October 2023. While the UK's framework differs from the EU's MiCA, UK crypto companies targeting EU markets must comply with UK and EU regulations, including obtaining MiCA authorization and adhering to the Transfer of Funds Regulation (TFR) when offering services in the EU. 

AML Crypto Regulations in China 

China plans to majorly change its AML legislation by 2025, emphasizing cryptocurrency-related transactions. This is the first significant update to China's AML regulations since 2007, driven by the increasing popularity of digital assets for money laundering. The revisions proposed by the State Council aim to impose stricter restrictions and heavier penalties for large-scale money laundering, defined as transactions above 5 million yuan ($685,000). 

Despite an overall ban on cryptocurrencies since 2021, their decentralized nature has allowed Chinese consumers to continue accessing crypto exchanges, increasing the risk of money laundering. China's strict AML measures, such as its focus on the digital yuan and its strict sanctions, contrast with the more regulated and market-friendly approaches of other countries in the region, such as South Korea and Japan. 

AML Crypto Regulations in India 

In India, cryptocurrency regulation is evolving but remains fragmented. The Prevention of Money Laundering Act (PMLA) requires crypto businesses to comply with AML regulations and obtain licenses from the Financial Intelligence Unit-India (FIU-IND). The Consumer Protection Act (2019) also mandates transparency in crypto transactions to protect consumers. 

Cryptocurrencies are taxed at 30% on profits, with a 1% tax deducted at source for transactions over ₹ $50,000 ($600). Despite regulatory uncertainty, India is exploring structured regulations, with initiatives like the Telangana Web3 Sandbox indicating potential future developments. The industry must navigate these evolving rules amid cautious but progressive governmental attitudes. 

AML Crypto Regulations in Türkiye 

Turkey's bitcoin sector is expanding due to economic instability and a tech-savvy population. Regional countries such as Georgia have also implemented cryptocurrency rules, demonstrating a broader trend. Türkiye approved legislation to regulate cryptocurrency in 2021, restricting payments but allowing trade and custody. Following changes to AML legislation, crypto service providers are now required to conduct KYC checks and report suspicious activity to the Financial Crimes Investigation Board (MASAK). 

In 2024, Türkiye introduced comprehensive rules to enhance its cryptocurrency market. The new Crypto Asset Law requires crypto service providers to get Capital Markets Board (CMB) licenses and comply with strong anti-money laundering requirements. The legislation, which responds to previous scandals such as the Thodex fraud, aligns Türkiye with international standards and addresses FATF concerns. As Türkiye promotes itself as an important player in the regional cryptocurrency environment, new measures are intended to protect market integrity and attract investment. 

Top 10 Crypto-Friendly Countries 

As cryptocurrencies change the global financial landscape, the need for supportive regulatory environments rises. Countries that embrace digital currencies through favorable legislation, clear tax regulations, and solid blockchain infrastructure open the way for widespread application and innovation. The top ten crypto-friendly countries that have led in developing conditions that promote digital currency growth are listed below. 

What are Crypto Exchanges and Wallets? 

Cryptocurrency exchanges are online marketplaces that allow users to purchase, sell, and trade cryptocurrency. They enable users to transfer fiat currency like dollars or euros into cryptocurrencies such as Bitcoin or Ethereum. Users can also trade a variety of digital assets, including NFTs, using these platforms. Unlike traditional exchanges, cryptocurrency exchanges do not have a physical presence and are subject to different regulatory rules. They focus more on compliance with AML and data collection requirements rather than direct oversight by organizations like the SEC.  

Crypto wallets are applications for managing and storing cryptocurrencies. Despite their name, they do not contain physical money. Instead, they store the digital keys required to access and manage your cryptocurrency assets. Wallets offer a user-friendly interface for managing crypto assets and carrying out blockchain transactions. They can take a variety of forms, including software applications for computers or mobile devices, as well as physical devices that improve security. A crypto wallet allows users to send, receive, and view their crypto balances.  

These digital assets present unique problems for regulatory bodies as they do not have issuing authority. As the cryptocurrency business grows, regulators have responded by establishing specific guidelines, such as AML and KYC compliance for crypto exchanges and wallets, to combat money laundering and terrorism financing.  

How Cryptocurrency Works? 

Cryptocurrencies operate through a decentralized network of computers that use advanced algorithms. Here is a step-by-step breakdown of how cryptocurrency transactions are processed: 

1. Initiating the Transaction: A cryptocurrency transaction begins when a user sends a request to transfer a particular amount of cryptocurrency to another user. This request goes out to the whole network. 
2. Node Verification: The transaction request is sent across several network nodes. Each node independently confirms the transaction by cross-checking it against other nodes. 
3. Transaction Pool (Mempool): Verified transactions are stored in a pool called the mempool. During this step, miners pick transactions from the mempool to include in the next block. 
4. Mining and Block Formation: Miners utilize computing resources to solve complex cryptographic puzzles. The first miner to solve the challenge wins the opportunity to produce a new block containing the chosen transactions. This technique is referred to as mining. 
5. Blockchain Integration: The newly mined block is shared throughout the network. Other nodes verify the block and update their blockchain versions to include it, maintaining network-wide consistency. 
6. Transaction Finalization: Once the block is uploaded to the blockchain, the transaction becomes permanently recorded. It gets uploaded to the public ledger and can be accessed and verified by nodes across the global network. 

Risks and Challenges in the Cryptocurrency Market 

Cryptocurrency has changed the financial industry, providing new potential for investment and decentralized finance. However, over time, cryptocurrencies have become a popular target for criminals, such as money launderers and scammers. The anonymity given by crypto transactions, combined with the lack of central supervision and ease of cross-border transfers, presents serious concerns. Criminals exploit those weaknesses by employing strategies such as smurfing, mixing, and exchange hopping to cover up the origins of illicit funds, transport them across jurisdictions with inadequate AML standards, and steal victims' crypto funds by various scamming techniques. 

AML Risks for the Crypto Industry 

The risks of money laundering with cryptocurrency are becoming more appealing to criminals. Criminals increasingly adopt cryptocurrency to protect themselves and facilitate money transfers between countries. Here are some of the reasons why the cryptocurrency business is at risk of financial crime: 

1. Decentralized Finance (DeFi) 

In the cryptocurrency sector, implementing Know Your Customer (KYC) measures, monitoring transactions, and effectively reporting suspicious activity is challenging because there is no central authority to enforce these regulations. 

The lack of strict procedures allows criminals to remain anonymous even when carrying out large transactions, making it difficult for regulators to track the flow of illicit funds. This creates an even safer atmosphere in the cryptocurrency market for criminal activities like money laundering and terrorist financing, which are much harder to perform in traditional financial systems. 

2. Malicious Software (Ransomware) 

In the cryptocurrency sector, ransomware is increasingly being used to launder money. Attackers encrypt the victims' data and demand payment in cryptocurrencies such as Bitcoin. They use cryptocurrencies to prevent law enforcement from following their tracks. Criminals then launder the funds through exchanges or by hiding transaction history with techniques such as coin mixing, making it difficult to track the money trail. The rise of ransomware as a service (RaaS) has only heightened these risks and raised AML concerns in the cryptocurrency industry. 

3. Security Vulnerabilities 

Money launderers are especially intrigued by cryptocurrency vulnerabilities. Criminals use vulnerabilities in exchanges and wallets to steal large sums of cryptocurrency, which they then launder through complex networks to conceal the source of the funds. These decentralized and anonymous transactions make tracking down and recovering stolen assets challenging. Furthermore, sophisticated attacks such as "51% attacks" can undermine the reliability of markets and pose significant challenges to AML efforts. 

4. The Anonymity of Transactions 

Some cryptocurrencies include advanced privacy features that hide transaction details, making tracking the transfer of funds more difficult. Even mainstream options, such as Bitcoin, can be used anonymously using techniques like multiple wallets or mixing services. Criminals use this to commit illegal activities, launder money, and avoid detection. The rise of Decentralized Exchanges (DEXs) has also complicated AML efforts in the cryptocurrency industry. 

These risks tempt not only money launderers but also scammers to engage in financial crimes. Scammers frequently trick people into giving over their cryptocurrency or personal information in the name of legitimate investment opportunities, exchanges, or services. They take advantage of the digital currency market's decentralized and relatively new characteristics, allowing them to remain anonymous and easily target their victims.  

Common Types of Crypto Scams 

Of the many types of crypto scams, the most common are: 

1. Ponzi Schemes  

Ponzi schemes are becoming increasingly common in the cryptocurrency sector and are a type of financial fraud in which investors are tricked into believing they will receive guaranteed returns. Early investors receive returns from new investors' funds in these schemes, giving the impression that scheme investors are making a profitable investment. However, the flow of new investors eventually slows, the scheme collapses, and most participants suffer substantial losses. 

The main signs of a Ponzi scheme are usually guaranteed high returns, complex and vague investment strategies, and pressure to recruit new investors. 

2. Bitcoin Scams  

Bitcoin scams are schemes aimed at Bitcoin investors, taking advantage of the cryptocurrency's popularity and value to steal people's money. The scammers initially request a fee from the investor, but instead of investing the funds, they deposit them in their accounts. The scammers may also request personal identification information to perform identity thefts.  

Another type of cryptocurrency scam involves using fake celebrity endorsements. Scammers post photos of real celebrities on fake accounts or in advertisements to create the impression that the celebrity is making a significant return on investment. 

3. Rug Pull Scams  

Rug Pull Scams are an increasingly popular scam in the DeFi space, in which developers create seemingly legitimate cryptocurrency projects only to abandon them after receiving significant investment. The scammers steal the money and then disappear with it.  

One of the most well-known rugs pulls happened in 2021, featuring the Squid Game token. The Netflix series contributed to making the token highly popular. After the project's price surged, the developers shrank all liquidity, leaving an estimated $3.38 million and investors with tokens they couldn't exchange. 

4. Phishing Scams 

Phishing Scams are the most dangerous scams on the internet. Cybercriminals impersonate reputable organizations to deceive users into disclosing sensitive information like private passwords or login credentials. Once the victim submits this information, the hackers can immediately withdraw cryptocurrency from the victim's account. 

5. Fake Cryptocurrency Exchanges  

These are typical scams that attract investors with claims of exceptional rates, cheaper fees, or early access to new coins. However, these exchanges are not real, and the trader is unaware they have been tricked until they lose their money. You can detect these scams by investigating the licensing and regulation and reading user reviews. 

6. Fake Initial Coin Offerings (ICOs)  

Fake ICOs take advantage of the popularity and promise of new cryptocurrencies to mislead investors. Many companies gained a lot of money through ICOs, which are open fundraising events where investors may buy coins before they are published on exchanges. However, these offers were only cultivated frauds created to take advantage of the excitement around digital currencies, even if some led to profitable and legal companies.  

7. Pump and Dump Schemes  

These schemes refer to market manipulation in which cryptocurrency prices are artificially boosted. Coins are then sold at an inflated price, resulting in a drop in value and significant losses for other investors. These scams typically employ false advertising, social media excitement, and fake news to inflate prices. 

8. Romance Scams 

Romance scams are a con game in which people are tricked into believing false information—typically via online dating services—to be financially exploited. The objective in the context of cryptocurrencies is to trick victims into purchasing a fraudulent cryptocurrency or stealing their money. 

9. Giveaways  

Giveaways are a common promotion tactic in cryptocurrency markets. They frequently involve fake presents that promise significant perks in return for personal data or a small upfront payment. The fraudsters then vanish when the necessary information or money is obtained. 

10. Blackmail  

Blackmail in the crypto world typically occurs when scammers obtain sensitive information or images about a victim and threaten to disclose them unless the victim pays a ransom in Bitcoin or another digital currency.

Red Flags for The Crypto Industry 

While criminals exploit industry loopholes through criminal activities such as money laundering or scamming, they are becoming more frequently caught as regulators improve regulations' comprehensiveness and effectiveness. In 2019, $2.8 billion was estimated to have been laundered through the crypto industry. Therefore, understanding the red flags in the crypto industry is becoming as important as improving regulations to keep the industry safe. In this regard, Financial Action Task (FATF) has prepared a report to assist cryptocurrency companies in developing anti-money laundering programs. The report focuses on the following indicators: 

1. Technological Features That Allow Users to Cover Their Personal Information   

Criminals use technology that protects their personal information and underpins virtual assets, or VAs, to transfer funds without being tracked down. Companies should launch an investigation when they catch one of their users using these technologies. While using such technologies is not illegal, they pose potential risks to companies. 

2. Geographical Risks 

AML regulations for the crypto industry still need to be more well-developed than those of other industries, and as such, there are still countries with little or no AML regulations on cryptocurrencies. Criminals use this to move virtual assets more easily across countries and launder money through Virtual Asset Service Providers. Consequently, companies in the crypto industry can protect themselves by investigating transactions from countries that do not have the regulations recommended by the FATF. 

3. Transaction Size and Patterns 

The size, frequency, and patterns of transactions are significant red flags for the crypto industry. Some of the red flags are: 

• Making several high-value transactions in a short time 
• Transactions made with funds detected as stolen 
• Transactions from jurisdictions with less developed AML laws 
• Instant withdrawal of crypto assets after transaction 
• Multiple transactions without a commercial basis 
• Cryptocurrency accounts that don't match the customer profile. 

4. Suspicious Sender or Recipient Profiles 

Some behaviors of senders and receivers on crypto exchanges are red flags for money laundering. Inconsistencies in customer account IP addresses and frequent changes of personal IP, email, and customer personal information are all examples of these behaviors. Companies should investigate such situations. 

5. Source of Funds 

The source of cryptocurrency assets may be connected to financial crimes. Organizations can identify suspicious activity by using red flag indicators, which include: 

• Transfers from companies with inadequate CFT and AML regulations  
• Transfers from a single digital wallet connected to several different bank accounts. 
• Larger-scale withdrawals from a single cryptocurrency wallet connected to a bank account. 

While identifying red flags is critical for identifying criminal activity in crypto, the market's complexity requires more comprehensive strategies. The decentralized and anonymous nature of cryptocurrency transactions complicates standard compliance measures, with over $1 billion in illegal crypto activity estimated each year. Effective anti-money laundering requires advanced techniques. 

Future of AML in the Cryptocurrency Market 

The crypto market has faced notable scandals, including Crypto.com's €2.85M fine by a Dutch bank for regulatory breaches, the US blacklisting of the crypto-mixing service Tornado Cash, and the high-profile case of Ruja Ignatova, who remains a fugitive from a massive crypto scam. These and similar incidents have increased global concerns about crypto-related crimes, leading to a significant shift in the regulatory landscape. Authorities worldwide focus on tightening regulations and finding new effective solutions to prevent money laundering. 

Looking forward, RegTech (regulatory technology) is expected to continue to play an important role in AML efforts in the bitcoin sector. Regtech solutions address the crypto market's flaws by providing advanced compliance and risk management tools that use technology such as AI, machine learning, and blockchain. They also assist crypto organizations in complying with changing rules while saving costs and manual labor by automating operations such as KYC verification and transaction monitoring. 

The Regtech market is predicted to grow to $29 billion by 2025, showing a significant rise in investment and acknowledgment. As blockchain technology advances, its integration with Regtech will likely improve the efficiency and security of AML operations while also providing a solid defense against financial crime in the expanding crypto ecosystem. 

How Sanction Scanner Can Help AML Crypto Compliance 

Sanction Scanner provides a comprehensive suite of tools designed to address the unique AML challenges cryptocurrency businesses face. Here's how we support our clients in the crypto sector: 

• Customer Risk Assessment: Our solutions help conduct thorough risk assessments, identifying vulnerabilities related to the secure storage of private keys and transaction transparency. 
• Customer Name Screening: Our solutions support comprehensive identity checks, including PEP and Sanction List Screening. Continuous monitoring of customer accounts helps adapt to the crypto market's decentralized nature. 
• Ongoing Transaction Monitoring: The Sanction Scanner offers advanced transaction monitoring capabilities to detect large, unusual, or suspicious transactions.
• Fraud Detection: Sanction Scanner’s advanced AI-driven system offers fraud detection to prevent crypto scams and safeguard your crypto business effectively.  
  

Sanction Scanner has a proven track record of assisting clients in the crypto sector, including ICrypex, Eksit, Coino and Metatime. Our solutions have enabled these companies to enhance their AML compliance, streamline processes, and safeguard against financial crimes. Request a demo to see how we can help you navigate the complexities of AML compliance in the cryptocurrency industry.