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Welcome to our series – Crypto Money Laundering Explained – where we break down individual risk categories and help you learn how criminals use digital assets and the mechanisms involved in laundering the proceeds of crime.
In this edition, we will explore how and why bad actors are trying to use tokens and stablecoins to bypass existing cryptocurrency compliance systems and effectively launder their funds.
Innovation in the crypto industry is moving at breakneck speed, and these new technologies present both opportunities and threats. The emergence of tokens and stablecoins over the past five years underscores this reality.
Since their conception, both of these innovations have been used by criminal entities to aid in money laundering and offer an effective ramp between fiat currencies and more volatile cryptoassets.
But what exactly are “tokens” and “stablecoins”? And how are they exploited by criminals?
What is a token?
A token is a programmable unit of value that is recorded and transferred to the blockchain. Since their conception, tokens have been used by bad actors to complicate the flow of funds and increase anonymity through DEX-like uses.
The most popular token standard is ERC-20 on the Ethereum blockchain, with Tether (USDT) being the most commonly used.
What is a stablecoin?
Stablecoins are a type of cryptoasset designed to maintain a stable price compared to unsupported counterparts such as Bitcoin.
To achieve this stability, coins are pegged to other assets – including fiat currencies, commodities and other cryptoassets – to reduce their volatility. The US dollar is the most commonly used asset to peg stablecoins.
Although many features of stablecoins present great opportunities for criminals, they come with one significant drawback; transactions involving stablecoins may be reversible depending on how smart contracts are programmed. This means that issuers could potentially recover funds in cases where fraud or other crime is confirmed.
How these mechanisms are used for money laundering
Now that we have clarity on these terms, let’s explore a few scenarios that show exactly how tokens and stablecoins are misused to effectively launder illicit funds.
Scenario 1: using tokens and stablecoins to “clean” funds of illicit origin
By sending illicit assets like Ethereum through services like DEXs that don’t require KYC information, criminals can exchange them for “clean” ERC-20 tokens or stablecoins.
This “layering” makes it much more difficult to detect illicit origins and increases the likelihood that criminals can successfully cash in fiat currencies.
Scenario 2: Using DEX to launder stolen tokens and stablecoins
Similar to scenario 1 but in reverse, in this case the criminal uses the DEX to exchange the stolen ERC-20 tokens and stablecoins for “pure” Ethereum.
Again, like the first scenario, the criminal is able to engage without sharing KYC information, adding new layers beyond the criminal origins of the fund while maintaining their anonymity.
Scenario 3: using new token sales for “carpet pulling” and other scams
Scammers launch a fake initial coin offering (ICO) or token to convince victims “to invest” by sending Ethereum to a specific crypto address to purchase a non-existent asset.
The criminals then close up and remove all remnants of their offering and leave with the collected funds.
How blockchain analytics helps fight bad actors using tokens and stablecoins
Traditional blockchain analytics cannot be traced through services like DEX, which means tokens and stablecoins present great opportunities for criminals to avoid detection by using such non-KYC compliant services to launder illicit funds.
This highlights the significant need for organizations cross-chain detection capabilities available in their blockchain analytics systems, ensuring that they can immediately identify illegal and high-risk activities, despite the use of money laundering techniques that move funds through the chains.
Instead, companies can alternatively identify exposure to fraud such as tokens by using wallet and transaction verification to identify and assess the ultimate source of funds.
As with most crypto innovations, tokens and stablecoins have entirely legitimate uses, but create challenges for compliance teams trying to protect their organizations from exposure to illegal activity.
Learn more about the crypto risk categories, their associated red flags and how to counter them in our comprehensive “Report on typologies for 2023”which you can find here.
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