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Welcome to our cryptocurrency laundering explainer series, where we break down individual risk categories and help you learn how criminals use the platforms and mechanisms involved to launder the proceeds of crime.
Most blockchains are inherently “transparent” by design. This means that anyone with the right tools can see any activity that has taken place on the blockchain. With this in mind, criminals are always looking for ways to disguise the source and destination of their illicit crypto assets. Mixers and privacy wallets – while not inherently illicit – can help them do this.
In this blog, we will explore how and why bad actors try to use these methods to bypass existing cryptocurrency compliance systems and launder their funds.
First, let’s make sure we’re all aligned on what mixers and privacy wallets actually are.
What is a mixer?
Mixers are services that allow users to mix their cryptoassets with those of other clients and then withdraw them to another destination, with the aim of disguising their ownership and breaking the link between funds sent and received.
What is a privacy wallet?
Privacy wallets usually refer to open source cryptocurrency wallets. These wallets have built-in functionality to spoof the senders and receivers of funds going in and out of them. This makes it harder for law enforcement to trace funds on the blockchain and can allow bad actors to more easily hide the flow of their ill-gotten gains.
How these mechanisms are used for money laundering
Let’s look at a few scenarios that show exactly how these mechanisms are being abused to effectively launder illicit funds.
Scenario 1: using a mixer or privacy wallet to hide the source of funds
By sending ill-gotten funds through a mixer or privacy wallet before depositing them on an exchange, criminals can disguise the source of those funds. This helps them give the impression that a particular crypto-asset may not be related to a fraud, theft or other problematic event that they, in fact, have. The use of these obfuscation technologies reduces the likelihood that an unauthorized source will be detected by an organization’s compliance system.
Some companies use a leap-based compliance approach to manage risk mitigation. This means that if criminals can add enough steps between the original illegal activity and the organization they want to do business with, they can effectively hide their illegal activities and avoid detection. This then allows them to convert their cryptocurrencies into fiat or other less transparent currencies, such as privacy coins.
Scenario 2: Using Mixer or Privacy Wallet To obfuscate the destination of funds
By sending funds from an exchange to a mixer or privacy wallet before committing illegal activities, criminals are able to disguise the destination of the funds. This helps them increase their anonymity before engaging in illegal activities such as buying stolen credit card information, malware or drugs on the dark web.
This added anonymity makes it harder to trace the flow of funds and prevents a non-holistic compliance system from tracing activity back to the criminal. For example, if the target in question uses a fully licensed exchange to purchase their cryptocurrency, then they need a means by which they can mask this information and terminate the connection to prevent law enforcement agencies from tracking them in the future.
How blockchain analytics help fight bad actors with a mixer or privacy wallet
Typically, blockchain analytics firms cannot trace through mixers or privacy wallets on an automated basis. However, what they can do is identify when a transaction has interacted with such a service.
Using this information, organizations can then take steps to assess the relevant risk based on their risk appetite and decide whether to allow or deny a given transaction. Factors that typically come into play in this decision-making process include the size of the transaction and how often the customer has engaged in potentially risky services.
While both have legitimate uses, these scenarios highlight why it’s important that your blockchain analytics tools can identify exposure to privacy mixers and wallets.
Learn about the categories of crypto risk, their associated red flags and how to counter them in our comprehensive 2023. “Report on typologies”, which you can find below.
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Crypto Crime Global Compliance
