Anti-Money Laundering in the Era of Digital Finance

Money laundering is the process of concealing the ways illegal money has been obtained, towards presenting and using it as legitimate income. It is a criminal act that entails a complex sequence of transactions involving banks, enterprises, and other commercial stakeholders. Money laundering has significant economic implications such as reduced government revenues and increased tax rates for honest taxpayers.  At the same time, it has considerable societal implications as it fuels the activities of drug traffickers, smugglers, and other criminals.

In this context, Anti Money Laundering (AML) activities aim at deterring criminals from laundering money through exposing the sources of illegal money and making it very difficult to transfer and use such money. At the technical and technological forefront, AML activities aim at tracking and tracing money flaws towards exposing potentially illegal activities. Likewise, at the regulatory forefront, financial institutions adhere to AML regulations that oblige them to keep track of monetary transactions, identify potentially suspicious activities, and reporting to regulators and law enforcement agencies.

In recent years, AML activities have been expanding and made more efficient. Specifically, financial organizations employ disciplined processes for tracking money flows and detecting activities that are likely to be fraudulent.  Nevertheless, the scale of money laundering activities has been recently increasing. According to the United Nations, the estimated amount of money laundered globally in one year is $2 trillion. There are various recent large-scale money laundering cases such as the Danske Bank money laundering case in 2018 that involved almost $200 billion of potentially fraudulent financial transactions. Overall, designing and implementing AML activities is a very challenging task given the complex ecosystem of digital finance transactions.

Understanding Money Laundering Activities

AML activities track all the phases of money laundering including:

• Placement: During this phase, the money that is acquired based on a criminal activity enters the financial system. In most cases, cash from criminal sources is transformed to other forms of liquid cash such as bank deposits in savings accounts, traveler checks, and bank drafts. A common placement tactic involves breaking down large amounts of illegal funds in smaller cash amounts that are not likely to raise suspicion among the financial institutions involved.
• Layering: This phase involves the separation of the money from its original illegal sources. The process is quite complicated and entails transferring different amounts of money to various locations (e.g., different countries and financial institutions) around the globe. In the scope of this process, several transformations of the money from one form of asset to another may take place. Furthermore, the speed of transfers and transformations is key in this phase. Specifically, the success of the layering phase lies in performing transfers faster than regulators, and law enforcement agencies can detect and analyse them.
• Integration: This is the last and final phase of the process. It aims at returning the money back to the criminals that originally performed the illegal activities that produced it. The money can be returned in both direct (e.g., like cash) and indirect ways. The latter may involve other assets like a business, real estate, gold, or other goods.

Tracing money and its transformations across the above phases is generally challenging. This is because several transactions take place by different people and across different institutions. Moreover, they entail multiple assets that are not obviously connected to the original money flaws. In recent years, the process has become even more complicated because of the emergence of new digital platforms and their integration in the global digital finance ecosystem. For example:

• The expanded use of the Dark Web for illegal financial activities. The dark web is a specific part of the Internet that hosts encrypted content, which is not indexed by Google and other mainstream search engines. As such the Dark Web offers privacy and data protection for financial transactions that make use of it. Criminals use dark web tools (e.g., message boards, chat rooms, virtual marketplaces) for buying and selling illegal products and services.
• The use of Cryptocurrencies to conduct private payment transactions. Mainstream cryptocurrencies like BitCoin and Ethereum provide the means for executing private payment transactions that are hardly traceable. Many criminals take advantage of the privacy characteristics of the BitCoin network to hide information about their transactions.
• New Payment Networks: The rise of Open Banking, along with new payment directives (e.g., the Second Payment Services Directive (PSD2) in Europe) leads to the emergence of new complex payment networks. The latter involves new payment services providers beyond conventional banks while employing novel technological solutions. Such services increase the complexity of the digital finance ecosystem, which makes it more difficult to track and trace money flows.
• Co-existence of cash and virtual currencies: In several cases, money flows across both cash and virtual currency networks. This is another factor that complicates the task of tracking suspicious financial transactions.

In an environment of multiple stakeholders, technologies and payment modalities, money laundering criminals are offered with increased opportunities for concealing the source and flow of money acquired in illegal ways. Likewise, digital channels enable them to act much faster than in the past, even when transactions take place across different countries and digital finance ecosystems. These are some of the reasons why existing AML systems and regulations fall short when it comes to dealing with sophisticated laundering activities that involve multiple internet platforms worldwide.

AML Solution Guidelines

To cope with money laundering activities in a complex digital finance landscape, financial organizations, regulators, and law enforcement agencies had better adhere to the following best practices:

• Information Sharing: Money laundering activities take place across the digital finance supply chain. AML processes can benefit from the continuous exchange of money laundering related information between interconnected financial organizations. Special emphasis should be put in sharing information about suspicious events (e.g., break down of large transactions in many smaller ones) that can be indicative of fraudulent activities. Such events could lead regulators and law enforcement authorities to scrutinize certain transactions towards discovering the underlying money laundering activities.
• Cross-Network Tracing and Interoperability: The interconnection of different digital platforms (e.g., dark web, surface web) and monetary ecosystems (e.g., cryptocurrencies, stock markets, on-line betting agencies, peer to peer payment platforms, investment platforms) can greatly benefit AML processes. Nowadays there is no easy way to track transactions across these platforms, which is a powerful weapon at the hands of financial criminals.
• Artificial Intelligence: Even with proper information at hand, it is very difficult for human officers to link diverse data sources and transaction chains. Big Data analytics and Artificial Intelligence (AI) algorithms can greatly boost the automation and intelligence of money tracing processes. For example, AI algorithms can be used to identify links between diverse transactions, including non-obvious links. Specifically, AI techniques can unveil hidden relationships between the people involved in the transactions, as well as other potential links that may relate to monetary amounts, the dates of the transactions, as well as to the locations where the transactions originated.
• Legal and Regulatory Updates: Financial criminals tend to exploit the fact that the digital finance ecosystem must always respect citizen rights. They leverage on the confidentiality of financial transactions while taking advantage of privacy and data protection laws. On the other hand, many countries have recently revised their laws to facilitate the scrutiny of suspicious transactions. For example, they made it easier to gain access to financial transactions of suspicious individuals and ask for more frequent and detailed reporting. Likewise, financial institutions are currently obliged to audit transactions that fulfill certain criteria. Overall, there is a need for a legal framework that balances citizens’ data protection with the need to fight money laundering.

The rapid evolution of the global digital finance ecosystem enables the delivery of improved services to citizens and businesses. It also facilitates the development of innovative products and services. Nevertheless, it creates new opportunities for conducting financial crime, including money laundering opportunities. Fortunately, advanced digital technologies are not only a source of the problem but also a part of the solution. In the next few years, financial organizations and law enforcement agencies will be increasingly deploying such technologies to enhance the effectiveness and timeliness of their AML activities.