#explain-card ## Introduction **Anti-Money Laundering (AML)** refers to a set of laws, [[Regulation|regulations]], and procedures intended to prevent individuals and organizations from disguising illegally obtained funds as legitimate income. Money laundering is the process of making "dirty" money—proceeds from criminal activities like drug trafficking, terrorism, or corruption—appear "clean." AML measures are crucial for maintaining the integrity of financial systems and combating crime. - **Importance/Purpose:** AML regulations aim to detect and deter money laundering and terrorist financing. They typically require financial institutions and other regulated entities to monitor customer transactions, verify identities ([[Know your customer]]), and report suspicious activities. - **Target Audience:** Financial institutions, regulators, law enforcement agencies, businesses in regulated sectors (including many cryptocurrency exchanges), and compliance professionals. ## Core Concepts & Mechanism ### Key Pillars of AML 1. **Know Your Customer (KYC):** Verifying the identity of customers to understand who they are and assess their risk profile. This is a foundational element of AML. 2. **Customer Due Diligence (CDD) / Enhanced Due Diligence (EDD):** Beyond initial identification, CDD involves ongoing monitoring of customer transactions and risk assessment. EDD is applied to higher-risk customers (e.g., Politically Exposed Persons - PEPs) and involves more intensive scrutiny. 3. **Suspicious Activity Reporting (SAR):** Requiring institutions to report transactions or activities that appear unusual or potentially linked to illicit activities to relevant authorities (e.g., Financial Crimes Enforcement Network - FinCEN in the US). 4. **Record Keeping:** Maintaining comprehensive records of customer identities and transactions for a specified period, which can be used for investigations. 5. **Compliance Programs:** Obligating institutions to develop and implement internal AML policies, procedures, controls, designate a compliance officer, provide ongoing employee training, and conduct independent audits of the program. ### The Money Laundering Process (Typically Three Stages) 1. **Placement:** Introducing illicit funds into the financial system (e.g., depositing cash into bank accounts, often in small amounts to avoid detection – known as smurfing). 2. **Layering:** Conducting complex financial transactions to obscure the source and ownership of the funds (e.g., wire transfers through multiple accounts, converting cash into financial instruments, investing in assets). 3. **Integration:** Making the laundered funds appear legitimate by re-introducing them into the economy (e.g., investing in legitimate businesses, real estate, or luxury assets). ### AML in the Context of Cryptocurrencies Cryptocurrencies present unique challenges and opportunities for AML: - **Challenges:** The pseudonymous nature of many cryptocurrencies, the global reach of transactions, and the emergence of privacy-enhancing technologies (like [[Privacy coins]] and mixers) can make it harder to trace illicit funds. - **Opportunities:** The transparency of public blockchains (like [[Bitcoin]] and [[Ethereum]]) means that all transactions are recorded on an immutable [[Ledger|ledger]]. Blockchain analytics firms specialize in tracing cryptocurrency transactions and identifying links to illicit activities. - **Regulation:** Regulators globally are increasingly applying AML rules to cryptocurrency exchanges, [[Wallet|wallet]] providers, and other virtual asset service providers (VASPs). The Financial Action Task Force (FATF) has issued guidance, including the "Travel Rule," which requires VASPs to collect and share information about the originators and beneficiaries of crypto transfers. ## Use Cases & Implications ### Why AML is Important - **Combats Crime:** Disrupts the financial networks of criminals and terrorists. - **Protects Financial System Integrity:** Prevents financial institutions from being used for illicit purposes. - **International Cooperation:** AML standards facilitate cooperation between countries in fighting cross-border financial crime. - **Regulatory Compliance:** Failure to comply with AML regulations can result in severe penalties, fines, and reputational damage for institutions. ### Limitations & Challenges - **Cost of Compliance:** Implementing robust AML programs can be expensive for financial institutions. - **Customer Friction:** KYC and CDD processes can be cumbersome for customers. - **Effectiveness Debate:** Critics argue that current AML regimes are overly burdensome and not always effective in stopping sophisticated money launderers, while potentially excluding legitimate users from financial services. - **Evolving Threats:** Money launderers constantly adapt their methods, requiring AML strategies to evolve continuously. - **Cross-Jurisdictional Complexity:** Differing AML regulations across countries can create compliance challenges for international businesses. ## Related Concepts - [[Counter terrorist financing]] - Regulation - [[Centralized exchange]] - Privacy coins