24 February 2016, Bachir El Nakib (CAMS) Senior Consultant Compliance Alert LLC

Despite concern that Bitcoin and other cryptocurrencies are being used by money launderers, so far little attention has been paid to the risks posed by the "mining" of such currencies, industry sources have said.  The anti-money laundering (AML), know-your-customer (KYC) and counter-terrorist financing (CTF) risks associated with mining digital currencies are unclear, and little is known about those who purchase powerful computers to mine for such currencies.                                                                                                                                          "Bitcoin mining" is the process whereby "miners" use specialised software to solve mathematical problems and, in exchange for their computer processing power, are issued a certain number of Bitcoin in exchange. This process determines how cryptocurrencies are issued and brought into circulation, thereby creating an incentive for more miners to enter the fray. 

The anonymous nature of Bitcoin transactions has unnerved international financial regulators and policymakers, and has led some to call for stricter regulation of cryptocurrencies. 

Attractive opportunity

"Bitcoin mining does represent an attractive opportunity for criminals to launder their money and finance their activities," said Aurélien Menant, chief executive and founder of Gatecoin, a digital currency exchange based in Hong Kong. "There are real risks to consider as some [fraudsters and gangsters] enter the cryptocurrency mining industry."

For example, a criminal group looking to launder funds could use their ill-gotten gains to buy powerful "mining rigs", enabling them to recoup the investment through the creation of new Bitcoin which could be converted into cash through a Bitcoin exchange. 

Since the purchase of powerful computers and servers, whether for Bitcoin mining or other purposes, is in many instances a regular transaction, it is not typically subject to regular AML and KYC controls, unlike banking transactions.


Sales of computer hardware are restricted in cases where the buyer is under sanctions imposed by the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC), but such sanctions usually do not touch upon organised crime groups. Ultimately, merchants only have to obtain enough information to satisfy domestic laws and regulations, said Brian Stoeckert, managing partner at Stratis Advisory in San Francisco. "Sanctions screening, such as selling or purchasing with prohibited individuals or countries, would still be required to be performed to comply with sanctions requirements under OFAC," he said.

Even if faced with a requirement to register ownership of mining equipment, criminals could easily evade suspicion by using a legitimate "front company" for their activities, just as they do to mask traditional money laundering activities.

High capital investment and overhead costs

Not everyone sees Bitcoin mining as a money laundering threat, however, particularly given the increasing costs associated with mining.

"It is highly unlikely [that anyone would] mine Bitcoin solely for the purpose of money laundering. As the capital investment and overhead costs associated with setting up and mining coins are huge and time-consuming, miners usually do it [to] sell coins to make profit, and not for laundering money. However, when miners come to our platform to sell their Bitcoin or any other cryptocurrencies, they need to go through the same KYC and AML requirements to verify their identity in order to sell their mined Bitcoin into fiat currency," said Ken Lo, chief executive and co-founder of the ANXBTC Bitcoin Exchange in Hong Kong. A 2014 report by the European Banking Authority recommended that EU legislators should consider declaring market participants at the direct interface between conventional and virtual currencies, such as virtual currency exchanges, to be "obliged entities" under the EU Anti-Money Laundering Directive, and thus subject to its AML and CTF requirements. Regulators in Hong Kong have taken the position that cryptocurrencies are electronic commodities and that market participants trade in and use them at their own peril. The territory's banking regulator has also made it clear that the local Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (2012) applies to cryptocurrencies. 

Registered Addresses

Gregory Simon, president of the Bitcoin Association and co-founder of in New York, said he expected either legislation requiring registered Bitcoin addresses, or that the industry would voluntarily only do business with registered addresses. Even if legislation were introduced requiring only registered Bitcoin addresses to be used for commerce, it could not eliminate the use of anonymous addresses, which would create a schism among users of Blockchain, the technology and algorithm upon which Bitcoin and other digital currencies are predicated.

"This will create a division in the Bitcoin community and likely a protocol fork to create two Blockchains: one Blockchain requires address registration and one does not," Simon said. "This would be a volatile event as users would have to choose which Blockchain to retain their value in and miners would have to choose which Blockchain to continue to mine," he said. Simon also saw another problem with unregistered addresses: "The Internal Revenue Service has [deemed] Bitcoin to be property. If that property was stolen or laundered at any point in the past, any current legitimate owner can have it confiscated from them, even if they acquired it by legitimate means," he said. He expected that if the Blockchain became "mainstream" it would not have anonymity of addresses as a feature.

AML Compliance implications

With more than one company selling or mining Bitcoin, each could, conceivably, choose different rules for identifying their customers and providing audit trails to track crime if necessary.

"There is nothing to stop criminal organisations from using Bitcoin for transactions between themselves without further extending their customer base, thereby creating a closed system purely for criminal use," said Julian Russell, director of Pacific Risk, a boutique commercial risk consultancy in Hong Kong. Some compliance solutions do exist, however. Mitigating the financial crime risks of virtual currencies is not so different from regular AML, except that "following the money" is easier. For example, tools such as BlockSeer enable Bitcoin to be traced from miners all the way to the last transaction. Nevertheless, this is not a panacea as, even in such a new medium, launderers can cover their tracks.

"It is possible to obfuscate this trail," said Erik Wilgenhof Plante, chief compliance officer at BitX in Singapore. "But that would raise an immediate red flag, and legitimate Bitcoin exchanges do file suspicious activity reports."

Additionally, a central registry could be developed where those engaged in mining activity could register to verify their identity. The larger the scale of the operation, the more critical this would become, Stoeckert said. "Objectively, this could serve as a method to detect and deter illicit financiers from funding a mining operation and seeking to remain at arm's length in the process." Stoeckert said that, in the United States, the mining function was regulated and required money service business registration once a miner sold digital currency for real currency, .

Menant said, however, that if Bitcoin acceptance continued to grow at such a rapid pace, miners might soon not need exchanges since they would be able to spend their Bitcoin anywhere.

The independent intergovernmental organization FATF or The Financial Action Task Force (on Money Laundering), headquartered in Paris, has published a report as a guide for using digital currencies titled “Guidance for a Risk-Based Approach to Virtual Currencies.” It includes benefits of digital currencies as well as potential risks of money laundering and terror financing.

The report is essentially the conclusion to the recent meeting held at Brisbane that was participated by 34 member nations and two regional organizations – the European Union and the Gulf Co-operation Council — to discuss policies, regulations and compliance for digital currencies. The 48-page extended report issued by the FATF described bitcoin payment services and products as potential tools for money laundering, and announced that digital currency service providers and companies must identify and notice potential risks of using the currency.

FATF heavily emphasized the importance of its member nations to understand the technicalities and the technology behind digital currencies such as bitcoin, and encouraged its nations to introduce regulations and restrictions for digital currency exchanges that are similar to that of traditional financial establishments, thus requesting all digital exchanges to register and subject to the same regulations of other financial institutions and money transfer businesses. The FATF’s “guidelines” of bitcoin are predicted to have the same effect as BitLicense had on New York-based bitcoin startups – this time on a global scale. Despite the report’s persistent connection of bitcoin to money laundering and terrorist financing cases, the report does point out positive usages and applications of the technology behind digital currencies. The FATF respects the attention of venture capital firms and billionaire angel investors who have invested hundreds of millions of dollars in digital currency startups.

“Virtual currency has the potential to improve payment efficiency and reduce transaction costs for payments and fund transfers,” the report said. “For example, Bitcoin functions as a global currency that can avoid exchange fees, is currently processed with lower fees/charges than traditional credit and debit cards, and may potentially provide benefit to existing online payment systems, like PayPal.”

FATF also explained that digital currencies are one of the only financial instruments that enables the transfer of microtransactions, which optimizes financial processes of small online businesses and individuals with low-cost goods and services. Moreover, the advantages of digital currencies for both the unbanked and banked contributed to a significant part of the report, as digital currencies offer extremely low transaction fees, which is very benefitable for those without bank accounts or those using expensive remittance services and bank transfers.

However, FATF finalized the report with a concern that decentralized systems like digital currencies are vulnerable to anonymity risks.

“For example, by design, Bitcoin addresses, which function as accounts, have no names or other customer identification attached, and the system has no central server or service provider,” the report said. “The Bitcoin protocol does not require or provide identification and verification of participants or generate historical records of transactions that are necessarily associated with real world identity. There is no central oversight body, and no AML software currently available to monitor and identify suspicious transaction patterns. Law enforcement cannot target one central location or entity (administrator) for investigative or asset seizure purposes (although authorities can target individual exchangers for client information that the exchanger may collect). It thus offers a level of potential anonymity impossible with traditional credit and debit cards or older online payment systems, such as PayPal.” In a short period of time, virtual currencies, such as Bitcoin, have developed into a powerful payment method with ever growing global acceptance. Virtual currencies offer an innovative, cheap and flexible method of payment. At the same time, the unique and often unfamiliar business model of virtual currencies poses a challenge to regulators around the world who are unsure how to deal with this payment method.  The policy responses vary considerably, with some countries embracing this new technology and others severely or totally limiting its legitimate use. The FATF conducted research into the characteristics of virtual currencies to make a preliminary assessment of the ML/TF risk associated with this payment method.  An important step in assessing the risks and developing an appropriate response, is to have a clear understanding of the various types of virtual currencies and how they are controlled and used. This report establishes a conceptual framework of key definitions, which could form the basis for further policy development. 

The legitimate use of virtual currencies offers many benefits such as increased payment efficiency and lower transaction costs.  Virtual currencies facilitate international payments and have the potential to provide payment services to populations that do not have access or limited access to regular banking services.  

However, other characteristics of virtual currencies, coupled with their global reach, present potential AML/CFT risks, such as:  

1. the anonymity provided by the trade in virtual currencies on the internet;

2. the limited identification and verification of participants;

3. the lack of clarity regarding the responsibility for AML/CFT compliance, supervision and enforcement for these transactions that are segmented across several countries;

4. the lack of a central oversight body;

The report provides law enforcement examples a number of examples of money laundering offences involving virtual currencies to demonstrate how this payment method has already been abused for money laundering purposes. 

Also available - Monnaies virtuelles: Définitions clés et risques potentiels en matière de LBC/F

Contribution of: (Ajay Shamdasani is a senior staff writer with Thomson Reuters Regulatory Intelligence in Hong Kong. He covers regulatory developments in Hong Kong, India and South Korea. He also writes about money laundering, fraud, corruption, data privacy and cybercrime.)

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