AML CHALLENGES
How is a digital currency different from
a virtual currency? The term “digital
currency” is sometimes used interchangeably
with the term “virtual currency.” The two are
distinguishable in part by how they developed and how they are used.
will not necessarily know the original source
of the fiat that was exchanged for the digital
currency or who receives fiat upon exchange
of the digital currency unless it acts as an
exchanger or has built transparency into its
system to allow it to view this information.
“Virtual currencies” are issued to play games
in virtual worlds like Entropia and World
of Warcraft. They often are referred to as
“tokens.” They typically are purchased and
redeemed from the owner of the virtual
world or the operator of a site within the
virtual world. Also, secondary markets have
developed to permit players to buy and sell
virtual currencies directly from each other.
The digital currency exchanger is uniquely
positioned to see who is exchanging fiat
for digital currency and vice versa. The
exchanger however will not have the ability
to see the transactions between accounts
within the system.
Increasingly, virtual currencies are also being
deployed in social/gaming networks and
the scope of their usage is expanding. For
example, Linden Labs, which owns and operates Second Life, sells Linden Dollars that
can be used to purchase both virtual and real
world goods and services. In this way, the
line between digital and virtual currencies
seems to be blurring.2
The incursion of virtual currencies into the
real world was underscored in 2009 when the
Chinese government, facing rapidly growing
use of virtual currencies in the “real” world,
issued a decree restricting the use of virtual
currencies to the virtual world. Taking the
opposite approach, the Korean government
sanctioned the use of virtual currencies in
both the virtual and the real worlds.
The proliferation of virtual currencies may be
attributable to the ease with which one can be
set up — at least 30 companies market technology platforms for deploying virtual currencies. While the platforms for virtual and digital
currencies differ, virtual currencies are not
immune to the types of criminal abuse that
digital currencies have experienced.
The AML compliance officer’s challenge?
Digital currencies present different types
of AML compliance challenges for different
types of entities.
Because digital currency systems operate
as closed systems (i.e., the digital currency
circulates only among account holders in the
system), a digital currency servicer or provider
is able to see all transactions in the system.
The digital currency used in one transaction
can be tracked through multiple transactions
and multiple accounts over long periods of
time. However, the digital currency provider,
A traditional financial institution is unlikely to
see any aspect of a digital currency transaction unless it is a digital currency provider or
exchanger, accepts digital currency deposits,
uses digital currency as a form of currency in
their regular business activities or, possibly,
provides banking services to digital currency
provider. On the other hand, a traditional
financial institution may see transactions
between their customers and digital currency
exchangers, although such transactions will
be in fiat.
Regardless of who sees what, understanding
the money laundering and terrorist finanicing
risks presented by digital currencies and
developing or enhancing an AML compliance program to mitigate such risks requires
an understanding of how digital currencies
work (including their transaction flows),
how criminals have abused them, the unique
challenges they present for law enforcement,
how they are currently regulated, and what
steps may be taken to mitigate money laundering and terrorist financing risks associated with their business models.
Why is law enforcement concerned? The
2005 U.S. Money Laundering Threat Assessment (Threat Assessment) analyzed 13
money laundering methods involving among
other things “new and innovative online
payment services,” including digital currencies.3 Although not well documented and
somewhat rambling, the report identified a
number of specific vulnerabilities that could
make such services subject to abuse for
money laundering and other financial criminal purposes.
Appearing to draw heavily from the details
of an investigation underway at the time
involving e-gold Ltd, the “oldest and best
known” digital currency services, the Threat
Assessment outlined the following concerns:
The digital currency
exchanger is uniquely
positioned to see who
is exchanging fiat
for digital currency
and vice versa
• International Person to Person Payment
Capability. The ability to transfer value
across jurisdictional lines creates difficulties for law enforcement authorities
attempting to pursue enforcement or legal
action outside their jurisdiction.
• Lack of Customer Identification and Verification. The type of personal information
required at account opening varies by
service provider with many lacking effective customer identification or recordkeeping, “ill-equipped” to verify customer
identification or “openly” promoting anonymous payments.
• Acceptance of Cash and Money Orders.
Acceptance of cash and money orders by
currency exchangers facilitates anonymous transactions and shortens law
enforcement’s “investigative trail.”
• Multiple methods used to transfer of
value. Cash, money orders, credit and
debit cards and wire transfers used to
move value to currency exchangers. Funds
transferred to exchangers via money transmitters globally.
• Criminal Abuses. Used (a) by operators
of Ponzi schemes, (b) to facilitate Internet
auction fraud, investment schemes, computer intrusions, and credit and debit
card fraud schemes and (c) to launder the
proceeds of other criminal activity originating outside the system.
• Nonrecourse transactions. All transactions
are final, and customers have no recourse if