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Money
Money laundering with laundering
cryptocurrency: open doors and with
cryptocurrency
the regulatory dialectic
Daniel Dupuis and Kimberly Gleason
Department of Finance, School of Business Administration,
American University of Sharjah, Sharjah, United Arab Emirates Received 17 June 2020
Revised 3 July 2020
Accepted 3 July 2020

Abstract
Purpose – The purpose of this study is to describe the opportunities and limitations of cryptocurrencies as a
tool for money laundering through six currently available “open doors” (exchange mechanisms). The authors
link the regulatory dialectic paradigm to know your customer and anti-money laundering evasion techniques,
highlight six tactics to launder funds with virtual assets and investigate potential law enforcement and
regulatory alternates used to reduce the incidence of money laundering with digital coins.
Design/methodology/approach – The methodology used is the analysis of significant recent events
and the availability of “fintech” crime-fighting tools and a literature review focusing on the application of the
regulatory dialectic to innovations in existing crypto-asset markets that make them compelling to money
launderers.
Findings – The authors examine the illicit use of cryptocurrency through Kane’s regulatory dialectic
paradigm, identify a number of avenues for crypto to fiat exchange that are still available for those seeking to
launder money using digital coins, review recently “closed doors” and make recommendations regarding the
regulation of crypto-related markets that may assist in making them less desirable for potential criminals.
Research limitations/implications – The research is constrained by the state of the market for crypto
to fiat exchange as of time of writing; the technology and products to launder money using these open doors is
continually changing (as predicted by the regulatory dialectic).
Social implications – The regulatory dialectic predicts that regulatory response is reactive and often
increasingly burdensome or oppressive. There is continuous innovation in the cryptocurrency market, which
seeks to preserve privacy and anonymity with which regulators seek to keep up. From a social perspective,
the response of bank regulators worldwide to existing open doors for crypto to fiat exchange used for money
laundering may prove costly to individuals engaging in legitimate transactions, as well as financial criminals
and may also erode the ability of individuals to maintain privacy regarding their financial information.
Originality/value – To the authors’ knowledge, there are yet no broad overview regarding the feasibility
of money laundering across crypto-related assets within the paradigm of the regulatory dialectic.
Keywords Bitcoin, Cryptocurrency, Money laundering, Internal controls, KYC, AML, Regulatory Dialectic
Paper type Conceptual paper

1. Introduction
Bitcoin and other digital coins are of great interest to speculators, criminal entities, law
enforcement and regulators. While many of those who hold Bitcoin have legitimate
purposes in mind such as investment or payment for goods and services, there is
evidence that cryptocurrency is linked to criminal activities resulting in money
laundering. Foley et al. (2019) examine the scope of the use of cryptocurrencies and note
that, based on their estimates, approximately 46% of Bitcoin transactions facilitate Journal of Financial Crime
illegal activity, arguing that “cryptocurrencies are transforming the black markets by © Emerald Publishing Limited
1359-0790
enabling black e-commerce”. DOI 10.1108/JFC-06-2020-0113
JFC Recently, law enforcement authorities foiled several large-scale money laundering
attempts using Bitcoin. Khatri (2019) discusses the washing of $2.8m in proceeds from
controlled substance sales in New York and Petersen (2020) provides highlights of the same
for $300m in Ohio. Accordingly, on June 19 2019, the European Union published its Fifth
Anti-Money Laundering Directive (AMLD5). For the first time, the Directive addressed the
use of due diligence related to virtual-currency exchange platforms and digital wallet
holders as part of its anti-money laundering (AML)/counter terror finance framework
(European Union, 2018). The driver for these new know your customer (KYC) policies was
concern over the perceived utility of cryptocurrencies for subversive tactics by market
participants and the evolution of private coins with features that would better facilitate
anonymous transactions. However, Houben and Snyer (2018) argue there are a number of
“blind spots” in AMLD5 that could be successfully exploited by criminals, stating that it
does not address the anonymity of cryptocurrencies in the near term. They thus conclude:
“this approach is not very convincing if the legislator is truly serious about unveiling the
anonymity of cryptocurrency users to make the combat against money laundering, terrorist
financing and tax evasion more effective”.
Sophisticated new products have also been developed to further erode the ability of
criminals to launder money. For example, Chainanlysis helps regulators and banks to track
the origins of funds from anonymous wallets, regardless of the trail muddling or multiple
transactions. Given the demand for tax-evasion tactics, money laundering and anonymity
protection worldwide, these products are continually evolving. Correspondingly, regulators
react strongly to these developments in the banking system and asset markets to lower their
loss liability. The outcome is a process of market innovation followed by regulatory
reaction, referred to as the regulatory dialectic by Kane (1977).
Despite the current regulatory response, several vehicles still exist through which the
proceeds of predicate crimes can be transformed into clean money. In this paper, we provide
insights into the mechanisms where cryptocurrency still remains a vehicle for money
laundering and describe several currently open doors, which protect the anonymity of
digital users i.e. tumblers, the over the counter (OTC) market, privacy coins and
decentralized exchanges (DEXs). We also review the present state of regulation related to
these open doors.
The paper proceeds as follows. We first introduce Kane’s regulatory dialectic theory and
link it to the cycle of innovation and regulation in the cryptocurrency market. We refute
popular misconceptions regarding the anonymity of cryptocurrencies and blockchain
transactions. We then provide a description of the outlets currently open to money
launderers using digital coins. We review the current state of regulation regarding open and
recently closed doors and make predictions through the regulatory dialectic lens in the
context of the innovation-regulation process. Finally, we conclude the paper and provide
leads for future research endeavors.

2. The regulatory dialectic and innovation in money laundering through

cryptocurrency
Kane (1977) articulated a theory – the regulatory dialectic – that describes a continual
interplay between bank managers and the banking supervisory body. In simple terms, the
regulatory dialectic is a model of control leading to regulatory avoidance and change, where
the dialectic process begins anew and perpetuates itself. The regulatory dialectic, in its
initial development, predicted that to evade regulations (Kane, 1977), within the framework
of capital adequacy requirements, bank managers will innovate to appear compliant, while
still dodging the intended intrinsic behavior targeted by the regulation. This would yield an
additional round of reactive edicts from regulators, through the process of designing new, Money
politically motivated rules that meet the approval of powerful governmental entities. Bank laundering
managers then react with new and more creative methods, thus closing the loop.
Kane (1988) predicts that, as each sequential round of evasion and re-regulation occurs,
with
directives becomes less effective because of organizational learning and the market-driven cryptocurrency
incentives of bank managers. This “cat and mouse” game between regulators and market
participants culminates when economic incentives disappear:
Customarily a network of controls continues to expand unless and until the budgetary cost, social
inconvenience, economic waste, and distributional inequity associated with the system become
painfully obvious even to the ordinary citizen.
Research examining the evolution of new products, markets and services frequently cites
the regulatory dialectic. For instance, the evolution of shadow banking prior to the financial
crisis of 2007 is due to the desire of banks to evade national-level supervision (Acharya et al.,
2013; Thiemann, 2014). During the crisis, these creative financial maneuvers collapsed,
yielding another round of regulation and supervision, which market participants will likely
learn to circumvent. AML and CFT (combating the financing of terrorism) regulations were
a reaction to the evolution of the offshore markets. As noted by Mayes and Woods (2007),
some banks and financial entities such as currency exchanges globally sought to retain the
highly profitable business of international money transmission and reacted using
innovation to circumvent AML/CFT controls. In the literature, the regulatory dialectic has
been less frequently applied to the cryptocurrency markets, although innovation in
cryptoassets and the associated regulation evolve on a quasi-daily basis [1]. Accordingly,
researchers at a recent Max Planck Institute conference on blockchain-related assets argued
for a “new regulatory dialectic” related to a supervisory framework in the era of blockchain
technology. Tufano (2019) applies the regulatory dialectic theory to the “fintech” industry as
a whole and states that he anticipates innovation to occur where regulators would seek to
play “catch up” and in the process overreact.
In the context of cryptocurrencies and money laundering, the regulatory dialectic implies
that, as governments seek to undermine criminal activity and inhibit tax avoidance, new
technologies and methods of laundering will emerge. For instance, several countries have
issued or are in the process of issuing, digitized currencies with the aim to retain control over
users. To date, the majority of these countries are offshore jurisdictions, namely, Anguilla,
Antigua and Barbuda, Dominica, Grenada, Marshall Islands, Montserrat, St. Kitts and
Nevis, St. Lucia and Saint Vincent and the Grenadines. However, others include large,
developing countries such as China and Venezuela or members of the European Union such
as Ireland and Lithuania (Library of Congress, 2018). The hope behind these central bank
digital currencies (CBDC) is that they could potentially displace the current generation of
non-fiat virtual money.
Other countries have explicitly restricted access to virtual money. Six (Algeria, Bolivia,
Morocco, Nepal, Pakistan and Vietnam) implemented complete bans on cryptocurrency
transactions; for example, in Vietnam, the prevailing 2017 regulations criminalized issuance,
supply and use of cryptocurrencies and imposed fines for these activities (Fischler, 2018).
Seven others (Bangladesh, Iran, Thailand, Lithuania, Lesotho, China and Colombia) restrict
financial institutions from participating in digital coin transactions within their borders
(Library of Congress, 2018) while India still sits on the fence with ongoing legal battles and
conflicting court decisions. Most countries are seeking to limit the abuse of cryptocurrencies
through various legislation such as mandating suspicious reports to include all crypto
JFC transactions, subjecting initial coin offerings to consumer protection laws and ensuring that
exchanges implement proper internal controls.
Market participants recognize that, regardless of the nature of the incursion of
governments and central banks into the virtual markets, the eventual outcome will be an
erosion of privacy and a greater ability for oppressive regimes to control financial
transactions including the movement of money outside of their jurisdictions. As regulation
narrows the ability of individuals to hold non-government issued digital coins or use them
as payment, innovation will necessarily occur to protect the valuable features of
cryptocurrencies. Furthermore, the doors currently open for money launderers as described
in this paper are the result of previous regulatory attempts to restrict illegal activities using
cryptocurrency. As doors closed over the past decade, new methods offering advantages in
cost, liquidity and feasibility in the laundering of large amounts of money have emerged.

3. Research on the use of cryptocurrency in money laundering

Very little research addresses the use of cryptocurrency in money laundering or terrorist
financing. Wegberg et al. (2018) show that the proceeds of criminal activities can be
laundered through various dark web services, and investigate five mixing and exchange
services available on the dark net. Their experiment reveals that there are reputation-based
services that can handle transactions in a cash-out strategy. The authors argue that Bitcoin
is “already relatively anonymous,” and that further innovations in virtual coins may better
facilitate money laundering. While it provides valuable insights into the mechanisms by
which cryptocurrency can be used to wash illicit gains, they do not assess whether such
cash-out strategies using dark web services are sufficient to facilitate the laundering of large
amounts of currency as required by international criminal organizations and terror groups.
We argue that, counter to Wegberg et al. (2018) and popular belief, Bitcoin is characterized
by a relatively low level of anonymity and that there are relatively few simple, open doors
available for money laundering using cryptocurrencies. The regulatory dialectic predicts an
impeding cycle of innovation in the use of virtual money for laundering purposes, followed
by an expected reactive behavior by governments.

4. Debunking the myth: Transparency of cryptocurrency transactions

Since the inception of Bitcoin in 2008, the opacity of encrypted contracts has greatly
troubled law enforcement agencies and governing bodies alike; initially, they offered great
promise to those that sought to undermine the law. In the context of decentralized ledgers,
the most common criticism of virtual coins is that the transactions are reputed to be
anonymous. Thus, digital coins are alleged to be the weapon of choice for criminal or illicit
activities, overtaking fiat currencies such as the dollar, as the latter is already subject to
numerous controls and restrictions. Consulting groups like S&P’s Crisil use phrases such as:
“Bitcoin is widely used as a means to move money around quickly and anonymously. With
no central monitoring authority, this raises concerns on the legitimacy of both the source
and the destination of the funds transferred” (Paris and Upadhyayula, 2017).
The reality is somewhat more complex than the appearances. Most cryptocurrencies can
be traced to their original owner with a relatively high probability of success [2]. The
inherent secrecy of virtual coins resides in the microstructure of the custodial solution.
Similar to the wallet in your pocket, a digital e-wallet contains no identification feature, only
private/public keys for the various currencies and an access code. Therefore, once the coins
are in the crypto wallet, they are essentially anonymous, as are the dollars in your personal
billfold. With the exception of a few coins (called “privacy coins”), all transactions in and out
of digital wallets are recorded in an open, transparent blockchain network. It is relatively
easy to retrieve the path for each of the transfers and backtrack to the original issuance of Money
the coin. For example, if a Bitcoin is located in the wallet “X,” a quick search of the laundering
transaction data recorded on the block (part of the blockchain) will provide the details of the
sending party (wallet “Y”). Following the thread to the source or creation of the coin (miners’
with
wallet “M”) becomes a matter of processing power. cryptocurrency
If we limit our investigation to the blockchain data, cryptocurrency trades remain
shrouded in secrecy. Nevertheless, the trail left by the digital coin will possibly cross an
organized exchange market at some point in the currency’s life cycle. The taxonomy of
these various exchanges highlights three main types of transactions, namely, crypto-to-
crypto, crypto-to-fiat with AML/KYC and crypto-to-fiat with no client identification.
Because of rigorous legislation, most of the worlds’ major markets that support
cryptocurrency trading are centralized and subject to KYC rules: Coinbase, Kraken,
itBit, Gemini, Bitstamp, OKEx, bitFlyer, OKCoin and many others all belong to this
category. At the time of writing, Poloniex still stands out and does not require end-user
identification for daily fiat withdrawals under US$10,000. Although based in California,
it has lost the right to serve US clients in 2019 but some customers simply switched to a
combination of offshore corporate accounts/virtual private networks to avoid the ban.
Exchanges such as Binance, BitMax, KuCoin, BitFinex and StormGain are considered
hybrids; they allow anonymous crypto-to-crypto trading but not fiat withdrawals; if a
client wants to convert digital coins to dollars, euros or yen, AML limitations apply.
Some online tools such as KYCNOT.ME (www.kycnot.me) even go as far as providing a
comprehensive list of exchanges that do not require identification.
Figure 1 shows a simplified version of transaction tracing capabilities. If exchange (E) is
a centralized market ruled by AML procedures, all traders are identified and potential
suspect individuals that conduct fiat-to-crypto trades are flagged. E-wallet (A), which has a
direct link to the market, ranks as a high-probability laundering node (solid line) with
ownership attributable to the initial individual under suspicion. Subordinated nodal wallets
(C) symbolize lower risk (dotted lines) but remain under surveillance should their path
intersect or converge. The system can also detect structuring or smurfing; should an illicit
trader attempt to parse funds from the exchange (as shown in cluster D), then regroup the
coins in the wallet (B), the latter now becomes part of the investigation. The solid lines

C
A x

x B
x
D
C x
x

E High probability
Figure 1.
x Tracking wallet
Medium probability
Suspect e-wallet on Exchange
Low probability
transactions
JFC represent a high likelihood of involvement in illegal activities while the dashed links rank
lower but can be compounded to gain importance.
In the wake of the Mt. Gox debacle of 2013, Koshy et al. (2014) [3] show that Bitcoin
transactions can effectively be mapped with a high degree of probability (>90%). The realm
of crypto tracking has since moved from the academic sphere to the commercial world.
Software packages such as CypherTrace, Orbit or Elliptic AML now allow neophyte users to
deanonymize digital transactions and assess the likelihood that a source is illegitimate[4].
These computer programs use advanced clustering and proprietary algorithms to link e-
wallets and transfers. Furthermore, the internal revenue service (IRS), Federal Bureau of
Investigation and drug enforcement agency have recently entered into a strategic
partnership with Chainanalysis, a service firm specializing in Bitcoin tracking [5]. Thus, the
complete record of the path taken by a coin exists, but the identifiable owner remains
elusive as long as all the nodes are devoid of KYC requirements. As such, Bitcoin anonymity
is more akin to pseudonymity and the protocol is not strong enough to protect users’ privacy
(Figure 2).
This summary overview highlights a main fact: the gate from the encrypted world to
fiat currencies is relatively well-guarded in organized markets. Any entity who wants
to convert illicit gains should to go through a crypto-to-fiat portal at some point in time
thus, risk identification. The wallets that contains Bitcoin, Ethereum, Litecoin, etc. are
nameless, but the digital threads can be traced to a beneficial owner when the fiat
threshold is crossed. The node that represents the identifiable market account serves as
an anchor to assign ownership of all linked transactions, with the closest e-wallets
receiving a higher probability that the accounts’ beneficial owner is the same as that of
the exchanges. For example, if a trader converts fiat to Bitcoin using a crypto exchange
and often sends the coins to the same wallet, she is deemed the owner of that account.
Whether this method would be acceptable in a court of law remains untested and
results will depend on the jurisdiction. Of course, there are still alternate pathways open

Figure 2.
Screen output from
Orbit
to preserve anonymity, and the next section describes potential methods used to Money
circumvent licensed exchanges and KYC rules. laundering
with
5. Evasion tactics: open doors
As predicted by the regulatory dialectic, regulators are in a constant battle against
cryptocurrency
innovation by criminals. We next describe the features of six “open doors” through which
money launderers can still use to clean money, as well as the current regulatory response to
these doors and limitations to their use for large scale money laundering activities. First,
however, we note that crypto-fiat transactions are different from crypto-crypto transactions.
There are a number of mechanisms by which cryptocurrency is converted to other coins
such as Monero, Zcash, Ripple or others. This, however, is of limited use by organized crime
organizations except as a temporary means to muddle tracks. To fully enjoy the proceeds of
illegal activities, the returns to the criminal must eventually be denominated in fiat currency.

5.1 Tumblers
Tumblers are one of the prominent tools for crypto to crypto/fiat laundering and focus
predominantly on top major currencies such as Bitcoin, Litecoin or Ethereum. Also known
as mixing services, they operate from websites on the clearnet (Smartmixer, Bitcoin Mixer,
JoinMarket, etc.) or on the dark net through Tor (dream market, Alphabay – now defunct,
etc.). Mixers effectively disrupt the transactional link between wallets by literally blending
legitimate Bitcoin transfers with illicit gains and sending the resulting virtual funds to a
new address [6]. After removing service fees, the laundered coins are cashed out through
Paypal or Western Union. The size limitations attached to the fiat threshold limit the
effectiveness of tumbling facilities but, once the coins are clean, other cash-out avenues
open, as the transactions are no longer under suspicion. Furthermore, no size limits apply to
crypto-for-crypto trades.
Recently, the funds obtained through the Chinese scam Plus Token, totaling over US
$3bn, were moved with impunity from multiple but tracked Bitcoin wallets [7] to a tumbling
service and the trace was lost. It is believed that these coins found their way to legitimate
exchanges and caused a crash in the BTC price when they were liquidated in August 2019.
Law enforcement is beginning to actively target illicit trades and the Department of
Justice in the USA recently charged an individual named Larry Harmon with laundering
$300m using Bitcoin. However, thus far, the regulatory response on mixers has been
relatively muted because of the difficulty in legislating online sources and the dark net. In
March 2020, the USA law enforcement set up the cryptocurrency intelligence program [8] to
combat the use of unlicensed crypto capital flows but simply identifying the problem does
not offer a solution; case in point, tax evasion using offshore havens was recognized for
decades but could not be dampened.

5.2 The OTC market

For crypto-to-fiat (and vice-versa) trades, the OTC market is hard to beat. The over-the-
counter volume of transactions is estimated to be three or four times the size of the official
markets’ output. There are two main avenues for OTC trades; through a broker (Kraken,
Bitstocks, Genesis Trading, etc.) or person-to-person. Hedge funds and miners tend to prefer
brokers for obvious reasons – size, liquidity and speed. The off-ramp (crypto-to-fiat) for
these transactions still require a banking relationship so they are of less interest to money
launderers, unless the coins were laundered prior to reaching the broker. As crypto
transactions do not require an organized exchange, two people can simply swap public keys
[or scan a quick response (QR) code] to complete a crypto-to-crypto trade. Fiat conversions
JFC require a face-to-face meeting with cash on the table and OTC service providers usually
charge a 3%–8% fee for their services.
One of the authors of this paper has first-hand experience using OTC markets. This legal
transaction took place in Dubai in 2017, and the format is the same all over the world. The
author (buyer) found the seller on localbitcoins.com. This global website offers
comprehensive information for potential transacting parties, ratings and number
of completed trades for individuals, escrow services, rates, maximum transaction amounts
and contact details. The author called the seller and arranged for a meeting in a public but
quiet coffee shop. The total purchase amount was agreed upon at AED370,000 or roughly
US$100,000 with a negotiated fee of 3%, relatively low but enough to keep good relations.
The next step was withdrawing the capital from the bank, a surprisingly easy task in the
UAE. The bank teller had the funds ready in 15 min. For the readers who watch too many
movies, note that it is a disappointingly small pile! Plate 1 shows a picture of the actual cash
prior to the transaction.
At the coffee shop, the seller pulled out his smartphone and accessed the Bitfinex
exchange to fix the price, which was roughly $6,000 at the time. In the meantime, the author
logged into his Exodus wallet and retrieved the Bitcoin’s “receive” public key and QR code
for his account. As the money was simply sitting on the table, the seller scanned the buyers’
QR code and hit the “send” on his phone. While sipping coffee and counting the cash, the
transaction was recorded on the Bitcoin blockchain, verified by both parties and after a few
minutes, appeared in the balance of the authors’ wallet as an additional BTC16.2. The seller

Plate 1.
US$100,000 in
dirhams; a
disappointingly small
pile
also paid the usual transfer fee of BTC0.0005. The trade completed, the envelope containing Money
the cash was swept off the table and both parties left the coffee shop. Yes, it is that simple. laundering
There are many legitimate reasons to use the OTC market for crypto transactions. Large
orders may have a significant price impact on organized exchanges when the order book is
with
visible but OTC desks are efficient at searching for liquidity. Furthermore, crypto exchanges cryptocurrency
have prohibitive weekly limits on fiat deposits and trading. With a standard account, it
could take 10 weeks to make a US$100,000 purchase and, as it is well-known, the price of
Bitcoin moved fast in December 2017, reaching over US$19,000. Under those circumstances,
10 weeks is a lifetime! Furthermore, the fees are comparable; moving the fiat to an organized
market would entail banking fees, a 2% market charge (fiat deposit) and the trading spread
on the exchange on top of the BTC0.005 transfer cost. The implications for money
laundering are obvious; although this author withdrew the money from the bank, the
provenance could easily be drug sales or any other criminal activity. Large amounts do not
appear to be an issue and, with a little precaution, the transaction is within reach of all
individuals. Other avenues (blogs, chat rooms, etc.) are also available to arrange a
transaction, illicit or not.
A recent news article highlights the regulatory response to OTC dealings [9]. In March
2020, the USA Homeland Security Investigation department arrested and charged an
individual for operating an unlicensed money transmitting business and laundering funds.
The undercover agents contacted the trader through LocalBitcoins and allegedly made it
clear that the transaction originated from the proceeds of human trafficking but to no avail,
multiple deals were concluded with the seller. This is not the first example of an arrest and
conviction but case-by-case intervention is tedious, expensive and relatively inefficient so
enforcement is naturally limited while the practice remains widespread and OTC markets
are still thriving. As we conduct this study, LocalBitcoins.com still locally lists hundreds of
willing, potential qualified counterparties for crypto and fiat conversions.

5.3 Privacy coins

In response to the 2008 crisis, Nakamoto (2008) introduces a transparent currency devoid of
external control; of course, we know it as Bitcoin. Thus far, this revolutionary endeavor is
relatively successful but the traceability of Bitcoin left some hardliners with a sense of
vulnerability. Developers were soon at work to find an alternate solution and, from 2014 to
2016, coins such as Monero, Dash and Zcash were created with one goal in mind: anonymity.
These coins actively implement an obfuscated public ledger where any trader can transmit
but the source, amount and destination are hidden. Zcash and Dash are both hard forks of
the Bitcoin blockchain so they share similar vulnerabilities. The credence is that the secrecy
associated with these cryptocurrencies is ironclad but the reality is that a significant number
of trades are traceable. Shielding may require an active intervention by the beneficial owner,
and few have the required knowledge. Quesnelle (2017) and Kappos et al. (2018) show that
only 3.5% of Zcash addresses are shielded and, of those, 31.5% can be traced using
advanced analytical tools. This leaves 98.9% of Zcash trades open to tracking, hardly the
“secrecy” it promises. Monero remains, by far, the most popular privacy coin – the
combination of stealth addresses and the ring confidential transactions protocol render this
cryptocurrency quasi-untraceable. Möser et al. (2018) estimate that close to 25% of all
Monero transactions are illicit. They also show that pre-2017 some trades can be traced via
advanced mathematical analysis but it remains unclear if this is still the case.
While the popular belief is that concealment in cryptocurrencies is possible, the theory
suggests that it is nothing but an illusion. The capacity to track privacy coins, thus still
resides in the realm of academia but remains out-of-reach for commercial purposes and law
JFC enforcement cannot hope to implement restrictive strategies in the near future. Thus far, the
regulatory response is muted at best. In 2019, the Financial Action Task Force (FATF)
published a guidance document on virtual currencies recommending that all jurisdictions
impose AML requirements on financial and non-financial activities involving
cryptocurrencies, effectively throwing a wide net over the crypto industry. Unfortunately,
enforcement is the prerogative of sovereign regulatory bodies, and thus far, remains to be
implemented. Some minor exchanges (OKEx, BitBay, etc.) bowed under the pressure from
the FATF and delisted suspicious coins but many of the bigger markets never listed them in
the first place. For example, Coinbase provides liquidity for Zcash but not Monero or Dash.
Furthermore, many wallets such as Exodus, offer a conversion feature allowing crypto-for-
crypto transfers without leaving the confines of the unsigned e-wallet. The fact remains that
many avenues to obtain privacy coins still remain, and this author presently owns both
Zcash and Monero, purchased openly through organized exchanges – as an academic
exercise, naturally [. . .].

5.4 Decentralized exchanges

Standard organized markets operate under the vigilance of a custodian, a corporate
entity who is ultimately responsible for compliance with regulatory bodies, thus
accountable. These exchanges have a notable drawback; the users do not have access to
their private keys as these are kept in a consolidated depot controlled by the custodian.
As the saying goes: “not your keys, not your coins!” Furthermore, centralized
exchanges are constantly under attack by hackers and some are successful. For
example, the Japanese trading platform Coincheck was robbed of NEM230m (with a
market value of US$530m) in 2018 [10]. A new breed of exchanges has recently
surfaced; DEXs [11]. Lin (2019) defines DEXs as “[. . .] distributed ledger protocols and
applications that enable users to transact cryptocurrencies without the need to trust a
centralized entity to be an intermediary for the trade or a custodian for their
cryptocurrencies.” These markets operate online anonymously, using on-chain smart
contracts and do not even require an email address to complete a transaction. DEXs
allow users to control their private keys, they are distributed so they do not suffer from
a potential single point of failure (server down time), involve no third parties, no
counterparty risk and cannot be shut down by governments. Obviously, there are no
KYC rules. In essence, crypto users become their own banks (Figure 3).

Figure 3.
Classification of
decentralization in
crypto exchanges
On the flip side, DEXs operate independently of their parent company and are difficult to Money
regulate. They are not user-friendly, often lack support and do not offer off-ramp (to fiat) laundering
services. Most of these services (Uniswap, Bancor, Cryptobridge, WavesDEX, AirSwap, etc.)
entered the crypto-world in the past year and some are still at the project stage of
with
development. Therefore, there has been no regulatory response yet. Shapiro (2018) suggests cryptocurrency
that the IRS lacks the ability to track the non-custodial financial transaction and offers a
potential solution; the IRS should update its definition of a “withholding agent” to include a
notion of profit rather than control. Nevertheless, it is expected that they will become a tool
of choice for crypto-to-crypto laundering.

5.5 Direct retail purchases using cryptocurrencies

The most guarded portal in crypto laundering is the off-ramp process; the swap from
digital coin to fiat such as dollars, euros or yen. In most instances, the sheer volume of
criminal proceeds makes cash cumbersome and direct bank deposits leave a trace. A
common practice is to purchase large assets (real estate, cars, jewelry, art, wine, etc.)
with the illicit proceeds, in cash, then resell the asset on the open market. The literature
on the subject is extensive (De Sanctis, 2017; Thiemann, 2014; Tiwari et al., 2020). Even
today, bringing a suitcase full of dollars to buy a house would raise eyebrows –
although the practice still exists in some markets. One of the authors of this paper sold
a condominium unit in Istanbul and, unbeknownst to all parties, the buyer showed up
with a bagful of liras. Unfazed, the lawyers handled the transaction without batting an
eye. Nevertheless, a similar situation would probably not go so smoothly in the USA or
other developed markets.
The same process applies to crypto purchases, minus the negative stigma. While the
fad lasts, it is actually considered innovative and remarkable, in a positive way, to
purchase real estate with Bitcoin. The practice is gaining such popularity that Bitcoin
RealEstate is presently developing a website, Dubai property developers now accept
cryptocurrency and popular home-related magazines publish articles on the subject
[12]. The absence of mortgage facilities is a possible drawback, but certainly not a
concern for money launderers. Furthermore, a plethora of other assets is available;
among others, Vaultoro [13] facilitates the purchase of physical gold directly from
Bitcoin, Dash or other coins, Diamonds-Bitcoin [14] sells, you guessed it, diamonds for
BTC, BitCars offers supercars for crypto, etc.
Although cumbersome and expensive when used for large-scale laundering, the swap
crypto-for-asset is still an open door to wash the proceeds of crime, and thus far, to our
knowledge, no legislation exists to prevent this activity.

Applicability to large
Tactic Cost scale transactions Regulatory status

Tumblers Average High Preliminary

OTC markets (exchanges) Average Medium Varies with
jurisdiction
Privacy coins Low High Preliminary
Decentralized exchanges Low Increasing Unresolved Table 1.
Direct retail purchases using cryptocurrencies High Medium Varies with Summary of
jurisdiction presently available
Mining as a front Average Limited Non-existent evasion tactics
JFC 5.6 Mining as a front
This is a remake of the well-known tactic used worldwide; funnel the illicit funds to a cash-
intensive business, pay the resulting taxes and spend at leisure the “rinsed” money. The
most common counter to this form of laundering consists in the analysis of cash flows for
suspect businesses but to be effective, this method relies on statistical data, which is most
likely incomplete for a relatively new field like virtual currency mining. These operations
are well-suited to hide income as it is relatively difficult for outside entities to assess output
that depends on efficiency, hashrate and market conditions. The illegal coins are easily
mixed with the regular mining proceeds and become indistinguishable, thus completing the
laundering cycle. To the authors’ knowledge, no regulatory framework exists for this
activity.
Table 1 below summarizes the money-laundering schemes presently available to

6. Predictions, policy implications, directions for future research and

conclusions
When one door closes, the regulatory dialectic predicts that another door opens, providing insights
into the “cat-versus-mouse” cycle of innovation by those who seek to evade regulation and the
reactive regulatory response. As the demand for money-laundering tools increases because of the
legislative tightening, financial criminals seek “open doors” through which they can wash
the proceeds of their illicit activities. Correspondingly, regulators must justify restrictions to the
public to close the loopholes. In this paper, we explore the feasibility of conducting large-scale
anonymous money laundering transactions using crypto-based mechanisms.
We review six currently open doors through which criminals can manipulate their illegal
gains through digital money. We argue that, as it stands now, it is possible albeit problematic
to launder significant sums of money without detection using cryptocurrencies and existing
conversion vehicles due to limits on liquidity and technological advancements, casting a
shadow on the conclusion reached by Wegberg et al. (2018). Based on the regulatory dialectic,
we anticipate that cycles of innovation and further evolution of both digital assets and
exchanges will dampen the increasingly invasive KYC/AML restrictions on digital trades.
Furthermore, as regulators attempt to control nefarious activities such as tax evasion,
terror financing and the laundering of the criminal proceeds, market participants will adopt
new tactics using virtual currencies or other methods of distancing criminals from the origin
of their gains. Furthermore, in the process of regulatory oversight of cryptocurrencies and
exchanges, it is likely that society will experiment greater restrictions on personal freedom.
As Kane (2012) explains with regard to the objectives of governments in the banking sector:
“the long-run goal is to develop a well-behaved child who takes pride in living up to the set
of parental rules, which is to say a child who has developed a keen sense of shame. When
conformance with parental rules becomes a child’s own preferred course of behavior (and
ideally a source of self-esteem), enforcement problems melt away. However, most parents
show a rescue reflex of their own, so that conditioning efforts at least partially backfire.
Children who recognize this reflex and refuse to be bound by parental rules may pursue
either of two paths: defiant disobedience or creative avoidance”.
The nature of the innovation in the cryptoasset markets may manifest itself through the
creation of new currencies or exchanges that provide openings for anonymous transactions,
such as the crypto-funded visa cards announced by the Coinbase exchange in the UK in 2019
(Kaminska, 2019). The regulatory response may well be the creation of central-bank backed
digital coins, perhaps, combined with a prohibition on the use of cryptocurrency for
commercial transactions, further eroding the usefulness of non-fiat digital coins for money
laundering purposes.
 Future research will need to document the cycle of innovation predicted by the Money
regulatory dialectic as new crypto-related assets and mediums of exchange are introduced in laundering
the field of money laundering, and the potentially asymmetric response of regulators.
Furthermore, the evolution of CBDC will provide ample material for future research,
with
particularly, in the context of the implications on the privacy rights of individuals. In cryptocurrency
addition, future research can provide guidance on the effect of blockchain-related technology
in black-market transactions using cryptocurrencies.

Notes
1. The discussion in this paper is bound by the contemporaneous state of regulations and
cryptocurrency innovation, as of the date that this paper is written, and will certainly evolve over
time.
2. Monero, Zcash and Dash are notable exceptions because of their particular transactional
protocols.
3. Earlier work by Reid and Harrigan (2013), Androulaki et al. (2012) and Meiklejohn et al. (2013)
show similar results using different methods.
4. https://miloserdov.org/?p=3231
5. https://klasing-associates.com/irs-track-bitcoin-cryptocurrencies/
6. Wegberg et al. (2018) provide an in-depth view of the microstructure of tumbling services.
7. See https://boxmining.com/plus-token-ponzi/#Laundering_stolen_funds_into_exchanges for an
exhaustive list of the e-wallet addresses.
8. https://thepaypers.com/cryptocurrencies/us-regulators-to-act-against-illegal-use-of-crypto–
1241244
9. See www.coindesk.com/us-homeland-security-charges-localbitcoins-seller-on-money-laundering-
charges
10. See https://news.bitcoin.com/tokyo-police-arrest-2-men-for-buying-cryptocurrency-tied-to-530m-
coincheck-hack/
11. See https://coinsutra.com/decentralized-exchange-cryptocurrency/ for more details.
12. See www.hgtv.com/lifestyle/real-estate/how-to-buy-real-estate-with-bitcoin
13. https://vaultoro.com/
14. www.diamonds-bitcoin.com/home/

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Corresponding author
Kimberly Gleason can be contacted at: kgleason@aus.edu

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