Money Laundering Considerations in Blockchain-based Maritime Trade and Commerce

Abstract

There is much to be welcomed concerning the role blockchain technology can play in modernising and enhancing international trade, creating a more level playing field and reducing costs. However, it goes without say that the technology also brings with it the risk of abuse leading to trade-based money laundering. This article explores how anti-money-laundering legislation should respond to the use of blockchain technology in shipping and trade. Maritime trade poses unique challenges because of several significant factors: the fact that it concerns large sums but many linked trading transactions over the same goods; its use of documents and involvement of numerous faceless entities; and its cross-border setting. Drawing on tried and tested forms of blockchain technology-based trade transactions, this work examines the fault lines in the current regulatory system and questions how best these gaps should be remedied. It also stresses that even states that have banned the issue and trade of cryptoassets might not be immune to these new challenges.

I. Introduction

It is undeniable that the much-vaunted introduction of blockchain and smart contracts in shipping and trade is now very much becoming a reality. This article explores how anti-money-laundering (AML) legislation should respond to the use of blockchain technology in shipping and trade. Money laundering usually entails three stages: placement, layering and integration of the assets in question. The way blockchain technology helps with the placement, layering and integration of unlawful funds will be explored against the backdrop of shipping and international trade.

There are several reasons why shipping-based trade ¹ is a good case-problem template. Broadly speaking, shipping-based trade is cross-border in nature and can involve the movement of goods in high volume or of high value. More importantly, shipping-based trade is principally conducted on the basis of documents in which the identities of the participants are not commonly considered to be essential. Contract terms such as INCOTERMS 2020, which are frequently used in international trade, entail the sale, purchase and distribution of goods simply on the tender of documents rather than proof of identity. Compounding this, where full blockchain technology is to be adopted, the movement of goods and payments would be directed by computing systems automatically, leading to an even higher degree of anonymity.

This article therefore highlights the key risks of blockchain-based shipping and trade in the fight against money laundering. The focus is on the compliance role for banks and other stakeholders, arguing that despite the introduction of some important milestones by regulators, there are certain gaps in the existing regulatory system that need attention. This work also stresses that even in countries that ban or prohibit the use and trading of cryptoassets, blockchain technology-based trade money laundering continues to pose a problem for regulators.

The backdrop of this work is mainly the international system for combating money laundering. Domestic and European Union (EU) regulatory systems will be mentioned in passing for comparison purposes. As regards the methodology, this work presupposes a broad, generic understanding of blockchain technology and smart contracts. The author carried out a survey of the relevant literature on trade-based money laundering (TBML) to examine how this form of money laundering is understood by regulators and to ascertain the scale of the problem. ²

This study uses what are widely perceived to be the pioneer stories of successful blockchain-driven trade as observational targets. The focus, as briefly mentioned above, is those cases that run on conventional trade finance processes and lines and that have involved reputable organisations (eg Maersk, Barclays, IBM, HSBC, ING and BBVA). Using atypical cases would simply not be appropriate in a study of the money laundering opportunities in blockchain technology-based trade finance given the modus operandi of money launderers, which is to “fit into” the conventional methods of trading. This work has relied on archive-based materials and data published by the trade participants themselves. However, in order to avoid bias and self-generated exaggerations, information was also drawn from related secondary resources, such as trial project websites, news and media reports and external reviews. These case studies are then used to build a general process that blockchain technology-based trade would follow.

Taking the approach of a text-based evaluation of the literature on TBML, this work identifies the fault lines in the regulatory regime and offers suggestions to fill these gaps as regards blockchain technology-based trade money laundering.

II. Blockchain technology and international sales ³

It is beyond the scope of this article to detail in full the workings of blockchain technology. The literature, both in legal and non-legal sources, is voluminous. It suffices for our purposes to understand how a blockchain technology-based trade in goods system might work and to appreciate the reasons as to such a system’s increasing acceptance.

A blockchain is a decentralised, distributed record or ledger of transactions or activities. Those transactions are stored permanently using cryptographic methods. They are different from traditional databases that are administered and organised by a central entity. Blockchains, on the other hand, rely on a peer-to-peer network that no single person has control over; the blockchain is managed by computers or servers – called “nodes” – on a peer-to-peer basis without the need for the intermediaries who traditionally authenticate transactions (such as banks in the case of financial transactions). Transactions are authenticated using cryptographical methods, notably a mathematical “consensus protocol”. That protocol is a pre-fixed system that determines the rules by which the ledger is updated. This means that the participants can trust the authenticity of the record or ledger because no single person has control over the technology or system. There is therefore no need for any trusted third party – the system itself is trustworthy.

The word “distributed” in this context means that identical copies of the ledger database are downloaded from the World Wide Web and kept on numerous computers spread across a site, an organisation, a country, multiple countries or, indeed, the world.

A blockchain can be permissioned or permissionless – that is to say, there are blockchains where access can be granted only to those with permission, whilst others are more publicly accessible.

A blockchain as a ledger allows access to a participant at any time, thus improving access. Furthermore, there is open transparency in that every transaction added to the blockchain will be time stamped. There is little risk of tampering because the data are held not in any one place but across the entirety of the peer-to-peer network (which may include thousands of computers or servers). These features of a blockchain make it very useful for reliably tracing transactions or activities.

Smart contracts, ⁴ which are built on blockchain technology, are computer programs that self-execute when certain conditions are present. Those conditions may or may not be premised on any pre-existing agreements between the parties. ⁵ With a programmable protocol, the smart contract can allow automatically (without human intervention) the execution and performance of its terms. This automated execution of the terms of the arrangement is ideally suited to the global trading environment where distance, costs and lack of trust could lead to contract failure. In open account-based transactions, the smart contract – taken to its natural end – could enable the automatic release of payment. As to conventional documentary credit processes, these are premised on centralised business operations – the smart contract system, which is built on the distributed blockchain technology, reduces the risks that centralisation brings about, such as fraud, forgery and malicious alteration. ⁶

1. How does this new technology change the way international trade is structured?

This new technology might start with the seller or manufacturer setting up or deploying the smart contract exclusively for the buyer’s account. The buyer then places an order for the goods in question with a quantity equal to X in the seller’s smart contract. The order is sent (for coding or programming purposes, we might label this event something like “SendOrder”), and the seller’s system would receive the order data and process them. The seller looks for the best shipping price in the carrier’s smart contract. It then sends the price (of the shipment and goods) to the buyer (this event might be labelled “PriceSent” for coding purposes).

The buyer then performs the secure payment of the price; if this is performed through cryptocurrencies (or “virtual assets” in the terminology preferred by the Financial Action Task Force (FATF) ⁷ ), the coins could be paid into the smart contract. The coins would be held there until the goods have been delivered. Where this is paid for using fiat currency, the buyer’s bank performs the payment function by paying into the smart contract. In this case, the bank is a permissioned participant to the smart contract. The money is not released until delivery is confirmed.

The seller issues the invoice with a delivery date and other relevant information. The buyer receives the data (this event might be labelled “InvoiceSent” for coding purposes). The carrier would concurrently instruct the goods to be collected and transported. Upon delivery to the buyer, the carrier marks the order on the smart contract as delivered. The smart contract releases payment to both the seller and carrier, as appropriate.

It should be remembered that all of the participants (seller, buyer, carrier, etc.) have nodes connected to the blockchain.

This is merely one possible means by which an international sale transaction might be executed using a smart contract.

Thus far, we have not factored the element of trade financing – conventionally in shipping-based international trade this is provided for by documentary credits. So how does a blockchain-based letter of credit work? A simplistic model might assist our understanding. The process might work as follows:

1. (1) The buyer creates a documentary credit application for the issuing bank to review and stores it on the blockchain.

2. (2) The issuing bank receives notification to review the letter of credit. It can approve or reject this based on the data provided. Once approved, access is then provided to the advising or nominated bank automatically for approval.

3. (3) The advising or nominated bank approves or rejects the letter of credit. If approved, the seller is able to view the terms of the letter of credit. It is further prompted to examine the original application.

4. (4) The seller ships the goods. It prepares the invoice, the export paperwork and any other shipping documents required under the letter of credit. These are then digitised or converted into electronic data and stored on the blockchain.

5. (5) The nominated bank is notified of the completion of the electronic records on the blockchain. It then checks the shipping and commercial documents and makes a decision to approve or reject the application.

6. (6) The issuing bank will then examine the data and images. It will identify and highlight any discrepancies for review by the buyer. If the buyer approves the data, the letter of credit is completed and payment is made.

7. (7) On the other hand, where the buyer is dissatisfied with the discrepancy, it can reject the tender.

Three conventional blockchain-based transactions might be used to demonstrate the extent to which blockchain technology is being used in recent trading relationships.

2. Case study A: BBVA (Ethereum blockchain) ⁸

In 2018, Banco Bilbao Vizcaya Argentaria (BBVA), a Spanish bank, used blockchain technology as a substitute for traditional trade documents. The bank reported that transaction times were reduced from ten days to around three hours. This project consisted of the exportation of frozen tuna from Mexico. Payment was by means of a letter of credit issued by BBVA. The blockchain solution provider, Wave, would use digitised documentation to replace traditional paper-based documents. The digitised documentation would be verified by an agreed electronic signature. Electronic presentation is enabled during the transit period. Crucially, the digitisation technique could extend to bills of lading in the letter of credit payment processes. Moreover, smart contracts were programmed in accordance with contractual agreements that specified commercial terms and conditional statements of the letter of credit. Blockchain-based ⁹ letter of credit and bill of lading systems would allow for financing execution through the autonomous features of smart contracts. No manual checking of the documentation is thus required. The bank pays upon satisfying itself that the documentation is in order. However, it is important to note that payment is not made through the blockchain – money is released in the traditional way. Automatic notifications were transmitted to the various participants following each relevant stage; for example, upon delivery enabled by the smart contract, the shipper would be notified.

3. Case study B: HSBC (R3 Corda blockchain) ¹⁰

In this case, the end-to-end transaction was executed on R3’s Corda blockchain platform. The platform, as was intended, was a single shared application. There was no need for multiple isolated digital systems across various counterparties based at various locations around the world. It is in essence a private or permissioned blockchain whereby only participants who have been approved can join the network. This mirrors a real-life trade finance arrangement in which the participants are generally known to each other. However, the system allows additional participants to be added, thus improving scalability. This platform is also able to give access control to “dominant parties”, ¹¹ which means there can be a central party managing the flow of data. The letter of credit was issued by ING Bank for Tricon Energy USA (the buyer), with HSBC India as the advising and negotiating bank for Reliance Industries, India (the seller). However, it is important to note that transfer of funds did not happen over the blockchain, only the title in the goods was transferred via the blockchain “transfer” of the bill of lading. It is questionable whether scaling up of this system will increase the risk of money laundering proportionately. This system also raises specific challenges for an AML regulatory system in the event of the key operators losing control over the technology or the permissions not being properly set to admit only those users whose probity and credentials have been ascertained. ¹²

4. Case study C: Maersk (Hyperledger Fabric) ¹³

In December 2016, Maersk initiated a tracking project with IBM for flower shipments from Kenya to the Netherlands. Participating parties in the blockchain using Hyperledger Fabric included the traders, shippers, freight forwarders and customs authorities. The rationale was to determine how the logistical chain could be better monitored and how the shipment traceability could be improved. The shipping company, Maersk, and the IT services provider, IBM, worked jointly to digitise and dematerialise the traditional documentation. The controlling party in the blockchain was Maersk. The blockchain allowed all participants to track and trace the movements of the goods, thereby reducing the necessity for physical tracking processes and constant communications between the parties. The information about the shipment was held in the blockchain for all of the participants to consult, including approvals and clearances given by customs. Cryptography was used to prevent counterfeiting of the records. In this particular example, Maersk had also provided the necessary trade financing for the sale and purchase ¹⁴ – this means that the shipping company itself, not a bank, had taken on the role of making payment on behalf of the buyer. In other words, if the Maersk trade finance was not being used, any letter of credit might be outside the blockchain. More recently, Maersk and IBM have developed their own blockchain platform called TradeLens, which works on similar lines. ¹⁵ Most certainly, the choice of their own blockchain platform affords them better control – it is thus a vital question as to what are the implications for AML measures if other traders were to replicate such a system but on an open or less closely guarded blockchain platform.

It is vital to note that, as these case studies demonstrate, in most conventional blockchain-based trade the payment by letter of credit is not made through the blockchain, although the terms of the letter of credit are embedded in the blockchain. This means that payment in these conventional cases remains to be made using traditional methods and in fiat currency. The next ambitious step is to enable payment to be made automatically and using cryptocurrencies, thereby potentially bypassing the banks, which are currently relied on by the regulators to combat money laundering.

We shall return to these case studies following a discussion of the money laundering context.

III. The money laundering context

TBML has been recognised by the FATF ¹⁶ in its landmark study published in 2006 as one of the three main methods by which criminal organisations and terrorist financiers move money for the purpose of disguising its origins and integrating it back into the formal economy. ¹⁷ This FATF study highlighted the increasing attractiveness of TBML as a method for laundering funds compared with misuse of the financial system (both formal and alternate) and through physical movement of cash (cash smuggling). ¹⁸ The revision of FATF standards undertaken in 2003 entailed stricter controls on the financial system and on cash couriers, which may have had an unintended consequence of leaving the trade finance sector more vulnerable to money laundering and terrorist financing. ¹⁹ There is no doubt that the increased volume, speed and value in globally traded goods and services coupled with often opaque and complex trading arrangements have led to increasing abuse of trade financing as a means to commit money laundering. The casting of blockchain technology into the mix creates additional problems for regulators.

The FATF also took pains, when its report was released, to state that TBML has long been under the radar and had not benefitted from the same level of analysis and study as other forms of money laundering schemes had attracted. ²⁰ In 2011, the Australian Institute of Criminology published a research paper ²¹ expressing the same sentiments. Since then, more work has been done on TBML, but there remain various controversies and debates around definitions and the means of combating TBML. ²²

1. How should trade-based money laundering be defined?

A useful starting point for a general definition of money laundering might be the Vienna Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances 1988. Article 3(1)(b) of the Convention is a good starting point for providing the essence of the money laundering offence, which contracting states should then adopt in their domestic legal systems. That article provides:

1. (i) The conversion or transfer of property, knowing that such property is derived from any offence or offences established in accordance with subparagraph a) of this paragraph, ²³ or from an act of participation in such offence or offences, for the purpose of concealing or disguising the illicit origin of the property or of assisting any person who is involved in the commission of such an offence or offences to evade the legal consequences of his actions;

2. (ii) The concealment or disguise of the true nature, source, location, disposition, movement, rights with respect to, or ownership of property, knowing that such property is derived from an offence or offences established in accordance with subparagraph a) of this paragraph ²⁴ or from an act of participation in such an offence or offences.

A similar concept of money laundering was extended to cover assets and proceeds derived from organised crime by the Convention against Transnational Organized Crime 2000, or the so-called Palermo Convention. ²⁵ The subsequent Convention against Corruption 2004 extended the fight against money laundering to proceeds from bribery and corruption.

At a generic level, from this definition it follows that money laundering involves three phases: placement, layering and integration of the assets in question. Placement involves the transfer of the illicit assets into the legitimate financial system. Layering is that part of the process that sets out to hide or disguise the true source of the asset. Once the asset has been “laundered”, it is removed from the legitimate repository and used by the criminal beneficiary.

There are three primary methods of money laundering: the laundering of money through the financial system; the physical movement of money (such as through cash couriers); and TBML. ²⁶ The FATF has defined TBML as “the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise their illicit origins”. ²⁷ On the other hand, in its Best Practices Paper on TBML, “trade-based money laundering” is defined more broadly as “the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise their illicit origins or finance their activities”. ²⁸ That said, it is submitted that the words “finance their activities” do not add much to the working definition. The important consideration in this form of money laundering is the use of trade transactions to place, layer and integrate the “dirty” assets.

The FATF considers trade primarily to be international trade – domestic trade does not appear to be included in its working definitions. ²⁹ Again, it is not clear whether this absence (if it is indeed an absence) would leave a significant gap in the law. Most AML systems are domestically orientated, and the FATF recommendations are merely for guidance purposes. It is difficult to envisage a situation in which domestic AML would exclude home-based trade money laundering from the definition of the money laundering offence.

2. How extensive is trade-based money laundering?

It is not easy to estimate the scale of the problem of TBML due to the clandestine nature of the crime. The work presented in this paper draws on an extensive cross-jurisdictional literature review ³⁰ to give the reader a sense of the scale of the problem. The net conclusion is that these works all have various limitations as regards the methods used in delineating the scale of the problem, but there is enough evidence – even if it is not properly empirical – to show TBML to be a substantial problem. The following quote from the US Government Accountability Office is worth noting:

Some U.S. officials and knowledgeable sources believe that, based upon available evidence, TBML is likely one of the largest forms of money laundering. In addition, as countries have strengthened their controls to combat other forms of money laundering, various U.S. government reports and officials, as well as knowledgeable sources have stated that there are indications that criminal organizations and terrorist organizations have increased their use of TBML to launder their funds. For example, FinCEN ³¹ has reported that since the Mexican government increased restrictions on U.S. dollar cash deposits at Mexican financial institutions in 2010, Mexican drug cartels appear to have increasingly turned to TBML as an alternative means of repatriating profits from U.S. drug sales. Similarly, in Australia, as controls on large cash deposits at ATMs have increased since 2017, criminals have increased their use of TBML to hide their profits, according to U.S. officials at the Embassy in Canberra. In addition, the 2020 National Strategy for Combating Terrorist and Other Illicit Financing notes that there has been a steady decrease in seizures related to bulk cash smuggling from 2012 through 2018 and states that this decrease could indicate that criminal organizations are increasingly turning to other means to move illicit money, including TBML. ³²

The continued growth in blockchain technology in international trade is likely to have an exacerbating effect on this.

IV. Blockchain technology trade-based money laundering

Our case studies, as has been stressed, represent by and large the current, conventional forms of blockchain technology-based trading arrangements. Lessons learnt from how they work will be useful in our evaluation of the money laundering perspective.

From the case studies discussed above, there are several features of blockchain technology-based trade that could be envisaged as giving cause for concern. It certainly goes without saying that these risk aspects are what make blockchain technology-based trade attractive to business. The position taken in this article is that regulation must balance the risk of money laundering against the benefits of blockchain.

Those features are:

1. (1) Paperless;

2. (2) Ease of establishing the contractual networks;

3. (3) No central party in the blockchain consortium;

4. (4) Removal of intermediaries – human agency replaced;

5. (5) Possible use of cryptocurrency or virtual assets – diffused loci of assets.

Looking at the case studies, one commonality is clearly the dematerialisation of paper documentation. There is potential for documentation, including supportive, secondary documents such as packing lists, survey reports, inspection reports, etc., also to be embedded into the blockchain. A blockchain system that does not adequately allow for cross-checking of the information could be abused by money launderers to create trade description fraud. A blockchain-based system could go beyond simply a digitisation of the documents for the purposes of international trade – blockchain-based technology on which smart contracting is based could effectively automate the document-checking process. The effectiveness of the system at preventing anomalies and other “red flags” ³³ being picked up is questionable.

Trade description fraud is one of the more common forms of TBML. It can include:

1. (1) Over- and under-invoicing of goods and services. As the FATF explains, “[t]he key element of this technique is the misrepresentation of the price of the goods or service in order to transfer additional value between the importer and exporter”. ³⁴

2. (2) Multiple invoicing of goods and services (also called carousel transactions), where the same goods are invoiced repeatedly, often using multiple financial institutions to pay. In a highly publicised fraud in the port of Qingdao, People’s Republic of China (PRC), companies controlled by a China-born Singaporean businessman were alleged to have used invoices for the same metal stockpiles several times to milk banks of large sums of money. ³⁵

3. (3) Under-shipment of goods, in which documents are created to indicate a misrepresentation of the true (and smaller) amount of goods shipped and there are no genuine buyers at the point of discharge.

4. (4) False description of goods, such as misrepresenting the goods to be of a higher quality or value than they really are.

These TBML activities could also be facilitated by the fact that blockchain technology-based trade could be exploited for the setting up of false or fictitious entities. In order to prevent false entities from being established, the blockchain-based system will need to create systems to replicate physical checks on identity. Due diligence must be exercised not just with respect to the exporter – it is tempting take a more lackadaisical approach with the importer, erroneously assuming that the money laundering risk lies primarily with the “seller”. Blockchain technology can facilitate the creation of a distributed marketplace in which not only are there multiple buyers, but also buyers can become sellers and vice versa in chains of contracts. A large-scale distributed marketplace could make it more challenging to apply customer due diligence (CDD) and “know your customer” (KYC) principles. ³⁶ It is more difficult to evaluate the risk properly when there are many small-scale purchasers and sellers compared to a single large transaction.

The challenge of identifying the user or participant and carrying out due diligence is further exacerbated by the fact that in a blockchain-based system there is usually no central controller – the platform provider, unlike in conventional digitised trade involving electronic bills of lading and electronic letters of credit, is not in theory involved in monitoring the execution of the smart contracts. The smart contracts are intended to be self-executing. That said, as we have seen in the HSBC (R3 Corda blockchain) case study above, there can be a controller (usually the bank, which is under a duty, generally speaking, to carry out checks for AML purposes), thereby actually modifying the pure form of blockchain technology. Where there is no controlling party, this would mean that AML legislation might well be frustrated. Moreover, where the blockchain users all have access to the same information held in the blockchain, data protection laws might make it even more difficult for any interested participant (if any exists) to discern any identity anomalies.

A much-lauded benefit of blockchain technology-based trade is the fact that intermediaries could be dispensed with through its use. Although it is undeniable that intermediaries are often the cause of delays and additional costs, they also play an important role in helping to verify the various supply chain nodes and participants. In AML legislation, where knowing the customer is a key plank of the law, this added layer could assist in the customer identification and verification process. Moreover, these third parties are often involved in verifying the goods and their descriptions. For example, an inspector might well notice that a shipping container does not appear to be as heavy as the declared weight might suggest. ³⁷ In a blockchain world, unless the contract calls for the intervention of a third-party inspector and/or the computing system is programmed to detect anomalies such as this, then such TBML activities could go undetected.

We have seen in our case studies that none has gone to the extent of enabling actual payment using cryptocurrencies through the blockchain. However, it would be ill-advised to assume that crypto-payment will not be used to pay for international sale contracts. Indeed, despite serious setbacks, it cannot have gone unnoticed that Venezuela attempted to require its oil buyers to use its virtual currency, Petro, as a result of the lack of tradability in its fiat currency due to economic sanctions. ³⁸

Once cryptocurrencies come into the picture, the scene does get rather murkier. The argument that cryptocurrencies could be conveniently used for money laundering purposes is well rehearsed. In this work, the focus is on how crypto-payment facilitated by blockchain-based trade might be used for money laundering. For ease of reading, we shall use the term “cryptoasset” or “cryptocurrency” instead of the FATF’s preferred terminology, “virtual asset”.

1. Cryptocurrency and trade-based money laundering

The use of cryptocurrency in TBML is not unknown. The US Drug Enforcement Agency has reported that TBML involving cryptocurrency has been observed in schemes whereby goods from the PRC are being shipped to Mexico and South America. ³⁹ Whereas in the past “wire or bulk cash smuggling” would be used for payment, this has been replaced in a number of cases by payment in bitcoin. Payment by bitcoin, it is reported, is preferred by certain PRC manufacturers as it allows them to avoid the PRC’s capital controls. Moreover, and of greater interest to us, is the fact that the purchase of bitcoin from a licenced money service business (MSB) faces less scrutiny compared to a wire transfer from the USA to the PRC. It is also not unusual that bitcoin would also be purchased from unregulated brokers in jurisdictions outside the USA who would intertwine its use for TBML with capital flight devices. Cryptocurrency works best in money laundering where it can be converted back to fiat currency easily. ⁴⁰

Another type of cryptoasset needing consideration are so-called “stablecoins”. Although there is no universal definition of “stablecoins”, it might be useful to borrow that which has been applied by the Financial Stability Board, which describes stablecoins as a type of cryptocurrency “that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets to other assets”. ⁴¹ As regards TBML, the type of stablecoins most at risk of abuse are those that could be scaled up quickly for mass adoption. That said, even where stablecoins are used in a small-scale setting, the facts that they can be used under a cloak of anonymity and may be easily exchanged or converted into another cryptoasset make them highly relevant to money laundering activities. ⁴²

In certain jurisdictions such as the PRC, the issuing and trading of cryptoassets, other than the state-backed digital yuan, are currently banned. ⁴³ The digital yuan, too, is not based on blockchain technology. However, three points should perhaps be mentioned. Firstly, the banning of cryptoassets and removing blockchain from the state-backed digital currency do not mean that blockchain technology has been excluded from international trading. Indeed, the PRC has taken a lead in introducing its own national blockchain-based service network – akin to a grand-scale platform backed by the state. The platform is intended to enable all blockchain technology apps to operate across any cloud, portal or framework. ⁴⁴ Secondly, this state-backed service is intended to be accessible to as wide as userbase as possible, with various access points. ⁴⁵ The Blockchain-based Service Network (BSN) development team also stated that “in principle, the BSN is a multi-chain, multi-ledger blockchain system”. ⁴⁶ The availability of such open access, despite the fact that permission might be required, does not remove the risk of money laundering nor the challenges facing financial institutions and other stakeholders (the so-called AML Reporting Entities) who are required under PRC law ⁴⁷ to undertake the necessary checks. Indeed, many of the guidance papers on CDD issued by the China Banking Regulatory Commission and the People’s Bank of China currently do not refer to blockchain technology-based trade as a money laundering typology. ⁴⁸ Thirdly, where the digital yuan is to be used in place of more conventional cryptoassets, in theory, this has some value for AML efforts. The digital yuan trials were concluded in October 2020. It is reported that the digital yuan’s use in the sale and purchase of goods has been successful. ⁴⁹ As regards money laundering, the advantage with the digital yuan is that, as it is not blockchain based and is more like electronic cash, the banks issuing it will have a record of what has been exchanged for the digital yuan. This record should allow the banks to monitor the flow of the digital yuan in the economy, which in turn could help law enforcement agents track illicit flows of funds, including money laundering or terrorist financing activities. In practice, the issue is that once the digital currency or the fiat currency used to exchange for the digital currency is internationalised (which is part of the PRC’s plan to reduce its reliance on the US dollar), then that tracking and tracing would not be an easy exercise for the issuing banks. In sum, more work needs to be done to develop better practical measures for all reporting entities.

2. The impact and reach of anti-money-laundering controls

In the UK, the USA, the EU and elsewhere, the AML regimes have evolved to provide controls over those individuals involved in the movement of cryptoassets, whether blockchain technology-based trade is used or not. On the other hand, by default, any transaction using blockchain technology but not involving the use of cryptoassets would not be subject to these special rules. Instead, the general rules would apply. In short, this means that the case studies presented in this article would all need to be dealt with using traditional KYC and CDD. In the light of the discussion of the risks given above, even if the traditional risk-based approach is adopted for CDD and KYC processes, special protocols may need to be established to ensure good practice in conducted amongst financial institutions involved in the sanctioning of funds transfers and payments. There has been a rise in the number of commercial enterprises providing, for a fee, programmes to assist in the KYC and CDD processes. Whilst this is not objectionable and, indeed, can be of tremendous assistance to smaller financial institutions and firms tasked with undertaking AML checks, firms must be careful not to place the entirety of their responsibility on those for-profit service providers.

KYC and CDD are protocols to be undertaken by regulated financial institutions or firms. However, blockchain technology-based trade, as we have seen in our case studies, could well dispense with the need for a controlling or central entity. Without this key entity, the AML regime will need to focus, in the main, on the entrance or exit points – namely, where the money laundering proceeds are placed into or taken out of the system to be spent. As to whether AML legislation applies to blockchain platform providers, the issue depends very much on whether they could be deemed to be providing services in like manner as financial institutions, lawyers, accountants, foreign exchange dealers, art dealers, auction platforms, etc., ⁵⁰ or whether they are also cryptoasset exchange platforms. ⁵¹ If the latter is the case, they could be directly bound by the due diligence and reporting duties of AML regulations.

The pressure is more palpable when cryptoassets or cryptocurrencies are used in international trade. Here, too, there is often no central body responsible for controlling the movement of these funds. As a result, the FATF’s recommendation is for national authorities critically to ensure that the originators and beneficiaries of financial transactions are identifiable and are not anonymous. Cryptoasset providers ⁵² and financial institutions must comply with the “travel rule”. ⁵³ The travel rule is a non-legally binding recommendation ⁵⁴ exhorting countries to ensure that originating cryptoasset providers obtain and hold required and accurate originator information and required beneficiary information on cryptoasset transfers, submit that information to the beneficiary cryptoasset provider or financial institution (if any exist) immediately and securely and make that information available on request to the appropriate authorities. Countries should ensure that beneficiary cryptoasset providers obtain and hold required originator information and required and accurate beneficiary information on cryptoasset transfers and make this information available on request to the appropriate authorities. Other requirements that were applied to traditional funds transfers (such as monitoring of the availability of information, taking freezing action and prohibiting transactions with designated persons and entities) would apply on the same basis to cryptoassets. ⁵⁵ The same obligations apply to financial institutions when sending or receiving virtual asset transfers on behalf of a customer.

The FATF Recommendations also require states to take effective and proportionate enforcement measures against firms and financial institutions that fail to enforce AML standards. ⁵⁶ However, the MSBs providing cryptoasset services tend to be decentralised and could be established in multiple geographical or even non-geographical locations. Many cryptocurrency exchanges also do not have the necessary infrastructure to obtain, hold and transmit identifying information of the participants in a transaction. ⁵⁷ There is no denying that at present there is no universal consensus as to the technology on which information and data sharing would be managed, resourced and regulated. A compounding fact making compliance with the travel rule exceedingly difficult is the existence (and, anecdotally, prevalence) of crypto mixers, which mask and hide the actual source of the cryptoassets. Thus, the net result is that there will be many cryptoasset providers that will be outside the reach of the law and also many providers who intend to apply the travel rule but are actually unable to do so properly.

The FATF Recommendations also expressly provide for sanctions and enforcement measures to be taken against the perpetrators of money laundering. ⁵⁸ These measures include criminal prosecutions and, importantly, asset confiscation. The 2019 FATF Recommendations state that countries must adopt measures that include the power:

… to: (a) identify, trace and evaluate property that is subject to confiscation; (b) carry out provisional measures, such as freezing and seizing, to prevent any dealing, transfer or disposal of such property; (c) take steps that will prevent or void actions that prejudice the country’s ability to freeze or seize or recover property that is subject to confiscation; and (d) take any appropriate investigative measures. ⁵⁹

It is immediately obvious that if the asset in question had been dematerialised into a cryptoasset or if it had been mixed, these sanctions and seizures would be hugely problematic, even before factoring in the question as to where the asset is located. Where no cryptoasset is involved, such as in a “conventional” blockchain technology-based trade, the key to enforcement lies very much in international cooperation. ⁶⁰ However, many developing countries (also often being exporting countries) do not have a sufficiently developed international law enforcement cooperation infrastructure.

Against this backdrop, it is indeed a positive feature that the EU’s new 6th AML had introduced a new package of weaponry. The 6th AML Directive, for example, clarifies the term “criminal activity” in Article 2, ⁶¹ and narrows it down to twenty-two predicate offences. ⁶² A predicate offence is a criminal activity that enables a more serious crime. For example, a predicate offence would be any crime that generates the money, but the larger crime would be the laundering of that money or the use of that money to finance terrorism. Both the predicate and larger offences would be subject to criminal law. There have been increased criminal sanctions on the natural persons who have committed crimes ⁶³ under the 2018 Directive. The maximum jail term has risen from one year to four years. Moreover, Article 6 of the 6th AML Directive provides that the regulator shall have the power to request the removal of any person convicted of money laundering, any of its predicate offences or terrorist financing from the management role of the “obliged entities”. Supervisors shall have the power to remove members of senior management that are not deemed to have acted with honesty and integrity and not to have possessed the knowledge and expertise necessary to carry out their functions. The inclusion of the requirement for knowledge and expertise is problematic – does this mean that the firm would be prevented from relying on third-party expert blockchain-based trade financing service providers? It is submitted that the provision is not intended to have such a far-reaching effect, on the basis of the principle of proportionality in EU law, but there is no precedent. With managers being well aware that the consequences for getting things wrong could be highly damaging to their firms, the upshot is that firms might avoid blockchain-based trade financing altogether. Whether that is indeed EU policy thus comes under a direct spotlight.

V. Conclusion

The current AML risk-based approach advocated by the FATF recognises the magnitude of the problem of TBML but considers that as there are many socioeconomic impediments to scaling up in the mass adoption of cryptoassets, the measures being taken are reasonably acceptable.

It is argued that although a reality-premised approach is appropriate, it must be appreciated that, given the scale of TBML, the use of blockchain and cryptoassets in international trade could well make matters worse. This is not to say that blockchain should not be a present and important feature in international trade. Indeed, the technology itself could be exploited to provide helpful AML solutions; blockchain technology can assuredly assist in satisfying the requirements of the travel rule, KYC and CDD. So, too, are market forces and structures important in this arena – if there is no easy way to extract the laundered assets, for example, the money launderer would try something else. However, as regards policy and law, it is important to keep watch regarding the continually shifting and changing nature of TBML activities. The AML rules and standards should thus continue to be reviewed in the light of such changes. This article serves, in some modest way, to identify how TBML might evolve in the light of blockchain technology and smart contracting and to demonstrate what AML law should be alert to.