Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)

What Is AML/CFT? 

TL;DR

Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) refers to the controls and processes an organization, like Kraken, performs in order to prevent money laundering and terrorist financing and to achieve compliance with its legal requirements and regulatory obligations. This includes risk assessing clients, actively monitoring transactions for money laundering indicators, and reporting suspicious activities.

The goal of AML/CFT laws is to prevent the movement of funds associated with these crimes and to halt the operations of those who would use the financial system to facilitate their illegal activities.

Compliance with AML/CFT regulations is critical to prevent the financial system from being used for illicit activities, which can undermine the integrity of financial markets and lead to economic instability. An effective AML/CFT Program can help to deter criminals, reducing the overall level of crime and in turn, make society safer.

What is Money Laundering?

Money laundering is a financial crime that allows criminals to disguise the origins of illegally obtained money. It’s a process that turns “dirty” money – earned through criminal activities like drug trafficking, fraud, or corruption – into “clean” money that appears legitimate and can be freely used in the economy.

Governments and financial institutions around the world work to actively combat money laundering because it can fund organized crime, terrorism, and facilitate corruption. But how does money laundering actually work? Let’s break it down.

  • Placement: This is the initial step, where illicit funds enter the financial system. Criminals try to avoid detection by breaking up large sums into smaller deposits (a method called “structuring”) or by using cash-heavy businesses like jewelers or restaurants to mix illegal funds with legal earnings.
  • Layering: Once funds have entered the system, criminals use complex transactions to obscure its origins. They might transfer funds between multiple bank accounts, move money across different countries, buy and sell assets, or use shell companies to hide ownership. The goal is to obscure the ownership of the funds and make it difficult to trace the money back to its original source.
  • Integration: At this stage, the “cleaned” money is reintroduced into the economy as seemingly legitimate wealth. It may be invested in businesses, used to buy luxury goods, or deposited into accounts without raising suspicion.

Common Money Laundering Techniques

Money launderers use a variety of methods to move and disguise illicit funds, including:

  • Using fake or inactive businesses to move money without providing real services or products.
  • Depositing illegal funds into a cash-heavy business like a casino, gambling, and then withdrawing “winnings” as clean money.
  • Falsifying invoices and trade transactions to move money between countries.

Why is Money Laundering a Problem?

Money laundering isn’t just about criminals getting rich – it has serious consequences for society:

  • It fuels crime and corruption. Laundered money often finances drug cartels, human trafficking, and terrorism.
  • It harms economies. When illegal funds flow unchecked, it distorts markets, raises inflation, and weakens financial institutions, ultimately undermining the integrity of financial markets and leading to economic instability
  • It damages businesses. Legitimate businesses may struggle to compete with criminal enterprises that use laundered money to operate unfairly.

Fighting Money Laundering

To help combat money laundering, governments and financial institutions use a variety of tools, including:

  • Anti-Money Laundering (AML) Laws – Regulations requiring certain businesses, including financial institutions and cryptoasset service providers, to report suspicious transactions.
  • Know Your Customer (KYC) Rules – Financial institutions and cryptoasset service providers must verify the identities of their clients.
  • Financial Action Task Force (FATF) – A global organization that sets anti-money laundering standards.
  • Law Enforcement Investigations – Agencies like the FBI, Interpol, and financial crime units track and prosecute offenders.

What Is Terrorist Financing? 

Terrorist financing is the process of providing funds or financial support to terrorist organizations, individuals, or activities. Unlike money laundering – where criminals try to hide illegally obtained money – terrorist financing often involves both legal and illegal sources of funds, all directed toward carrying out attacks, supporting terrorist networks, or spreading extremist ideologies.

Governments worldwide work to prevent terrorist financing because it enables violence, disrupts economies, and threatens national security. But how does terrorist financing work, and why is it so difficult to stop? Let’s break it down.

How Terrorist Financing Works

Terrorist financing follows a general flow:

  • Fundraising: Terrorists acquire money from various sources, both legal (charities, donations, businesses) and illegal (drug trafficking, extortion, fraud).
  • Movement of Funds: The money is transferred using fiat, cryptocurrency, shell companies, hawala networks (informal money transfer systems), or smuggling.
  • Use of Funds: The money is spent on recruitment, weapons, propaganda, operational costs, or logistics to carry out attacks.

Sources of Terrorist Financing

Terrorist groups raise money through both legitimate and criminal means:

  • Donations and Charities:  Some terrorist groups receive funding from individuals or organizations that support their cause, often under the guise of humanitarian aid.
  • State Sponsorship: Some governments provide direct or indirect financial support to terrorist organizations for political or strategic reasons.
  • Businesses and Investments: Terrorists may own businesses, invest in real estate, or engage in trade to generate income.
  • Drug Trafficking: Groups like the Taliban and Hezbollah have been linked to the global drug trade, using it to fund operations.
  • Kidnapping and Ransom: Terrorist organizations often kidnap people and demand ransoms from governments, companies, or families.
  • Fraud and Cybercrime: Credit card fraud, identity theft, and online scams help generate illicit funds.

How Terrorists Move Money

Terrorists use a variety of methods to move money while avoiding detection:

  • Bank Transfers: While banks have anti-money laundering (AML) safeguards, transactions may be structured below transaction monitoring thresholds.
  • Hawala Networks: An informal and unregulated money transfer system used in many countries, particularly in the Middle East and South Asia.
  • Trade-Based Financing: Terrorists may manipulate trade transactions, such as inflating invoices, to move funds across borders.
  • Cash Smuggling: Some groups physically transport cash to bypass banking regulations.

Why Terrorist Financing Is Hard to Stop

Unlike traditional financial crimes, terrorist financing can involve small, seemingly innocent transactions, making detection difficult. Some reasons it’s so challenging to combat include:

  • Use of Legal Funds: Unlike money laundering, which involves hiding criminal profits, terrorist financing often involves legally obtained money that’s redirected for illicit purposes.
  • Decentralized Networks: Many terrorist organizations operate through independent cells, making financial tracking harder.
  • Lack of Global Coordination: While many countries pass and enforce anti-terrorism financing laws, this varies, and loopholes exist.

Combatting Terrorist Financing

To combat terrorist financing, governments and financial institutions use a variety of tools, including:

  • Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) Laws – Regulations that require certain businesses, including financial institutions and cryptoasset service providers to monitor and report suspicious transactions.
  • Sanctions and Asset Freezing – Governments can freeze the financial assets of suspected terrorists and their supporters.
  • Know Your Customer (KYC) Requirements – Financial institutions and cryptoasset service providers must verify the identities of customers to prevent anonymous transactions.
  • Law Enforcement and Intelligence Efforts – Agencies like the FBI, Interpol, and financial crime units track and prosecute offenders.

What is Know Your Customer? 

In today’s financial landscape, preventing money laundering, fraud, and terrorist financing is a top priority. One of the most effective tools in this fight is Know Your Customer (KYC) – a critical process that financial institutions use to verify the identities of their clients.

But what exactly is KYC, and why is it so important in combating financial crime? Let’s break it down.

What Is Know Your Customer (KYC)?

KYC is the process of establishing and verifying a customer’s identity before and during their relationship with a financial institution. It involves collecting and assessing personal information to ensure that customers are who they claim to be and are not engaging in illegal activities. 

KYC is a fundamental requirement for banks, financial service providers, and other regulated industries to comply with Anti-Money Laundering (AML) laws and Counter-Terrorism Financing (CTF) regulations.

Key Components of the KYC Process

A strong KYC framework consists of three main components:

  1. Customer Identification Program (CIP)

A Customer Identification Program (CIP) is a set of procedures that verify a customer's identity. CIPs are used by financial institutions to prevent money laundering, terrorist financing, and other illicit activities. 

  1. Customer Due Diligence (CDD)

Once a customer’s identity is verified, financial institutions assess the risk they pose. This involves:

  • Understanding the customer’s financial background and transaction patterns.
  • Checking whether they are involved in high-risk industries or jurisdictions.
  • Screening against sanctions lists, politically exposed persons (PEPs), and watchlists.

Depending on a customer's risk, they will undergo varying degrees of due diligence, which may include enhanced due diligence. As part of this process, we may also request documents, for example, a proof of Source of Wealth or Source of Funds document.

  1. Ongoing Monitoring

KYC is not a one-time process – financial institutions must continuously monitor transactions and update customer information. This helps detect:

  • Unusual or suspicious financial activity.
  • Sudden changes in transaction behavior.
  • Links to money laundering, fraud, or terrorism financing.

If suspicious activity is detected, the institution must file a Suspicious Activity Report (SAR) with regulatory authorities.

Why Is KYC Important in Fighting Financial Crime?

KYC plays a crucial role in preventing various forms of financial crime. Here’s how:

  1. Prevents Money Laundering

Criminals use fake identities and shell companies to launder illicit funds. KYC helps financial institutions identify and stop suspicious individuals before they can exploit the system. Terrorist organizations often disguise funding sources through seemingly legitimate accounts. KYC ensures financial institutions can detect high-risk individuals and flag suspicious transactions that may support terrorism.

  1. Reduces Fraud and Identity Theft

Fraudsters use stolen or synthetic identities to commit financial crimes. KYC protects businesses and customers by verifying identities and preventing unauthorized access to financial services.

  1. Enhances Regulatory Compliance

Governments worldwide enforce strict AML and KYC regulations. Non-compliance can lead to hefty fines, reputational damage, and legal action. A strong KYC program helps businesses stay compliant with local and global laws.

  1. Builds Trust in the Financial System

When financial institutions implement robust KYC measures, they create a safer and more transparent financial services  environment. This protects customers, investors, and businesses from financial crime risks.

Know Your Customer (KYC) is a cornerstone of financial security, helping institutions prevent money laundering, fraud, and terrorist financing. While it poses challenges, advancements in technology are making KYC more efficient and effective. As financial crime evolves, strong KYC processes will remain essential in safeguarding the financial system and maintaining global regulatory compliance.