Money laundering: How dirty money enters the financial system

Money laundering is the process of cleaning illegally obtained money to make it appear as if it was obtained through legitimate sources.

• Money laundering is the process of concealing illegally obtained money to make it appear as if it was acquired through legal means.
• Money laundering takes place in three stages: placement, layering, and integration.
• Though all money laundering originates from crime, money laundering itself became a crime after the Money Laundering Control Act of 1986.
• Read more stories from Personal Finance Insider.

Money laundering might evoke an image of drug trafficking rings and shady businesses portrayed in shows like Ozark or Breaking Bad. Yet, hiding the origins of your profits from a less-than-honest day's work is a practice that dates back to the Golden Age of Piracy, when pirates would conceal their plunder from European vessels in the 16th through 18th centuries. 

Unfortunately, money laundering remains a big issue, with an estimated $800 billion to $2 trillion laundered each year globally, according to the United Nations. 

Here's what to know about money laundering and how it works.

What is money laundering? 

Money laundering is the process of disguising the source of illegally obtained money — which is known as 'laundering' or cleaning —  so that it appears as if it's been obtained through legitimate sources. It's a white-collar crime that falls under racketeering, according to the FBI.

"Money laundering is always born out of a crime," says attorney and expert witness in anti-money laundering issues Ross Delston. "There has to be a predicate crime first that generates profits or proceeds. And then it's those criminal proceeds that are moved, disguised, concealed, transferred, that constitute money laundering."

How money laundering works 

Money laundering takes place in three steps: placement, layering, and integration.

Placement: This is the first step and is how the "dirty money" enters the financial system. The funds are deposited into a financial institution through various transactions, such as checks and wire transfers. 

Financial institutions have several regulations in place that are designed to combat illegal financial activity — one of which is the Bank Secrecy Act, which requires banks to report cash transactions that exceed a daily total of $10,000. And so someone who's laundering funds will often break up large amounts into much smaller sums to avoid this and raising suspicion. "Criminals don't like to have those reports filed, because then their name or account or something about them becomes accessible to the government," says Delston. 

In order to avoid this threshold, money launderers will break their funds into amounts under $10,000 spread across multiple bank accounts. This is a form of structuring called smurfing and often happens during the next step: layering.

Layering: Once the money has been placed into a financial institution, money launderers will begin the layering process in which funds are distanced from their criminal origins. This can be done by moving money through various transactions to multiple financial institutions, lengthening the paper trail so that it will be more difficult to pin down the origins of the funds. 

Integration: This is the end goal of money laundering. The freshly laundered money is introduced into the financial system and to the money launderer. It is often used to buy assets such as real estate, artwork, or other luxury items. Once the money enters the financial system, it becomes more difficult to track down the laundered money.

Money laundering and crypto

The rise in cryptocurrency has presented money launderers with another method for cleaning dirty money, with the Financial Crimes Enforcement Network issuing an advisory in an effort to aid financial institutions in identifying illegal or suspicious activity around cryptocurrency. Though cryptocurrency transactions are available for anyone to see on the blockchain, the appeal of cryptocurrency money laundering is its decentralization. The currency transaction moves from peer to peer instead of through a financial institution. 

Money launderers skirt around the blockchain by using privacy coins. While cryptocurrencies like as Bitcoin or Ethereum provide easily trackable information, transactions using privacy coins are encrypted. "They really are intentionally obfuscating the blockchain transactions" says white collar crimes attorney and former money laundering prosecutor Arnold Spencer. "Now that information is not publicly available." 

This has left law enforcement agencies racing to keep up with cryptocurrency developments. "Most state and federal regulators are somewhere between implementing a well-thought-out regulatory platform all the way down to just trying to understand their role in regulating cryptocurrency," Spencer says.

Despite new developments in cryptocurrency-based money laundering, the principles – placement, layering, integration – remain the same, as do the consequences.