3 Stages of Money Laundering Explained

Does breaking larger sums of money into smaller deposits and then transferring them into multiple different bank accounts sound familiar? Yes, that’s structuring, one of the many ways that bad actors use for money laundering. However, it’s not as simple or innocent as it may sound to some. Criminals launder funds that come from human trafficking, arms deals, drugs, fraud, or bribery.

According to Europol, in one year, they reported recovering $22.5 million in cash, 118 bitcoins, gold and silver coins worth $6.26 million, and $2.39 million in assets from money laundering and fraud. Unfortunately, even some legitimately seeming financial service providers can use laundered cash to “invest” into their business. That’s why many organized crime groups launder funds professionally and do this full-time for a living, making it hard to trace the original source of the funds.

That said, anti-money laundering (AML) measures are here for a reason and not just for compliance or reporting purposes. In this blog post, we’ll talk more about the three main stages of money laundering and how to identify the red flags that you should know to avoid unwanted consequences.

What is Money Laundering?

Money laundering is the process of turning dirty money from illicit activities, such as terrorism funding or drug trafficking, into appearing as legitimate funds. In other words, money laundering is the process of cleaning and laundering money to make it look like it came from legitimate sources and not criminal activities. As a result, to prevent such cases, financial institutions and other regulated entities must have a proper AML program in place.

Throughout recent years, the fastly emerging fintech space and digital assets, such as crypto, have unintentionally opened new doors for criminals to launder money. This is a classic example since bad actors can’t solely rely on cash despite the contrary belief that “cash is king.” So, by converting cash into clean money and integrating it into the financial system, criminals protect their identities, scaling their “business” and aiming for bigger targets.

What is the Money Laundering Process?

Money laundering consists of three stages. The process starts with criminals depositing (or placing) the cash into the financial system. They often do this by converting cash transactions into digital ones, this way, cleaning the dirty funds. Then, we have layering, which is based on multiple transactions and dividing the cash into smaller sums as a technique to conceal the money’s true origin.

Lastly, through integration, dirty money is quietly combined with legitimate funds and integrated into society, appearing as proper, accessible funds. Since the money is mixed with legitimate transactions, detecting and determining its origin becomes a true challenge for law enforcement. Naturally, AML regulations are getting stricter, as money laundering is often linked to other serious crimes, such as terrorism financing, sanctions evasion, and others, which need to be detected as early as possible.

For example, a common money laundering measure is when criminals buy a cash-based business, such as a gift shop, and inflate its revenue on purpose so that they can mix illegal proceedings with the shop’s legitimate earnings. This works as a front for money laundering, and there are many other ways that bad actors can use to achieve such a result.

Popular Money Laundering Techniques

Some common money laundering schemes that fraudsters use involve:

Gambling and Casinos

One of the oldest tricks in the book is when criminals go to casinos and other gambling establishments to launder cash. They buy chips and use the quick cashout method to deposit the funds into their bank accounts. Since there are many iGaming platforms, multiple fraudulent techniques can be used, such as collaborating with other players to place bets using deposited funds or deliberately losing chips to another player at a poker table to covertly transfer funds.

Crypto

We all heard the drill. The anonymous nature of crypto has been in the negative light for a while now since it has become the preferred channel for criminals for money laundering and other crimes, like buying drugs online. Cryptocurrency is also “good” for layering transactions, which is why criminals succeed in hiding the connection between buyers and sellers, hiding their addresses. However, this is now changing, as new regulations, such as the Travel Rule for virtual asset service providers (VASPs).

Shell (Fake) Companies

While shell companies are legal in general, criminals often use them for money laundering, making them exist only on paper. Because these companies hide the flow of money, criminals can avoid detection, as the companies’ activities appear legal. This allows the shell company to falsely claim it has sold legitimate services. Similarly, fake companies, like the gift shop example, are funded entirely by dirty cash. Since the illegal funds are mixed with legitimate sales, it becomes difficult to tell whether the money came from criminal activity or from the sale of items.

Real Estate

Some jurisdictions still accept large sums of cash for real estate transactions without strict screening thresholds, which makes it easier to hide illicit funds. Many criminals invest in multiple properties after receiving dirty money, such as gained from selling drugs, and use it to buy houses, sometimes even fund whole companies that specialize in real estate. Some criminals also use the “flipping” scheme, where they quickly buy and sell the property at a higher price to make large amounts of cash fast.

What are the 3 Stages of Money Laundering?

Since money laundering is a complex process because it involves different methods, it’s easier to understand it as a whole when it’s broken down into three key stages: placement, layering, and integration.

We’ll go through each stage in more detail.

1. Placement in Money Laundering

The first stage is placement, which is a risky step for criminals because they aim to move large amounts of dirty cash into the system without getting any sort of attention from the legal authorities or financial institutions. That is when illicit funds are introduced into the financial system by breaking larger amounts into smaller and less noticeable sums. It can be done by transferring the money to offshore accounts, for example, as a way to wash the dirty cash.

Some popular placement techniques involve:

Using false invoicing, where no goods or services are actually provided.
Using smurfing and depositing money into bank accounts just below the AML reporting threshold.
Mixing and blending dirty cash with legitimate funds through cash-intensive businesses.
Purchasing high-value goods, such as art or luxury items, to sell them for clean money.
Trading illicit funds through forex exchanges, especially in less regulated markets.
Using trusts and offshore companies to conceal the true ownership and launder funds.
Transporting small amounts of cash abroad, specifically below the customs declaration limit abroad, then depositing it in foreign accounts.

2. Layering in Money Laundering

The second stage is layering. It involves moving dirty money through multiple transactions, often using fraudulent and complex schemes in order to hide the true origin of the funds. The main goal here is to layer the illicit funds in the general financial system and hide the audit trail from legal authorities. Since multiple fraudulent methods and transactions are used, this stage is called “layering.”

The difference between the first and the second stages of money laundering is that the structure introduces illicit funds into the financial system while layering disguises their origin through a series of transactions.

Some common layering tactics include:

Depositing regular transfers into one bank account, then buying and selling cryptocurrency, and finally moving the money to a different bank account.
Using the stock market to move the dirty funds.
Using the chain-hopping technique to convert crypto and move it across different blockchains.
Investing in real estate or using shell companies to launder the dirty cash.
Exploiting loopholes in certain jurisdictions to transfer the funds online in order to appear “legal.”
Mixing and tumbling transactions across multiple exchanges to hide their traces.

3. Integration in Money Laundering

This is the third and final stage in the money laundering process. In integration, criminals blend illegally obtained funds, making money appear legitimate or “clean.” They pay taxes and accept losses as part of the money laundering process. From their perspective, this is a major factor if they want to avoid any sort of suspicion from both tax authorities and law enforcement agencies. That’s how integration allows criminals to bring their illegal money into the regular economy through legal methods, such as buying luxury items.

This makes it difficult to distinguish between illicit funds and legitimate wealth. Once that’s done, criminals can use the funds without any restrictions. However, criminals typically don’t end their operations and want to invest the funds elsewhere to continue their money laundering. For example, they might buy businesses using laundered money as capital and create legitimate income through salaries.

Other popular examples of integration methods include:

Creating fake invoices that have a higher value than the actual goods, then withdrawing the “clean” money from such transactions.
Using non-existent employees in a company to withdraw clean money.
Employing different financial instruments, such as investing in bonds or stocks, to generate legitimate returns.
Creating fake loans or mortgages and making the funds appear as legitimate debt repayments.
Distributing dividends to shareholders of companies that are linked to criminal activity and money laundering.
Abusing life insurance policies and using laundered funds to pay premiums, then cashing out for legitimate funds.

Why is Money Laundering Bad?

Obviously, money laundering is a serious offense and is harmful to everyone involved. That’s because cleaning dirty cash allows criminals to use the money freely, broadening the spectrum of their illegal operations. It’s especially harmful to those countries where there’s a lack of AML regulations, and the dirty cash inflow makes up a second layer of “informal economy” — all based on black money. This mix of illicit funds can drive up consumption rates and increase prices for imports, exports, and inflation, leading to unemployment.

For example, if a company exists purely to launder money, selling products or services isn’t that important. As a result, criminals can offer products at extremely low prices. That’s how bad actors transfer power from the financial sector to themselves, allowing criminals like drug traffickers to expand their money laundering operations, negatively impacting tax income and the economy.

Other negative socio-economic effects that come with money laundering include:

Increased crime and corruption rates.
Slower economic growth.
The loss of trust from foreign investors.
A bigger gap between the poor and the rich.
Reputational harm for businesses regarding non-compliance fines.

Risk Mitigation and Management Using AML Solutions

There’s no surprise here that money laundering and other risks should be identified, assessed, and monitored in order to minimize the chances of getting tangled in a fraudulent scheme. For that, companies build risk management strategies and use robust AML programs, which include multiple fraud prevention measures, such as training staff to keep up with AM requirements or employing independent testing to see if your internal AML controls are effective.

At iDenfy, we have a complete RegTech suite of different tools that help you mitigate money laundering risks. For example:

Adverse media screening (to detect negative news automatically based on simple keyword research).
Sanctions screening (to prevent onboarding risky, sanctioned individuals).
eIDV, or database verification (to cross-check KYC data, including other details like SSNs, with reputable databases).
UBO verification (to identify and screen ultimate beneficial owners, or UBOs, that are typically considered higher-risk).
KYC/KYB risk assessment (to automatically assess client risk scores — from low to high).

These are just a fragment of our AML screening and monitoring software capabilities. For more information and a hands-on experience, book a free demo.