When thinking about money laundering, most people will picture the idea of old school gangsters sitting on piles of cash while smoking cigars and planning the opening of some shady business to clean up all their dirty money. In reality, there’s much more behind it and, in the last years, technology changed the way money gets laundered in multiple ways.
But before diving into the finest – and very illegal – details of what money laundering is, let's give you a brief introduction.
The term "money laundering" seems to have originated with the Italian mafia in the U.S., where Al Capone allegedly purchased laundromats to blend its illegal profits from prostitution and bootlegged liquor sales with legitimate business sales. At its simplest, it’s the act of making money that comes from source A look like it comes from source B, where source A is a criminal activity, and source B is a legitimate source. In practice, criminals try to hide the origins of money obtained through illegal activities, so it looks like it was obtained from legal sources.
Let’s use an example to illustrate this. Let's say you're running a lucrative and very illegal enterprise, like a drug distribution ring. Your ill-gotten cash gains are too significant to conceal from the authorities without raising their suspicions. You can’t just deposit them in a bank account without having to explain where they came from. So, you begin ploughing the funds into a legitimate-seeming enterprise: let's say a neighbourhood pizzeria owned by a loyal associate, who will take a cut for their trouble.
You direct most of the money you make selling drugs through the pizzeria, spending it on kitchen equipment, food products, supplies, services, even labour.
Once on the restaurant's balance sheet, the illicit funds blend with legitimate gains from paying customers. It's nearly impossible to determine whether a given expense involves legit or illegal funds – the answer is probably both, which is the whole point.
To untrained observers, you're running a very successful, totally above-board pizza parlour and nothing more. The origin of your income appears now legit and you feel safe, even though much of your revenue came from an activity that would usually land you in prison. This is a typical textbook example of how money laundering works. But like I said before, there’s much more behind it.
Money laundering is a three-step process: placement, layering and integration. Dirty money isn't considered clean until the last step is completed.
First things first: cleaning up money requires starting by placing your ill-gotten gains into the financial system. This phase is particularly risky due to reporting requirements for deposits above a certain amount (the amount varies depending on the country). And, in general, people like to ask questions when large sums of money appear out of the blue.
Have you ever heard of smurfing? It’s one of the most common ways to place ill-gotten gains into the financial system. Smurfing is the art of making lots of relatively small bank deposits over time, usually in multiple accounts. It often involves lower-level participants (smurfs) who physically deposit cash in their bosses' accounts. Some money launderers turn to alternative financial systems like cryptocurrencies to avoid scrutiny.
Other alternatives to smurfing include adding the money to the accounts of an existing business or disguising the dirty money through a transaction (for example, for products that will never be provided).
Ok, now the money is in the financial system, and your legitimate business is covering up for whatever illegal business you're managing off the books. But this happens only on the surface. To a person with proper training, your dirty money still looks pretty dirty. That's when layering enters the game.
Layering is the stage where the illicit money is blended with legitimate money or placed in constant motion. To layer successfully, you need to do a series of complex financial manoeuvres that slice and dice the initial placement. The process varies dramatically according to which laundering scheme you're following, but in every case, the purpose is the same: to make it difficult for even a skilled accountant to differentiate between money that came from legal transactions and money that came from funds that were placed for laundering. Illicit money can be used to gamble, then placed into stocks, then shuffled around in different currencies, and then used to buy financial products like life insurance policies.
The more money you'll try to layer, the more complex and varied these manoeuvres will have to be.
Integration is the final step where laundered funds finally become legitimate and usually re-enter the economy through legal transactions. This stage of the process usually involves only legal transactions, and that's why it's considered the lowest-risk part of the laundering process.
It's also common to use integrated cash to purchase assets that will facilitate money laundering in the future. Following the simplified pizzeria example we used before, an integration transaction might involve buying a new oven or making a bulk order of pizza ingredients.
OK, so now you know the basics. No worries if it’s all a bit confusing. Let’s go through an example to figure out how the three-step process works in real life.
The cash business scheme
Do you remember our pizzeria? Let’s place, layer and integrate our laundered money through it.
Placement: in this stage, we bring our money, likely physical cash, to the manager of the pizzeria. They store it and wait for business to start.
Layering: as the restaurant sells pizza, they slip some of the illegitimate cash into the legitimate profits. It could be a fake customer that on paper buys pizza, but in reality is just cash we put into the register. Maybe we go out and buy flour with the illegitimate cash, make pizza from it and record the profits as belonging to the restaurant.
Integration: As the day progresses, your cash slowly turns into on-paper profits for the restaurant. You take the cash you made from selling pizza, some of which came from the original illegitimate cash, and deposit it at the bank as part of the daily revenue the restaurant makes. You record it all as legitimate business, file a tax return, and in the end, enjoy your spoils. Provided you don’t get caught, of course.
This was just a brief introduction to how money laundering works and what's the structure behind it. It's a serious threat that has devastating effects on the financial system and allows people to profit from criminal activities.
But how can you protect yourself from something that you don't know? Well, you can't, and that's why we decided to dig into it a bit. We aim to provide our readers with the instruments to understand what happens around them, because knowledge is always the best form of protection.