AML/CFT Part 3: Comparing Illicit Activity in Crypto and Traditional Financial Markets

Illicit financial activity is hard to measure. Even the best estimates are just that — estimates.

But that doesn’t mean we can’t track and analyze criminal financial activity. Doing so provides important insights about the scope and scale of illicit activity, both in traditional financial markets and in DeFi.

Critics often charge that there is a rampant, unacceptable level of illicit financial activity in decentralized markets. Yet this allegation doesn’t square with the facts. In reality, the best available information suggests that the level of illicit activity in crypto is actually lower than the level of illicit activity in traditional finance.

Chainalysis estimates that illicit transactions made up only 0.15% of all cryptocurrency transactions in 2021, down from 0.62% in 2020. For comparison, the International Monetary Fund last estimated in the late-90s that between 2–5% of activity across the traditional financial system is illicit. Later investigations by the U.N. in the 2000s put that number at around 2.7% of global GDP, or about $1.6 trillion.

One thing that should be immediately striking here is how much more specific, and recent, the estimate of illicit activity using cryptocurrencies is. That’s because there’s a comparative lack of transparency — and therefore data available — in traditional financial markets. The fact that the most recent macro estimate of illicit activity in the traditional financial system is from the 90s raises the question whether pursuing AML/CFT objectives in traditional financial markets is fundamentally easier than in DeFi and crypto.

That we can consistently analyze the level of illicit activity in crypto markets while being unable to in the traditional markets is a massive improvement! Crypto markets allow for a more activity-based and targeted approach to AML/CFT than traditional financial markets. That said, the effectiveness of AML/CFT efforts in DeFi markets isn’t perfect and can still be improved.

That’s true for traditional financial markets as well, of course. But unlike those markets, DeFi markets, and the cryptocurrency space in general, have access to some cutting-edge tools to make scaling up AML/CFT effectiveness easier and more successful.

Some of this is clear in the most recent conversations around sanctions. Not only can the U.S. government enforce sanctions on cryptocurrency users, as even the Department of Treasure has pointed out; but crypto advocates and industry insiders have repeatedly pointed out that they possess the on-chain tools to track money laundering and other forms of illicit finance. It simply isn’t all that easy, at the end of the day, to hide where your money is coming from and where it is going when you’re operating on transparent blockchains.

In sum, the traditional financial ecosystem’s lack of transparency makes it incredibly difficult to compare the levels of illicit financial activity in DeFi markets and traditional markets. Nonetheless, the best available evidence suggests that crypto markets are “cleaner” than traditional markets. The ability to more precisely estimate the level of illicit activity across crypto markets is a feature not a bug, and it demonstrates the novel level of transparency into financial activity provided by transparent blockchains.