What is money laundering: mechanisms and methodologies of illegal fund transfer

Money laundering is one of the most complex mechanisms in the criminal world, allowing offenders to give the appearance of legality to illegally obtained income. The process involves systematically hiding the true source of funds derived from drug trafficking, organized crime, terrorism, smuggling, and other criminal activities. Authoritative international bodies, such as the Basel Committee on Banking Supervision, define money laundering as activities where criminals use the financial system to transfer funds between accounts to conceal the original source and ownership relationships to the ultimate beneficiary.

Understanding the Essence: Subjects and Objects of Money Laundering

It is important to understand that the subjects of money laundering include both financial institutions and individuals who perform one of the following actions. They may provide accounts for depositing funds, facilitate converting assets into cash or financial instruments, enable transfers through banking operations or other payment systems, conduct cross-border transfers, or hide income sources by other means.

The object of money laundering refers to so-called “dirty money” — income obtained from criminal activities. This can include proceeds from drug trafficking, smuggling, arms trade, fraud, theft, robbery, corruption, tax evasion, and many other illegal acts.

Criminal structures use money laundering with a dual purpose: on one hand, to hide traces of their criminal activity and obtain “legitimate” income; on the other hand, to penetrate into legal business, creating the appearance of normal economic activity and expanding their criminal operations.

Three-Stage Money Laundering Mechanism

The full cycle of money laundering theoretically consists of three consecutive stages, each with its own specifics and purpose.

First Stage: Placement of Funds

The placement stage, also called “insertion” of funds, is the starting point of the entire scheme. At this stage, assets obtained illegally are physically processed and introduced into the laundering system. The most common scenario: criminals receive large volumes of small cash amounts from street crimes, such as drug sales. Such fragmented small sums are inconvenient to carry and easily attract law enforcement attention.

To overcome this obstacle, criminals transform the form of the funds. They may deposit money into a bank as regular deposits or use it to purchase various securities and financial instruments. Once a large sum of small cash is placed into bank accounts or converted into portable financial assets, the placement stage is considered complete.

In practice, placement is carried out through various methods: from smuggling large cash sums across borders to mixing dirty money with legitimate deposits in financial institutions. Modern financial markets offer laundering opportunities ranging from traditional cash operations and remittances to mobile banking and electronic payments.

Second Stage: Layering and Source Masking

The layering stage, also known as “separation” or “fragmentation,” is considered the most critical link in the entire process. At this stage, criminals perform numerous complex financial transactions and transfers aimed at breaking the link between the funds and their original source. Through successive transactions, they gradually obscure the illegal nature of the income, making it nearly impossible to trace the connection between the money and the crime.

Money launderers skillfully exploit the complexity and scale of modern financial systems. They conduct operations through banks, insurance companies, brokerage firms, as well as use precious metals markets, car markets, and even retail sectors. Criminals create tangled chains of transactions, perform multiple transfers and resales of assets, sometimes deliberately using anonymous operations to mislead auditors or bypass control systems.

At this stage, techniques such as opening accounts under fictitious names or aliases, creating fake trading operations with false purchase and sale receipts, acquiring and selling registered securities, and other complex financial manipulations are often employed. If such operations are conducted in so-called “tax havens” or regions with weak financial oversight, the masking process becomes even more effective.

Third Stage: Integration into the Legal Economy

The integration stage is the final phase of money laundering. At this point, funds that have successfully passed through layering are converted into “clean” money and introduced into official economic activity. Criminals transfer assets under the guise of legitimate income to official institutions or individuals with no apparent links to criminal groups.

If the layering stage is successful, the proceeds from crimes become virtually indistinguishable from normal income. Criminals gain full freedom to dispose of these funds: they can invest in legal businesses, open accounts in official financial institutions, and perform any lawful operations. “Laundered” funds re-enter the financial system, now without any signs of their criminal origin.

Practical Methods and Schemes of Money Laundering

History and current practice show that money laundering is a constantly evolving process. Criminals adapt their methods to changing conditions and improvements in control mechanisms. Broadly, several categories of such methods can be distinguished.

Traditional Cash-Based Schemes

Smuggling cash across borders remains a fundamental method. Many countries lack sophisticated reporting systems for cash transactions, facilitating the import of criminal proceeds and their subsequent placement through banking channels.

The “splitting” method involves dividing a large sum into many small deposits. In countries with strict reporting requirements for large cash transactions, criminals intentionally break down money into amounts below the reporting threshold and deposit them gradually, avoiding automatic alerts to financial regulators.

Cash-intensive sectors such as casinos, entertainment venues, bars, and jewelry stores serve as traditional cover. Criminals declare their income as “legitimate” earnings of these establishments through fictitious transactions.

Use of Movable and Immovable Property

Direct purchase of high-value assets — such as residential properties, luxury cars, antiques, art pieces, securities — is an effective method. Later, reselling this property converts it into “clean” money, which is then placed into financial systems.

Speculating on the real estate market allows front persons to buy properties from developers at discounted prices (50-70% of market value), paying in cash, and then quickly reselling at a profit of 50-100%, especially during pre-sales.

Financial and Specialized Instruments

The securities sector offers extensive opportunities due to the large volume of transactions and variety of financial instruments. Criminals often perform operations with stocks, bonds, and futures as a means of masking.

The insurance industry is also actively used: launderers buy insurance policies for large sums and then claim payouts as reimbursement or return of premiums in a “legitimate” form.

Traveler’s checks are attractive because they can be moved across borders without restrictions, unlike cash. They require deposit in a bank for cashing, but the original issuer remains difficult to trace.

Exchanging chips in casinos via intermediaries creates the illusion of winnings in gambling. Chips are transferred to third parties, who then exchange them for cash (usually with about a 5% commission), creating the appearance of legitimate income.

Antiques, jewelry, and rare collectibles enable large sums to be transferred using forged purchase-sale documents. Items are bought without obvious identifying marks to complicate tracing their origin.

Charitable foundations and organizations often become tools: politicians and businessmen create funds, make “donations,” and then deplete them. Enterprises use fictitious contributions to controlled funds to transfer money and evade taxes. Cross-border operations of charitable organizations under different names serve as currency conversion and money transfer methods.

Data Manipulation Methods

Fake loans are often used in corruption schemes: the recipient of a bribe holds a promissory note or check with a deferred maturity date. If financial traces are later discovered, they can be presented as a normal credit relationship. After the attention subsides, the document can be transferred to a third party or repaid via bank.

Fake currency accounts are frequently opened in the names of proxies unaware of their existence. This prevents the proxy from reporting the account loss or signature change.

The “ant method” involves numerous small deposits of foreign currency, which are later withdrawn in foreign countries. This method is often combined with the use of straw accounts.

Manipulation of Trade Data and Commerce

Overstating import prices and understating export prices is a classic scheme. Corrupt officials collude with foreign partners, overpaying for imported equipment and raw materials via inflated commissions and discounts, then receiving kickbacks left abroad.

Falsification of trade documents and creation of fictitious companies for virtual transactions allow converting criminal proceeds into “operational income.” Deals are arranged that are disproportionate to the actual activity volume of the target organization.

Cross-border multiple payments exploit loopholes in regulation of transaction record-keeping periods. In sectors without physical goods (services, consulting), transaction amounts are falsified: money is first transferred to an foreign broker’s account, then distributed through foreign accounts.

Trade in various locations involves purchasing goods at artificially inflated prices and transferring large sums to foreign accounts as payment for goods, or vice versa — selling goods at high prices, enabling foreign partners to transfer money into the country.

Specialized Financial Methods

Underground currency exchange is common in low-quality jewelry stores. Besides illegal currency exchange, cash can be exchanged for foreign traveler’s checks, allowing clients to deposit them into foreign accounts.

Fake or counterfeit coins and banknotes are used for multiple small consumer expenses or for exchange via vending machines, after which counterfeit currency is laundered into real money.

Gift certificates from department stores, despite the difficulty of direct cash exchange, can be resold to corporate wellness organizations and used as a means of paying holiday bonuses. Thus, gift certificates are distributed among unsuspecting third parties, and original owners recover cash close to their value.

Cross-Border Schemes and Special Structures

Creating straw companies for foreign investments involves registering a fictitious company abroad and then using its position to transfer illegal proceeds abroad as foreign investments.

Transfers through underground banks have been documented in the Yuanhua case, where 12 billion yuan were linked to underground banks via financial managers. People transported money in cars to underground banking institutions, from where Hong Kong partners were notified for foreign currency payout.

Bribing officials of financial regulators allows criminal syndicates to weaken oversight. In the early 2000s, Hong Kong’s Independent Commission Against Corruption uncovered a major cross-border money laundering scheme. Criminals opened accounts in bank branches, bribed senior managers, and transferred dirty money into various accounts as regular transfers, not wire transfers, making tracking difficult.

Use of offshore financial centers and tax havens with high confidentiality helps conceal the true source of income after it enters these regions.

Direct cross-border money transport is carried out by special aircraft or individuals with immunity from customs inspection. Usually, hundred-dollar bills are used.

Modern Methods Using Financial Technologies

The use of online banking for transferring illicit funds is becoming more widespread. Some criminals even use online gambling to launder money.

Cryptocurrency methods open new horizons for money launderers due to their decentralized nature and relative anonymity of some transactions.

Ways to Penetrate the Legal Economy

There are special schemes allowing criminals to legitimize their income through official businesses. “Earn first, then launder” — corrupt officials earn money while in office and then create enterprises and companies. The feature of this method is that after resignation, they often openly display their wealth, pretending to be successful entrepreneurs.

“Simultaneous earning and laundering through relatives” — when corrupt officials use their power to obtain income, while relatives open entertainment venues, restaurants, and create enterprises. The connection between the official and relatives is hard to detect, making such schemes seem safer.

“Simultaneous earning and laundering through delegation” — when government officials or managers of state enterprises create private companies, which are formally managed by others. In practice, the authority remains with the official, allowing not only to transfer illicit funds through economic operations but also to create the appearance of normal tax activity.

Investments in hotel construction, opening companies, purchasing commercial real estate, and real estate investments are traditional tools for legalization. Some criminals even establish companies abroad to give their criminal income the appearance of legitimate business.

Final Remarks

Money laundering is the result of a constant “arms race” between criminals and law enforcement. As control methods improve, launderers develop new schemes. Understanding the mechanisms of money laundering is critical for financial regulators, law enforcement, and financial institutions themselves. Modern AML (Anti-Money Laundering) and KYC (Know Your Customer) systems are designed precisely to detect and prevent such schemes early. However, the development of financial technologies and new financial instruments require continuous updates and adaptation of anti-money laundering systems.