Understanding Money Laundering: From Definition to Modern Methods

What is money laundering and how does it really work? This question is becoming increasingly important to understand the complex methods criminals use to conceal their illegal profits. Money laundering is the systematic process by which proceeds from crimes such as drug trafficking, organized crime, terrorism, or corruption are disguised through various techniques to hide their illegal origin and ultimately appear as legitimate assets.

What is money laundering? Basic definition and objectives

Money laundering describes the process of injecting illegally obtained money into the formal financial system while concealing its criminal origin. The Basel Committee on Banking Supervision and Practice defines this phenomenon from a practical perspective: criminals and their accomplices use the financial system to transfer funds between accounts, hide true ownership, or deposit assets into custodial services.

The main actors in this crime are either financial institutions or individuals engaging in five types of illegal activities:

1. Providing accounts for suspicious funds
2. Converting assets into cash or financial instruments
3. Transferring money via wire transfers or settlement methods
4. Moving funds abroad
5. Obscuring the origin and nature of illegal proceeds through alternative methods

Why do criminals launder money? The answer lies in their goals: on one hand, they can conceal their criminal activities and enjoy their profits as if they were legitimate. On the other hand, money laundering allows criminal organizations to enter legal businesses, expand their control, and continue their illegal operations.

The three stages of money laundering in detail

The money laundering process theoretically follows a three-stage scheme. Each phase serves a specific function in the overall concealment of illegal assets.

Phase 1: Placement – Initial steps of money concealment

The placement phase is the critical first step, where criminals must process their cash proceeds from illegal activities. The main problem: large amounts of small bills are suspicious, difficult to transport, and easy to detect.

The solution is to quickly convert these funds into another form. Common methods include:

• Bank deposits: Cash is deposited in smaller tranches into bank accounts
• Securities purchase: Money is converted into portable securities or bonds
• Asset acquisition: Direct purchase of real estate, vehicles, or jewelry
• Cash smuggling: Large amounts of cash are brought into countries with weak reporting requirements

Once the cash is deposited into a bank account or converted into other assets, this phase is complete. Modern financial markets offer numerous options: from traditional bank transfers to credit cards and online banking systems.

Phase 2: Layering – Asset confusion and disentanglement

The layering phase is the core of the entire money laundering activity. Here, criminals attempt to manipulate their illegal assets so that the connection to the original crime is completely broken.

The approach is sophisticated: through multiple buying and selling transactions, international money transfers, and complex business structures, confusing flows of assets are created. Criminals utilize:

• Pseudonym accounts: Opening bank accounts under false names or strawmen
• Fictitious trade flows: Conducting sham transactions to justify money movements
• International transfers: Moving funds multiple times between countries
• Offshore centers: Operating in countries with weak regulation or banking secrecy
• Anonymous securities: Trading bonds and futures under pseudonyms

This phase becomes especially difficult for authorities when it occurs in so-called “tax havens” or weakly regulated areas. The multitude of transactions, structural complexity, and geographic dispersion make it nearly impossible to reconstruct the original illegal origin.

Phase 3: Integration – Returning to the legal system

In the integration phase, the “washed” money is reintroduced into the legitimate economy. After successful layering, the illegal assets are so distorted that their criminal origin is no longer recognizable.

Criminals transfer the funds under the guise of legitimate business activities to legal companies or individuals. The money is mixed with normal business income, justified through formal economic transactions, and flows back into the financial system—only now as seemingly clean profits.

This integration finally allows criminals to freely manage and deploy their assets without ordinary people or authorities recognizing the illegal nature of the money.

Practical methods of money laundering: 31 documented techniques

Reality shows that criminals are creative and pragmatic. Here are the most frequently documented methods:

Traditional cash methods:

• Direct cash smuggling into countries with lax reporting requirements
• “Smurfing”: Dividing large sums into smaller amounts to evade reporting
• Using cash-intensive industries (casinos, bars, restaurants) as cover

Asset-based methods:

• Direct purchase of real estate, artworks, antiques, or luxury goods
• Rapid resale of these items at higher prices to simulate legitimate gains
• Financial “explanations” for suspicious assets through collector stories

Financial sector methods:

• Buying high-value insurance policies and then repaying premiums to criminals
• Anonymous bonds and futures trades via complex securities systems
• Using offshore financial centers and secrecy havens for asset custody

Business methods:

• Over- or under-invoicing import/export prices to transfer money
• Establishing and managing shell companies for apparent business activities
• Fictitious business relationships with foreign partners to justify large cash flows

Corruption-specific methods:

• Establishing own companies run by corrupt officials or strawmen
• Involving family members in profitable businesses (entertainment, restaurants)
• Faking business profits and investment returns

Cross-border techniques:

• Multiple international transfers to obscure origin
• Transfers via private jets or individuals with customs exemptions
• Hidden currency operations under the pretext of education costs or insurance premiums

Specialized methods:

• Underground banks: The famous Yuanhua case illustrates this—12 billion yuan was laundered through underground currency exchanges in Jinjiang and Shishi before being transferred to Hong Kong
• Travelers checks and phishing: Unlimited use of endorsed travel checks that can be passed on without name designation
• Casino chips: Converting cash into casino chips, handing them to the actual beneficiary, who cashes them out, feigning gambling winnings
• Foundations: Fake donations to controlled foundations for money transfers; abuse of disaster relief collections
• Head accounts: Opening bank accounts in the names of unsuspecting third parties in weakly regulated countries
• Fake loans: Using undated bills or checks issued as loan evidence
• Vouchers: Selling department store vouchers that are then converted back into cash

From traditional to digital methods: money laundering in the age of cryptocurrencies

Digitalization of financial markets has created new opportunities for money laundering. Cryptocurrencies offer anonymity, speed, and cross-border transferability, making them an increasingly attractive medium for criminals.

Online banking enables quick and discreet transfers. Online gambling is used to convert suspicious funds into apparent winnings. And cryptocurrencies themselves open new avenues: digital wallets, decentralized exchanges, and staking mechanisms make tracking significantly more difficult.

The combination of traditional methods and digital technologies makes money laundering more complex and harder to combat than ever before. For regulators and financial institutions, keeping pace with these developments is an existential challenge.

Conclusion: Why understanding money laundering is important

Understanding money laundering—its definitions, phases, and methods—is essential for financial institutions, regulators, and the public. Each phase reveals new vulnerabilities in the system that criminals seek to exploit. The only effective countermeasure is to recognize these patterns, enforce international standards, and leverage technology for oversight. Money laundering will persist as long as there is illegally earned money—but a deeper understanding of the phenomenon is the first step toward combating it.