Understanding the Three Stages of Money Laundering and Prevention

Money laundering is a constant and growing challenge for fintechs, banks, crypto, and private equity firms. With illegal funds moving through complex methods, it's crucial to understand how money laundering works to prevent financial crimes and protect your institution. However, tracking and spotting these transactions can often feel like solving a complex puzzle.

In this article, you'll explore the 3 stages of money laundering, the common techniques used, and the role of Anti-Money Laundering (AML) regulations. In addition, you'll discover strategies to prevent money laundering and solutions for modern AML compliance efforts.

What is Money Laundering?

Money laundering is the process of making illegally earned money look legal. Criminals use banks, credit unions, and investment firms to move this money through the financial system, sometimes without the institution even knowing it's happening.

Research shows that between January and March 2025, the Financial Crimes Enforcement Network (FinCEN) received 6,830 Suspicious Activity Reports (SARs) linked to money laundering.

To stop this, fintechs, banks, crypto, and private equity firms must follow strict anti-money laundering (AML) rules. These include checking who their customers are, keeping an eye on transactions, and reporting anything suspicious.

While understanding the concept of money laundering lays the foundation, it's equally important to look at how it affects the broader financial system.

Impact of Money Laundering

The impact of money laundering on fintechs, banks, crypto, and private equity firms can be both immediate and far-reaching. When illicit funds pass through banks or other financial entities, these businesses face serious legal, financial, and reputational risks. 

Below are some of the key consequences of money laundering:

• Legal and Regulatory Penalties: Institutions may face hefty fines, sanctions, or criminal charges for non-compliance with AML laws.

• Reputational Damage: Even allegations can erode customer, investor, and partner trust.

• Operational Disruptions: Resources are diverted to investigations, system upgrades, and compliance fixes.

• Loss of Business Opportunities: Past violations make it harder to form partnerships or enter new markets.

• Increased Scrutiny and Compliance Costs: Flagged firms face tighter oversight, frequent audits, and rising costs for tools and training.

• Economic Impact: On a broader scale, money laundering distorts competition, fuels crime, and weakens financial systems.

These widespread consequences aren't accidental; they result from a deliberate and structured process.

3 Stages of Money Laundering

From 2022 to 2024, the IRS Criminal Investigation division identified $21.1 billion in fraudulent assets and seized $8.2 billion linked to criminal activities, much of which involved the movement of illicit funds through financial systems.

Money laundering within fintechs, banks, crypto platforms, and private equity firms often plays a central role in this, following a structured, three-stage process designed to disguise the origin of illegal money.

Each stage plays a specific role in moving illicit money through the financial system and making it appear legitimate. Below are the 3 stages of money laundering:

1. Placement

The placement stage marks the initial phase where illicit funds enter the financial system. Criminals introduce these funds by making small deposits or transactions to avoid detection. Common methods include:

• Cash deposits into bank accounts
• Purchasing assets like real estate, precious metals, or high-value goods
• Wire transfers to foreign accounts

2. Layering

During the layering stage, the objective is to obscure the origin of the illicit funds. Criminals engage in complex financial transactions to create a network of activities that distance the money from its criminal source. Common techniques involve:

• Multiple transfers between accounts within the same institution or across different institutions, sometimes internationally
• Converting cash into financial products like bonds, checks, or money orders
• Currency exchanges or buying and selling assets such as securities or real estate

3. Integration

In the integration stage, the laundered money is reintroduced into the legitimate economy, appearing to come from legal sources. The funds are typically used for:

• Investments in legal businesses or real estate
• Purchases of luxury goods like cars, jewelry, or art
• Legitimate financial transactions, such as loans or investments

Understanding the three stages helps reveal how illicit funds are cleaned, but it's equally important to see how these stages play out in real-world scenarios.

Common Money Laundering Techniques

Common money laundering techniques are strategies used by criminals to hide the illegal origin of funds and move them into the legitimate financial system. These methods often take advantage of the high volume and complexity of financial transactions to avoid detection. Below are the common money laundering techniques:

1. Structuring (Smurfing)

This method breaks down large amounts of illicit money into smaller, less noticeable transactions. Criminals use this approach to stay under regulatory radar and avoid triggering alerts in transaction monitoring systems.

2. Layering

Layering is used to obscure the origin of illicit funds by moving them through multiple accounts or transactions. This can include both domestic and international transfers. It often takes the form of routing money through digital wallets or payment apps to confuse audit trails.

3. Shell Companies

Shell companies are commonly used to disguise illegal money as legitimate income. Criminals often route funds through these companies, which may then invest in private equity or other financial instruments. Financial institutions may unknowingly facilitate these transactions if due diligence is lacking.

4. Mixing Services (Tumblers)

In the crypto space, mixing services are designed to make it difficult to trace the source of digital currencies. These services pool together multiple transactions and redistribute the funds, creating layers of anonymity. This is especially effective due to the pseudo-anonymous nature of blockchain.

5. Use of Privacy Coins

Privacy-focused cryptocurrencies like Monero and Zcash provide improved anonymity features. Criminals use these coins to avoid detection, as they make transaction tracking nearly impossible. This poses challenges for both crypto platforms and regulators.

6. Trade-Based Money Laundering (TBML)

TBML involves disguising illicit funds through inflated or manipulated trade transactions. This is especially relevant in private equity and international business dealings, where goods or services are mispriced to move money across borders under the cover of legitimate trade.

7. Money Mules

Money mules are individuals who are used to transfer illicit money through their personal bank or FinTech accounts. These transfers often cross borders and help disguise the original source and ultimate destination of the funds.

8. Prepaid Cards

Prepaid cards offered by FinTech platforms can be loaded with funds and used like cash, making them an attractive tool for money launderers. Once loaded, the funds can be spent, transferred, or withdrawn in ways that make the original source harder to trace.

Recognizing how money laundering schemes are carried out makes it clear why strong preventive measures are necessary.

Read More: The Future of Finance: How Embedded Finance is Revolutionizing Customer Experiences and Business Growth.

The Role of Anti-Money Laundering (AML) Regulations

Anti-Money Laundering (AML) regulations are central to the fight against money laundering and terrorist financing. These regulations protect the financial system from criminal misuse while ensuring institutions follow due diligence practices that uphold economic integrity and trust.

Here's a closer look at the role of AML regulations in the U.S. for financial institutions:

1. Compliance with the Bank Secrecy Act (BSA)

In 2024, approximately 1,246 BSA reports flagged suspected fentanyl-related activity, uncovering $1.4 billion in suspicious transactions linked to potential money laundering.

These reports are part of the Bank Secrecy Act (BSA), also known as the Anti-Money Laundering Act of 1970, which serves as the cornerstone of AML regulations in the U.S.  It mandates financial institutions to maintain detailed transaction records and report any activity that could suggest money laundering or criminal behavior. Key requirements include:

• File Suspicious Activity Reports (SARs) for potentially illicit transactions.
• Submit Currency Transaction Reports (CTRs) for cash transactions over $10,000.
• Implement Know Your Customer (KYC) policies to verify client identities and assess risk.

2. Combating Terrorist Financing

Strengthened by the Patriot Act, AML laws also focus on identifying and disrupting terrorist financing. These measures promote intelligence-sharing and enhance financial system oversight. Key requirements include:

• Establishing programs to detect and report transactions linked to terrorism.
• Freezing assets and blocking transactions involving individuals or entities on OFAC's sanctions lists.

3. Know Your Customer (KYC) and Customer Due Diligence (CDD)

Understanding who customers are and monitoring their behavior is central to AML compliance. KYC and CDD help institutions assess whether client activities align with legitimate financial behavior. Key requirements include:

• Collecting and verifying personal and business identification information.
• Monitoring ongoing customer activity for consistency and red flags.
• Applying Enhanced Due Diligence (EDD) for high-risk clients like politically exposed persons (PEPs).

4. Reporting Suspicious Activities and Transactions

AML regulations mandate the timely reporting of transactions that raise red flags. These reports are submitted to the Financial Crimes Enforcement Network (FinCEN) to help track illicit financial movements. Key requirements include:

• Filing SARs for activities that may indicate money laundering or fraud.
• Submitting CTRs for cash transactions of $10,000 or more.

5. Preventing Financial Crimes Through Technology

Technology plays a critical role in AML efforts. Institutions can proactively detect suspicious behavior and ensure real-time compliance by leveraging advanced tools. Key requirements include:

• Using transaction monitoring systems to detect abnormal patterns.
• Employing AI and machine learning tools to flag high-risk transactions more efficiently.

6. Enforcement and Penalties

Agencies like the DOJ, SEC, and FinCEN enforce AML compliance. Non-compliance can result in serious consequences, both financial and reputational. Key consequences include:

• Fines and sanctions for regulatory violations.
• Criminal charges for willful non-compliance.
• Reputational damage that may impact customer trust and business stability.

7. The Role of Financial Institutions in Preventing Money Laundering

Fintechs, banks, crypto exchanges, and private equity firms are frontline defenders against money laundering. Their ability to implement and maintain strong compliance measures is essential. Key responsibilities include:

• Establishing internal controls and clear AML procedures.
• Maintaining active compliance programs and conducting regular audits.
• Providing continuous staff training to recognize and respond to suspicious activities.

Understanding the regulatory framework is only part of the equation; effective action depends on how these rules are applied in practice. This leads to a closer look at the strategies financial institutions use to prevent money laundering on the ground.

Strategies to Prevent Money Laundering

Money laundering continues to be a major global concern, allowing illegal funds to move through legitimate financial channels. To stay ahead, financial institutions, regulators, and businesses need strong and proactive measures. Below are the key strategies to prevent money laundering:

• Implementing Strong Know Your Customer (KYC) Procedures:

KYC involves verifying customer identity to prevent using financial systems for illegal activities. Institutions should collect valid ID, address, and tax documents, verify business legitimacy, and assess risk based on transaction patterns and geography.

• Conducting Enhanced Due Diligence (EDD) for High-Risk Clients:

EDD is necessary for clients with elevated risk profiles, like politically exposed persons or those from high-risk regions. It includes verifying the source of funds, reviewing business operations, monitoring unusual transactions, and maintaining thorough records for timely reporting.

• Implementing Effective Transaction Monitoring Systems:

Real-time monitoring systems help identify irregular activity, such as large or unusual transfers. Setting transaction thresholds and using tools that track cross-border activity enhance oversight. AI and machine learning further improve detection by identifying hidden patterns.

• Regular Staff Training on AML Procedures:

Employees must be equipped to recognize and report suspicious activity. Ongoing training ensures awareness of money laundering indicators, regulatory changes, and internal reporting procedures.

• Developing a Suspicious Activity Reporting (SAR) System:

An effective SAR system enables staff to flag suspicious transactions efficiently. Institutions should establish clear procedures for identification, documentation, and escalation, ensuring timely reporting to regulatory bodies when required.

• Using Technology for Advanced Analytics and Pattern Detection:

Advanced tools like AI and machine learning enhance the ability to detect complex laundering schemes. Predictive analytics can identify anomalies early, while continuous updates ensure systems evolve with emerging threats.

• Conducting Regular Audits and Risk Assessments:

Routine audits and assessments help evaluate AML effectiveness. Reviewing transactions, identifying gaps, and assessing risk by region or business area ensures controls remain strong and relevant.

• Maintaining Strong Internal Controls and Compliance Programs:

Effective internal controls include defined roles, oversight mechanisms, and reporting lines. Appointing a compliance officer, separating duties, and monitoring internal activity reduce the risk of misuse or oversight.

• Collaborating with Regulatory Bodies and Industry Groups:

Engagement with regulators and industry networks supports compliance and knowledge sharing. Staying informed about evolving risks and regulatory updates strengthens institutional AML efforts.

• Enforcing Sanctions and Asset Freezing Procedures:

Institutions must screen clients and transactions against current sanctions lists. Automated tools help identify flagged entities, enabling timely action such as freezing assets or blocking transactions to maintain compliance.

• Outsourcing to Specialized Firms:

Outsourcing companies like Fraxtional specialize in managing money laundering risks, providing businesses with expert services to monitor financial transactions, ensure compliance, and implement preventive measures. This allows organizations to focus on their core activities while mitigating the risk of money laundering with the help of experienced professionals.

While preventive strategies form the backbone of anti-money laundering efforts, real-world cases often reveal how gaps can still be exploited.

Real-World Examples of Money Laundering

Money laundering remains a persistent threat across fintechs, banks, crypto, and private equity firms. These real-world cases from the U.S. highlight the critical need for strong anti-money laundering (AML), Know Your Customer (KYC) practices, and strong due diligence frameworks.

FinTech Sector: TransferWise (Now Wise)

In 2016, Wise faced regulatory review over possible AML lapses in cross-border transfers due to weak KYC checks. No charges were filed, but the company overhauled its compliance protocols, spotlighting the AML challenges FinTechs face globally.

Banking Sector: JPMorgan Chase

In 2014, JPMorgan was scrutinized for processing billions in suspicious transactions linked to Russian oligarchs. The case revealed serious gaps in risk monitoring, resulting in fines and a major compliance overhaul.

Cryptocurrency Sector: Bitfinex and Tether

In 2019, Bitfinex and Tether were investigated for allegedly covering up $850 million in losses and facilitating money laundering via stablecoin transfers. A settlement was reached, prompting improved transparency and global calls for stricter crypto AML rules.

Private Equity Sector: 1MDB and Goldman Sachs

The 1MDB scandal saw over $4.5 billion laundered through shell companies and luxury assets. Goldman Sachs was fined $2.9 billion for failing to conduct proper due diligence, highlighting the importance of AML in private equity and investment banking.

Exploring real-world examples offers meaningful insights into the complexities of money laundering, but it also highlights the evolving challenges financial institutions face.

Challenges & Solutions for the Modern AML Compliance Efforts

Modern AML compliance is growing more complex as financial institutions navigate evolving risks, sophisticated laundering methods, and shifting regulatory demands. However, despite these hurdles, innovative technologies and smarter compliance frameworks pave the way for more adaptive and effective AML strategies.

Below are the challenges and solutions for the modern AML compliance efforts:

How Fraxtional Supports Combating Money Laundering?

In today's fast-changing financial world, fighting money laundering is a big challenge. Fintechs, banks, crypto exchanges, and private equity firms must keep up with changing regulations and complex money laundering methods. Fraxtional provides a smart solution with part-time compliance leadership tailored to the specific needs of these institutions.

It supports you by providing the following services:

• Expertise Without Full-Time Commitment: Fraxtional provides experienced compliance officers on a part-time or project basis, delivering specialized expertise without requiring a full-time hire.

• Tailored Compliance Programs: The company designs and implements customized Anti-Money Laundering (AML) and Bank Secrecy Act (BSA) compliance programs, addressing specific regulatory needs and concerns.

• Agility in Adapting to Regulatory Changes: Fraxtional ensures that compliance programs are updated promptly to meet new regulatory requirements, helping institutions stay ahead in a rapidly changing environment.

• Enhanced Training and Monitoring: Bringing fresh perspectives and up-to-date knowledge, Fraxtional enhances training programs and monitoring systems, improving the detection and prevention of suspicious activities.

• Scalable Solutions for Growing Institutions: As your institution grows, Fraxtional offers the flexibility to scale compliance services according to your current needs, ensuring efficient resource allocation.

Ready to Strengthen Your Compliance Program?

Fraxtional is here to guide you through the complexities of AML compliance with tailored, cost-effective solutions. Our team of experts is committed to improving your institution's ability to detect, prevent, and respond to money laundering activities effectively.

Connect with Fraxational Today.

Conclusion

Money laundering continues to be a major threat to financial institutions worldwide, eroding the integrity of the financial system and enabling criminal activity. For fintechs, banks, crypto exchanges, and private equity firms, it's crucial to implement strong anti-money laundering (AML) practices to identify, prevent, and mitigate risks associated with illicit financial flows.

By adopting comprehensive KYC procedures, utilizing advanced technologies, and staying aligned with regulatory requirements, these institutions can shield themselves from regulatory penalties, reputational damage, and involvement in criminal activities.

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FAQs (Frequently Asked Questions)

1. What is Placement, Layering, and Integration?

Placement is the introduction of illegal funds into the financial system. Layering involves moving the money through multiple transactions to hide its source. And, integration is when the funds are reintroduced as seemingly legitimate assets, like real estate or business income.

2. What Does MLRO Stand For?

MLRO stands for Money Laundering Reporting Officer. This senior compliance role manages a company's anti-money laundering (AML) efforts. The MLRO ensures that internal policies align with regulatory standards and is the main point of contact for reporting suspicious activities to authorities.

3. What Is the main objective of KYC?

The core purpose of Know Your Customer (KYC) is to verify a customer's identity and assess their risk level. KYC procedures help financial institutions prevent fraud, money laundering, and other financial crimes by ensuring they know who they are doing business with.