Part 1: How Money Laundering works

Liam Scotchmer
References listed below.

3 Minute Read

Most businesses incur transactional costs, including search, bargaining, and compliance costs (Juma, 2025). However, for criminal organisations, they incur an odd cost: the possibility of being caught, and when revenues rise, the probability only rises with it. However, “these transaction costs can be minimised by effective laundering, an activity whose distinctive economic function is precisely to transform potential purchasing power into actual purchasing power.” (Masciandaro, 2007)”.

According to Intuition.com (Ruairi O’Donnellan, 2024), money laundering has three stages:

Placement
Layering
Integration

In part 1 of 3, we dive into how money laundering works. Later, we go deeper into the economics of money laundering and crime.

Part 1: How money laundering works:

“the process by which criminals attempt to conceal the fact that their assets originate from crime.” (Ruairi, 2024)

Placement

Placement is putting cash into circulation in the financial system. According to an article by LexisNexis (n.d.) methods include:

- Smurfing: where “Smurfs” turn large sums of money into smaller parts (eg.: sent to foreign bank accounts or small transactions are made)
- Cuckoo smurfing: where a consumer of country A has money sent from country B but via a third party business, who unbeknownst to the consumer, is a money laundering business. The consumer of country A does ultimately receive their money. (Commonwealth Bank, n.d.)

Layering:

The point of placement was to get the money into the financial system, but now it needs to be put to use and traded so authorities cannot easily track where it originated from. This second stage is called layering - similar to placement, but transactions are purposefully “repetitive and voluminous.” (Kenton, 2025) According to Unit21 (n.d.), examples of layering include:

- Asset investment: criminals invest in high value assets like stocks, bonds, or physical property like real estate, or artwork.
- Crim to crim cycle: (this is a wild one) where criminals startup businesses offering products or services (like private loans) but their customers are the criminals themselves!
- Simply sending money to personal or business accounts within, or out of an financial institution.
- Cryptocurrency trading - usually information about the receiver and sender of a crypto traded is stored, however with programs like Tornado Cash, this information can be detached from the transaction. (Unit 21, A, n.d.)

Integration

Now that the criminal has placed the money into financial circulation making it look legitimate, and then carried out various transactions to conceal its origin, the criminals money is “clean.” However now they need to return the money to their personal account that look “conceivably ordinary for an individual.” (Unit 21, B, 2021)
According to Unit 21 (B, 2021), integration can be done by:

- Directly transferring to the criminals bank account
- Sell the assets purchased during the layering stage
- Fake payrolls: criminals setup a fake businesses with fake employees, called payroll fraud (Unit21, B, n.d.)
- Fake loans similar to the example in layering.
- Dividend payments the criminal can invest into legitimate companies and then receive dividend payments
- Gambling

Now the money is clean!
According to Unit 21 (B, n.d.) whilst the criminal(s) does need to be cautious of the authorities, they can go binge shopping. This is especially in countries with light anti money laundering regulations who are under the black list, such as Iran and Myanmar who have “serious strategic deficiencies to counter money laundering.” (FATF 2024)

Read part 2 on the economics of crime when it is released ;)

REFERENCES

AUSTRAC. “AUSTRAC Takes Action to Stamp out Financial Crime through Cryptocurrency ATMs | AUSTRAC.” Austrac.gov.au, 6 Dec. 2024, www.austrac.gov.au/news-and-media/media-release/austrac-takes-action-stamp-out-financial-crime-through-cryptocurrency-atms.

Bahrani, Mahmoud. “The Economics of Crime with Gary Becker.” Chicago Maroon, 2012, chicagomaroon.com/15630/grey-city/the-economics-of-crime-with-gary-becker/.

Becker, Gary. “Chapter Title: Crime and Punishment: An Economic Approach Crime and Punishment: An Economic Approach.” National Bureau of Economic Research, vol. ISBN, 1974, pp. 0–87014, www.nber.org/system/files/chapters/c3625/c3625.pdf.

Commonwealth Bank. “Scams Targeting Migrants.” Commbank.com.au, 2025, www.commbank.com.au/support/security/scams-migrant-communities.html. Accessed 5 Oct. 2025.

Corcoran, Kevin. “Rational Crime and Subjective Probability - Econlib.” Econlib, 8 Jan. 2025, www.econlib.org/rational-crime-and-subjective-probability/.

Downey, Lucas. “What Are Transaction Costs? Definition, How They Work, and Example.” Investopedia, 30 Apr. 2021, www.investopedia.com/terms/t/transactioncosts.asp.

FATF. ““Black and Grey” Lists.” Www.fatf-Gafi.org, 2024, www.fatf-gafi.org/en/countries/black-and-grey-lists.html.

Hayes, Adam. “Smurf.” Investopedia, 30 June 2021, www.investopedia.com/terms/s/smurf.asp.

Juma, Andrew. “What Are Transaction Costs? (Types and Examples).” Indeed Career Guide, 2025, www.indeed.com/career-advice/career-development/transaction-costs.

Kenton, Will. “Anti Money Laundering (AML).” Investopedia, 23 June 2024, www.investopedia.com/terms/a/aml.asp.

---. “What Is Market Distortion?” Investopedia, 7 Oct. 2021, www.investopedia.com/terms/m/marketdistortion.asp.

LexisNexis. “Three Stages of Money Laundering: An In-Depth Guide & Prevention.” Www.lexisnexis.com, www.lexisnexis.com/en-gb/glossary/money-laundering-stages.

Masciandaro, Donato. “Economics of Money Laundering: A Primer.” SSRN Electronic Journal, 2007, https://doi.org/10.2139/ssrn.970184. Accessed 20 May 2019.

Ruairi O'Donnellan, and Ruairi O'Donnellan. “Money Laundering Explained - Intuition.” Intuition, 13 June 2024, www.intuition.com/money-laundering-explained/. Accessed 5 Oct. 2025.

Sanction Scanner. “Al Capone: Origin of the Term 'Money Laundering - Sanction Scanner.” Sanctionscanner.com, 2021, www.sanctionscanner.com/blog/al-capone-the-one-who-gives-us-the-term-money-laundering-348.

Schmidt, Alicia. “Impacts of Money Laundering and Terrorism Financing: Final Report.” Impacts of Money Laundering and Terrorism Financing: Final Report, 9 July 2024, www.aic.gov.au/sites/default/files/2024-07/impacts_of_money_laundering_and_terrorism_financing.pdf, https://doi.org/10.52922/sp77543.

Tabarrok, Alex. “Still Under-Policed and Over-Imprisoned - Marginal REVOLUTION.” Marginal REVOLUTION, 17 Aug. 2022, marginalrevolution.com/marginalrevolution/2022/08/still-under-policed-and-over-imprisoned.html. Accessed 6 Oct. 2025.

Unit 21. “Tornado Cash: How It Works & Applicable Sanctions.” Www.unit21.Ai, www.unit21.ai/fraud-aml-dictionary/tornado-cash.

Unit21. “Layering: The Second Stage of Money Laundering.” Unit21.Ai, 2025, www.unit21.ai/fraud-aml-dictionary/layering-money-laundering.

United Nations. “Money Laundering.” United Nations : Office on Drugs and Crime, www.unodc.org, 2024, www.unodc.org/unodc/en/money-laundering/overview.html.