Synthetic identity fraud (SIF) is one of the most rapidly growing forms of financial crime in the U.S., with the Federal Trade Commission (FTC) estimating that it accounts for up to 80% of all credit card fraud losses (Federal Trade Commission, 2022). In SIF, criminals combine real information—such as a legitimate Social Security number (SSN)—with fabricated details like names, birthdates, and addresses to create entirely new identities. These synthetic identities are used to establish credit, open bank accounts, and more recently, to gain access to cryptocurrency exchanges. Once criminals gain entry to the cryptocurrency market, they can engage in illicit trading and launder illicit funds, making it difficult for authorities to trace their activities.
This article focuses on how synthetic identities are used within the U.S. to bypass traditional financial and identity verification systems, allowing criminals to exploit cryptocurrency platforms. Specific examples of synthetic identity fraud cases in the U.S. highlight the complexities and challenges law enforcement faces when attempting to combat this crime.
The Mechanics of Synthetic Identity Fraud
Creation of Synthetic Identities
In the U.S., synthetic identity fraud typically begins with the use of an SSN that belongs to someone unlikely to check their credit report regularly. For instance, fraudsters often target children, the elderly, or deceased individuals, creating a new identity by combining that SSN with fabricated personal details. According to the Social Security Administration (SSA), children’s SSNs are particularly vulnerable because most parents do not regularly monitor their children’s credit (Social Security Administration, 2022). The criminal then uses the synthetic identity to establish a credit profile, which may involve applying for low-limit credit cards or small loans. Once the synthetic identity builds a sufficient credit history, it can be used to access more substantial financial resources, including cryptocurrency exchange accounts.
An example of this occurred in 2021, when a crime ring in New York used the SSNs of minors to create dozens of synthetic identities. These identities were then used to open cryptocurrency accounts on major exchanges like Coinbase and Kraken, where the criminals laundered millions of dollars in proceeds from drug trafficking (Department of Justice, 2021).
Role of U.S. Financial Institutions and Credit Bureaus
In the U.S., financial institutions and credit bureaus have traditionally played a role in verifying the legitimacy of identities by cross-checking information against government records and credit histories. However, synthetic identities can often slip through these systems undetected. Credit bureaus like Equifax, TransUnion, and Experian focus on tracking the financial activities of consumers but may not scrutinize whether the identity itself is legitimate. A fraudster can use a synthetic identity to apply for a loan, establish a credit line, or even open a checking account, all without triggering suspicion.
For instance, in 2018, a group in Florida used synthetic identities to open multiple accounts at local credit unions. Once these accounts were established, they transferred funds into cryptocurrency and made trades on various platforms, effectively laundering the proceeds of identity theft and bank fraud (Federal Bureau of Investigation, 2019). The synthetic identities in this case were built over several years, making them appear legitimate to the financial institutions involved.
Synthetic Identities in Cryptocurrency
Circumventing Know Your Customer (KYC) and Anti-Money Laundering (AML) Measures
Cryptocurrency exchanges in the U.S. are required to comply with KYC and AML regulations as part of the Bank Secrecy Act (BSA) and related regulatory frameworks. These measures require users to verify their identities by providing government-issued identification, proof of address, and other personal details. However, criminals using synthetic identities often have enough real information to pass these checks. For example, a synthetic identity might include a valid SSN and a forged driver’s license that appears legitimate, allowing the fraudster to open an account on a cryptocurrency exchange.
One notable case involved a Texas-based criminal group that used synthetic identities to create multiple accounts on U.S.-based crypto exchanges in 2020. They successfully passed KYC checks using forged documents and real SSNs stolen from minors. These accounts were used to launder the proceeds of a large-scale unemployment fraud scheme, where millions of dollars in fraudulent unemployment benefits were converted into Bitcoin and sent overseas (Internal Revenue Service, 2021).
Use of Synthetic Identities in Money Laundering
Once a synthetic identity is established on a cryptocurrency platform, it can be used to launder money through a variety of techniques, including mixing services, cross-chain transactions, and the use of privacy coins like Monero. For instance, in 2021, a criminal enterprise in California used synthetic identities to open accounts on several cryptocurrency exchanges. They converted the proceeds from a multi-million-dollar credit card fraud scheme into cryptocurrency, which was then funneled through a series of wallet addresses, mixed with other transactions, and eventually withdrawn in fiat currency at an offshore exchange (FinCEN, 2021).
In another example, a Detroit-based cybercriminal used a synthetic identity to trade on a U.S.-regulated crypto exchange. After laundering funds through a Bitcoin mixer, the criminal attempted to cash out $500,000 in cryptocurrency by converting it into Tether (USDT) and transferring it to an overseas account, where it was subsequently converted into cash. The transaction was flagged by the exchange’s AML system, but the synthetic identity used made it difficult for authorities to trace the origin of the funds (Financial Crimes Enforcement Network, 2022).
Challenges to Law Enforcement
Identifying Synthetic Identities
Law enforcement agencies face significant challenges in identifying synthetic identities used in cryptocurrency fraud. Since synthetic identities are not associated with real people, it is difficult to tie them back to a single individual. Traditional investigative techniques—such as credit checks or subpoenaing financial records—may yield incomplete or misleading information, as the synthetic identity may have passed as legitimate through multiple financial institutions. For example, in a 2022 case in Illinois, law enforcement spent over six months tracking a synthetic identity linked to a money laundering ring before realizing that the identity was entirely fabricated (Department of Homeland Security, 2022).
Jurisdictional and Regulatory Gaps
Cryptocurrency exchanges in the U.S. are subject to various regulatory regimes, but criminals often exploit differences in how exchanges implement KYC and AML policies. Additionally, international jurisdictional issues complicate law enforcement’s ability to investigate and prosecute synthetic identity fraud cases. In one high-profile case, a fraudster used a synthetic identity to trade on both U.S.-based and offshore crypto exchanges, moving millions of dollars between jurisdictions that lacked effective regulatory cooperation (Office of Foreign Assets Control, 2021). Even when U.S. authorities managed to freeze the fraudster’s assets, a significant portion of the funds had already been laundered through offshore accounts, rendering recovery efforts ineffective.
Solutions and Future Outlook
Enhanced KYC and AML Protocols
To address the threat of synthetic identity fraud, U.S. cryptocurrency exchanges must strengthen their KYC and AML protocols. Some exchanges are beginning to implement more advanced identity verification technologies, such as AI-powered facial recognition, biometric data collection, and real-time document verification, which can detect fraudulent documents and prevent synthetic identities from passing initial checks (Allen, 2022). AI and machine learning (ML) tools can also be used to identify suspicious patterns in user activity that may indicate synthetic identity fraud.
For example, Chainalysis, a blockchain analysis firm, has developed machine-learning models that help detect synthetic identities by analyzing transaction patterns and flagging suspicious activity. These systems can identify when multiple accounts share similar behaviors, such as using the same device or IP address, which may indicate the use of synthetic identities across various exchanges (Chainalysis, 2022).
Regulatory Harmonization and Interagency Cooperation
In addition to technological improvements, U.S. regulators and law enforcement agencies must collaborate more effectively with international counterparts to address the global nature of synthetic identity fraud in cryptocurrency markets. The U.S. Department of Justice (DOJ), Financial Crimes Enforcement Network (FinCEN), and the Office of Foreign Assets Control (OFAC) have been actively involved in tracking and prosecuting crypto-related crimes. However, broader collaboration with international organizations and law enforcement agencies is necessary to close jurisdictional gaps that criminals exploit.
In 2023, the U.S. Senate proposed a bill that would create a centralized identity verification system for financial institutions, including crypto exchanges, as part of a broader effort to curb synthetic identity fraud (U.S. Senate, 2023). If passed, this legislation could significantly reduce the effectiveness of synthetic identities by requiring a standardized, government-verified digital identity for all crypto exchange users.
Synthetic identity fraud is a growing threat to the U.S. financial system, particularly in the cryptocurrency sector. Criminals exploit weaknesses in traditional identity verification systems to create synthetic identities, open crypto accounts, and launder illicit funds. The decentralized and pseudo-anonymous nature of cryptocurrencies makes it difficult for regulators and law enforcement to trace the movement of these funds. However, with stronger KYC and AML protocols, enhanced identity verification technologies, and greater international regulatory cooperation, the cryptocurrency industry can mitigate the risks associated with synthetic identity fraud. Specific U.S. cases highlight the urgent need for legislative and technological innovations to combat this evolving form of financial crime.
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References
Allen, C. (2022). AI and Machine Learning in Combating Synthetic Identity Fraud. Journal of Financial Crime, 28(4), 101-117.
Chainalysis. (2022). Machine Learning in the Fight Against Crypto Crime. Retrieved from https://www.chainalysis.com/reports/ml-fraud-crypto
Department of Homeland Security. (2022). Synthetic Identity Fraud in Cryptocurrency: Case Study from Illinois. Retrieved from https://www.dhs.gov/case-study
Department of Justice. (2021). New York Crime Ring Involved in Synthetic Identity Fraud and Cryptocurrency Money Laundering. Retrieved from https://www.justice.gov/press-release
Federal Bureau of Investigation. (2019). Synthetic Identity Fraud and Cryptocurrency in Florida. Retrieved from https://www.fbi.gov/reports/fl-synthetic-id-fraud
Federal Trade Commission. (2022). Protecting Consumers from Synthetic Identity Fraud. Retrieved from https://www.ftc.gov/reports/synthetic-id-fraud
FinCEN. (2021). Money Laundering through Cryptocurrency and Synthetic Identity Fraud. Retrieved from https://www.fincen.gov/reports/aml-crypto-fraud
Internal Revenue Service. (2021). Unemployment Fraud and Cryptocurrency Laundering in Texas. Retrieved from https://www.irs.gov/criminal-investigation
Office of Foreign Assets Control. (2021). Case Study on Cross-Jurisdictional Crypto Fraud. Retrieved from https://www.treasury.gov/ofac
U.S. Senate. (2023). Proposed Legislation on Identity Verification in Financial Institutions. Retrieved from https://www.senate.gov
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