is it possible to launder bitcoin by exchanging it for litecoin and then back to bitcoin? The scenario I was thinking of was I have some bitcoin from doing Bad Things (TM) that I want to launder.  I could register with kraken.com and trade only virtual currencies with the L1 verification ( un/pw, country of residence, phone ).
Process


deposit dirty BTC
buy LTC
transfer to another LTC address
transfer back to another kraken account.
buy BTC
transfer BTC to another exchange that I have linked to a bank account
cash out BTC


What issues do you see with this?  From what I understand kraken.com only has a un/pw ( easy to create a throwaway ) country of origin ( no verification, can lie ) and phone ( easy to buy a burner ).  And even that isn't public knowledge.  Once I transfer to LTC those litecoins are now clean.  Does that make sense?  There is no link between BTC sold and LTC bought except for at the exchange and that only has untraceable details ( un/pw/fake country of origin/burner phone)
Because all transactions in both Litecoin and Bitcoin are stored in the block chain, you run into the same issue you do here if you were just to try and withdraw USD for bitcoins, i.e., does your intermediary store logs of the off chain transactions? When you buy LTC using BTC on Kraken, if Kraken decides to log this transaction then there is now a link between the BTC and the LTC. This link could be used by law enforcement if they are trying to trace some dirty BTC. From an LEO point of view, this is how they would follow the money:


Use the BTC blockchain to trace the money to a Kraken account.
Ask Kraken for information about where that money went. Kraken gives them an LTC address.
Use the LTC blockchain to trace the money to another Kraken account.
Ask Kraken for information on where the LTC went. Kraken gives them a new BTC address.
Use the BTC blockchain to follow the "laundered" money.


The blockchain stores all transactions. The only way to clean money is to do some sort of transaction off of the block chain. To do that you need an intermediary who is willing to do that for you, and take the risk of LEO or some other regulatory firm calling them on it. Shady mixing pools might be willing to do this for you, but Kraken or other legitimate commercial exchanges will not.