Opinion: Why crypto businesses need anti-money laundering regulations

The idea of regulation and cryptocurrency has, at least in the past, been strongly opposed. Evidence of this can be found in a bitcoin subreddit post from four years ago on crypto regulations, where the idea of adding security controls was seen as a terrible idea.

However, much has changed in the world of cryptocurrencies since then. Crypto fraud and Ponzi schemes like OneCoin have made a mockery of cryptocurrency and hastened the need for regulatory management.

Today, the people behind the crypto platforms want regulation to help prevent the massive levels of fraud that the industry suffers.

Here is a look at why regulating crypto is essential and how to achieve compliance.

In an interview with the Financial Times last year, US Securities and Exchange Commission (SEC) chair Gary Gensler said that he believed crypto platforms need regulation to survive. In the last few years, crypto platforms have become the darling of the cybercrime community.

This is a far cry from the original idea by Satoshi Nakamoto, who developed bitcoin after the 2008-2009 financial crisis to opt out of state-controlled financial systems. But philosophies evolve as landscapes change:

Crypto-scams: According to the Federal Trade Commission, in the 14 months to Q1 2022, fraudsters stole more than $1 billion from 46,000 people in crypto-scams. The privacy-enhancing properties of the decentralized blockchain platform that cryptocurrencies are based upon provide an ideal playground for money laundering and cybercriminal activity.

Ransomware payments: Blockchain analytics company Chainalysis records the number of ransomware payments made via crypto. The company’s 2022 report on ransomware payments recorded more than $692 million in extorted money during 2020, almost double the amount recorded in the previous report.

Money laundering: Chainalysis also recorded a 1,964% increase in cryptocurrency laundered through decentralized finance (DeFi) protocols, which equates to about $900 million in laundered money.

Even without exploiting cryptocurrencies for cybercriminal activity, crypto would benefit from regulation.

In the interview with The Financial Times, Gensler summed up the situation perfectly. “At about $2 trillion of value worldwide, it’s at the level and the nature that if it’s going to have any relevance five and 10 years from now, it’s going to be within a public policy framework,” he said. “History just tells you, it doesn’t last long outside. Finance is about trust, ultimately.”

A recent DIFC Fintech conference provided some interesting insights into the current situation in terms of regulations and cryptocurrencies, including:

The Financial Action Task Force (FATF) recently defined virtual asset service providers to include cryptocurrency exchanges, stable coin issuers, DeFi protocols, and non-fungible tokens (NFT) marketplaces.

This definition helps set the tone for regulation, with laws and directives following. As a result, the current global outlook for crypto regulations is buoyant and developing.

For example, the UK and the US are actively developing regulations to control cryptocurrencies. The UK's HM Treasury states that: “HM Treasury expects financial crime including anti-money laundering requirements will apply to all wallets and issuers and that these will also have to register under AML [anti-money laundering] registration for their activities in relation to all types of crypto-assets.”

In the US, crypto assets are now considered legal and fall under the Bank Secrecy Act (BSA) jurisdiction. In effect, cryptocurrency exchanges must register with FinCEN and comply with AML and combating the financing of terrorism (CFT) regulations.

The world of crypto regulations had a boost with the Financial Stability Board (FSB) – a body of regulators, treasury officials and central bankers from the Group of 20 economies (G20) – expected to propose global rules for cryptocurrencies in October.

Like all other financial infrastructures, crypto needs to be built upon trust. Having regulations in place to verify the identity of recipients and ensure that checks are done to prevent money laundering and other fraud is essential to building that trust.

The crypto industry understands this, which is why they are pushing for regulations. Much of these regulations revolve around AML and KYC.

The UK’s Financial Conduct Authority (FCA), for example, specifies compliance with AML/CFT reporting and customer protection requirements. In the UK, crypto-businesses must register with the FCA and be compliant with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

In March 2022, Biden published an Executive Order on Ensuring Responsible Development of Digital Assets, which includes the following statement: “...[The] United States has an interest in ensuring that digital asset technologies and the digital payments ecosystem are developed, designed, and implemented in a responsible manner that includes privacy and security in their architecture.”

As these regulations bite into the infrastructure of the crypto industry, globally, cryptocurrency exchanges and other industry participants must be AML and KYC compliant.

Systems that can help to achieve regulatory compliance include:

KYC: Customer onboarding to crypto platforms is a crucial industry compliance area. Robust identity verification checks during onboarding and transactions can help ensure traceability for money-laundering purposes and other criminal activity. Platforms that offer dynamic KYC provide the basis for ongoing checks required to prevent fraud. Platforms such as EastNets SafeWatch-KYC, for example, use scoring methodologies to assess risk on a 24/7 basis.

Politically exposed persons (PEP) and sanction screening: Identity verification and KYC prevent cybercriminal activity at the outset with customer due diligence (CDD) and extended customer due diligence (EDD). These checks include sanction screening for high-risk individuals and those who are politically exposed persons. These checks also include “high-risk third countries”. Sanction lists, however, are dynamic and require mechanisms that keep these lists up to date. EastNets provides a blockchain service, Chainfeed, to ensure that CDD and EDD checks are compliant with regulations.

AML: Anti-money laundering checks cover comprehensive requirements to prevent using financial structures, including crypto platforms, to launder money. They typically encompass KYC checks. Europe’s 5th Anti-money Laundering Directive (5AMLD) added new powers to control crypto exchange providers, including CDD checks and ongoing monitoring to file suspicious activity reports (SARs). The latest version of the law, 6AMLD, has added even more stringent requirements and increased penalties for non-compliance. Ensuring crypto businesses meet these stricter regulations requires advanced methods such as behavioural analytics. Platforms such as SafeWatch-AML use artificial intelligence (AI) to keep ahead of the fraudsters and provide reports to evidence regulatory compliance.

The lack of control from central banks and authorities over cryptocurrency, the anonymity surrounding the crypto transactions, and the volatility of the price, all these concerns put the banks and other traditional financial institutions in the mood of wait-and-see.

But cryptocurrency is here to stay. It is time for banks and all financial institutions to get ready to support cryptocurrency, otherwise, they will be out of the game very quickly.

The changes in the financial industry and the waves of digitalization brought new players to the value chain introducing alternative and more attractive financial solutions. These new players are very adaptive to new technologies and not hesitant to provide crypto services to their customers. This is changing the competitive landscape for banks.

With the noticeable extended scope of global regulation in AML and KYC to govern the crypto transactions, financial institutions must get prepared by hiring the needed skill sets, building the relevant platforms, and having the proper controls in place to comply with the new regulations.