The push for crypto regulations
Do crypto businesses need AML 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 One Coin 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.
Why crypto needs regulation
In an interview with the Financial Times last year, the U.S. Securities and Exchange Commission (SEC) chair 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 over $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, Chain analysis records the number of ransomware payments made via crypto. The company’s 2022 report on ransomware payments recorded over $692 million in extorted money during 2020, almost double the amount recorded in the previous report.
Money laundering: Chain analysis recorded a 1,964% increase in cryptocurrency laundered through DeFi (decentralized finance) protocols; this equates to around $900 million in laundered money.
Even without exploiting cryptocurrencies for cybercriminal activity, crypto would benefit from regulation. In an interview with The Financial Times, the chair of the SEC summed up the situation perfectly:
“At about $2tn 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,” “History just tells you, it doesn’t last long outside. Finance is about trust, ultimately.”
Current state of crypto regulations
A recent DIFC Fintech conference provided some interesting insights into the current situation in terms of regulations and cryptocurrencies:
- 95% of regulators have a team working on Crypto regulations now.
- The crypto industry is lobbying to push for clear regulations: it sees regulations as a positive development that will skyrocket the industry.
- When global cryptocurrency exchange Binance introduced KYC, more than 96% of its customer base complied.
- The SEC imposed approximately $2.35 billion in total monetary penalties against digital asset market participants in 2021.
- Of the 20 SEC enforcement actions in 2021, 65% alleged fraud, 80% alleged unregistered securities offering violation, and 55% alleged both.
The FATF recently defined Virtual asset service providers to include cryptocurrency exchanges, stable coin issuers, DeFi protocols, and 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 U.K. and the U.S. are actively developing regulations to control cryptocurrencies. The U.K HM Treasury Office states this:
“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 registration for their activities in relation to all types of crypto-assets.”
In the U.S., 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/CFT regulations.
The world of crypto regulations had a boost with the Financial Stability Board (FSB) expected to propose global rules for cryptocurrencies in October.
How to regulate crypto
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 frauds 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 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 this:
“...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 (Know Your Customer): 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. KYC platforms that provide dynamic KYC provide the basis for ongoing checks required to prevent fraud. Platforms such as EastNets SafeWatch-KYC use scoring methodologies to assess risk on a 24/7 basis.
PEP and sanction screening: Identity verification and KYC prevents 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 (PEP checks). 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): AML 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 behavioral analytics. Platforms such as SafeWatch-AML use artificial intelligence (A.I.) to keep ahead of the fraudsters and provide reports to evidence regulatory compliance.
