How to deal with Compliance Risks in the age of Cryptocurrencies

Paul Zhong April 25, 20194 mins read

The rapid development, enhanced functionality and increasing adoption of advanced technologies and related payment products and services globally continue to pose great challenges for private-sector institutions and regulators.

This is especially the case when it comes to ensuring that these technologies are not used for money laundering and financing of terrorism practices. In the last couple of years, a significant number of virtual currencies or cryptocurrencies have emerged, most of which have attracted significant investments in payment infrastructure built on the relevant software protocols. These payment protocols and infrastructures aim to provide a new method of transmitting value over the internet or through decentralized peer-to-peer networks. Being a relatively new concept, regulators globally are still unaware of all the Anti Money Laundering (AML) risks associated with cryptocurrencies. The lack of regulation makes it easier for criminals, terrorist financiers and other sanction-evaders to store and transfer illicit funds thus increasing money laundering risks.

Central regulators and financial institutions are formulating new policies that will aid in handling AML risks within cryptocurrencies. This might, however, take a while since it’s a form of new technology.

The first step would be to strengthen AML procedures at financial institutions. These institutions should focus their attention on improving their interface function. This simply refers to the interchange between financial institutions and basic crypto exchanges. In order to distinguish possible money laundering from normal customer behavior, a lot of factors should be put into consideration. Higher risks are found in situations such as when a customer’s main source of funds is derived from cash, digital currency exchanges or third-party payment providers. Situations, where multiple customers send similar values in the same time frame to digital currency exchanges, cash-intensive activity and fast outgoing cash in retail banks, should be held with suspicion. In order to rectify this, banks should assess their processes and systems to ensure they don’t accept proceeds from privacy coins or flows from exchanges that don’t require identification.

Transaction monitoring is also another effective way to combat money laundering involving cryptocurrencies. Despite the fact that the anonymity of cryptocurrency prevents financial institutions from knowing a transaction’s beneficiary, IT systems can use advanced algorithms for fiat currencies or currencies with little intrinsic value. This way, the algorithms will be able to identify patterns that might be an indicator of money laundering. Due to the cemented history of the public ledger, as soon as an account is associated with criminal activity, the flow can be compiled in the ledger in order to formulate powerful intelligence which will come in handy for law enforcement. 

The lack of identification information throughout a transaction with cryptocurrency is an obstacle to monitoring and curbing money laundering. However, there are certain elements such as party identity and information as well as recording transactions that would be instrumental in detecting and containing cryptocurrency risks. There should be strict global standards developed such as being more rigorous during issuing out of e-wallets. New regulations require that all e-wallets should be registered to an existing person. This prevents anonymity or usage of e-wallets with pseudo-names while enhancing real-name verification. Such course of action would, however, require approval by key industry players and complementary regulation.

Unlike fiat currency, blockchain technology has more potential to reduce AML risks. An online public ledger is used to maintain a blockchain hence promoting validation, supervision and recording each transaction's history. Crypto miners and public ledger readers get notified once transactions take place. As opposed to hard currency that can be made into counterfeit, it is impossible to forge cryptocurrency since each type has its unique features verified through end-to-end miners. Without verification of all transaction phases namely departure and destination wallet, currency amount and type, the transaction would get blocked. The digital trail serves AML regulation better than existing fiat paper trails making blockchain an effective solution.

Last but not least, enforcing state supervision of third-party ID providers would also help reduce AML risks. These ID providers are crucial in guaranteeing anonymity for law-abiding citizens and at the same time allowing authorities to pursue any criminals laundering money. They could avoid identification and data collection by organizations active in the crypto-world which aren’t as strong in safekeeping identification details of their customers. Korea has experienced incidents whereby personal information stored with crypto organisations has been prone to identity and data theft. Supervising third-party ID providers in charge of data storage for crypto organisations would, therefore, help in terms of their accountability.

Virtual currencies are still in development and gaining momentum fast. As adoption increases and innovation relevant to AML compliance becomes embedded in its genetics, there could be possible emergence of improved currency built with proper built-in controls, transaction monitoring, and digital identity interfaces. With the help of these standards, compliance risks will be mitigated.

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Paul Zhong - R1110469's picture
Senior Consultant | Compliance Recruitment


My client is a global corporate investment bank.
My client is a global foreign bank with strong presence in Asia