Before we delve into the notion of Anti-Money Laundering (AML) Compliance for Cryptocurrency Transactions, we first need to define what constitutes a cryptocurrency transaction.
A cryptocurrency transaction is just like any other type of transaction – the only differences are that digital or virtual currencies are used instead of fiat currencies, and that cryptocurrencies are controlled using the blockchain, which is a distributed ledger technology that serves as a decentralized method of recording and validating cryptocurrency transactions across a huge network of computers.
Whilst nobody can question the importance of AML monitoring of fiat transactions, it is vitally important that cryptocurrency transactions are also subject to the same level of assessment and scrutiny mainly to prevent the potential facilitation of money laundering and terrorist financing as well as the overall misuse of cryptocurrencies as a whole.
The below article will delve into the importance of AML compliance in the rapidly growing world of cryptocurrency transactions. It will also discuss the challenges and risks associated with cryptocurrency transactions and provide tips on how to ensure compliance with AML regulations.
Unique Challenges of AML Compliance for Cryptocurrency Transactions
There are a number of unique challenges which present difficulties in enacting AML Compliance for cryptocurrency transactions. One of the biggest challenges arises due to the fact that the regulation of cryptocurrencies around the world is not harmonized and that different regulatory regimes exist in different countries. This unfortunate situation enables regulatory arbitrage to occur between jurisdictions, where cryptocurrency service providers may establish themselves in jurisdictions that have a very lenient if not a non-existent cryptocurrency regulatory regime.
Another challenge of AML compliance lies in the fact that certain cryptocurrencies facilitate anonymous transactions. Crypto-currency transactions that involve virtual assets such as Bitcoin and Ethereum can be traced publicly on their own public blockchains, and information regarding transactions involving these coins such as the amount of crypto sent as well as the addresses involved is readily available. However, cryptocurrencies such as Dash, Monero and Zcash (also known as privacy coins), allow users to hide transaction data due to anonymity and privacy features that are programed within their systems.
Additionally, the use of mixers and tumblers may also be apparent in cryptocurrency transactions. Mixers and tumblers are mainly used to obfuscate the true origin of certain cryptocurrency funds and as a result make it very difficult for transaction monitoring systems to capture the source of funds of a transaction.
The global borderless nature of cryptocurrency transactions also presents a unique challenge for AML compliance. Cryptocurrencies by their very nature do not discriminate by country or geography and were initially created to enhance cross-border payments that would by-pass the traditional payment networks and their corresponding regulatory scrutiny. In their very basic and natural form, cryptocurrencies are pseudonymous and as a result do not display information regarding the originating or destination country of a cryptocurrency transaction. This allows users to transfer funds to countries that are associated with higher risks of corruption, terrorist financing, and money laundering without enacting any control measures whatsoever.
Despite the above-mentioned challenges of dealing with cryptocurrency transactions, the next part of the article will now delve into detailed tips on how to ensure AML compliance with respect to cryptocurrency transactions.
Tips for Ensuring AML Compliance in Cryptocurrency Transactions
Cryptocurrency transactions are typically conducted through cryptocurrency service providers that receive and send cryptocurrencies. Therefore, it is vitally important to ensure that such service providers adhere to the Travel Rule guidance which was issued by the Financial Action Task Force (FATF). The Travel Rule requires cryptocurrency service providers to collect information on the senders and receivers of cryptocurrency transactions that would allow the receiving service provider to securely and immediately communicate details about the receiver to the sending service provider and vice versa would allow the sending service provider to communicate details about the sender to the receiving service provider.
More specifically, for transactions that are lower than 1,000 EUR/USD, service providers must collect information on the name of the originator and the beneficiary as well as information on the wallet addresses being used.
For transactions that exceed the 1,000 EUR/USD threshold, the following information must be collected:
- The Sender’s name.
- The Sender’s wallet address.
- The Sender’s residential address, or national ID number, or customer identification number, or date and place of birth.
- The Receiver’s Name.
- The Receiver’s wallet address.
The Travel Rule helps to ensure AML compliance as it aids in blocking terrorist financing, it stops payments to sanctioned individuals and entities, it enables law enforcement agencies to track crypto transactions more effectively, measures which all help to prevent the money laundering of cryptocurrencies.
Whilst collecting information regarding the originator and the beneficiary of a transaction is no doubt important, another essential component to ensuring AML compliance is transaction monitoring. Monitoring cryptocurrency transactions is necessary in order to ensure that such transactions are consistent with the cryptocurrency service provider’s knowledge of the customer and their respective risk profile. Unusual activity must be questioned by the cryptocurrency service provider and where necessary, the source of funds must be identified and, in some cases, even verified by collecting supporting documentation accordingly.
Ideally, such a transaction monitoring system has the following features in place:
- The ability to monitor transactions using the risk-based approach.
- The ability to identify transactions which are unusual or suspicious in relation to the customer’s profile.
- The ability to establish customer transaction profiles as well as the corresponding ability to identify and flag transactions which fall outside of such profiles.
- The ability to identify black-listed and sanctioned wallet addresses or wallet addresses that are attributed to adverse media.
- The ability to identify the use of multiple wallets for the same cryptocurrency.
- The ability to identify the use of mixers or tumblers.
- The ability to identify and flag transactions that have at some point on the chain passed through dark web cryptocurrency providers.
Another tip for ensuring AML compliance is for cryptocurrency service providers to appoint a designated Money Laundering Reporting Officer (MLRO). The role of the MLRO would be to set up and implement systems that help to identify and detect suspicious cryptocurrency transactions as well as implement robust internal AML policies and procedures for the service provider to adhere to as a whole. This will allow the service provider to detect and report suspicious activity to the MLRO, whose job would be to analyze such activity and report it to the local Financial Intelligence Analysis Unit (FIAU) in case suspicion of money laundering or terrorist financing exists.
The MLRO will also serve as the point of contact for regulators and law enforcement agencies, and collaborating and responding promptly to any requests for information will all help to ensure that service providers and regulatory bodies work together to ensure overall AML compliance.
Benefits of Ensuring AML Compliance in Cryptocurrency Transactions
Whilst there is a lot of work involved in ensuring AML compliance, there are a significant number of benefits that are attributed to being compliant. Ultimately, the biggest benefit lies in the positive reputation that a service provider builds up over time – such goodwill takes many years of hard work to accrue and only one moment of negligence or bad faith to destroy it. There are so many recent examples of financial services firms’ failures due to compliance and due diligence shortcomings that just a reminder of such failures should be enough to ensure that service providers try their very best to adhere to all the necessary AML requirements with respect to cryptocurrency transactions.
Another benefit of ensuring AML compliance is that it reduces the risk of crippling regulatory fines and penalties. There are a huge number of examples of service providers being fined for AML compliance deficiencies with such fines sometimes running into the tens if not hundreds of millions. This is especially applicable for cryptocurrency service providers, which sometimes do not have the necessary liquidity to cope with such fines, particularly in certain regulatory regimes that do not apply strict capital and liquidity requirements.
Being AML compliant helps to build trust and confidence in the market, in particular with customers and investors. The goodwill that is created by ensuring compliance will also help to attract potential customers and investors, which will help to boost sales, increase profits and investment, improve the quality of product/service, and generally act as a solid basis for growth in untapped markets thereby increasing overall market share as a result.
Lastly, efficiency improvement is another byproduct of being AML compliant. Having the necessary systems in place to ensure AML compliance requires service providers to invest in structured data storage systems, it requires them to streamline and improve overall efficiency of business processes, and it requires them to generate regular reports on risk, compliance, and performance which all help cryptocurrency service providers to improve overall efficiency and reduce costs in the long run.
Concluding remarks
There is no doubting the importance of AML compliance for cryptocurrency transactions. A positive reputation, increased goodwill, enhanced customer and investor trust, lower risk of regulatory fines and reputational harm, as well as improved efficiency are all positive takeaways of being compliant.
Whilst one might argue that there are financial costs to compliance, such as the costs of hiring of specialized staff and the cost of implementing enhanced compliance and transaction monitoring solutions, no one can dispute the fact that the benefits of AML compliance outweigh the costs, and that all cryptocurrency service providers should leave no stone unturned in pursuing this objective and goal.
Disclaimer: The above-mentioned article is simply based on independent research carried out by Dr. Werner and Partners and cannot constitute any form of legal advice. If you would like to meet with up with any of our representatives to seek further information, please contact us for an appointment.
