News
The crypto nexus: the next compliance challenge
Cryptocurrency has become increasingly professionalized in recent years, offering millions of transactions to a global base of daily users. However, this mainstream investing trend has occurred alongside recent high-profile lawsuits against former crypto executives.
The decentralized nature of cryptocurrencies still presents opportunities that bad actors can exploit, including to launder money. Around $72 billion in illicit transactions are paid for with cryptocurrencies each year, much of which is used to clean dirty money, according to a recent Europol study. report.
The reality of crypto’s role in financial crime, alongside its growing popularity, presents challenges for compliance teams, who must balance development and growth, while preventing fraud and money laundering. There is enormous pressure on them to implement robust anti-money laundering strategies to stop bad actors without slowing the widespread adoption of cryptos.
The crypto link
One of the key areas of risk to address is the intersection of traditional financial assets and digital crypto assets, two different types of currencies that, when combined, can create levels of obfuscation. Traditional finance remains the foundation of global economies and is tightly regulated by centralized authorities. The crypto landscape is relatively recently regulated and is decentralized in nature. Yet despite this decentralization, blockchain, which records incoming and outgoing peer-to-peer transactions, can enable visibility into every transaction made using digital currencies.
As these two financial landscapes continue to converge, the financial trading environment is evolving. The convergence of digital and fiat universes at the cryptographic nexus creates a new paradigm for financial payments. And with new opportunities comes new risks.
Chain
The simultaneous emergence of risks and opportunities at the cryptographic link also applies to blockchain technology. Recorded on-chain, blockchain data can be an asset to compliance professionals, providing a continuous, granular financial record of all crypto transactions. For those who need to analyze and trace the flow of money, on-chain data is an immutable ledger.
The challenge arises when cryptocurrencies are exchanged off-chain for traditional fiat currencies. Once cryptocurrencies are integrated into fiat and off the blockchain, finances can quickly become much more difficult to trace. Some exchange platforms were created solely to facilitate this type of exchange.
Even though the majority of cryptocurrency transactions are legitimate, the risks of criminals exploiting the vulnerabilities are clear.
Sophisticated crime
Criminals are increasingly using cryptocurrencies in more complex ways. Some are part of ransomware operations, like The North Korean group Lazarus. To take another example, money mule schemes see individuals become intermediaries for money transfers – sometimes unknowingly participating in brokerage transactions that take money on-chain and transfer it to the off-chain world. The mule receives the funds, then transfers them to another wallet or converts them to fiat currency and obscures the trail of the assets being washed.
It is crucial that many criminals target non-compliant or unlicensed exchanges to ensure that the transfer of assets from crypto to fiat currency progresses unimpeded. Crime never sleeps. Bad actors are continually looking for new ways to use crypto for nefarious purposes.
Different forms of activity
The threat of dirty money flowing through crypto exchanges to legitimate organizations is twofold.
- Direct exposure occurs when organizations interact with bad actors, such as sanctioned entities or crypto exchanges that facilitate the cleanup of dirty money.
- Indirect exposure involves more links in the chain, where members of a business network or customer base are involved in illicit activities elsewhere. For example, a bank could provide a loan used to purchase a cryptocurrency linked to a sanctioned entity.
The repercussions of association with criminals or sanctioned entities are significant, even if the association is indirect. Moody’s reported a 114 percent increase in sanctions evasion last year. The result of inadequate transaction monitoring is clear. This can open the door to sanctioned, high-risk individuals engaging in transactions that result in compliance breaches and reputational damage.
Compliant crypto
To address the challenges of illicit activities leveraging cryptocurrency, it is essential that organizations deploy blockchain analytics technology, enabling both scalable and real-time analysis of the cryptographic nexus.
By aggregating and reviewing blockchain data, compliance teams can help prevent fraud and money laundering. They integrate on-chain data with sophisticated analytics to identify risks associated with a client’s funds and clarify the identity of the ultimate beneficiaries. Likewise, features that control crypto wallets, monitor transactions, employ and map fund movements, and identify associated risks can all help identify illicit activity.
As companies delve deeper into the cryptocurrency space, it becomes crucial to keep regulatory compliance in line with continued innovation. Integrating detailed on-chain analytics and in-depth know-your-customer (KYC)/anti-money laundering (AML) practices is necessary to unlock the potential of digital assets and also maintain the integrity of the financial system .
Image credit: With Olszewski / Shutterstock
Chor Teh is a Director and Practice Leader for Financial Crime and Banking Compliance at Moody’s.