Cryptocurrency compliance

To truly become a full-fledged powerhouse in the financial system, cryptocurrencies will need to have effective compliance measures in place. Approval from regulators will help provide a route to full legitimacy for the cryptocurrency industry, opening up participation from more institutional and general public participants.

There has been significant progress by various regulatory bodies on how to oversee different cryptocurrencies and all their permutations. There have also been major changes on the technical side, such as the Bitcoin halving and Ethereum 2.0, which all together seem to point to major changes in the space.

Revised FATF standards on virtual assets

In June 2019 the FATF, an inter-governmental body that sets international standards to prevent money laundering, established a set of Global Standards for virtual assets and virtual asset service providers (VASPs). They also agreed to a 12-month review to determine the effect of these Standards, and published that review in June.

One Standard that stood out for the VASP industry was the so-called Travel Rule, the “obligations to obtain, hold, and transmit required originator and beneficiary information in order to identify and report suspicious transactions, monitor the availability of information, take freezing actions, and prohibit transactions with designated persons and entities.” The technical complexity of having multiple VASPs, in different jurisdictions, with different technologies and systems, all working together to properly share originator and beneficiary information was daunting, to say the least.

Fortunately, there has been development on that front with the introduction of interVASP Messaging Standard IVMS101 by a cross-industry, cross-sectoral joint working group of technical experts. Implementing the standard is a work-in-progress, as each VASP has to analyze and integrate the Messaging Standard into their systems. The next FATF review on the subject, which is due in June 2021, should provide a better understanding if interVASP is able to get the traction and widespread implementation to be effective.

There are other concerns, though. As the technology continues to advance quickly, and other global developments are changing the financial landscape dramatically, the FATF will be watching the sector closely. The growth of stablecoins and their opportunity to enable peer-to-peer transactions might be problematic. As the FATF states, “a rapid expansion in the number and value of transactions not subject to AML/CFT controls under the revised FATF Standards would however present a material ML/TF vulnerability.”

Overall, the FATF does indicate that there has been progress:

  • 35 out of 54 reporting jurisdictions have implemented the revised FATF Standards
  • 32 of these 35 have regulated VASPs and three jurisdictions have prohibited them
  • A further eight out of the 54 jurisdictions are in the process of passing legislation
  • “There is no clear need to amend the revised FATF Standards”

Many of the jurisdictions that have implemented the Standards have made VASPs obliged entities, and under the same rules as many other financial institutions. As many VASPs are new organizations, they often don’t yet have the sophisticated compliance programs necessary. While progress is being made, there are common deficiencies such as:

  • “Expanding operations more rapidly than their compliance function can manage
  • Failing to implement adequate controls to mitigate risks involved with anonymity enhanced virtual assets
  • Reliance on manual transaction testing and not conducting appropriate levels of due diligence to understand the risk profile of customers' activity off-platform.”

OCC rules on cryptocurrency custody services

The Office of the Comptroller of the Currency (OCC), the regulator of U.S. national banks and federal savings associations, provided an interpretive letter in regard to the authority of a national bank to provide cryptocurrency custody services for customers.

While banks have long been able to provide the safe storage of assets, the extension of that ability to digital assets is an important step. Of course, there is big gap between the ruling and banks providing a variety of cryptocurrency services; significant technical and legal challenges still exist. But as Nathan McCauley, CEO of digital asset custodian service Anchorage, states, “the OCC letter is a positive development for the entire crypto industry. A lack of regulatory clarity has been a big roadblock to more institutional activity in crypto, and major pronouncements like this help move the needle.”

New cryptocurrency laws

Cryptocurrency laws and regulations around the world continue to be introduced and evolve:

Canada

Amendments to the Canadian Know Your Customer/Anti-Money Laundering (KYC AML) regulations — the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) are now in effect.

Therefore, all dealers of cryptocurrency are now considered money service businesses (MSBs) and have the same requirements in regards to due diligence, record-keeping, monitoring and reporting. VASPs have to register with FinTRAC and have Know Your Customer (KYC) procedures in place, including customer identification. Additionally, any cryptocurrency transfer over CAD $10,000 needs to be reported.

EU

Under 5AMLD, crypto exchanges and crypto wallet providers will be considered “obliged entities” and face the same requirements as financial institutions. These requirements include AML, customer due diligence, transaction monitoring and suspicious activity reports.

Russia

The Russian Central Bank is on record as being strongly opposed to cryptocurrency. As stated by Sergei Shvetsov, the first deputy governor at the Bank of Russia, “crypto purchases are not an investment. It is more like a financial pyramid or roulette games, and does not apply to the financial market.” However, a new law coming into effect January 1, 2021 will classify digital financial assets as “digital rights comprising money claims, ability to exercise rights under negotiable securities, rights to participate in equity of a non-public stock company and right to claim transfer of negotiable securities set in a resolution on the DFA issue.” They won’t be able to be used as payments.

Nigeria

While some countries are trying to restrict the use of cryptocurrencies, the use in other countries is exploding. Nigeria, for example, has seen a 60% increase in crypto wallet creation since April. The country has tabled bills that will provide a clear legal framework; according to Attorney General Abubakar Malami, “the expected bills will prepare Nigeria for emerging realities relating to digital cash, bitcoin and e-currency.”

As cryptocurrency technology and its use evolves, so will the regulations around it. Will the increased use of cryptocurrency provide substantial financial benefits? Will criminals and money launderers exploit cryptocurrency to further their illicit activity? As the industry and governments grapple with these complex questions, hopefully a balanced model can emerge that supports the economic growth potential of these new digital systems while protecting the public from the dangers of financial crimes.

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