In a little over a decade, Bitcoin and other crypto assets have progressed from an idea to an economic phenomenon. We have seen cryptocurrencies explode as a viable way to trade currency. Due to its very nature and initial lack of regulation, it resulted in a large stream of illicit activity – namely money laundering.

In this blog post, CX Financia Ltd’s Legal and Compliance team addresses:

• Several AML issues relevant to cryptocurrencies;
• The key factors that influence these issues as well as;
• The solutions that Obliged Entities can take to reduce the AML risks.

How has AML and KYC compliance changed concerning cryptocurrency in the past few years?

Crypto assets have been on the Regulator’s radar for a while now. More specifically the nature of the new asset class is something that concerns lawmakers in terms of AML. Some factors that categorise crypto assets as a High Risk class in AML are the below:

• The anonymity of transactions made
• Security vulnerabilities in the systems relevant to cryptos
• Malicious software (ransomware) which can hack crypto wallets
• The use of illegal goods and services to pay for terrorist finances

It should have been noted that crypto assets are subject to AML regulation since 2018 (refer to the 5th AML Directive and recently issued FATF recommendations). Thus, there is a massive shift in terms of the regulations of this sector.

However, the traditional AML rules, which are currently applicable, also apply to the new asset class. As crypto is a new product and service, entities need to incorporate it into their existing AML Rules and infrastructure. Thus, entities need to consider crypto as a new addition within an existing infrastructure. As mentioned above, most of the AML regulations are already in place. It’s all about enhancing these and make them more relevant to the new product.

Another point to add is that while AML is a material risk for all Obligated Entities, there are also other compliance and regulatory factors that we also need to consider. Things like protection for consumers or governance and culture haven’t received the same level of focus and attention from a regulatory point of view. We would expect to see these pick up in the coming future.

Bitcoin and other cryptocurrencies are joining mainstream banking. What are the risks from an AML perspective?

The issues concerned from an AML perspective is understanding who your clients are , where their source of wealth or income is coming from and their line of business. Hence, traditional due diligence still applies, however Banks need to take the due diligence a step further. This entails performing on-going monitoring on the clients’ crypto wallets and transactions. Enhanced analysis can facilitate Banks in making sure that there are no connections to terrorist financing or money laundering.

Furthermore, one advantage that the crypto sector has over many of the other sectors within financial institutions is the availability and access to data. Banking institutions have far greater access to information than any other financial institution. Thus, they are technically in a stronger position to identify AML fight the terrorist financing risks more quickly than other institutions. The key issue here is whether they’ve got sufficient infrastructure and setup internally to use that data to its best ability to support the monitoring of its financial crime risks.

How can companies serving crypto exchanges detect AML red flags and transactions, and what are the key indicators?

While cryptocurrencies represent a new frontier on the money laundering landscape, traditional criminal strategies remain relevant. FATF found that the following types of transactional behaviour, involving conventional means of payment, often indicated an attempt to launder money:

• Structuring cryptocurrency transactions in small amounts to avoid reporting thresholds.
• Making a series of high-value cryptocurrency transactions in a short period.
• Immediately transferring cryptocurrency deposits to a service provider in a low regulation jurisdiction.
• Immediately withdrawing cryptocurrency deposits with no transaction activity or converting deposits to multiple cryptocurrency types while incurring fees.
• Depositing into cryptocurrency wallets with illicit funds
• Amounts in cryptocurrency accounts are inconsistent with the owner’s customer profile and wealth.
• Funding of new accounts with a large initial deposit that is then traded or withdrawn in its entirety on that same day (or shortly thereafter).
• Transactions are being made involving multiple cryptocurrencies or multiple accounts with no logical business explanation.
• Frequent transfers of large amounts of crypto within a set timeframe (day, week, month) to the same account from more than one person.
• Transferring to another wallet or withdrawing for fiat currency incoming small-amount transactions from unrelated wallets.
• Making multiple crypto exchanges  at a potential loss due to commission fees.
• Making frequent conversions of large amounts of fiat currency into a cryptocurrency with no logical business explanation.

What kind of tools/procedures can Obliged Entities use to properly identify Cryptocurrency AML Red Flags?

Companies can rely on various tools to detect red flags and transactions, such as KYT tools. Know Your Transaction (KYT) is a process used to monitor the merchants’ businesses by analysing transaction data. The production of essential evidence required upon suspicions over any fraudulent merchant activity  allows accurate and data-driven conclusions to be made

The advantage of KYT is that it targets evidence that is available in real-time, which is hard to manipulate or change. Examining transaction data can produce both quantitative and qualitative analyses to determine the true business activities of merchants. With concrete supporting evidence in hand, KYT can help to generate highly accurate insights and allow data-driven conclusions to be made.

The right tools, resources, and technology are essential to effectively implementing KYT. To effectively extract data and trace transaction details to its roots, advanced technology and professional data analytic experience is vital.

In conclusion, even the most elaborate money laundering schemes can be traceable with sufficient resources and time.

Crypto assets are here to stay

As cryptocurrency adoption continues to grow, AML professionals must stay on top of the rapidly developing regulatory and cryptocurrency landscape to ensure that their organisations remain compliant and can identify and mitigate risks. Furthermore, the public and private sectors will need to continue working together to establish regulatory frameworks and investigative techniques to keep the cryptocurrency and global financial ecosystem safe.

How can we help you with your crypto business?

CX Financia is here to help you register with the CySEC in order to conduct crypto asset services in a proper manner. Learn more about how to register with CySEC as a Crypto-Asset Service Provider (“CASP”) here

Setting up a CASP company is easy. Engage CX Financia to successfully register as a CASP to conduct your virtual asset holding and management services. You may contact us at [email protected]