AML for Digital Assets and Crypto-currencies
The increasing innovation in blockchain, proliferation of digital assets and cryptocurrencies and growth of smart contracts are driving regulators from various countries to bring digital assets in the regulatory boundaries without stifling the innovation. On the other side, crypto communities need to adhere to a common-sense regulatory framework to clean up their networks and transactions so that wrong organization and groups can‘t use their shoulders to conduct illicit activities.
With the list of financial institutions involved in digital asset transactions growing rapidly, firms will need a deeper understanding of various regulations. A clear understanding will be important to not only support potential new business opportunities but also follow through on multiple regulations and across jurisdictions until a consensus is achieved.
This paper looks at the current landscape of AML/CFT regulations for digital assets, implications of digital assets to financial institutions, and how financial institutions can successfully extend their businesses from traditional assets to digital in a compliant manner.
The growth of digital assets has brought tremendous AML/CFT risks exposure to financial institutions. The participation in digital assets and crypto-currencies is touching new milestones every single day. As of June 2020, the global digital asset market size has reached USD 281 billion[2].
Over the next seven years, the market is projected to grow at the CAGR of 11%[3]. Additionally, the number of Ether addresses created exceeded 100+ million, with 100+ thousand new addresses being generated every day[4].
With the recent Coronavirus outbreak, the individual’s willingness to use cash or even handing over a credit card to a clerk has taken a hit.
As more mainstream consumer and institutional investors embrace cryptocurrencies, financial institutions can hardly disentangle themselves with the crypto economy. Even there is increased interest across several countries for experimenting with Central Bank Digital Currency (CBDC) or ‘Digital Money‘. However, not having an active and automated way to assess the relative risk associated with digital asset transactions can cause tremendous exposure to AML/CFT regulatory risks.
Banking and Virtual Currencies Are Increasingly Intertwined [6]
Regulatory Landscape for Digital Assets
Regulatory bodies around the world have begun to update the regulatory frameworks to expand the coverage of digital assets.
United States
In February 2020, U.S. Treasury released the new 2020 National Strategy for Combating Terrorist and Other Illicit Financing, highlighting the heightened potential AML risks posed by anonymity-enhanced currencies.
- Digital asset activities meeting the FinCEN’s definition of money transmission services should follow Money Services Businesses (MSBs) regulatory framework
- Digital asset activities involving securities or commodities would fall under SEC and CFTC regulatory framework
“The 2020 National Strategy declared “digital assets” to be one of the most significant illicit finance vulnerabilities, replacing the 2018 National Strategy, which assessed “virtual currencies” to be an emerging illicit finance risk.”
CFTC, FinCEN, and SEC also published the joint statement on the requirement for Financial Institutions to establish and implement an effective anti-money laundering program (AML Program) and record keeping and reporting requirements, including suspicious activity reporting (SAR) requirements for digital assets.
“Libra’s (Facebook’s stablecoin) intended global reach would likely necessitate a consistent global anti-money-laundering framework.” — Lael Brainard, Federal Reserve governor
Which US Agencies Regulate and Enforce Regulation on Blockchain Entities and Activities[6]
UK
HM Treasury has implemented the Fifth Anti-Money Laundering Directive (5AMLD) through amending the UK’s Money Laundering Regulations (MLRs) to include a broader set of crypto-asset business activities, including Fiat-to-crypto exchange, Crypto-to-crypto exchange, Custodial wallet provider, Initial Coin or Exchange Offering (ICO/IEO) and Crypto-asset ATM.
A glimpse of Current AML/CTF Regulations Globally[8]
Regulatory Gaps
There are still AML regulatory gaps that makes it hard to address illicit finance problems created by digital assets. The U.S. regulatory framework for money transmission does not cover the full range of illicit activities through digital asset. Additionally, given the borderless nature of the cryptocurrencies, there are gaps in other jurisdictions to follow the Financial Action Task Force (FATF) standards, which makes it difficult to ensure effective regulation and supervision of digital assets globally.
Elevated AML/CFT Risks of Digital Asset
The anonymity, liquidity, and borderless nature of digital assets introduce elevated AML/CFT risks for financial institutions.
Roadmap for Success
While each financial institution will have its challenges and successes, we have identified five key themes (5Ks) that financial institution can consider to re-examine their AML/CFT processes around Digital Assets.
To learn more about framework and partnership with CipherTrace, please use the following link to access more detailed:
https://www.infosysconsultinginsights.com/insights/uncovering-financial-crime-risks-with-crypto/
Conclusion — looking to the future
Although most of the financial institutions currently have several advanced tools and methods for AML/CTF compliance for conventional assets and payments, they are not well equipped to identify and monitor risks associated with digital assets or lack the expertise and resources to monitor digital asset businesses successfully.
Financial institutions need to lay a good foundation of data analytics and AI/ML capabilities along with emerging RegTech to build effective and efficient AML/CFT compliance to cover various aspects of the transactions related to digital assets.
Infosys along with industry leading partners like NICE Actimize and CipherTrace, provides comprehensive AML solution. With our solution, financial institution can uncover risk exposure not only for conventional payments but also digital assets transactions. This will enable FIs to offer innovative products and services with confidence and seize business opportunities in digital asset space.
