The meteoric rise of cryptocurrency has been fueled by its decentralized nature and the anonymity it offers, presenting significant potential for secure, efficient and global financial transactions. While these features also lend themselves to misuse, they provide a ground-breaking framework for privacy and security, empowering individuals and businesses to engage in fast, low-cost and borderless financial activities.
The popularity of crypto is evident in the huge market capitalization it commands — as of June 2024, the global cryptocurrency market was valued at USD 2.25 Trillion, with Bitcoin dominating the space at USD 1.2 Trillion.1
Managing and monitoring cryptocurrency transactions pose significant challenges, raising concerns among regulators about potential destabilization of the financial system. Governments are wary of embracing it as legal tender as the inherent anonymity makes it difficult for central banks to monitor and control transactions. There is also no global consensus on its classification and jurisdiction, creating legal ambiguities.
The cryptographic nature of blockchain technologies and the use of private “cold wallets” combined with the speed and irrevocability of transactions complicate recovery and settlement processes, raising concerns about security and fraud.
Cryptocurrency Goes Mainstream: Increasing Adoption and Integration
However, things are slowly changing. Cryptocurrency is becoming mainstream as more banks offer it as a service alongside other payment instruments such as credit cards and digital payment services.
Global banks, including Goldman Sachs, USAA, Banco Masventas, Fidor Bank and Worldcore, now offer cryptocurrency services like deposits and transactions. A survey by HSB, a cyber-insurance company and part of global re-insurance company Munich Re, finds cryptocurrency acceptance has extended beyond 2One-Third of Small Businesses Accept Cryptocurrency | HSB: US-based with a global reach (munichre.com) financial companies. A significant number of businesses, including 36 percent of small to medium-sized US businesses, now accept Bitcoin as payment.2
Major corporations such as Tesla, Microsoft, Amazon, Starbucks, The Home Depot, Burger King and Virgin Galactic also accept cryptocurrencies. Furthermore, entire companies are now focused solely on cryptocurrency-related services, including exchanges, wallet providers and intermediary services like Purse, to facilitate retail e-commerce transactions.
The Regulatory Scenario
With the increasing adoption of cryptocurrency as a financial instrument, governments around the world are in a hurry to regulate the sector. Led by Canada — which cleared the first Bitcoin exchange-traded fund — and the EU, other countries including the UK and the US recognize cryptocurrency as an authorized medium of exchange.
As a new financial instrument rooted in blockchain technology, cryptocurrency is rapidly evolving. However, many grey areas present a quagmire of regulatory challenges.
The global debate over regulating cryptocurrency transactions has persisted for years, with countries like the US, EU and Canada classifying exchanges and administrators as Money Service Businesses (MSBs) and subjecting them to Anti-Money Laundering (AML) regulations.
Many countries, including China, Egypt, Iraq and the UAE, have rejected cryptocurrency, just as many others have yet to include digital currencies in the regulatory framework. This has led to inconsistent and diverse global approaches to crypto regulation.
Stringent Compliance, a Necessary Step to Establish Credibility
Given the unpredictability of the environment, cryptocurrency exchanges and virtual asset service providers must operate responsibly and adhere to global and local regulations to establish cryptocurrency’s credentials as a reliable instrument for financial transactions. However, crypto players often act in an unbridled manner, attracting fines and prosecution by regulators.
For instance, Binance did not register as a foreign money services business in Canada and did not report approximately 6,000 virtual currency transactions between June 2021 and July 2023. For this, Canada's financial regulatory agency, FINTRAC, imposed a USD 4.38 Million fine on the crypto exchange.3
Similarly, the US SEC filed charges against Geosyn Mining 4 for engaging in unregistered and fraudulent securities offerings, and the Dutch Central Bank, De Nederlandsche Bank, imposed a fine of Euro 2.85 Million on Crypto.com5 for failing to register in the Netherlands before offering services
Regulators are watching the sector closely because cryptocurrency’s digital nature and anonymity provide criminals with opportunities to exploit the system. Financial crimes are easier due to the ease of setting up online accounts and the strong encryption that conceals the movement of funds, making it difficult to trace and monitor illicit activities.
Blockchain Makes Financial Crimes Easier
A common approach criminals use to exploit the system is “micro-laundering,” which entails opening multiple accounts to make many small payments to different recipients. Although many crypto exchanges conduct Customer Due Diligence (CDD), ongoing monitoring and reporting of suspicious transactions can be challenging, especially at scale. The lack of transparency, speed of transactions and irrevocability inherent in blockchain technology complicate the money trail once funds are converted from real-world currencies.
After a cryptocurrency transaction is confirmed and added to the blockchain, it cannot be reversed or altered. This is due to the decentralized and immutable nature of the blockchain, which ensures that all transactions are final and tamper-proof. While this feature enhances security and prevents fraud, it also means that any mistakes or unauthorized transactions cannot be undone.
Therefore, it is not possible to obtain asset freezing or injunction orders, which hampers authorities’ ability to intervene in suspected fraud, money laundering and other illicit activities. Unlike traditional financial assets that can be quickly frozen or seized by court order, cryptocurrency’s decentralized and anonymous nature makes it challenging to identify and control specific assets, allowing illicit transactions to flourish. This lack of enforceability complicates efforts to monitor and regulate the cryptocurrency market effectively.
In light of these challenges, the Financial Action Task Force (FATF), an inter-governmental organization that tackles money laundering and terrorist funding, and other regulators recommend banks and financial institutions to perform Enhanced Due Diligence (EDD) on customers in digital currencies.
Leveraging Strategic Partnerships for Enhanced CDD
For cryptocurrency exchanges, conducting CDD poses significant challenges due to the anonymity and pseudonymity of transactions. The global nature of many transactions adds complexity, as exchanges must navigate diverse regulatory requirements across jurisdictions.
High volumes of rapid transactions require efficient and scalable due diligence processes, while the complexity of transactions, including mixing services and decentralized exchanges, makes verification challenging.
Crypto exchanges can successfully overcome such CDD challenges and investigate suspicious investments and transactions by partnering with domain and tech experts with extensive experience in assisting banks, crypto service providers and financial institutions.
Experienced service providers in the field of financial crime and compliance have the wherewithal to conduct comprehensive investigations and ensure transactions are transparent and compliant. They utilize thorough private investigations and analytics to verify customers' Source of Funds (SoF) and Source of Wealth (SoW), as well as profiling to identify illicit activities involving digital wallets.
Given the sustained popularity of cryptocurrencies, EDD services can bring transparency to money source and flow through crypto exchanges, establishing credibility and adherence to regulatory requirements.
Contact us to know more about our Financial Crimes – Enhanced Customer Due Diligence services for cryptocurrency exchanges.
References
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10 Best Cryptocurrencies To Invest In July 2024 – Forbes Advisor INDIA
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One-Third of Small Businesses Accept Cryptocurrency | HSB: US-based with a global reach (munichre.com)
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Canada fines Binance $4.38 mln for money laundering violations | Reuters
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SEC.gov | Geosyn Mining, LLC, Caleb Joseph Ward, and Jeremy George McNuts
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Fine for Foris DAX MT Limited (Crypto.com) for providing crypto services without the required registration (dnb.nl)