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AmericasSeptember 29 2021

Banks’ AML travails suggest a tough road ahead for cryptoassets

Time will tell as to what extent regulators impose stringent anti-money laundering requirements on cryptocurrency operations.
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Banks’ AML travails suggest a tough road ahead for cryptoassets
Charlie Steele headshot

We’re still in the early stages of the cryptocurrency market evolution; investor interest is soaring and growth is booming. All the while, regulators are wary and sceptical. Their general mood was succinctly summarised by US Securities and Exchange Commission chair Gary Gensler in August, when he referred to the market as the “Wild West”.

With concerns ranging from investor protection to money laundering, terrorist financing and the environment, regulators have been flexing their muscles, signalling intent to police cryptocurrencies and clamp down on those committing or facilitating unlawful behaviour.

As the growing industry is increasingly granted legitimacy by various US states, private-sector companies and high-profile entrepreneurs, businesses will have to adapt and evolve accordingly. When it comes to anti-money laundering (AML) efforts, the example presented by the banking sector may make life difficult for crypto operations.

Crypto and money laundering

Regulators’ AML concerns are borne of the view that cryptocurrencies are highly vulnerable to exploitation by money launderers. Some of crypto’s key features, such as its relative anonymity and fast payments, make it particularly susceptible to such activity. What’s more, crypto generally lacks industry-wide implementation of the key features employed by banks and other financial institutions to mitigate such risks.

Crypto’s perceived vulnerability has been highlighted by several recent US government actions, including the August enforcement action by the Financial Crimes Enforcement Network (FinCEN) and the Commodity Futures Trading Commission against convertible virtual currency exchange BitMEX, and the Office of Foreign Assets Control’s September 21 sanctions against nested virtual currency exchange Suex.

With regards to AML, the banking sector provides a particularly unflattering comparison to crypto. Banks are heavily regulated for safety and soundness, as well as compliance with applicable laws, including AML and economic sanctions rules. They are also required to have multiple preventative controls, including know-your-customer and other due diligence mechanisms, and — unlike cryptos — are regularly examined for compliance.

Regulators’ AML concerns are borne of the view that cryptocurrencies are highly vulnerable to exploitation by money launderers

These features give regulators some comfort that banks have effective measures in place to identify and plug AML gaps, prevent violations altogether, and respond to and remediate them promptly when they occur. However, banks and other financial institutions assert that AML compliance requirements can be too onerous, as they impose burdens that are disproportionate to the benefits to law enforcement. Such complaints have generally not prevailed, and there haven’t been significant burden-reducing changes to the regulatory regime as a result.

Regulators have little difficulty concluding that the cryptocurrency market is more susceptible to exploitation by money launderers, financial criminals and terrorist financiers, compared to other financial institutions and banks in particular. At this stage, proof showing that such exploitation is taking place is not always required — at least not by regulators. Crypto’s anonymity, speed and relative lack of mitigation measures are sufficient to justify deep concern and, in turn, heavy and sceptical scrutiny.

By contrast, exponents insist that cryptocurrency companies pose no greater risk of money laundering than banks or other, more traditional, financial institutions and payment processing companies. However, this argument is unlikely to impress regulators. Being classed as risky as other entities and mechanisms that have been used to launder money isn’t a great selling point. What’s more, these arguments are largely — if not entirely — conceptual, as there isn’t yet a lot of real-world case data to support or refute them.

How it may play out

Of course, regulators’ arguments are also largely conceptual, but they will typically err on the side of caution, especially in a new environment. The last thing a regulator wants to do is give a novel and risky new industry the benefit of the doubt, and then have to explain to its overseers and the public how and why it dropped the ball.

This effectively puts the burden of proof and persuasion on crypto advocates until either sufficient data is generated to persuade the government, or some brave provider decides to sue to challenge a regulator’s oversight and wins.

However, regulated companies almost never sue a regulator, particularly in the US. Courts typically give regulators considerable deference and companies usually want to avoid friction with their regulators. Therefore, for the most part, regulators stay in the driver’s seat and develop the rules of the road as they see fit.

Time will tell as to what extent regulators impose stringent, bank-like, AML requirements on cryptocurrency companies. Every new high-profile misstep by a crypto firm can make that more likely. This would throw a wrench, at least in the short run, into crypto’s evolution, and open a new front in the ‘burden versus benefit’ debate.

Charlie Steele is a partner at fraud investigator Forensic Risk Alliance.

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