Cryptocurrencies & Anti-Money Laundering Compliance

5 Things That Cryptocurrencies Should Know for Anti-Money Laundering Compliance

The whitepaper of “Bitcoin: A Peer-to-Peer Electronic Cash System” by Satoshi Nakamoto which was published in October 2008 introduced a secure electronic payment system via which the users can transfer values to each other without a need to an intermediary party or a financial institution for the processing. The blockchain is the foundation of this electronic payment system which is described as a distributed ledger of a whole transaction record of the network so that it does not allow spending of a unique user’s balance twice. Cryptocurrency blockchain and the transaction history it carries are fully transparent to everyone within the blockchain system. The users are not requested to provide any personal data for joining the network. In order to open an account, they need to create a public and a private key which together generates the cryptocurrency address. Since cryptocurrencies like Bitcoin can be used for peer-to-peer, fast and cross-border payments, it has caught the attention of the criminals for the purpose of using it for criminal activities. 

Ensuring anti-money laundering compliance for the cryptocurrencies has been a recent challenge that needs to be addressed urgently and there are five main topics to focus on in order to prevent criminals to abuse cryptocurrencies for the purpose of money laundering activities which are strengthened Know Your Customer (KYC), remaining cautious for the sanction avoidance, modifications to the 5th AML Directive, privacy limitations to decentralized coins and FATF standards on cryptocurrencies.

1. Know Your Customer (KYC)

According to a report prepared by CipherTrace in 2021 on “Cryptocurrency Crime and Anti-Money Laundering”, in 2020, 36% of international Bitcoin transactions are done via very weak or inefficient KYC procedures. The fact that decentralized payment systems such as Bitcoin, do not require personal identity data from their users, namely they do not collect information needed for Know Your Customer (KYC) procedures and by nature, there is no possibility of suspending or freezing the funds as in the centralized exchange systems, leaves cryptocurrencies vulnerable to the threats of money-laundering crimes. As the effective KYC processes are one of the essential parts of the Anti-Money Laundering protocols, implementing strong KYC requirements into cryptocurrencies can be an efficient solution in managing risks and fighting money laundering via cryptocurrency systems.

2. Sanction screening and Blacklist filtering

Virtual currencies are also seen as a way of avoiding specific sanctions as the cryptocurrency players are not included in sanction screenings or blacklists in most cases. Therefore cryptocurrencies remain open to exploitation and weak for the AML checks. Realizing this fact, the Treasury’s Office of Foreign Assets Control (OFAC) of the US took the necessary actions and started including cryptocurrency players to its sanction lists and blacklists to ensure that they are detected in sanction screenings and blacklist filterings and to detect those who use cryptocurrencies to avoid sanctions.

3. Adjustments to the 5th AML Directive

The 5th Anti-Money Laundering Directive of the EU included regulations that increased the transparency of crypto transactions with an aim to provide more information to the European financial regulators in order to fight money laundering and terrorism financing. Additionally, the 5th AML Directive focuses on new adjustments for the virtual asset service providers (VASPs) including custodian wallet providers and virtual-to-fiat exchanges. The fines are also very disincentive as the cryptocurrency systems that are not compliant with the new regulations may get penalties up to €200,000.

4. Privacy limitations to decentralized coins

The Financial Crimes Enforcement Network (FinCEN) in 2020 proposed that financial institutions and VASPs should collect and verify the identity of their customers, keep track of convertible virtual currency (CVC) transactions which are more than $3,000, and submit reports for CVC transactions over $10,000, if the counterparty in the transaction uses a non-custodial or “otherwise covered” wallet. The aim of this proposal is to make sure that the decentralized nature of cryptocurrencies are somewhat regulated against crimes of money laundering and terrorism financing.

5. FATF standards on cryptocurrencies

The Financial Action Task Force (FATF) released the “Draft Updated Guidance For a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers”, which was an update to guidance released in 2019. The new updates mainly focus on 6 topics:

  • Extending the definitions for what constitutes a VA (virtual asset) and a VASP (virtual asset service provider)
  • How FATF Standards apply to stablecoins
  • Additional guidance about risk and risk management for peer-to-peer transactions
  • Updated guidance about the licensing and registration of VASPs
  • Additional guidance for the “travel rule” in terms of the VASPs operating domestic and international transfers of VA
  • Motivating information sharing and collaboration between VASP supervisors and regulators

The current gaps in the regulatory landscape to cover cryptocurrencies result in financial criminals to illegally benefit from the crypto world for money laundering crimes . Data show that in 2020, $41.2 million worth of BTC were sent directly to criminals via US exchanges and 41% of the total international bitcoin volume sent by US VASPs are received by the VASPs due to weak or insufficient KYC procedures. With the increase in the legitimization of the process, the numbers for the crypto crime could decrease. In 2019 the volume of crypto crime was $4.5 billion and in 2020 it was $1.9 billion with a drop of 57%. Recognition and inclusion of cryptocurrencies into the regulatory framework can improve the overall quality and security of the virtual financial assets market and prevent the financial crimes of money laundering and terrorism financing to a great extent.