Chuck Taylor
Midyear, Janet Yellen the current administration’s Treasury Secretary weighed in on Virtual Currency (Crypto) “To the extent it is used, I fear it’s often for illicit finance. It’s an extremely inefficient way of conducting transactions, and the amount of energy that’s consumed in processing those transactions is staggering.” She has also called Bitcoin a “highly speculative asset.”[1] Crypto advocates while likely agreeing with these sentiments on some level will protest that these views are too narrow and short sighted.
Throughout 2021 more and more legitimate players have entered the Crypto arena. Established Crypto exchanges have been joined by new start-ups. These entities tout their regulatory compliant onboarding processes and transaction monitoring to identify and report suspicious activity. Many also now offer products beyond Crypto investing and exchange; offering debit cards that draw down Crypto wallets, payment processing via Crypto, and Non-Fungible Token (“NFT”) marketplaces. In addition, traditional financial institutions have searched for ways to assist customers with Crypto through custody and investment opportunities. The Office of the Comptroller of the Currency (OCC) has provided interpretive letters to assist the institutions with information on custody services and other virtual currency related activities.
These moves appear to show the tide of Crypto moving toward legitimacy as increasing numbers of individuals and entities invest in a varied array of Cryptocurrencies. Doing so is as simple as downloading and app to your smartphone, being validated in their onboarding process and linking a payment method such as a bank account or credit card. In a matter of minutes, an individual can be purchasing and/or receiving Crypto from other parties.
At the time of this writing Crypto.com was tracking more than 8,000 Cryptocurrencies that purport to facilitate or support varied concepts such as smart contracts or file storage to novelty coins like Dogecoin. They have a range of controls, but most have a public blockchain where transactions can be seen and a cap on the number of coins that will ever be mined or created.
Though apparently more legitimate and accepted than in the past there is still skepticism, “I personally think that Bitcoin is worthless,” Jamie Dimon, CEO of JPMorgan said recently. Many other important voices share the same view and, it is worthless. Cryptocurrency has no inherent value and is only worth what the next purchaser will pay for it. This is evident in the daily fluctuation of Crypto prices. So called “stablecoins” attempt to mitigate the volatility by having their value linked to a government issued currency or other asset, such as gold, with a more stable value. Stablecoins though have limited appeal as most see Crypto as an investment opportunity.
Investing comes with risk above and beyond the volatility as many Crypto coins are set up just to facilitate pump and dump schemes. These schemes involve creating a new coin and then promoting it on social media. Early investors may see a return but getting out too late can wipe out all remaining funds invested in a matter of minutes.
An ongoing investigation by the Justice Department and the IRS of Binance, the world’s biggest Crypto exchange, for apparent money laundering and tax offenses, indicates that there is room for improvement in compliance controls even among well-known facilitators. Binance is incorporated in the Cayman Islands and has an office in Singapore but does not have a US presence operating largely outside US regulatory controls. US customers using Binance though can bring those activities under US jurisdiction. Other Crypto exchanges set up in lax jurisdictions have few controls around traditional Know Your Customer (KYC) guidelines, sometimes allowing purchase and exchange transactions with little more than an email address.
Crypto transactions can be take place completely outside any hosted or third party tools via wallets maintained on personal computers and “Over the Counter” transactions that are strictly peer to peer only visible via the block chain when value is moved from ne wallet to another.
FinCEN’s proposed requirements for Crypto will potentially require covered Crypto entities to move closer to the reporting requirements of traditional financial institutions. While currently required to have AML programs and file Suspicions Activity Reports (SARs), Crypto entities would be required to file a Currency Transaction Reports (CTR) on Crypto transactions more than $10,000 USD.
Reporting and compliance controls do little to impact the fact that Crypto is the currency of choice for “darkweb” transactions, ransomware attacks and under the radar money movement. While these activities may represent a small amount compared to the investment only activity, it remains a huge challenge for law enforcement.
Where does this leave financial institutions that want to allow their customers to participate in legitimate Crypto transactions while detecting and deterring illicit activity? It remains a difficult task. If you ask most BSA Officers, they will tell you that their financial institution does not bank Crypto exchanges and that that type of client is prohibited. A recent survey of the Mid-Sized bank Coalition BSA Officers Roundtable indicated that 85% prohibited Crypto business but will allow their clients to transact with legitimate Crypto exchanges. Two percent prohibit all Crypto activity.
Saying that legitimate transactions are allowed is one thing, but identifying what is legitimate and what is illicit can be difficult. A transaction that goes out to a regulated exchange may appear innocuous but where it goes from there is out of the bank’s control. Conversely, incoming transactions could be sourced from criminal activity. The difficult part is identifying the gateways to unregulated Crypto exchanges that may be undetectable in keyword searches and other remedial controls. ACH or credit card transactions involving unregulated exchanges normally are undetectable via traditional transaction monitoring because they are normally under thresholds and involve entities with no apparent ties to the exchange. Various vendors have come up with ways to identify these gateways and risk rate exchanges but without these tools most banks are facilitating illicit Crypto activity that they cannot detect.
To close this gap, in is important to understand who your clients are transacting with, assess the risk of the activity, and determine what tools and processes are needed to mitigate risk so it is within your organization’s risk appetite.
[1] CNBC Interview Referenced by Washington Post 8/25/2021