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Cryptocurrencies and AML Compliance: Need to understand this is rising for the VASPs

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Cryptocurrencies are one of the most innovative, dynamic, and rapidly evolving parts of the financial technology and services landscape. The idea of regulations and cryptocurrency, in the beginning, was not quite appreciated because of its inherent properties of being a decentralized financial instrument. However, the lack of necessary regulations is making these virtual assets a dreamland for money laundering and other financial crimes. Regulators are therefore extending control in terms of AML and KYC compliance protocols and checks, making it a basic need for Virtual Asset Service Providers (VASPs). The blog discusses how crypto is used for money laundering along with the significance of AML compliance and KYC in the space.

How are cryptocurrencies used for money laundering?

Vaishali Moitra, an analyst at Quadrant Knowledge Solutions explains the use of cryptocurrencies in for money laundering purposes as follows:

The digital currency known as cryptocurrency uses encryption to ensure that transactions are authentic, and records are kept independently of a central authority. Since it is not issued by a single entity, it is theoretically shielded against intervention or manipulation by the government. Cryptocurrencies are more susceptible to fraud and money laundering than traditional currencies. Since no personal information can be associated with the public keys used in a transaction, they offer better anonymity than traditional payment options. Online accounts are opened by criminals with digital currency exchanges that accept fiat money from conventional bank accounts. Then comes a “cleaning” process (mixing and layering). Here, they transfer funds into the bitcoin network utilizing tumblers, mixers, and chain hopping (also called cross-currency). Money is transferred between cryptocurrencies and across digital currency exchanges, the less regulated the better, leaving a trail of transactions that is nearly impossible to follow. 

According to the Crypto Crime Report by the American blockchain analysis firm Chainalysis, cybercriminals laundered $8.6 billion worth of cryptocurrency in 2021, which represents a 30% increase in money laundering over 2020.

Given this state, the regulators are now extending control over cryptocurrencies by implementing strict AML and KYC compliance protocols. AI-powered document verification, OCR-enabled photo data extraction, face matching, and ML-based fraud filters to automate crypto KYC verification are some of the examples of how technology is growingly used for the said purposes. Staying up to date with the changing regulatory landscape and technology solutions for the same therefore becomes crucial for the VASPs and other FinTech businesses.

AML compliance and Cryptocurrencies

Cryptocurrency AML consists of laws, regulations, and practices devised to prevent ‘layering’, a process in which criminals move illegally obtained cryptocurrencies among multiple institutions to obscure their origins and convert them into fiat currencies.

The Financial Action Task Force (FATF) sets global standards for AML legislation. When it released cryptocurrency AML guidance in 2014, most regulatory bodies across the world also codified their recommendations. The examples of which could be the President Biden of the USA signing an Executive Order (EO) ensuring responsible development of digital assets in March 2022, the 5th Anti-Money Laundering Directive of the European Union, Payment Services Act (PSA), and the Financial Services and Markets Bill 2022 in Singapore along with many other laws in Australia, Asia Pacific, and other regions.

AML-compliant crypto transfers reduce the risks associated with money laundering and terrorist financing, which improves customer trust. Given these dynamics, multiple firms are providing AML compliance solutions. Following the risk-based approach and comprehensive risk assessments, and other fundamental analyses to offer correct compliance and ensure best practices.

KYC and Cryptocurrencies

The first stage of anti-money laundering (AML) due diligence is known as “Know Your Customer” (KYC), wherein the financial institutions identify and verify the customer’s risk profile and propensity for financial crime. Vendors providing crypto KYC solutions increase the security for both the trading platforms and the end-users. The KYC solutions generally include the following:

  • Customer Identification Program (CIP) which includes verifying their legal names, addresses, and government-issued ID.
  • Customer Due Diligence (CDD) which assesses risk presented by the customer based on background checks such as transaction history.
  • Continuous Monitoring wherein the VASPs consistently reviews ongoing transactions and are obligated to submit suspicious activity reports (SARs) to the relevant law enforcement agencies.

The AML and KYC compliance solutions provided by the technology vendors offer all these services along with many other capabilities. Crypto companies and other VASPs must adopt these technology solutions to comply with their obligations, gain the trust of their customers, reduce risks, and improve security.

Final Words

Cryptocurrencies will definitely be subject to regulations in the future, given the risks posed by these innovative assets. AML and KYC compliances are therefore becoming a common practice in the space. Businesses dealing with such digital assets must stay aware of the changing regulatory and industry dynamics. Quadrant Knowledge Solutions keeps track of what is happening in the AML and KYC compliance landscape. We conduct an in-depth analysis of the technology solutions in these domains to give you strategic insights on the key functionalities, competition analysis, vendor profiles, market dynamics and competitive positioning in our proprietary SPARK matrix in the detailed research report. Take the right step in achieving your business goals with right information and strategic growth advisory.

Author: Vaishnavi Dave, Content Writer, Quadrant Knowledge Solutions.