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November 30, 2023

Cryptocurrency Exchanges: Managing the Risks  

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Offering cryptocurrency as a payment method gives buyers another option for purchasing goods and services. But because cryptocurrency is decentralized – not controlled by any government or financial institution – exchanges dealing in this virtual currency operate while regulations are inconsistent across the board, and this is exactly what opens the door for illicit activity. 

If your portfolio includes merchants who deal in virtual assets or you’re considering adding this merchant category, you should be aware of the potential risks.  

In this article, we’ll tell you more about cryptocurrency, the types of risk posed by cryptocurrency exchanges, the methods criminals use in cryptocurrency scams, and more. 

What is cryptocurrency? 

Cryptocurrency is a digital or virtual currency that uses cryptography (the process of converting legible information into an almost uncrackable code) for security and operates independently of a central bank. 

Cryptocurrencies are typically stored in digital wallets called “crypto wallets" and can be bought, sold, and traded on cryptocurrency exchanges. They are often used for online transactions, peer-to-peer payments, and as a store of value. 

Who uses cryptocurrency? 

An increasing number of legitimate businesses offer cryptocurrency as a payment method to expand their customer base –including well-known companies such as Starbucks, Subway, AMC Theatres, and Microsoft. Cryptocurrency is also accepted by some sellers on popular online marketplaces like Etsy. 

The downside is that accepting cryptocurrency can also open the door to criminal activity. Criminals are drawn to cryptocurrency because it enables them to move large sums of money under the radar. In other words, they avoid the usual large transaction reports that banks are required to submit when they see suspicious movement of large amounts of money.  

It is also harder to trace cryptocurrency back to the owner’s crypto wallet, which can enable criminals to hide behind anonymity. This is what makes cryptocurrency so attractive to bad actors looking to launder money for illict activities like human trafficking, child pornography, and even terrorism. 

In addition, crypto on- and off-ramps, where users convert fiat money to cryptocurrency and vice versa, pose additional risks to exchanges and/or users of being hacked and having their funds stolen. 

Why verification of merchants dealing in virtual currencies is important 

In many jurisdictions, dealing in virtual currencies requires licensing and compliance with anti-money laundering (AML) and Know Your Customer (KYC) or Know Your Business (KYB) regulations. That’s why it’s important to verify all merchants dealing in virtual assets. Verification also reduces your risk of exposure to fraudulent and illicit activity. 

Unlicensed or unregulated cryptocurrency exchanges may operate without these safeguards, making them more attractive to bad actors looking to launder money or worse. 

4 methods associated with cryptocurrency 

A quick Google search returns dozens of stories of hard-working consumers being duped out of large amounts of money, even their entire life savings, through cryptocurrency scams. Here are four methods used by criminals that payment providers and financial institutions should consider when monitoring merchants trading cryptocurrency. 

  1. Exit scams – When an exchange suddenly shuts down and takes users’ funds with it. 
  2. Fake ICOs – Some fraudulent exchanges create fake initial coin offerings (ICOs) to trick people into investing in fake cryptocurrency. 
  3. Pump-and-dump scams – Some exchanges manipulate the price of a particular cryptocurrency by artificially inflating it and then selling off their holdings, causing the price to crash. 
  4. Hacking – Exchanges are more vulnerable to hacking attacks, which can result in loss of user funds. 

SEC crackdown on cryptocurrency 

Regulators have recently become more diligent about cracking down on cryptocurrency exchanges, and this year has been a rocky one for these platforms, with several crypto businesses denied the right to operate in a number of different countries.  

Binance, a global cryptocurrency platform, for example, announced that it would exit Canada in May after citing “regulatory tensions,” and it has since been denied the right to operate in countries which include the Netherlands and Belgium. The platform hasn’t been allowed to operate in the UK since 2021. And a recent investigation by the US Department of Justice resulted in a settlement that requires Binance to fully exit US markets, as opposed to the partial exit it claimed in 2019. The new CEO has pledged “responsible growth,” and regulators will be watching. 

Cryptocurrency has also taken center stage in the recent terrorist attacks, as it became clear that Hamas had derived millions of dollars in funding from crypto schemes. Interestingly, the transparency of the bitcoin blockchain also made it possible for governments to trace the ill-gotten assets and freeze the accounts 

Meanwhile, the losses to users of cryptocurrency exchanges keep going up. More than $20 billion dollars was reportedly stolen from users on cryptocurrency exchanges in 2022, and CoinDesk reports that cryptocurrency traders lost more than $303 million from “exploits and hacks” in one month alone this year in July. 

Mitigating risks associated with cryptocurrency 

Cryptocurrency and crypto mixers are decentralized and operate outside of regulatory frameworks. This lack of safeguards makes them an attractive method for criminals to use in money laundering and fraud, enabling bad actors to obfuscate payment origins and endpoints.  Strong verification procedures, as well as ongoing monitoring, are necessary to mitigate the risks of conducting business with merchants who deal in these virtual currencies. 

EverC can help to identify merchants that are potentially involved in suspicious or criminal activity, even when their activity is purposely hidden. Our technology leverages AI for increased speed and precision in detection rates, enhancements to features and tools, and unmatched customization capability, for solutions that that allow you to meet your business goals while aligning with your RBA and industry priorities.