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January 25, 2023

Regulators Zone in on Digital Assets

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In November 2022, one of the world’s largest cryptocurrency exchange platforms FTX filed for bankruptcy. It was valued at $32 billion just a few months prior. FTX’s founder and former CEO, Sam Bankman-Fried, was shortly thereafter arrested on multiple civil and criminal charges, including conspiracy to commit money laundering. Investigations are currently underway to determine if FTX improperly used customer funds, and, more specifically, to prop up Bankman-Fried's other trading firm, Alameda Research. As it stands, at least $8 billion of user funds are missing from FTX’s ledgers, with US prosecutors reportedly calling the incident “one of the biggest financial frauds in American history”.

While the collapse of FTX was simply the latest in a series of major crypto failures throughout 2022, it shined the spotlight on legal loopholes within the digital asset sector and the risks posed to consumers. 

Cryptocurrency failures prompt regulation

Legislators are now seizing the opportunity to address gaps in regulation. US Senators Warren and Marshall on December 14 introduced the bipartisan Digital Assets Anti-Money Laundering Act to expand anti-money laundering (AML) regulations to the digital asset ecosystem, including cryptocurrency. Like the ENABLERS Act advanced in June 2022, the Digital Assets Anti-Money Laundering Act aims to hold various nontraditional players responsible for facilitating transactions.

The Digital Assets Anti-Money Laundering Act 

According to the proposed legislation, crypto entities would be reclassified as “money service businesses” under the Banking Secrecy Act (BSA). This would increase oversight of the largely unregulated digital asset sector, requiring businesses dealing with crypto to implement appropriate risk management practices to prevent illicit activities and safeguard clients’ funds.

The proposed Digital Assets Anti-Money Laundering Act includes the following:

  • Regulators will establish risk-focused and review processes for money service businesses to assess compliance with existing AML regulations

  • Banks and other financial institutions will be banned from using or doing business with anonymity-enhancing technologies such as digital asset mixers

  • Americans engaged in digital asset transactions greater than $10,000 through offshore accounts to file reports with the Internal Revenue Service (IRS)

  • Digital asset ATM operators and administrators to submit and update the physical addresses of kiosks as well as maintain Know Your Customer (KYC) protocols

Is crypto legit?

FTX’s swift undoing not only devastated the wallets of its users and wide investor network, but rippled across the entire cryptocurrency market, losing the industry billions and inflaming distrust of the technology. That said, the collapse of FTX and other crypto giants in 2022 has not so far adversely impacted other financial markets as cryptocurrency remains a relatively nascent technology and disconnected from the broader global economy.

Generally speaking, the benefit of cryptocurrency as a decentralized paradigm is due to its ability to streamline the money transfer process, making it cheaper and easier for people to do business directly. Individuals and corporations can diversify their investment portfolios and generate profits using relatively secure blockchain technology.

However, exchanges, stable coin issuers, and other virtual asset service providers are higher risk for money laundering in that users maintain a high degree of anonymity as compared to the traditional banking system. Crypto exchanges are susceptible to hacks and users can easily obfuscate the movement of digital assets, particularly across international borders. According to leading blockchain intelligence company Chainalysis, criminals laundered 8.6 billion USD worth of cryptocurrency in 2021, constituting a 30 percent increase compared to 2020. This figure is expected to grow as virtual currencies become more widespread.

The need for increased oversight on digital assets

Authorities have stepped up efforts to detect and prevent criminal elements from exploiting gaps in AML regulatory oversight, including determining the source and beneficiaries of digital asset transactions. In August 2022, US authorities charged virtual currency mixer, Tornado Cash, of laundering more than $7 billion in virtual currency since 2019. The US Treasury Department stated that the company “repeatedly failed to impose effective controls designed to stop it from laundering funds for malicious cyber actors on a regular basis and without basic measures to address its risks”. Additionally, Tornado Cash was used by Lazarus Group, a state-sponsored North Korean hacking group sanctioned by the US, which posed a threat to national security.

Dealings with digital assets are vulnerable to possible misuse by a host of bad actors, including drug traffickers seeking to launder illicit proceeds or internationally sanctioned countries like North Korea, Iran and Russia using cryptocurrency to launder money across borders.

Like the US, lawmakers across the globe have been making similar moves in relation to increasing regulation in the digital asset sector. On December 7, Hong Kong legislators recently passed an amendment to the existing AML infrastructure to include a licensing regime for virtual asset service providers (VASPs). In the UK, the Financial Services Markets Bill (FSMB) is expected to be passed into law by Spring 2023. And in Australia, the government plans to establish licensing and regulation framework for crypto service providers in the first quarter of 2023.  

What’s next for digital currency regulation?

While all these countries take different approaches to regulating the digital asset sector, the upcoming changes nevertheless indicate that cryptocurrency has become a major player in the global financial landscape. The plethora of businesses using or facilitating virtual currencies ought to understand the impact of these changes and maintain an effective AML program to sift out the bad actors. Failure to do risks legal and financial ramifications, spanning from hefty fines to a cessation of business operations. Not to mention the reputational damage incurred should your company be found to have inadequate AML procedures.

EverC empowers businesses with the ability to identify crypto merchants and can offer insights into mitigating risks posed by possible fraudulent activity.   

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