3 Common Risk Assessment Mistakes Crypto Businesses Make

November 17, 2019
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It’s vital to control for the risks that come with running a cryptocurrency business, but how do you identify those risks in the first place? The first step all cryptos must take (before they open for business) is to compile a risk assessment.

A cryptocurrency risk assessment is a critical starting point toward developing the controls and processes you need for institutional AML compliance. It will not only show you where your business might be vulnerable to financial crime, but it will also point out the considerations you will need to take into account when it comes to detection and reporting protocols.

Your AML compliance program shouldn’t be built on regulatory guesswork. It should be based on the real risks you will face depending on how (and where) you do business as a cryptocurrency MSB/money transmitter.

While many budding entrepreneurs in the crypto space are aware of the need to develop a risk assessment, it takes a compliance professional with knowledge of cryptocurrency to make sure the appropriate points are addressed. To wit, we’ve worked with cryptocurrency businesses who attempt to author a risk assessment on their own, and have noticed that they often make the same key oversights.

This post covers the three most common we’ve observed. When you put together your risk assessment, this will help you make sure your analysis isn’t compromised.

Why Are Risk Assessments So Essential?

If there are already regulations in place to help you create a crypto AML program, why do you need a separate risk assessment?

Very simply, AML is not a one-size-fits-all process. You need to know what your unique risk profile is. Every city you operate in and every type of cryptocurrency service has its own risk factors which will inform the policies you put in place.

In addition, current cryptocurrency regulations comprise a mix of old banking regulations, reactionary policy, and a lot of patchwork. Thus, it’s important to create policies in the spirit of financial compliance as much as the letter. As new regulations are released, you want an AML program that is dynamic, scalable, and responsive to the cryptocurrency risk factors you’ll face.

Cryptocurrency Risk Factors For Businesses

The risk of doing business in cryptocurrency is a lot more than just losing your personal money or having your net worth go down if crypto values drop. Cryptocurrency risk management means knowing the risks you face from fraud, financial criminals, and black market activity.

You’re more open to attack than any other kind of financial institution. First, cryptocurrency businesses allow people to move money more quickly than any other method. That means everyone – including financial criminals – can be in and out in the blink of an eye, disguising their transactions before anyone knows what happened.

The funds can also go anywhere. That’s part of the attraction – there are no borders or walls with crypto. But it’s also part of what makes it more attractive to criminals. The value of cryptocurrency is consistent around the world, and there’s very little paper trail for transactions.

Cryptocurrency also offers a degree of anonymity in an increasingly digital era, though it is not completely anonymous. Regulations require businesses to use better Know Your Customer (KYC) processes, but it is still hard to determine the exact owner of a wallet. You can easily pass a wallet to another owner without a formal record, as well. This poses challenges for tracking criminal activity.

These are risks inherent to cryptocurrency as a technology; there are also geographic and customer risks that must be taken into account in a cryptocurrency risk assessment.

In short: it’s complicated.

Common Crypto Risk Assessment Errors

As you can see, there are a lot of risks you need to anticipate and mitigate. A company risk assessment, though not explicitly required by regulations, is a universally agreed-upon best practice.

However, we often see companies make significant mistakes when they approach the risk assessment process. Here are the top three mistakes and how you can avoid them.

1. Downplaying Risks

Red Flag for Risk Assessment - BitAML BlogCompliance, AML, and KYC processes take time and capital to put in place. Unfortunately, that leads a lot of crypto business owners to downplay the very real risks that they face. If you convince yourself that the risk isn’t significant, you can do less to prepare for it.

If you water down the risk, you’ll find yourself in hot water with regulators. More importantly, though, there will be a strong chance that your company will become a target for hackers or an associate of black market criminals and terrorists.

You may think that because you only facilitate small transactions or are a small part of the market you’re not a target for these types of people. The reality is that criminals target businesses of any size that are slack in their security. Don’t be that target!

From a regulatory standpoint, your business is the same as any other crypto company. A smaller bank doesn’t have less security or different rules, and a small cryptocurrency business doesn’t either. Plus, don’t you want room to grow?

Be honest about the inherent risk in crypto and the specific risks your business faces. To do otherwise appears dishonest or naïve.

2. Not Thinking Through The Analysis

A crypto risk analysis isn’t something that can be done casually or quickly. An examiner that looks at your risk assessment is going to ensure that you clearly understand the risks you face and are willing to take action on them.

If you don’t think things through, you’re less likely to qualify for necessary licenses and you may find yourself under more specific scrutiny from regulators.

Smart, detailed risk analysis is a sign of thoughtfulness with regard to compliance in financial institutions.

3. No Clear Formula For Determining Risk

Recognizing and measuring risk cannot be done in a few paragraphs in a memo. You’ll need to use real methodologies and formulas to identify and quantify risk. You don’t want your risk assessment method to be general guesswork.

A typical formula goes as follows: “Inherent Risk – Mitigating Controls = Residual Risks,” and you can use a variety of approaches to assess the score for each category. You want to accurately understand the inherent risk and have specific mitigating controls that give you as little residual risk as possible.

This portion of the risk analysis is where you show examiners and regulators what steps you’ve taken to handle the concerns in the industry and how much difference those measures are expected to make.

Key Takeaways For Crypto Businesses

Risk assessments are essential because cryptocurrency is an inherently risky business. Not only do you need to comply with a variety of regulations, but you also need to avoid becoming a vehicle for criminal activity.

Doing your own risk analysis can be daunting, especially if you don’t understand how to quantify risk and determine the amount of mitigation you get from each AML or security measure. The good news is that you don’t have to do it alone.

If you’re ready to tackle a risk assessment and would like some assistance, we’re here to help.

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