A look at how cryptocurrency is changing compliance

December 28, 2020
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Cryptocurrency financial institutions have invested significant resources into complying with traditional financial regulations. But how is this new technology improving financial compliance as a whole?

We spend a lot of time at the BitAML blog advising cryptocurrency business owners and up-and-coming entrepreneurs about how to build compliance operations.

Cryptocurrency is still very much in its infancy, and thus far, the regulatory response to the industry has been to require them to adhere to regulations designed decades ago for the traditional financial sector.

This has caused no shortage of pain and difficulty for cryptos. While it’s perfectly possible to create a robust AML compliance regime under the Bank Secrecy Act as well as associated policies and procedures for customer information collection, monitoring and reporting potentially suspicious activity, and training staff (to name a few), other awkwardly-implemented rules (i.e. the Travel Rule) present compliance challenges that are as-yet unsolved.

This might leave readers with the impression that cryptocurrency is in an impossibly reactionary position — always behind and with no hope of catching up.

But in fact, cryptocurrency has actually given back to AML compliance in interesting ways.

Its very existence, and the innovations that it has contributed, have trickled up into traditional finance and improved everyone’s ability to combat money laundering.

Cryptocurrency is often perceived as a scrappy “underdog” or black sheep of the financial space. In this post, we point out that it’s important for professionals in traditional finance, as well as financial compliance, to recognize the role crypto has played in improving our tools, resources, and understanding; how crypto has actually made us better at combating financial crime in all its forms.

To that end, we present four ways that cryptocurrency has changed compliance.

1. Detection and prevention of romance scams

The casual mention of cryptocurrency in some professional circles will be immediately accompanied by a confident declaration that the entire market is plagued by scams.

Crypto has certainly had its fair share, but this isn’t 2015 anymore.

As crypto has become more popular, the ability of businesses to detect and prevent scams has improved dramatically, even outpacing some more traditional financial markets, like the pre-paid card industry.

Simply put, scam detection and prevention is an area of compliance that other industries stand to learn something about from crypto.

As an example, romance scams have drastically increased in recent years (we’ve noted before that our blog post on the topic is among our most popular every month, a reflection of the topic’s place in compliance discussions).

Particularly in the COVID era, where people are experiencing unprecedented isolation and loneliness, social distancing and the number of people connecting to communities online has provided perfect cover for financial criminals seeking to exploit using this scam.

In light of that reality, leading cryptocurrency companies have upped their game significantly.

Cryptos employ warning screens and other disclosures frequently, use expanded typologies to catch suspicious transactions, and are proactive about customer outreach in ways that other industries are still behind.

Note as well, that these strides have primarily occurred within a self-regulated context. Crypto has embraced the challenge, and emerged from the trial by fire with genuinely innovative ideas.

2. AML software

Bitcoin ATM operators have some of the most innovative compliance resources at their disposal. Why? Because kiosk manufacturers provide extremely sophisticated software tools with their products.

Natural language processing helps root out fake names and aliases instantly. Where banning customers can often be a very long and laborious investigative process at traditional institutions, some kiosk compliance software allows business owners to ban customers immediately based on suspicious wallet activity and other attributes.

These tools are incredibly useful for cryptos, but could also be used to benefit other financial services.

3. Cooldown periods

The so-called “cool down period” is a clever compliance innovation from crypto that can also apply to other financial products.

First-time customers of bitcoin kiosks and exchanges will often be subjected to a cool down period, in which there are a set number of hours or days that must pass before that user is allowed to transact again.

It is an informal but clever solution aimed at preventing first time customers whose sole intention is to transact several transactions over a period of time, possibly to disguise illicit activity.

At more traditional financial companies, this concept is unused or underutlized. In crypto, it is a best practice.

4. Liveness detection

Though liveness detection is certainly used in financial services to some degree, it is an industry best practice in cryptocurrency.

Kiosks comprise a large portion of the cryptocurrency market, and while Know Your Customer and Enhanced Due Diligence typically require a customer selfie with driver’s license at specific transactional tiers, cryptos are typically more cautious.

Using liveness detection (issuing commands through the kiosk screen, asking users to look up, or right, etc.) to verify that a customer is a real person is quickly becoming the norm among kiosk operators.

This extra step goes a long way toward curbing fraud, and traditional finance could stand to gain from adopting liveness detection more quickly, and at more transactional points.

Key takeaways

Cryptocurrency has contributed much more to financial compliance than you might think at first glance.

Traditional finance industries experience periods of stagnant innovation, so whenever a new financial product comes along, it behooves us as professionals to take a look at the organic, innovative compliance measures being taken and try to learn from them.

In the case of cryptocurrency, it’s clear that this new industry has much to offer financial compliance. The embrace of new technology (e.g. AML, software, liveness detection) provides use cases for other industries. Informal workarounds (i.e. cool down periods) designed to solve a particular problem can easily be adopted by other financial institutions.

And the seriousness with which cryptos have rolled up their sleeves to take on financial scams serves as a positive example to us all. Further, it reveals a maturing industry full of smart, caring entrepreneurs devoted to an old-fashioned spirit of innovation and problem solving.

As always, if you are a cryptocurrency business owner or entrepreneur looking into the space and have questions about AML compliance, reach out to BitAML anytime.

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