The rise of cryptocurrencies has created more than a few challenges for governments and regulators. By their very nature, these currencies are decentralised, which means they are not reliant on a central authority like a bank. As a result, they are harder to track and easier to abuse, creating the perfect environment for money launderers.
In the following guide, we’ll look at some of the issues facing the crypto sector in 2023 while also asking how these issues can be resolved in the near and distant future.
What Are the Challenges of AML and Cryptocurrencies?
Cryptocurrency transactions have a high degree of anonymity, much more so than debit cards, credit cards, and web wallets. An individual can send and receive money using only a wallet ID—they don’t need to divulge their name, address, or even their age. This creates problems for the regulators, as it means they don’t have eyes on these transactions and there is no paper trail for them to check.
For this reason, it’s thought that criminals are using cryptocurrencies to launder huge sums of money. In fact, one estimate suggests that between 2016 and 2020, over $33 billion was laundered using cryptocurrencies, and that’s just the tip of this problematic iceberg.
Those numbers were calculated before the Russian invasion of Ukraine and the resulting sanctions. In the last year or so, it’s been suspected that individuals on sanctions lists have been using cryptocurrencies to get around restrictions and transact with entities all over the world.
Combine this with reports of cryptocurrencies being used on the dark web to facilitate drug deals and even to hire hitmen, and it’s no wonder that they have a reputation for being the currency of choice for criminals.
So, what can be done to stop these transactions and make life harder for the criminals?
What Are Regulators Doing About It?
Cryptocurrency regulation began with the exchanges, the place where most people buy, sell, and store these currencies. Before 2019, the industry was a veritable Wild West, with few regulations, no control, and lots of criminality.
This changed with the introduction of new rules and requirements from financial regulators like the SEC, CFTC, and FinCen. These US regulators put their heads together to establish new rules, such as classifying crypto exchanges as financial institutions and thus forcing them to abide by the rules of the Bank Secrecy Act.
This one seemingly small act made a massive difference, as it meant that exchanges were forced to abide by strict KYC and AML regulations.
Similar rules were introduced in the United Kingdom and the European Union. As a result, members of cryptocurrency exchanges are now required to submit proof of ID, address, and payment method. So, while cryptocurrency transactions can’t be tracked, every single transaction that occurs through the exchange can be tracked.
If we put it into a fiat money context, it’s as if the regulators are overseeing all deposits and withdrawals from bank accounts while ensuring they can track the people making them. However, they are unable to track what happens to a bundle of cash after it has been withdrawn and it could be used to fund crime.
What Are the Ongoing Problems?
The main ongoing issue concerns how all transactions are tracked. Technically, you don’t need a cryptocurrency exchange to acquire cryptocurrencies, nor do you need them to make a transaction, and that leaves the door open to fraudsters and money launderers.
There are a few potential ways that governments could initiate a complete crypto solution.
One of the best solutions is to continue targeting the platforms that use these currencies as a primary method of exchange. As noted above, this has already happened with cryptocurrency exchanges, but it is also happening in the online gambling sector.
Money launderers are drawn to online gambling like moths to a flame. These sites are often just as secure as many financial institutions and they are prepared to process huge sums of money, but they also accord their members a level of anonymity not available with banks, lenders, and investment platforms.
Regulators use Know Your Customer (KYC) rules to confirm the identity of everyone who uses these sites, making sure they are who they say they are. If red flags are raised, they can conduct additional source of funds requests to see where the money is coming from.
Stablecoins are also being proposed as a viable alternative.
A stablecoin is a cryptocurrency that’s backed by a fiat currency. It can be issued by a third-party (as opposed to the government), but as it’s backed by an existing fiat currency and used in secure transactions, it allows the regulators to maintain some control.
A central bank digital currency (CBDC) could also help and has been discussed by the UK government. A CBDC is a virtual currency designed to increase payment efficiency while reducing costs. Essentially, it is the virtual equivalent of a fiat currency (such as the Pound or Dollar) that the public can use to make digital payments in the same way as Bitcoin and Litecoin.
AML and the Future of Cryptocurrencies
Cryptocurrencies have given governments around the world a massive headache. Some have tried to block them and fight the tide, including China, which outlawed crypto trading and mining in 2021. Others have fully embraced them, with El Salvador making Bitcoin legal tender in the same year that China went the other way.
Everyone else seems to be looking for the middle ground. But finding that neutrality is proving to be very difficult. It’s hard to know what the future will look like, but it’s fair to assume that the current state of affairs can’t last and that governments will intervene sooner or later.
In the meantime, if you run a business that takes cryptocurrency payments, the onus is on you to stay compliant and keep your business and clients safe.
We offer state-of-the-art risk intelligence services to all companies subject to AML regulations, and these services include due diligence reports, database checks, and more. Contact us today for more information.
