As banks increasingly adopt digital asset services, there remain inherent challenges in getting institutions and customers onboard with crypto and its benefits. But the time left to overcome them is drawing to an end
How virtual currencies gain mainstream credibility, circulation and liquidity along with fiat currencies will depend largely on how the market manages anti-money laundering (AML) and know-your-client (KYC) issues. SAS and Asia Risk hosted a roundtable discussion between four leading experts on the current state of technology, monitoring and management of AML systems for cryptocurrency.
Regarding the battle of perception faced by digital assets, a representative from a Hong Kong-based forensic investigator/advisory said that, regardless of current talking points, the final result is a foregone conclusion: “There’s always a focus on adverse, bad news coming from cryptocurrencies. Let’s look at the broader picture and developments. Governments realise that the tide can’t be turned – crypto can’t be stopped. The UAE [United Arab Emirates] recently called itself a crypto hub.”
He further emphasised: “Regulatory shifts in the US will affect US banks as custodians of cryptocurrencies. The narrative around cryptocurrency depends on who is talking and your view of market information. But the reality is that it will be part of mainstream finance and the challenge is how to operationalise it.”
Wide acceptance of the credibility and usefulness of cryptocurrencies is now seen as a matter of time rather than niche or a passing fad. Their growing size and application has compelled major banks to offer these newer asset types alongside traditional products, such as increasing adoption by banks of blockchain for trade finance.
An Asia-Pacific (Apac) head of a major global bank’s digital operations said: “Adoption is moving quickly in the Asian region. It is broadly seen across Apac as a growth opportunity. Many exchanges and regulators are moving quickly to establish infrastructure. Regional investors are expressing interest in digital assets and funding availability; innovation is encouraged. It’s becoming part of mainstream finance.”
They continued to note Apac’s strength in fintech in areas such as liquidity and pragmatic regulatory support. They claimed they had seen efforts by Australia’s authorities “to provide more clarity”.
The growth of crypto has been plagued by volatility, compliance problems and criminal activity. Participants would claim no-one promised the journey to mainstream acceptance would be easy or stable.
A former global head of digital assets at a universal bank noted: “A lot of the products are very intertwined in the overall landscape, such as stablecoin, which plays a critical role in the process of on- and off-ramp trading. So traditional market factors play a big role affecting it. This is a genie that won’t go back into the bottle.”
He added: “The regulatory pace of cryptocurrencies has picked up and is catching up with the market. There is a divide between retail and institutional segments of the virtual market, especially in regulation. In retail, a great deal of consumer protection is considered. It is now on regulators’ radars in terms of risk. Institutional regulation is approached from a balance sheet viewpoint. Consumer protection in retail is seen in areas such as token authorisation. Participants must keep track of the evolution and beware of cross-border differences in regulatory treatment. A complex landscape is emerging, especially when you factor in CBDCs [central bank digital currencies].”
Significant disparity still exists among many exchanges as some do not operate robust KYC and AML functions. This is reflected among regulators where some have developed and enforced advanced regimes and others remain behind. For example, Financial Action Task Force Recommendation 16 requests information on the origin of every transaction, yet some jurisdictions do not enforce it.
The forensic investigator/adviser observed: “I foresee a new definition of what ‘ultra-high net worth’ means. How will the perception of wealth change?”
The former global head of digital assets at a universal bank said: “People are wondering what the impact of cryptocurrencies is. Warren Buffett thinks it’s absolutely worthless. Opinions are polarised. It represents a generational shift.”
He added: “There is a role for crypto as an investment asset rather than just a payment platform, despite its volatility.”
The strong growth of crypto or virtual currencies has made it an asset class banks want and need to enter to sustain competitive advantage in capital markets. Developing and rolling out products and services suitable for their clients has become a priority.
Ahmed Drissi, Apac AML lead at SAS, commented, “From a control perspective, crypto participants are labelled as high risk and must endure arduous compliance, which could result in accounts being shut down. We need to help customers understand the risks. It’s important to have the right controls and not frustrate customers.”
He further emphasised: “Don’t follow a de-risking approach. But how do we mitigate the risk to the bank and customers? We are collaborating with traditional finance and helping customers understand money laundering from the viewpoint of service providers. Certain products like NFTs [non-fungible tokens] pose a risk of money laundering. Regulators need to understand what can be done on the blockchain to avoid frustrating users.”
Nevertheless, supporters and participants in the cryptocurrency market welcome regulation and support the end of anonymity, which was the original attraction and cornerstone of cryptos. Eventually, crypto exchanges will operate with the same obligations as traditional banks and financial institutions. The regulatory obligations and differences between exchanges and banks will narrow. Currently, some jurisdictions are accommodating while others assume a de-risking posture.
The former global head of digital assets at a universal bank said: “It is a tough situation for regulators. If you are too restrictive, you will restrict innovation. If you are too liberal, you risk exposing customers to big risks. Risk in this space is very significant and this is a new asset class. In a rapidly evolving and growing market, no single regulatory framework will provide the only answer.”
The Apac head of a major global bank’s digital operations commented: “There are traditional banks not involved in crypto, so they only see fiat. Other crypto exchanges do not have full KYC capabilities. If their customers are dealing with high-risk cryptocurrencies, this is where problems start because blockchain activity must be monitored. Banks need to monitor the blockchain and source of funds to be aware of illicit activity. Banks and exchanges need to combine online tools to do a proper investigation.”
Drissi stated: “Blockchain requires different tools and screens than traditional finance as different systems are required to conduct investigations. One needs to screen wallets against sanction lists, so the information and datasets required are different.”
Moneylending activities continue to represent a problem for regulators and international bodies. Products and activities such as decentralised exchanges that deal in anonymity or NFTs present unusual challenges. Person-to-person transactions in NFTs are difficult to investigate, regulate and enforce on unregulated exchanges. Custody is another challenge, as hacked accounts and theft must be reduced.
The forensics investigator/adviser added: “In that case, the traditional bank has a limited view by only seeing transactions between bank and crypto exchange. They don’t see the blockchain transactions coming on and off, especially higher-risk transactions in high-risk jurisdictions. It means identifying high-risk transactions.”
The former global head of digital assets at a universal bank said: “If you don’t have direct exposure, the risk is counterparty evaluation. It depends on looking at each counterparty’s onboarding and monitoring policy. It is still evolving due to machine learning and AI. You need to look for unhosted wallets – which are just public addresses you don’t know who is behind – hot transactions and privacy coins. How far you go in monitoring also depends on where your legal responsibilities end.”
Currently KYC, AML and due diligence for the crypto market are not unified, and the problem is magnified by too many exchanges. The correct analytical tools are needed to be able to apply risk weightings to KYC, AML and counterparty risks.
The forensics investigator/adviser pointed out contradictions, noting “AML cash is not traceable, but crypto is traceable. Yet risk is higher for crypto from banks. Why is there a perception that crypto is risky for AML? Doesn’t it depend on a bank’s risk appetite and tolerance? How do we see regulators and banks overcoming these hurdles to gain trust?”
The former global head of digital assets at a universal bank replied: “It’s not a new problem, as new asset classes have come along before. You need to clearly define risk appetite. You need clarity in client and counterparty selection and to scale up on a gradual basis. You have to move fast enough to keep up, but not too fast. Buyer beware, but have an exposure.”
He continued: “Cryptocurrency is an expertise-based domain; you need specialists to understand the technology and risk. Only time will tell if those policies inhibit development or force people into more unregulated spaces.”
The Apac head of a major global bank’s digital operations stated: “In three to five years we will have standards better established, giving banks a clearer sense of requirements and responsibilities in crypto. Foundation data needs to be better protected. They will speak the same language across borders. The integration will change, but there will still be a divergence between real and virtual.”
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