Crypto Has a Compliance Problem: A Challenge You Need to Know

13.04.2022

Crypto stands still and it is here to stay. However, we have a problem. Compliance is not only the tip of the iceberg, but rather a whole new one we are yet to break-off.

Throughout the years, the crypto market and how we view it had immensely evolved. Now, it is no longer perceived as some mysterious thing from the dark corners of the web. It’s a complicated thing that we have been able to accept and understand better, trying to come to grips with what it is and how it works – and we are continuing to do so.

Crypto Has a Compliance ProblemThe rapidly evolving nature of blockchain has shown great opportunities and potential in changing the financial market. However, the anonymity it provides had also shown the inherent potential of being abused by criminals for various scams and money laundering schemes. This and its popularity in the global market have caused scrutiny from the authorities.

By its very nature, cryptocurrencies are freewheeling, unrestrained from currently existing regulations, posing a problem to authorities who are used to well-defined assets, with clear-cut rules. This is the exact same reason why compliance has been, and still remains, a huge challenge for crypto users and operators.

In terms of regulations and compliance, there had been cases in the past which forced government agencies to take action.

Just last 2021, the Justice Department and IRS (Internal Revenue Service) of the U.S. investigated Binance, the largest cryptocurrency exchange platform. This is due to some reports of a potential money laundering s which had also been a concern by policymakers from Japan, the United Kingdom, and Germany.

Recently, the crypto trading platform BitMEX was prosecuted by U.S. courts for claiming that they will be prohibiting American citizens to trade, but allegedly doing the opposite.

These evidently show that we have a problem and so far, the picture is not looking good.

Compliance is a challenge crypto must face one way or another, the sooner, the better.

THE PROBLEM IS TOO BIG TO GRIP WITH

The digital market has never stood still. It constantly presents new forms of crypto-related assets constituting to a big part of the problem – a sundry of transactions to regulate. And as unbeholden and borderless the cryptocurrencies are, assets and transactions to regulate, and regulations itself, can come from different horizons.

For example, the need to comply with state sanctions creates unproportionate rules across the global market. The U.S. had provided specific controls over digital transactions in Iran and Cuba, forcing Binance to ensure the deactivation of accounts from these countries.

There’s also ConsenSys Academy which banned over 50 Iranian users from the platform, in the fear of legal sanctions from the government.

Now, what should the regulators do in facing this challenge?

In order to minimize the size of the issue, the authorities should try to shift their focus away from regulating decentralized and on-chain applications and concentrate on more centralized transactions. Trying to impose regulations on decentralized applications will most likely be nothing but a waste of time, given that these often provide new alternatives.

By applying more rules to fund owners from centralized businesses, we can ensure better integrity for the market, protection for investors, and provide other safeguards essential in ensuring AML (Anti Money laundering).

Crypto Has a Compliance ProblemBut does this does not mean that we should completely abandon retail investors out? Rather, concentrating on centralized protocols and exchanges would likely help avoid market manipulation by huge businesses, which would prevent abuse to retail investors.

ENACTMENT OF THE TRAVEL RULE

According to the CoinDesk, “The Travel Rule means that providers of virtual assets need to collect and share customer data for transactions over a certain threshold. It simply means crypto providers must stick to international rules that ensure the protection of legitimate finance and prevent illicit finance.

In the U.S crypto market, the Travel Rule was used by the Financial Action Task Force (FATF) by creating a threshold that once reached, a compulsory collection of information for any international transaction is being imposed, as well as a retention for related transfer of information. This is an attempt by the FATF to prevent the public from choosing the most favorable international compliance rules.

Banking firms were the only ones previously involved in the Travel Rule. But back in 2019, the FATF applied the same to crypto organizations, together with their local rules intended for AML.

With the current FATF regulations, the threshold applied is USD 1,000 for transfers involving the U.S. However, the Financial Crimes Enforcement Network (FinCEN) have recently brought forward a proposal, adjusting the threshold to just USD 250. This creates a new problem for crypto users.

However, it is very much ideal to fully implement the Rule. Realistically, it would be difficult to determine a definite travel system that would perfectly satisfy the market. Aside from this, there is also the issue of anonymity in the blockchain, presenting a challenge on identifying exact owners and addresses involved in the blockchain.

CUSTOMER VERIFICATION: THE UNDERLYING PROBLEM

One primary problem that most crypto businesses face in terms of compliance is the lack of proper customer verification. This makes them more at risk for scams and abuse, facing fake IDs, documentation, and leaked databases.

With a little bit of research, you will see fake accounts being sold at USD 1 on the internet. There are also verified IDs accessible for only USD 300 coming from intercepted databases. More high-end schemes involve seizing information using Deepfakes and unsecured browsers.

These are just a few examples of the overall picture of the problem the crypto market has. There are more sophisticated attacks out there, where users are directly routing themselves to the traps, creating more complicated issues for the industry.

These issues are also expected to strike banking firms that have been recently entering the crypto landscape. Recent studies have shown that banks devote around 4 to 6 % of their revenues to ensure compliance. However, around 10% of these banks lack proper customer verification process, risking insufficient data protection.

COMPLIANCE IS A SERIOUS MATTER

Crypto Has a Compliance ProblemPaul Brody of Ernst & Young Global recently said: “The only way that blockchains will deliver upon their true promise to the world is if public blockchain networks are the preferred path for enterprises and investors.” 

However, the crypto industry must work on ensuring protection and market integrity. Compliance is a huge challenge ahead of us. There is no way for us but to confront and deal with it head-on. Postponing the much-needed confrontation and overlooking the problems will just lead us to much more complicated challenges down the road.

In the traditional landscape, financial firms are mostly unenthusiastic in scrapping off their profit margin to deal with compliance. Businesses are mostly reluctant and tend to underinvest when it comes to ensuring proper regulations. However, investing as early as possible would likely save us from more issues that could snowball in time

Compliance problems have been here since the birth of the crypto industry. It is a challenge we must solve as soon as possible, or else, more damage might strike us that will be too late to cope with.

We in COREDO provide crypto compliance consultation and services. Reach us through the below link so we can help you.

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