AML Risks Mean Financial Institutions Need Caution When Working with Cryptocurrency

It is not a secret that cryptocurrency presents anti-money laundering and counter terrorist financing issues for financial institutions. But what is it exactly about cryptocurrency that makes it so risky? A 2018 Allen & Overy article explains the unique issues for financial institutions presented by cryptocurrency from an anti-money laundering perspective.

In some respects, the challenges presented by cryptocurrency are no different from any other new financial product or innovation. Allen & Overy notes that “untested business models, potential for abuse and fraud, lack of a clear understanding of how cryptocurrencies are sold and traded via DLT (distributed ledger technology), and the underlying uncertainty of a rapidly evolving regulatory environment” are common between cryptocurrency and many other new financial products. But cryptocurrency presents several unique challenges as well.

For one, cryptocurrencies peer-to-peer transaction authentication was deliberately designed to avoid institutional intermediaries, which, as Allen & Overy rightly observe, have acted as essential gatekeepers in global AML. Also, the anonymity of cryptocurrency counterparties makes it difficult to carry out Know Your Customer (KYC) and Customer Identification Procedures (CIP). Allen & Overy also alerts us to geographical issues with cryptocurrency: with no in-built geographic limitations, it is difficult to know which jurisdiction’s regulations apply to a given cryptocurrency transaction.

As I’ve detailed elsewhere, regulators are beginning to react to the reality of cryptocurrency, but compliance programs at emerging cryptocurrency businesses are not likely to be up to the standards of traditional financial service providers. Thus, in addition to the inherent AML difficulties cryptocurrency presents, AML programs will largely be in the hands of cryptocurrency entrepreneurs whose risk tolerance Allen & Overy likens to the “wild west.”

Countering the real AML hazards presented by cryptocurrency is going to be a serious challenge for financial institutions participating in the cryptoeconomy. Allen & Overy explains that the “[r]apidly evolving technology and the ease of new cryptocurrency creation are likely to continue to make it difficult for law enforcement and FIs to stay abreast of criminal uses.” Clearly, financial institutions need

Allen & Overy go on to provide some recommendations for financial institutions considering engaging with cryptocurrency. Financial institutions should fully understand the elevated risks of cryptocurrency, as well as the role they will place in managing the AML risk. Allen & Overy recommends that financial institutions complete a risk assessment to see whether they can meet their AML obligations in the cryptocurrency context.

AML programs, Allen & Overy remind us, require the ability to “confirm the identity, jurisdiction, and purpose of each customer…” With that in mind, financial institutions needs to make sure that even with the inherent challenges of cryptocurrency from an AML perspective, they can still perform these core functions. Financial institutions can bring on customers engaged in the cryptoeconomy, but financial institutions consider such steps as requiring additional diligence when onboarding and monitoring.