People
We’re in a crypto winter, but this dip is different. Values and trading may be down, but regulator interest is hitting new highs, and crypto exchanges need to be on the front foot in readying themselves for surging scrutiny.
With a market capitalization of over $900 billion, crypto will no longer be viewed as a sideshow. It’s in the limelight, on center stage. This means that crypto exchanges will need to ramp up their focus on anti-money laundering (AML) compliance and Know Your Customer (KYC) requirements, and account holders at those exchanges will need to be focused on getting their tax affairs in order.
Enforcement is heating up
In 2022 alone:
- The New York State Department of Financial Services fined the crypto currency arm of the Robinhood trading platform $30 million for failures in its anti-money laundering (AML) and cybersecurity processes.
- European Central Bank head Christine Lagarde urged the need for regulation and warned that crypto assets are being used as means to circumvent international sanctions imposed against Russia.
- The Joint Chiefs of Global Tax Enforcement (J5) announced the release of an intelligence bulletin to warn of potential dangers and risk indicators of illicit financial activity involving Non-fungible Tokens (NFTs).
- Numerous criminal enforcement actions have made headline news, including:
- The Department of Justice (DOJ) announced the indictment of two individuals for conspiring to launder more than $4.5 billion in stolen cryptocurrency during the 2016 Bitfinex Hack.
- The DOJ announced that it had seized and shut down Hydra Market, one of the world’s largest and longest running darknet marketplace.
- The US Department of Treasury’s Office of Foreign Assets Control (OFAC) announced the first ever sanctions on a virtual currency mixer Blender.io and later sanctioned virtual currency mixer Tornado Cash, which has allegedly been used to launder more than $7 billion in virtual currency since its creation in 2019.
- The DOJ charged an employee of the NFT marketplace OpenSea with wire fraud and money laundering in connection with operating a scheme to commit insider trading with NFTs.
- The operator of BTC-e was extradited to the US to face money laundering charges, allegedly valued at $4 Billion.
- In July, two major US crypto lenders, Celsius and Voyager, both of which advertised high interest rates on crypto deposits, filed for bankruptcy protection after they suspended customer withdrawals following the decline in prices earlier this year.
- The recent John Doe summons issued by the Internal Revenue Service (IRS) to the exchange SFOX follows several others that aim to reveal exchange customers that have made significant gains from cryptocurrency without reporting and paying tax on them.
As funds and investors have flowed into cryptocurrency in ever greater numbers, regulator interest has intensified globally, and the scale of the compliance challenge for crypto exchanges has grown, too. Indeed, in the US, the additional $80 billion the Internal Revenue Service (IRS) will receive is allowing it to build its headcount to process day-to-day tax matters (and to clear a backlog) and allow the IRS to recruit specialists to tackle more sophisticated financial dealings, like crypto trading.
Estimating exposure
For exchanges, their backers and their investors, the scale of the compliance challenge continues to rachet up. There are more investors than ever using the many platforms now available, and analysis of risk exposure from the crypto business is a complex task given the heightened enforcement environment and areas of regulatory uncertainty across the globe.
Exchanges and organizations investing in crypto platforms must ready themselves now for growing oversight and scrutiny by asking themselves a number of questions that will help establish a clearer view of risk exposure.
Compliance Checklist
As an exchange:
- Is risk management and compliance due diligence fit for purpose with today’s crypto investor base?
- What are the risks posed to the exchange, and what is the state of the AML safeguards?
- How can exchanges mitigate risks involving illicit schemes or scams being targeted on our business or our customers?
- How can exchanges adequately prepare to prevent liquidity issues arising due to price fluctuation?
As an investor in an exchange, platform, or crypto company:
- Have we done enough due diligence? What happens if there is an issue shortly after we make an investment?
- What is the cost of uplifting the risk management program of the target?
- What will future regulation mean to market prices?
- How do I know if my investments are protected or insured?
