“But is it real money?” This is a question asked by the average person when first discussing cryptocurrencies such as Bitcoin.  While the answer is complicated, the government is continuously working to enforce new regulations that will treat it as such.

In recent years, there have been numerous anti-money laundering laws set in place to prevent people from transferring crypto funds illegally. Although this is great news for those who would like to use crypto in a legitimate fashion, there are still many challenges that crypto exchanges face with heightened regulation requirements.

To discuss the nuances of crypto exchange regulation and the pros and cons of holding it to the same standards as other currencies, PaymentsJournal sat down with Neal Reiter, VP of Compliance Products at Acuant and Tim Sloane, VP of Payments Innovation at Mercator Advisory Group.


Cryptocurrency Exchange Compliances Pose Challenges for Decision Makers

PaymentsJournal Cryptocurrency Exchange Compliances Pose Challenges for Decision Makers

NEW: 2020 Anti-money laundering (AML) regulations

New Anti-money laundering regulations

In the most recent budget bill (US only), there are several hundred new pages of Anti-money laundering regulations, which is the first major update in the last 19 years. The new Anti-Money Laundering Act (AMLA) states that “every [financial institution] (FI), including crypto exchanges, has to review it, has to understand it, and has to integrate what it says into their AML programs,” explained Reiter. Once legislation is passed, the act becomes law and must be followed accordingly, so it is crucial that all FIs review the content and inform themselves of the impact it will have on their day-to-day operations.

“There [are] some things that are really going to benefit financial institutions,” added Reiter. “And one [benefit] is there [are] now federal standards for disclosure and reporting of beneficial ownership.” So what does this mean?

One big focus of the document is surrounding information sharing. Technically, Financial Institutions can share information via a 314b, but it’s a very slow and manual process. “And what the government is looking for is for financial institutions to start sharing data more safely, of course, both within their own institutions and with the government.” This is set to include everything from Currency Transaction Records (CTR) and Suspicious Activity Reports (SAR), which will be mutually beneficial for all parties involved.

Next, the AMLA is set to increase potential fines and penalties for those not abiding by the new regulation. Lawmakers have also made it easier and more lucrative for whistleblowing defectors to come forward when they witness potentially harmful activity.

Lastly, there are a handful of shell companies that exist and have existed for quite some time, and it can become difficult to find out who is controlling these companies. “What federal standards are saying is that no, that that can’t be the way,” continued Reiter. The new AMLA will now require start-up companies to disclose who is in charge and any changes of ownership, something that has never been required in the US and doesn’t exist elsewhere.

“Big four items [are]: FIs must read this [AMLA] and understand how it’s going to impact them; there’s now new standards for disclosure for [Know Your Customer] (KYC) or Know Your Business (KYB); information sharing has been increased; and potential fines have been definitely increased,” summarized Reiter.

What is the “Travel Rule?”

When funds are sent from Point A to Point B, certain information must be passed on. The server needs to know which FI is sending the money, how much, and on which date. It is also important to know who is receiving the funds. The required information is what is known as the Travel Rule. 

“It made total sense for swift messages and wires. And it’s a way for law enforcement to know who’s moving money,” explained Reiter. “The challenge here is there’s no way to do this with Bitcoin currently.” And it’s not just Bitcoin that poses a challenge, but cryptocurrency in general.

Currently, there’s no good way to get this information because of the numerous exchange rates. “What you have is fiefdoms popping up…and what this means is we, as crypto traders, cannot comply with [the Travel Rule]. There’s no way to do every crypto exchange,” said Reiter. If regulators start to enforce the Travel Rule, it’s going to be an issue for crypto traders because there’s no way for them to actually follow all the mandates stated within the Financial Action Task Force regulations.

On the other hand, “it means that there’s opportunities for those that are able to manage the compliance functions within their gated community to grow with those who want to use Bitcoin, or crypto in a legitimate fashion,” responded Sloane.

The impact of FBAR (Foreign Bank Account Report)

Everyone has to file their taxes, but for some, there are a few extra steps. FIs must file directly with Financial Crimes Enforcement Network (FinCEN) if the taxpayer is a US citizen who has had over $10,000 in a foreign bank account during one financial year. On the other side, there is the Foreign Account Tax Compliance Act (FATCA), which states that non-US FIs have to report US customers that are using their service.

“What this means with FBAR is that US customers will stop using Non-US crypto exchanges. And Non-US crypto exchanges are going to stop servicing US customers,” warned Reiter. In 2014, the IRS said Bitcoin was not considered to be a currency. But in the final moments of that year, the rule was applied to crypto. What this means is that an account holder with at least $10,000 in exchange in Europe, Asia, or Mexico would have to report to the US government. The same rule was applied to FATCA.

“This is [going to] be a big issue because no one is going to want to [report their funds]… it’s easier just to exit the relationship,” said Reiter. He fears that exchanges are no longer going to want US customers, and US customers are aware that the government is being notified of all money in non-US exchanges.

How is Acuant onboarding and transaction monitoring for crypto clients?

Regulators have made it clear that when considering crypto and anti-money laundering regulations, everyone wants to take a risk-based approach. But how are FIs expected to face new regulations head on without spending a bunch of money?

“You do it smarter.” In terms of onboarding, Reiter explains, FIs should not onboard everyone the same way. Mexico is currently using a risk matrix system that determines a customer’s risk score based on their location, age, and the source of their funds, then onboards them accordingly. “It’s a risk based approach; you do the most KYC for those with the highest risk.”

Next, FIs are looking toward transaction monitoring. Companies are combining KYC results and the associated risk with transaction monitoring profiles. “So you’re not setting everyone against the same set of rules, the same machine learning,” said Reiter. “You’re doing a lot of gradation.”

Lastly, there has been a rise in machine learning and its use in transaction monitoring in accordance with cryptocurrency exchange compliance. “Alert, prioritization, as well as alerts independent of the rules,” continued Reiter. “So you’re seeing some supervised machine learning with deviation and seeing some unsupervised machine learning with clustering.” FIs are seeing more and more crypto exchanges that are utilizing ML for a risk based approach and transaction monitoring, which has proven useful in increasing the speed of onboarding, monitoring customers, and decreasing costs.