Cryptocurrency has matured from obscure technology to a complete trillion-dollar industry. This has brought with it unbridled opportunities for innovation and inclusion for many around the world. These new businesses stemming from crypto have cropped up around the world as exchange services for digital assets, non-fungible token markets and cryptocurrency payment processors.
As cryptocurrency goes mainstream, it’s facing unavoidable scrutiny from global financial regulators. The same features that make crypto useful for startups, like borderless transactions, also make it a tool for money laundering and terrorist financing. The ‘Wild West’ days are over. Anti-Money Laundering (AML) regulations which used to apply generally only to major banks are now enforced on everyone. This includes small crypto startups with just a handful of employees.
For the average crypto entrepreneur this is quite a big obstacle. A founder must now understand financial compliance as well as a Wall Street expert. Failure means facing huge fines or being shut down.
What’s AML?
AML stands for Anti-Money Laundering. These are rules that apply to the financing world at large from traditional brokers like Eurotrader to the latest crypto companies. Essentially, money laundering is the process where unclean (illegally acquired) money gets “washed clean”. This usually involves three components:
- Placement, including putting the money into the system.
- Then there’s the Layering Process in which the money gets routed in complex patterns around the world.
- The third component is Integration, or getting the money back into circulation.
Illicit actors can leverage cryptocurrencies to obscure the origin of illegal funds. This is often achieved by purchasing virtual assets, using services known as mixers to obfuscate the transaction trail across various wallets and finally converting the funds back into fiat currency or using them to purchase other assets such as NFTs.
FATF
To reduce these risks, regulators like the Financial Action Task Force (FATF) have mandated that the “Travel Rule” apply to Virtual Asset Service Providers (VASPs). This regulation, traditionally applied to banks only, now requires VASPs (such as cryptocurrency exchanges) to collect, verify and exchange customer information during transactions to make sure that there is proper transparency. To learn more, check out Business Flare.
Big Rules, Small Teams
Following Anti-Money Laundering rules for small crypto businesses is a nightmare when compared to large banks’ huge departments and budgets allocated specifically for that. The two challenges involved here are:
- Extreme Cost: The cost of the specialized analysis software used to evaluate blockchain transactions remains quite high at tens of thousands of dollars per annum. The cost of employee training should not be overlooked either.
- Exaggerated Complexity: The regulations change on a constant basis and from country to country. For instance, an EU company must adhere to EU regulations. However, if it caters to only one US customer, it has to adhere to US regulations as well.
Building Your AML
The problem of implementing proper AML is definitely daunting, but not unsolvable. Regulators do not expect smaller businesses to have the resources of JPMorgan Chase on hand. They only ask that there be a sincere and honest effort and that it be based on a sound set of principles. This means allocating resources to discovering and tracking high-risk activity.
- First, you need a solid process to know who your customers are. This is often called a Customer Identification Program. It means you must get and check official documents to prove your customers are who they say they are. This connects to the next idea: checking customer risk. Not all customers are the same. For example, a new user who only makes a $50 transaction is probably low-risk.
- Transaction Monitoring. This means you must have a system running 24/7 that watches all the transactions and flags anything that looks suspicious. The main purpose of this system is to automatically check transactions against published bad lists (tied to illegal websites, online scams or other criminal activities).
- Finally, you need someone to be in charge of this whole program. You must appoint a dedicated AML Compliance Officer. This is one person who has the full responsibility and authority to make sure your entire anti-money laundering program is working correctly.
| Description | Action | |
| Risk Assessment | Identifying the specific money laundering risks a business faces. | Document your specific risks. |
| KYC | Verifying the true identity of users before they can transact. | Integrate a third-party identity verification service to automate. |
| Transaction Monitoring | Analyzing blockchain transactions in real-time to detect suspicious patterns. | Use a blockchain analytics tool to score wallet risk and screen transactions. |
| The AML Compliance Officer | Designating a qualified individual who is responsible for overseeing the AML program. | Appoint someone and invest in their training. |
| Record-Keeping | Filing Suspicious Activity Reports with the government and maintaining records. | Establish a clear process for when and how to file a SAR. |
Security Through Obscurity?
Many small crypto business owners mistakenly believe regulators only target major players and that is a fatal assumption. Regulators often make examples of smaller firms to send a message. The consequences are often existential to the business as the damage to reputation, finance and resources will be too much to recover from.
The first threat is de-banking: banks will sever ties, leaving the business without easy access to finance. You can’t pay employees or cash out crypto into fiat currency to use in the traditional financial world, such as on a stock trading platform. Second, regulators can use paralyzing fines large enough to cause bankruptcy. Finally, founders and executives face personal criminal prosecution and even prison time for ignoring their AML obligations. In short, the risk and reward ratio suggests that it is not worth under any circumstance to ignore AML rules.
