In this post, WCT Pay discusses some of the key strategies for developing effective AML compliance programs in the cryptocurrency and payments sector.
As blockchain technology integrates into payment systems, financial crime compliance programs must evolve. How can compliance teams effectively manage AML risks associated with crypto payments, and how do these controls differ from those for fiat currencies?
Understanding Blockchain Analytics for Effective Compliance
At the core of a robust financial crime compliance program for crypto lies blockchain analytics. Blockchains, as immutable public ledgers, record all transactions made. However, on the surface, they don’t immediately reveal the identities of the transacting parties.
A payment made on a public blockchain ledger typically displays alphanumeric strings, known as wallet addresses, which serve as the crypto equivalent of bank account numbers. Blockchain analytics platforms like Merkle Science and Chainalysis help de-anonymise this information. Through the use of advanced analytics, open-source intelligence, and information from law enforcement and fintech partners, these platforms can group or ‘cluster’ wallet addresses based on behaviours.
The real challenge is identifying the real-world entities behind these clusters of wallet addresses. This process is crucial for compliance.
Without utilising blockchain analytics, companies processing crypto transactions risk interacting with sanctioned entities unknowingly. Blockchain data platforms provide this intelligence not only to their fintech partners but also to law enforcement, intelligence agencies, regulators, and central banks to support investigations and market supervision.
Customer Due Diligence in the Crypto Space
Due diligence is essential for any compliance program. For banks or upstream providers, understanding the risks of working with partners who transact in crypto is crucial. Whether dealing in crypto or fiat, the necessary assessments are similar and include:
- Understanding the nature and purpose of the relationship
- Gaining an understanding of the client’s reputation
- Analysing the client’s customer base
- Investigating the jurisdictions in which the client operates
- Gaining a comprehensive understanding of the client’s financial crime risk framework
These assessments are also relevant when onboarding a crypto platform such as an exchange, wallet provider, liquidity provider, affiliate, or any other crypto, DeFi, or blockchain service provider. While many evaluations are the same, the broad category of ‘crypto’ requires an understanding of the specific product or service offered and the associated risks. After initial assessments, blockchain data platforms can verify whether identified risks are materialising, enabling more informed risk mitigation.
Developing a Crypto Risk Management Framework
Blockchain analytics tools provide a comprehensive picture of potential exposure to financial crime, which can be used to set thresholds and build controls.
Setting risk levels involves distinguishing between ‘low’ and ‘severe’ risks. It’s straightforward to decide which types of businesses to engage with based on risk exposure. However, a nuanced approach is necessary for moderate risks, where specific thresholds for exposure to various service categories can be established.
Monitoring and Compliance in Crypto vs. Fiat Transactions
The compliance landscape for crypto and fiat transactions shares similarities, especially where the Travel Rule applies. This rule mandates the sharing of information about the sender and beneficiaries of transactions. The information used for monitoring includes KYC data, IP addresses, device IP, and transaction history. These data points help build controls, such as geolocation controls, and identify patterns and deviations in customer activity.
In crypto transactions, the transparency of the blockchain allows compliance officers to see the entire transaction history of a counterparty’s wallet, providing a valuable source of intelligence. This transparency extends to indirect exposure, enabling a view of the entire flow of funds, which enhances the detection of financial crime patterns and risks.
Addressing Suspicious Activity Reports in Crypto
There’s a common perception that illicit activity is more prevalent in crypto than in fiat. However, the level of Suspicious Activity Report (SAR) filings is comparable between the two. According to a report by the United Nations, between $800 billion and $2 trillion is laundered annually. A report at the same time by Chainalysis estimated that $24.2 billion was received by illicit wallet addresses in 2023 – a fraction of the total global value. Crypto payments offer more extensive information, allowing a deeper investigation into the flow of funds. The key is to focus on meaningful indicators of ownership changes rather than the number of previous transaction hops.
The Future of Financial Crime Intelligence in Crypto
In short, compliance teams can build robust AML programs for crypto payments. The inherent transparency of blockchains, combined with advanced analytics tools and frameworks, enables a comprehensive intelligence picture of transactions. This comprehensive approach significantly enhances the ability to detect and prevent financial crime, making crypto the new frontier of financial crime intelligence.
For more information about how to provide your clients and customers with a safe, secure, compliant, and cost-effective crypto payment solution, visit wctpay.com or email [email protected] today.
For more information about WCT Pay’s innovative crypto payment solutions, please visit wctpay.com or contact WCT Pay Head of Marketing, Barry Tuck, at [email protected].
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WCT Pay
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