During the summer, an agent at the US’s Drug Enforcement Administration, Lilita Infante, said the ratio of legal to illegal activity in bitcoin has inverted. Talking to Bloomberg, she said illegal activity is now a problem in about 10 percent of transactions - not the 90 percent she saw five years ago.
Lilita thinks that it is speculation driving the cleaning up of transactions. We’ve also seen, over that five-year period, regulation coming into force, the professionalisation of exchanges and increasing numbers of individuals trading and investing paying attention to the anti-money laundering (AML) and know your customer (KYC) aspects of doing so.
But, even if regulations are in place, there are - as is the way with illegal activity in any industry - things to look out for that will be hidden. Whether you’re making payments in crypto, are involved in initial coin offerings (ICOs) or using any blockchain-based payment processes, companies and exchanges might say they operate in Honk Kong or Japan, but look deeper and there will be a contracting third party, with an office registered in Bermuda or the Channel Islands. From a regulatory and compliance perspective, offshore tax havens are considered higher risk, because they don’t, by definition, operate under the same level of scrutiny, or display the same level of transparency, as mainland jurisdictions.
And there are other things to think about. Who are you contracting with? Where are they based? Do they have policies and procedures in place for AML and KYC? What is the customer complaints process? Who would you go after if your money was lost? Who is behind the project? Can you check up on them? Is there any negative press about the company? These questions are not peculiar to crypto - you would apply the same common sense checks if you were gambling online or trading derivatives.
Extra legwork isn’t just a requirement for individuals - companies and countries face the same task. For companies, it makes sense to apply the reverse of the principles that hold for individuals operating in the market: i.e. establishing themselves in the right jurisdiction. If you want to gain a repute as a safe operator, this is plainly more important than any of the alternative benefits (like a low tax regime).
We are still seeing companies in this industry, which are frequently handling hundreds of millions of dollars’ worth of crypto, wondering why banks won’t accept them, and regulators are taking issue. A client of ours, Bancor Network, engaged us recently to locate $120m of bitcoin that had been stolen. We followed the funds and discovered them on one of the largest crypto-exchanges. Unfortunately, players frequently don’t know who they are dealing with, because they haven’t got the checks and balances in place to know, or because they simply choose not to.
Understanding what’s going on is equally important for countries. Crypto is a global market now, and having bad actors operating under your watch will serve only to deter companies doing things the right way, and investors. Regulators need to have oversight of activity in their countries, including an awareness of companies registered elsewhere but offering services to clients in their jurisdiction.
Moreover, regulators should not shy away from imposing frameworks. This includes guidelines for native financial institutions trying to navigate relationships with offshore firms: the former cannot make a decision on acting - say, blocking a transaction or dropping an account - if they can’t ascertain the level of risk associated with a particular actor. This is where regulators should be upping scrutiny, providing financial services companies with the data and information they need to make those calls.
The crypto world, dominated by speculators rather than drug dealers, is far less risky than it was even a matter of months ago. This trajectory will no doubt continue, but it will be accelerated by the right checks and balances, and a comprehensive, global approach to monitoring systemic risk. Regulators and industry can work together to protect consumers, as well as themselves.
By Pawel Kuskowski Contributor