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Crypto-assets and money-laundering control - some things to consider

Regulatory team, Laven Partners, London, 8 April 2021

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More and more anti-money-laundering regulations apply to crypto-asset businesses as the market for these assets grows and regulators try to impose a measure of control over it. In January last year, the European Union's fifth AML Directive came into force and imposed rules on crypto-asset-exchange providers and custodian-wallet providers.

The meaning of the phrase "crypto-asset-exchange provider" which 5AMLD redefined is fairly broad. It takes in any entity that provides one or more of the following services.

  • The exchange of, or the arrangement of the exchange of, crypto-assets for money or vice versa.
  • The exchange of, or the arrangement of the exchange of, crypto-assets for other crypto-assets.
  • The operation of a machine that uses automated processes to provide either of the above activities.

This change in the definition of the phrase that 5AMLD caused brought a lot more crypto-asset firms into the scope of AML regulation, whereas previously only those crypto-asset businesses that dealt with regulated tokens or had other regulated activities were included. The new crypto-asset firms were required, for the first time, to apply to the UK's Financial Conduct Authority for registration.

Can the blockchain prevent money laundering?

Many crypto-assets are underpinned by a decentralised register which logs all transactions and cannot be forged, since many members of the network are bound to have copies that verify the history of transactions or of a token. This, in theory, should help to offset the likelihood of crypto-assets being used to launder dirty money because this-or-that firm can verify the transaction history of this-or-that coin. This is not, however, the case in practice; there is not enough information on the register to identify the various holders of the token. There is also often no central authority to verify the identities of token holders, a fact that helps people remaini anonymous when dealing with crypto-assets. This anonymity, combined with the global reach of many crypto-assets, presents a major problem for the enforcement of AML rules and prevents firms from being able to trace sources of funds properly.

More and more money launderers are using crypto-assets to 'layer' their money, as the Financial Action Task Force (FATF) has noted. The anonymous use of crypto-assets can act as a break in the chain of ownership of the funds, making it almost impossible to determine the point from which the funds that the laundryman used to purchase the initial tokens originated.

What are the AML considerations for stablecoins?

The FATF has also expressed concern about the rising popularity of ‘stablecoins,’ which are crypto-assets that are backed by some asset (often a quantity of fiat currency) and are easily convertible at a fixed exchange rate. These coins have been growing in popularity as a crypto-asset class because their prices are less volatile than others and they are generally more useful. However, their easy convertibility and stable value make them a good target for fraudsters. The FATF, along with some national regulators, has been working towards a more coherent international response to the risks posed by stablecoins. For example, it has revised its standards that apply to stablecoins, which focus on the institutions that redeem and facilitate payments between users. Indeed, it wants national regulators to begin to regulate these entities and many are now doing so.

Crypto-asset regulation in the UK

In the United Kingdom, the FCA has brought some crypto-asset firms into the ambit of the UK's AML regulations in an effort to obey 5AMLD. More recently, it has gone further by announcing last August that it was going to oblige crypto-asset exchange providers and custodian wallet providers to report information about financial crime also. They will have to complete the REP-CRIM return on RegData every year.

The regulation of the crypto-asset market as a whole is fast developing as retail users - HNW individuals among them - and, more recently, large institutional investors are coming on board. This, in turn, is forcing regulators to consider and revise their approach to crypto-assets as a whole.

* Laven Partners can be reached on +44 (0) 20 7838 0010

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