High-Volume Crypto Exchanges Pose Anti-Money Laundering Hurdles

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By Jacob Rund

Cryptocurrency exchanges are coming to terms with anti-money laundering compliance obligations just as Congress is considering whether to scale them back.

Legislation related to the issue centers around a few provisions of the Bank Secrecy Act, including one that requires financial entities to report to authorities suspicious transactions worth at least $5,000. One bill ( H.R. 6068) would push that long-standing threshold up to $10,000.

Some crypto exchanges are embracing anti-money laundering rules as a way to combat investor skepticism and get more clarity about how they’re allowed to operate. Others either don’t know or prefer to run afoul of certain rules, enforcement consultants and financial technology users told Bloomberg Law.

Pro-banking groups have touted Congress’s proposed reduction in anti-money laundering reporting loads as a way to cut compliance costs and spur investment. Such a change could also help crytpocurrency exchanges, but might be less pressing for them than for their brick-and-mortar counterparts.

Increasing the suspicious activity report (SAR) threshold “could allow crypto exchanges and other crypto platforms more flexibility to grow without regulatory reporting burdens,” said Anant Handa, co-founder of Mandala Exchange, a virtual trading platform that’s expected to launch this year.

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) uses SAR data from banks and other money services to investigate money transfers that could be tied to criminal endeavors.

The biggest challenge for crypto exchanges is keeping track of the “sheer volume” of activity, Blockchain Intelligence Group President Shone Anstey told Bloomberg Law. An increase to the SAR threshold “won’t make a huge difference” to compliance efforts, he said.

Wheat From Chaff

Regulators and law enforcement agencies are ramping up their focus on the illicit use of cryptocurrencies such as bitcoin. FinCEN has said it will go after foreign crypto exchanges doing business in the U.S. that don’t comply with anti-money laundering laws, including SAR requirements.

Crypto exchanges that are already complying with reporting requirements bring a degree of certainty to investors, but the increased scrutiny from regulators could be trouble for new businesses that aren’t compliant.

Some oversight is needed in the industry to move it forward, Handa said. “I don’t think the next few hundred million people are going to come into crypto and digital assets until there are some safety nets and guards in place,” he said.

Investors will likely be more comfortable with additional rules, Anstey said. “I think investors and the general public will continue to foster [the exchanges] that have the compliance and that safety net around them. And knowing that they’re all regulated, there’s a little more clarity from an investor’s standpoint,” he said.

Anstey added that his company works with crypto exchanges that welcome regulation and “operate along the lines of a traditional financial institution.” As for the number of SARs these platforms submit, “they are being fairly aggressive because they want to show that they are” compliant, he said.

The uptick in SAR reports from these exchanges corresponds with a general increase in cryptocurrency usage within the past year, Anstey said. “There are [some] exchanges opening north of 100,000 accounts a day,” he said.

The corresponding spike in prices of bitcoin and other cryptocurrencies also boosts the amount that’s being transferred onto the platforms. As long as the price stays high, these larger transfers could generate more reporting.

Intelligence Worries

Some members of the law enforcement community are concerned that changing the SAR baseline could limit their ability to stop criminals from accessing the U.S. financial system.

Raising the threshold would “cut off an information flow that many in the intelligence and law enforcement world use to keep us safe,” Ross Delston, a Washington attorney and anti-money laundering expert witness, told Bloomberg Law.

“What you’re saying is, ‘Don’t tell us about every suspicious transaction you see. We only want to know about the big ones,’” he said. “Raising the threshold, if it applies to [money services businesses], they would be dancing in the streets, since they typically deal with much, much smaller transactions.”

Crypto Crime Tools

Crypto transfers pose distinct challenges in pinpointing the true source of funds. Criminals using bitcoin and other cryptocurrencies to launder money have a number of tools available to cover their tracks and disguise their activities.

Some cryptocurrencies can be purchased from specialized ATMs, which provide keys that are used to verify future digital transactions. These machines often require some form of personal data, such as a passport or photo ID. But that doesn’t prevent individuals from using falsified information, or from paying others to conduct these transactions for them.

Tumbler or mixer services take one crypto transaction and shuffle it with a group of transactions to mask the nexus of the original deal, much like a shell game.

Cryptocurrency “does make it a little bit different and complicated when you’re trying to trace money,” John Rollins, a financial crimes investigator and expert witness, told Bloomberg Law.

“On the one hand, all of that information is there,” so doing the tracing is “relatively simple,” he said. “It’s contained and fully transparent. The difficulty arises when you try to link the owner of the keys to the transactions.”

That’s because there isn’t account balance information linked to these transactions, unlike a typical bank deposit or purchase using a debit card.

Public blockchains and other distributed ledgers are popular because they’re meant to facilitate an open, up-to-date record of pseudo-anonymous transactions that is verifiable and tough to modify.

People may hold virtual wallets on a crypto exchange, and that data “could conceivably be subpoenaed or obtained from that exchange,” Rollins said. There are also services that take transaction information and turn it into data that looks like an account balance, which is based on an analysis of those digital transfers.

But, “it’s not as straightforward as just saying, I’m going to go to [a bank] and subpoena account records,” Rollins added.

To contact the reporter on this story: Jacob Rund in Washington at jrund@bloomberglaw.com

To contact the editor responsible for this story: Fawn Johnson at fjohnson@bloomberglaw.com

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