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By Jonathan Levin
Cryptocurrencies made headlines this year following the burst of 2017’s price bubble and subsequent market volatility. But in the background, regulators set significant market drivers in motion that will dictate the growth of the technology for years to come.
Regulation of cryptocurrency is no longer speculative, and interpretation of regulatory actions will become the new normal in 2019. Further, cryptocurrency technology, once perceived as a risk, will be lauded for enabling law enforcement and regulators to enforce mandates, power complex investigation units, uphold sanctions, and combat global money laundering.
In 2018, cryptocurrency received a lot of oversight attention, as the SEC continued to reject ETF requests and take action against unregistered and fraudulent ICOs. The Chicago Board Options Exchange (CBOE) and CME Group began trading cryptocurrency futures, and the Commodity Futures Trading Commission (CFTC), which has jurisdiction over these derivatives, dedicated public sessions to the process of certifying and launching these products. Internationally, Japan operationalized their reporting system for suspicious cryptocurrency activity and the Financial Stability Board updated its commentary on cryptocurrency markets and potential implications for traditional finance.
1: Cryptocurrency Will Be Embraced as ‘Regtech,’ Enabling Financial Institutions and Regulators to Manage Increased Complexity with More Productive Staff
As regulatory requirements have become increasingly complex to manage, new and diverse payments processes and the responsibilities and costs of compliance departments have grown in lockstep.
This isn’t just affecting traditional financial institutions. According to data from HR and organization consultancy Position, nearly 20 percent of staff at Circle, the global payment and investment platform built on blockchain technology and powered by crypto assets, are in legal and compliance, the firm’s fastest growing department after engineering.
Compliance departments need technology to automate certain activities, and regulators will increasingly rely on technology to oversee the financial markets. In the coming year, cryptocurrency will emerge as the much-needed standard for automated payments oversight.
I’ve heard from compliance leaders at financial institutions that about 80 percent of their budgets is spent on headcount and 20 percent on software; a ratio that needs to reverse to ensure anti-money laundering (AML) best practices. This shift will allow continued investment into in-house investigation units where needed, but increasingly lead to outsourced work.
Consultancies will take on more managed services. Banks’ internal Financial Intelligence Units (FIUs), which oversee analytics and complex investigations capabilities, will be heavily relied upon for automated technology to screen for high risk activity.
Cryptocurrency blockchains provide unprecedented insight for regulators, compliance departments, consultancies, and FIUs into how and why people move money across the world. And because they are not dependent on batch processing, they can screen transactions in real time. This visibility and velocity means cryptocurrency blockchains can, in many circumstances, help identify underlying risks better than traditional financial tools.
Federal regulators should use blockchain’s open ledger to transform today’s broken reporting regime into an efficient, technology-enabled oversight system that earns trust among institutions and serves the people it is meant to protect. Cryptocurrency will then become the model technology for regulators to apply best practices to traditional payment systems such as the Automated Clearing House (ACH) Network, Fedwire, and credit card networks.
2: Cryptocurrency Will Play a Vital Role in Sanctions Enforcement
Sanctions are arguably the U.S.’s most powerful nonviolent tactic for responding to major geopolitical challenges, ranging from counterterrorism to conflict resolution. Of course, sanctions are only as successful as they are enforceable, and leaders of sanctioned foreign nations and organizations have threatened to leverage cryptocurrency as a tactic to evade them.
President Nicolas Maduro of Venezuela launched the “Petro” token, an oil-backed cryptocurrency meant to serve as a means for the country to circumvent Western sanctions. It has also been reported that Russia, Iran, and North Korea intend to leverage cryptocurrency to do the same.
In response, The U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) issued guidance on cryptocurrencies earlier this year and FinCEN issued an advisory on the Iranian regime’s illicit activities to exploit the financial system. In November, OFAC added cryptocurrency addresses linked to individuals to its Specially Designated Nationals (SDN) list for the first time, setting a new precedent requiring cryptocurrency businesses and financial institutions to begin preparing for OFAC designations in the future.
The message is clear: cryptocurrencies are no longer a fringe technology and don’t offer shelter from sanctions.
Each week, about $100 billion is traded in cryptocurrency and $10 billion of bitcoin moves on-chain, according to Chainalysis’s data. Banks and financial institutions need to be aware of potential exposure and take appropriate actions to avoid unintentionally facilitating sanction evasion that could lead to hundreds of millions of dollars in fines.
Cryptocurrencies can enable greater enforcement than fiat currencies by using blockchains’ traceable architecture to identify suspects and understand the breadth of a sanction evasion operation. This effectiveness will become increasingly important and a driver for financial regulation in 2019.
3: Anti-Money Laundering Practices Will Strengthen in Asia as Businesses in the Region Expand Globally
Despite the lack of a uniform international approach or local guidance regarding AML regulations in most Asian markets (with some notable exceptions), cryptocurrency businesses in the region, critical of low security standards, poor AML policies, and inadequate regulatory guidelines will choose to adopt best practices from other regions.
Because cryptocurrency blockchains are decentralized and global, they are a democratizing technology that can serve as a platform for expansion into other markets. Asian cryptocurrency businesses will quickly adopt AML technology in order to compete in the global arena and engage with users in the U.S. and Europe.
For example, Binance, the world’s largest cryptocurrency exchange by trading volume, was originally founded in China and now plans to launch five to ten fiat-to-cryptocurrency exchanges. Other exchanges in the region will likely follow suit: scale their technology in Asia, adopt AML technology, expand globally. Asian exchanges already dominate global cryptocurrency trading, accounting for around two thirds of trading volumes. This strategy grants access to new audiences and delivers Asian liquidity to Western markets.
Asian businesses are using regulatory best practices to their advantage, expanding their footprints to new markets and, paradoxically, positioning themselves to overtake their U.S. and European-based peers on the global financial stage. Because cryptocurrency is borderless by design, AML technology can scale seamlessly across the world, regardless of local or international regulations, and businesses are now incentivized to adopt it.
2019 is poised to be a tipping point for cryptocurrency. Cryptocurrency blockchains’ technical attributes, once appealing to bad actors, will be harnessed by regulators and compliance departments to crack down on fraudulent activity and uphold critical economic policies. The market needs a regtech solution, and global businesses will benefit from playing by the rules.
There is a long road ahead before cryptocurrency breaks into the mainstream, but as adoption increases, so will cryptocurrency’s viability and the risk surface for financial institutions and governments not equipped to handle its unique characteristics. Building trust is a vital step in cryptocurrency’s transformation into an invaluable technology that protects our safety and enables greater prosperity.
Jonathan Levin is the co-founder and chief operating officer of Chainalysis, a technology firm that offers cryptocurrency investigation and compliance solutions to global law enforcement agencies, regulators, and businesses as they work together to fight illicit cryptocurrency activity.
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