The crypto industry, under regulatory scrutiny, is seeking a tailored compliance strategy to address unique cybersecurity risks, highlighting the need for innovative, sector-specific regulatory frameworks.
Compliance scandals in crypto are nothing new. Last year, CZ, the former CEO of Binance, the largest crypto exchange, pleaded guilty violation of anti-money laundering (AML) laws with a $50 million fine to be paid. Today, from the US Securities and Exchange Commission (SEC) pressure court about Binance.US to the Dutch regulator imposing a $3.1 million fine on Crypto.com, the industry is enduring scrutiny from regulators.
Discussing crypto compliance often leads to comparisons with traditional finance, where many envision a mix of both worlds. However, the simple import of traditional compliance models – which were only significantly shaped after the 2008 crisis – into crypto is not the best scenario. We would argue that this approach overlooks the unique aspects and needs of the crypto and decentralized finance (DeFi) landscapes, suggesting that a more nuanced strategy is needed to effectively navigate these new areas.
Comply or go out of business
Compliance has become crucial for fintech and crypto firms to survive. The clock is ticking, and crypto businesses in the EU have until the summer of 2024 completed with the new Markets in Crypto-Assets legislation (MiCA) requirements. No wonder compliance specialists like the recent blockchain developers are catching up row for overseas expansion for crypto companies increases the demand for these top-notch personnel.
These experts face the daunting task of adapting compliance frameworks for the crypto industry, where the nature of controls differs significantly from traditional finance. While some aspects, such as the verification of ultimate beneficial owners (UBOs) and the origin of funds, have similarities, the fundamental differences between cryptocurrencies and traditional currencies require different approaches to verification.
Blockchain technology was originally designed to operate outside the traditional financial ecosystem, while providing a transparent and immutable record of transactions. Initially, virtual asset service providers (VASPs) neglected standard Know Your Customer (KYC) and Know Your Transaction (KYT) protocols, viewing them as inconsistent with blockchain. However, this leniency has opened doors to fraud, highlighting the need for regulatory frameworks within the crypto sector.
As a result, crypto regulation has tightened, with many traditional financial oversight mechanisms now adapted to crypto transaction verification. The evolution of these regulations, along with ongoing legislative developments, highlights the importance of crypto companies staying abreast of changes. Compliance is crucial, not only for maintaining operational licenses, but also plays a key role in combating the advancing techniques of hackers and fraudsters.
What are the crypto-specific risks?
The primary risks that crypto businesses face are mainly in the area of cyber security. A significant concern is the breach of exchange security, which has put cryptocurrency exchanges squarely in the crosshairs of hackers. Such breaches not only lead to significant financial losses but also compromise customer data.
Another critical issue is the vulnerability of smart contracts. Despite their association with secure and autonomous transactions on the blockchain, cybercriminals can exploit flaws within smart contracts, such as re-entry attacks, syntax errors, and forerunner, to siphon funds from DeFi platforms.
Additionally, the rise of cryptocurrency has seen a parallel increase in ransomware claims and the sophistication of malware targeting digital currencies. In addition, phishing attacks and social engineering tactics exploit the human element, often the weakest link, tricking individuals into divulging sensitive information that allows attackers unauthorized access to crypto wallets and exchanges.
This landscape begs the question: What does an “ideal” compliance framework look like – one that addresses these complexities and supports crypto companies to manage them effectively?
Sharing is caring, more so in compliance
An “ideal” compliance and AML framework for crypto and crypto-fiat companies should merge traditional financial AML requirements with adaptations for the crypto sector’s unique challenges. It is essential to include advanced KYC/AML methodologies that use artificial intelligence to verify crypto transactions. In essence, this framework would be a hybrid, drawing from both traditional and crypto-specific AML systems.
Additionally, a critical element to improving security across the board involves collaboration and information sharing. Just as banks and traditional trading firms engage to share threat intelligence and security best practices, cryptocurrency firms can greatly benefit from a unified approach. Emulates JP Morgan’s Ethereum-based Interbank Information Network used by hundreds of financial institutions, can provide crypto companies with a powerful tool to combat fraud and increase overall fintech security.
The demand for skilled compliance specialists is set to increase significantly in the coming years. And establishing a robust compliance framework in the crypto sector is crucial at this stage. These specialists must skillfully blend fundamental best practices of traditional finance with the unique dynamics of the crypto landscape. After all, competent compliance practices are essential to foster greater trust and encourage broader adoption within the industry.
The convergence between traditional and decentralized realms is inevitable, and achieving full compliance could unlock full access to traditional banking services for crypto businesses, addressing long-standing regulatory constraints and streamlining financial interactions between fiat and cryptocurrencies.
About Elizabeth Jagelski
Elizabeth is an experienced lawyer and compliance specialist with a focus on the European crypto market and both fiat and crypto payment systems. Since 2023 Ms. Jagelski takes on the role of Chief Compliance Officer at Keytom, a neobank positioning itself as one bank for all digital assets.
About Dennis Kudrjašov
Dennis is a seasoned financial services professional who boasts over a decade of experience in the crypto market. From 2023, he holds the position of AML compliance officer at Keytom, a neobank that positions itself as one bank for all digital assets, where he oversees AML company responsibilities.
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While we love diving into the exciting world of crypto here at Uncirculars, remember that this post, and all our content, is purely for your information and exploration. Think of it as your crypto compass, pointing you in the right direction to do your own research and make informed decisions.
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