Use off-chain analysis for crypto compliance

Compliance officers are essential in implementing anti-money laundering (AML) and counter-terrorist financing (CFT) measures, especially in the ever-evolving digital asset landscape. The Financial Action Task Force (FATF) Recommendation 15 focus on the AML/CFT measures necessary for managing the risks of new technologies, including digital asset compliance. Although Recommendation 15 forms the cornerstone of global efforts to address financial crime risks in the crypto space, implementation has been seen as a challenge. There is much more that crypto compliance professionals need to know.

As the global standard setter for AML/CFT matters, the FATF sets guidelines that countries must adhere to in designing their regulatory frameworks. These guidelines then trickle down to compliance teams at virtual asset service providers (VASPs), who must design AML/CFT controls that meet those requirements. On-chain analytics can assist crypto businesses by providing robust data and insights to strengthen compliance frameworks and meet obligations. This article discusses critical considerations for compliance officers and blockchain analytics’ role in meeting key AML/CFT expectations as regulators worldwide seek to implement FATF Recommendation 15.

Understanding FATF Recommendation 15: Be careful, it does not stand alone

FATF Recommendation 15 on New Technologies addresses the regulation and supervision of virtual asset service providers (VASPs). This requires countries to establish regulatory frameworks to mitigate the risks associated with money laundering and terrorist financing activities facilitated by VASPs. This highlights the importance of robust customer due diligence (CDD), transaction monitoring, record keeping and reporting obligations within the digital asset sector.

Compliance officers must adapt traditional AML/CFT measures in the digital asset space to address the unique challenges of cryptocurrencies and blockchain technology. The pseudonymity of transactions, cross-border nature and decentralized infrastructure necessitate innovative compliance strategies and careful application of many TradFi-based practices.

Although Recommendation 15 is a guideline for VASPs, emphasizing the need for robust practices, it is interdependent with other non-crypto-specific recommendations. Therefore, it should not be interpreted or implemented in isolation from the other 39 FATF recommendations.

What does this mean, and what are some significant intersections?

Recommendations 15 and 10 on Customer Due Diligence (CDD) highlight the importance of robust CDD measures for VASPs. This alignment reflects Recommendation 10’s provisions for financial institutions to maintain diligent CDD practices with their clients, emphasizing the need for thorough due diligence in financial transactions. The two recommendations have similar requirements.

FATF Recommendation 15 resonates with Recommendation 11 on Record Keeping and Retention, which emphasizes the need for VASPs to carefully maintain accurate records of transactions and customer interactions. These guidelines highlight VASPs’ need to harmonize their recordkeeping practices with AML/CFT requirements, reflecting Recommendation 11’s compliance standards for financial institutions to retain comprehensive records for regulatory oversight and investigation.

The interrelationship of Recommendation 15 with Recommendation 20 on Reporting of Suspicious Transactions also comes sharply into focus. In line with Recommendation 20’s guidance, Recommendation 15 mandates that countries require VASPs to immediately report suspicious transactions to designated authorities, emphasizing the urgency of establishing robust procedures for reporting suspicious activity, thus vigilance in combating financial crimes increase.

In the global fight against illicit financial activities, FATF Recommendation 15 emphasizes the essential role of international cooperation, essentially Recommendation 29 on the importance of cooperation in combating money laundering and terrorist financing. Recommendation 15 emphasizes the need for coordinated efforts between countries, reflecting Recommendation 29’s emphasis on promoting cooperation through the exchange of information and mutual legal assistance protocols.

The so-called ‘travel rule’ set out in FATF Recommendation 16 aims to improve transparency and accountability within virtual asset transactions. Under Recommendation 16, VASPs are mandated to transmit information about the originator and beneficiary with virtual asset transfers, which is consistent with traditional obligations for wire transfers – also an essential element of Recommendation 15 implementation.

Blockchain Analytics: Helping VASPs Succeed

So, as regulators worldwide work to orchestrate meaningful and effective implementation of Recommendation 15, how can VASPs meet operational requirements such as CDD, transaction monitoring, record keeping and reporting obligations?

Blockchain Analysis can help Elliptical indexes openly available blockchain information and provides digestible data and insights to support the implementation of Recommendation 15 and beyond:

Transaction Monitoring: Elliptical tools enable continuous monitoring of transactions across multiple blockchains, flagging suspicious activity such as behavioral indicators of money laundering, mixing services and peer-to-peer transactions. On-chain analytics enables VASPs to monitor transactions executed on networks in real-time. By tracking the movement of virtual assets and analyzing transaction patterns, VASPs can identify suspicious behavior and activity, including transactions with high-risk counterparties. Through continuous transaction monitoring, VASPs can immediately detect and investigate potential cases of money laundering or terrorist financing, and ensure compliance with regulatory requirements. Address clustering: Through address clustering techniques, blockchain analysis can link multiple addresses to a single entity, uncovering complex money laundering schemes and illegal activities. Address clustering is a powerful feature of on-chain analytics that allows VASPs to identify addresses that are likely controlled by the same entity or wallet. By identifying relationships between addresses and entities, VASPs can assess the risk associated with specific addresses based on their transaction history and associations. Address clustering helps VASPs identify and mitigate risks associated with illegal activities, such as funds originating from darknet markets or known money laundering schemes. Data Insights: By analyzing transactional data, blockchain analytics can create risk profiles for VASPs’ customers, identifying high-risk entities for enhanced due diligence and monitoring. Elliptic offers a robust dataset that surfaces data that helps compliance teams make risk-based decisions and assess the risk level of transactions or entities based on factors such as transaction size, frequency, counterparties involved and historical behavior. These risk profiles allow VASPs to prioritize compliance efforts and focus on high-risk transactions or customers. Sanctions screening: On-chain analytics tools integrate with sanctions lists and databases to screen transactions and addresses against known individuals, entities or jurisdictions subject to sanctions or regulatory restrictions. These insights enable VASPs to identify and block transactions involving sanctioned parties, ensuring compliance with regulatory requirements. Sanctions screening is a critical component of AML/CFT compliance, and Elliptic provides VASPs with the necessary tools to effectively enforce sanctions compliance.
Compliance Reporting: Blockchain analytics facilitates the generation of comprehensive reports on VASPs’ compliance with AML/CFT requirements, aiding regulatory oversight and demonstrating compliance. Elliptical enables VASPs to extract insights, including SARs-relevant insights, in support of regulatory disclosures. This information may facilitate communication with regulatory authorities. VASPs can demonstrate their commitment to regulatory compliance and transparency by using on-chain analytics for compliance reporting, promoting trust and confidence among regulators and stakeholders.

Compliance officers are critical in the implementation of FATF Recommendation 15 within the digital asset sector and contribute to a safer and more transparent financial ecosystem in the digital age by embracing innovative technological solutions, fostering collaboration and adhering to best practices.

Self-assessment of your preparedness

Is your VASP in line with the obligations set out in Recommendation 15? Use our ‘Self-Assessment Tool for VASPs’ to assess how prepared your organization is. This assessment is designed for your internal organizational use.

Instructions:

Review each question carefully and respond in a way that best reflects your organization’s practices. Skip a question if it does not apply to your organization. Consider providing additional comments or explanations where necessary to clarify answers.

Customer Due Diligence (CDD)

Does your organization have written policies and procedures for due diligence (CDD)? Does your organization verify the identity of customers before providing services? Does your organization assess and document the risk associated with each customer and transaction?

Transaction Monitoring

Does your organization have automated systems in place to monitor transactions? Does your organization continuously monitor customer transactions for suspicious activity? Does your organization have procedures to identify suspicious transactions and report them to the relevant authorities?

Record keeping

Does your organization keep comprehensive records of customer transactions and interactions? Do your organization’s record keeping practices meet regulatory requirements? Does your organization have procedures for securely storing and retrieving transaction records?

Reporting obligations

Does your organization have procedures for reporting suspicious transactions to the relevant authorities? Are your organization’s reporting procedures in line with regulatory requirements? Does your organization provide staff training on identifying and reporting suspicious transactions?

Self-Assessment Conclusion:

After completing the self-assessment, review the responses to identify areas where improvements are needed to align with FATF Recommendation 15. Develop an action plan to address gaps or deficiencies, prioritize actions based on risk, and implement the necessary measures to strengthen your organization’s AML/. CFT Compliance Framework. Review the assessment regularly to track progress and ensure compliance with regulatory requirements.

Contact us to learn how Elliptic can help VASPs integrate insightful compliance tools and leverage blockchain analytics to improve AML/CFT measures and protect the financial system’s integrity.