Cryptocurrency and AML: What Do Institutional Bankers Need to Know?
Since its advent, cryptocurrency has served as a means for parties to conduct illicit transactions with limited oversight from federal regulators and financial institutions. The recent emergence of cryptocurrency as both a mainstream investment vehicle and means of payment has presented unprecedented challenges for federal regulators and financial institutions as well. While authorities such as the Financial Crimes Enforcement Network (FinCEN) and the Internal Revenue Service’s Criminal Investigation division (IRS CI) have bolstered their enforcement arsenals in recent years, they are still behind the curve due to limited legislation, and they are still heavily reliant on private institutions in the financial sector to help them uncover and prosecute fraudulent practices involving cryptocurrencies.
One area in which federal authorities are particularly reliant on financial institutions and institutional bankers is anti-money laundering (AML) enforcement. Several federal statutes establish obligations for financial institutions and institutional bankers in the AML realm. These statutes include:
- Bank Secrecy Act
- Money Laundering Control Act
- Annunzio-Wylie Anti-Money Laundering Act
- Money Laundering Suppression Act
- Money Laundering and Financial Crimes Strategy Act
- Anti-Money Laundering Act
However, none of these statutes address cryptocurrency directly. As a result, as discussed in a recent article on American Banker, “For decades, the government has leaned on banks to help crack down on illicit finance, requiring them to comply with a bevy of anti-money-laundering rules. But as cryptocurrencies enter the mainstream, policymakers are increasingly looking at how to expand the federal AML regime to include digital assets.”
Much like the Internal Revenue Code, federal authorities have done their best to apply the AML laws listed above to cryptocurrency and other types of digital assets. But the reality is that these laws are simply too old in many cases. As these laws predate the advent of cryptocurrency (by decades in many cases), they do not even contemplate the basic principles underlying the digital transactions that have become commonplace today.
So what does all of this mean for institutional bankers in 2022?
Institutional Bankers Cannot Ignore the Risks that Conducting and Facilitating Cryptocurrency Transactions Present
While there is still much to be determined, one fact is clear: Institutional bankers cannot ignore the risks that conducting and facilitating cryptocurrency transactions present. Anti-money laundering enforcement related to cryptocurrency is a top law enforcement priority not just for FinCEN and IRS CI, but for agencies and offices across the federal government. The American Banker article quoted above also references recent initiatives of the U.S. Securities and Exchange Commission (SEC), and it quotes U.S. Treasury Secretary Janet Yellen as stating last year:
“I see the promise of these new technologies, but I also see the reality: Cryptocurrencies have been used to launder the profits of online drug traffickers, they’ve been a tool to finance terrorism.”
Given that this is how federal authorities view cryptocurrency (a view which, frankly, is neither misguided nor unreasonable), institutional bankers need to take stock of what they are doing to help – or hinder – the government’s efforts. Ignorance is no longer a valid excuse when it comes to financial institutions directly or indirectly facilitating illicit cryptocurrency transactions, and it won’t serve as a defense in the event of a federal AML investigation.
Cryptocurrency-Related AML Measures Financial Institutions and Institutional Bankers Should Be Considering in 2022
What should financial institutions and institutional bankers be doing to address cryptocurrency-related AML concerns? Minimally, the following warrant immediate consideration:
1. Identify and Understand Your Current Cryptocurrency-Related AML Risk
Before looking too far toward the future, financial institutions and institutional bankers need to give due consideration to their current cryptocurrency-related AML risk. Cryptocurrency is no longer the Wild West. Institutions and bankers cannot turn a blind eye, and they cannot simply throw their hands in the air. While the federal government may be playing catch-up for the foreseeable future, private institutions can – and should – move more quickly. Federal authorities expect financial institutions to leverage the tools and knowledge they have available—even if they don’t yet have the same tools and knowledge themselves.
With this in mind, financial institutions and institutional bankers that have not recently re-assessed their AML compliance programs in light of the unique risks cryptocurrency presents need to make this a priority. Not only is this essential for ensuring that institutions’ and bankers’ compliance programs remain up-to-date, but also for demonstrating good-faith compliance efforts to the federal government. If institutions and bankers can show that they are proactively monitoring for signs of money laundering and examining cryptocurrency transactions for red flags for obfuscation, they can protect themselves while also doing their part to prevent illicit transactions involving cryptocurrencies and cryptocurrency-related financial crimes.
2. Evaluate the Need for Greater “KYC” Due Diligence
One of the main reasons why cryptocurrency became the financial vehicle of choice for many bad actors was its anonymity. Today, the federal government is working to legislate this anonymity away, and IRS CI and other authorities have had success identifying parties to cryptocurrency transactions through judicial means.
But, this doesn’t mean that bad actors are giving up. Instead, it has simply forced them to adapt.
As a result, in order to continue to meet their AML obligations, financial institutions and institutional bankers should determine whether they need to update or intensify their “know your customer” (or “KYC”) due diligence practices. Tracing tools are commercially available that institutions and bankers can use to identify (or at least locate) the parties to cryptocurrency transactions in many cases. Institutions and bankers may also now need to place greater emphasis on determining when the putative parties to cryptocurrency transactions are merely shell companies or fronts for criminal operations.
In an even more cryptocurrency-specific vein, financial institutions and institutional banks should also consider the particular risks associated with particular cryptocurrency exchanges. Certain exchanges are commonly known as safe harbors for individuals and organizations seeking to execute trades and other transactions in connection with criminal enterprises. By giving these high-risk exchanges the special attention they demand, institutions and bankers can substantially mitigate their risk of unknowingly playing a role in money laundering activities. Again, the goal here is twofold—to not only satisfy AML requirements, but to be prepared to demonstrate compliance to federal authorities as well.
3. Invest as Necessary
While money isn’t always the answer, in many respects, now is an important time for financial institutions and institutional bankers to consider investing in cryptocurrency-related AML compliance. Given the current state of the market and the federal government’s intensive focus on combating financial crimes in the cryptocurrency space, this investment is likely both necessary and worthwhile for many.
When it comes to investing in cryptocurrency-related AML compliance, there are two key areas in which financial institutions and institutional bankers should focus their compliance budgets. These are:
- Updated Technological Capabilities – As we’ve touched on a couple of times above, there are technological tools available that financial institutions and institutional bankers can use to bolster their cryptocurrency-related AML efforts. These tools not only automate much of the process, but they allow for more in-depth due diligence both within the U.S. and abroad.
- Updated AML Policies and Procedures – Outdated AML policies and procedures are liabilities for financial institutions and institutional bankers. If an institution’s or banker’s AML compliance program is outdated, with regard to cryptocurrency or otherwise, this is an issue that needs to be remedied promptly.
4. Consider Going Beyond What is Minimally Required
In light of the risks of AML non-compliance and the likelihood that Congress will adopt additional legislation pertaining to cryptocurrency-related AML, financial institutions and institutional bankers should consider going beyond what is minimally required. In all likelihood, what is legally sufficient now will not be legally sufficient in the future; and, if institutions and bankers take steps to get ahead now, they will be well-positioned to adapt to additional requirements as they come into play.
By working with experienced legal counsel and AML consultants who have prior federal government experience, institutions and bankers can anticipate cryptocurrency-related AML concerns, and they address them before they lead to the need for a costly compliance overhaul or a federal AML audit or investigation.
5. Don’t Go Overboard
While financial institutions and institutional bankers need to be cautious when it comes to cryptocurrency-related AML compliance, they shouldn’t go overboard. Cryptocurrency is here to stay; and, if institutions and bankers simply choose to stay away from cryptocurrency in order to avoid potential AML risks, they are going to put themselves at a major commercial disadvantage.
While cryptocurrency-related AML compliance presents challenges, these challenges can be overcome. By taking a proactive approach to addressing compliance in the cryptocurrency space, financial institutions and institutional bankers can protect their business, financial, and legal interests simultaneously.
Speak with a Federal AML Lawyer or Consultant at Oberheiden P.C.
The federal AML lawyers and consultants at Oberheiden P.C. work with financial institutions and institutional bankers nationwide on all aspects of cryptocurrency-related AML compliance. If you have questions or concerns and would like to speak with a member of our team in confidence, please call 888-680-1745 or request an appointment online today.