Crypto battle with regulators brewing, as G20 ministers attack anonymity

Chris Lee

It was inevitable. Regulators across the globe have gradually become more accommodating with respect to all things crypto, but there is one area where they, as a unit, refuse to budge – the anonymity provided by blockchain transactions. Yes, the blockchain is transparent to a degree and does provide an accurate record on public display of all transactions, but the identity of endpoint addresses is never disclosed. Law enforcement officials insist that the openness of the blockchain does help in their investigations, but compliance with KYC/AML/CTF regulations has been a challenge.

KYC AML CFT Compliance

Not only is compliance a challenge, but blockchain technology also cannot disclose any specifics about an endpoint destination, other than its physical address. There are even exchanges today that will “mix” transaction pools to further disguise the actual audit trail, or as crypto zealots proclaim, protect the privacy of individuals from peering eyes of any government officials. Libertarian zeal may have been an early dream, but adversaries have always countered that organized crime and all sorts of nefarious evildoers have benefited enormously from these “privacy” protections.

Critics always point back to the early days of Bitcoin when the “Silk Road” was one high profile example of criminal activity on display, selling all manner of illicit goods in defiance of international standards and the rule of law. The FBI eventually shut the operation down, but opponents continue to assert that cryptos are a crooks’ paradise. Studies have been funded that suggest as much as 50% or more of all transaction activity in Bitcoin is dominated by criminal elements.

Advocates argue that the real figure is nearer to 1%, a similar level as with many other financial services. Other studies also posit that crooks have a difficult time with the blockchain because large transaction amounts are so visible and that access issues also thwart criminal intent. At the end of the day, however, if cryptos are to mature to the next level and receive the regulatory approval that all desire, then this issue of anonymity must be dealt with in a concerted and consistent manner by all major exchanges in the network. There will always be “outliers”, but as long as they are isolated and known quantities, then regulators can deal with those elements separately, as necessary.

This ongoing debate or “cat-and-mouse-game”, as some have called it, however, is finally coming to a critical crossroads. The Financial Action Task Force (FATF) has been working on basic standards for the crypto industry that all G20 finance ministers gave their sign of approval at a recent meeting in Japan. As was announced in October of last year, these new guidelines would be ready for adoption in June of this year.

As has been reported: “The FATF is an inter-governmental organization that was founded in 1989, when G7 financial ministers created the initiative to develop global policies to combat money laundering. It later expanded its mandate to include the financing of terrorist groups. Up until this point in time, regulatory entities across the globe had been modifying policies and rulings on a case-by-case basis. It was time for an “ombudsman” to step forward to end the confusion and establish crypto standards for all jurisdictions to follow.”

In its statement last October, the FATF outlined its deliverable: “As part of a staged approach, the FATF will prepare updated guidance on a risk-based approach to regulating virtual asset service providers, including their supervision and monitoring; and guidance for operational and law enforcement authorities on identifying and investigating illicit activity involving virtual assets. In light of the rapid development of the range of financial functions served by virtual assets, the FATF will also review the scope of activities and operations covered in the amended Recommendations and Glossary in the next 12 months and consider whether further updates are necessary to ensure the FATF Standards stay relevant.”

Fast forward to today’s news and the report is: “On June 21, the Financial Action Task Force — a multi-government effort that develops recommendations for combating money laundering and financing of terrorism that’s followed by about 200 countries including the U.S. — will publish a note to clarify how participating nations should oversee virtual assets, FATF spokeswoman Alexandra Wijmenga-Daniel said in an email. The new rules will apply to businesses working with tokens and cryptocurrencies, such as exchanges and custodians and crypto hedge funds”.

What will be the impact on the crypto-verse going forward?

A single regulatory attack from one jurisdiction or another is one thing. A concerted attack by the SEC to shut down Initial Coin Offerings and take hard-line positions on other aspects of crypto activities can be decisive, but when the FATF and its 200+ following nations get together in one singularly directed assault, then all bets are off. Per Eric Turner, director of research at crypto researcher Messari Inc.: “[It’s] one of the biggest threats to crypto today. Their recommendation could have a much larger impact than the SEC or any other regulator has had to date.”

The proposed rule that causes the greatest angst at the moment seems innocuous enough, but Chainalysis, a respected crypto research firm, had advise the FTAF that its guideline was unworkable. It reads: “[All companies are] to collect information about customers initiating transactions of over $1,000 or 1,000 euros, as well as details about the recipients of the funds, and to send that data to the recipient’s service provider along with each transaction.”

John Roth, chief compliance and ethics officer at Seattle-based exchange Bittrex, which has about $58 million in daily-trading volume, noted: “It’s either going to require a complete and fundamental restructuring of blockchain technology, or it’s going to require a global parallel system to be sort of constructed among the 200 or so exchanges in the world. You can imagine difficulties in trying to build something like that.”

Mary Beth Buchanan, general counsel at San Francisco-based Kraken, which does about $195 million in daily volume, is of a similar mind: “Without enhanced technology systems, this is a case of trying to apply 20th-century rules to 21st-century technology. There’s not a technological solution that would allow us to fully comply. We are working with international exchanges to try to come up with a solution.”

Lastly, comments from Coinbase, the largest U.S.-based crypto exchange, echo similar sentiments. Per Jeff Horowitz, chief compliance officer at San Francisco-based Coinbase: “I get why the FATF wants to do this. But applying bank regulations to this industry could drive more people to conduct person-to-person transactions, which would result in less transparency for law enforcement. The FATF really needs to consider the many unintended consequences of applying this specific rule to virtual-asset service providers.”

What are the potential downsides and what can the industry do now?

When asked to explain the potential consequences of non-compliance of a country with the new guidelines, Jesse Spiro, head of policy at crypto investigative firm Chainalysis Inc. and who had worked with the FTAF in its development process, stated: “It can essentially lose access to the global financial system. Will it be a potential hardship? Certainly, at least initially. While it may be a hardship, it seems to be something that’s necessary. The road map at the end of the day after this is less arduous for this industry.”

Executives from major exchanges around the world are not waiting around to see what might transpire going forward. The group is determined to go on the offensive and has hastily arranged what has been billed as a “V20 Summit”, intended to coincide with the G20 Summit scheduled for Osaka, Japan, at the end of June. To date, executives from several large crypto exchanges have confirmed, including Circle, Coinbase, bitFlyer, Kraken, and Huobi.

Finance leaders, regulators, and policymakers have been asked to attend, as well, to debate the feasibility of one specific recommendation: “Global regulators [are] to ensure that “virtual asset service providers” – exchanges, custodian banks and others involved in the crypto markets – collect, hold and remit information on the counterparties to customers’ trades executed on their platforms, and make this available to law enforcement”

Elaine Sun, chief compliance officer at Huobi Group, one of the world’s biggest cryptocurrency exchanges by volume, summed up the need for such discussions: “Direct conversations with FATF to clarify the unique nature of the crypto industry will help to build a mutual understanding of regulatory exposure, and find industry-wide solutions to manage such exposures.” It is definitely time for all participants to sit at one table and debate the issues at hand, as well as proposed solutions that can be feasibly implemented without excesssive cost.

Concluding Remarks

Cryptocurrencies from their very inception have espoused Libertarian principles – the desire “to maximize political freedom and autonomy, emphasizing freedom of choice, voluntary association, and individual judgment”. These principles seem well and good, until you put them in the context of a financial service in today’s modern age of technology and then expect cooperation from the world’s banking and regulatory establishment. The criminal element in our society is organized, well funded, and prepared to take advantage of any perceived weakness in the financial infrastructure.

KYC, AML, and CTF regulations are necessary conditions to shore up any “perceived weakness in the financial infrastructure”. Cryptocurrencies have tiptoed about these rules for its first decade of development. It is time to conform by working with regulators to develop a workable solution that satisfies the needs of all parties without imposing an undue cost burden on the entire crypto industry. For now, the momentum is building for the next step that can only enhance the credibility of cryptocurrencies and thereby increase awareness and the eventual adoption of cryptos on a mainstream basis.

Chris Lee

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