A report released by the UK Treasury Committee last week argued that cryptocurrency should be treated and regulated in the same way as gambling. As Verdict covered, it’s a stance strongly rebuffed by crypto industry leaders, with calls instead to develop a tailored regulatory regime that doesn’t bracket crypto as gambling.
The dilemma of whether trading in cryptocurrencies should fall under regulation “as a financial service” is a split one. On the one hand, one could agree with the Committee’s point of view, arguing this classification would “create a ‘halo’ effect, leading consumers to believe this activity is safe and protected when it is not”. On the other, not treating it as a financial structure may free transactions from the added scrutiny of regulatory bodies like the Financial Conduct Authority, who have expert knowledge and reaffirms its position as sitting outside the laws and remits of the traditional financial system.
The latter, as Jemima Kelly from the FT argues, is crypto’s inherent quality:
“Crypto transactions are not subjected to the same fraud detection, anti-money laundering or suspicious activity checks that traditional ones are. Operating outside the system is its very raison d’être. And one only has to look at how the crypto industry behaves to see that crime is not a bug; it’s a feature.”
When it comes to money laundering specifically, one of crypto’s major assets is that it gives money launderers anonymity and allows them to transfer money between countries undetected and without institutional involvement. This means that regulating it effectively has proved a problematic task.
Yet when it comes to crypto regulation in action, in the same week as the report was released, the EU issued its own statement implementing rules to make crypto-asset transfers traceable between the sender and beneficiary. This traceability is key to regulation and unmasks any bad actors involved in transactions. It’s a positive step, but is it enough?
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How does crypto fuel illicit activity?
Rather than going through traditional methods of placing dirty money in cash-based businesses to clean money, money launderers are taking advantage of the virtual crypto world and, within this, mediums such as multiplayer games and crowdfunding. Avatars can be used to convert money into a game’s virtual currency, for example, and fake campaigns can launder illegitimate money through crowdfunding. These are the more innovative ways the technology can be used to outwit authorities.
In the matter of its transactional and wider use, traditional methods of ‘placing, layering and extracting’ money can be replicated in the online world. Crypto can now be stored in mixed wallets with transactions masked by browsers. This means illegal funds can be placed and mixed with legitimate sources and layered via online entities, which can then be extracted and converted back into assets and clean cash.
These transactions can all happen rapidly and in complex networks, making traditional anti-money laundering methods far less effective. And, unlike in the real world, the virtual world doesn’t have its own regulatory body to monitor and police illicit activity. Just as money launderers use cryptocurrency and its technology to replicate and advance real-world tactics, compliance methods must follow suit.
How can it be regulated?
Authorities need to find ways of transferring real-world practice and regulation into the virtual world. This starts with the source. The ‘on and off’ ramps of crypto begin with individuals converting traditional currency into cryptocurrency, and regulatory bodies could impose strict rules on this process to ensure such exchanges meet anti-money laundering protocols.
This could include making transactions more transparent and compliant through implementing concepts like shared wallets between users, helping to bolster ‘Know Your Customer’ processes.
But as crypto allows transfers to happen easily across borders, the key to the success of governance innovation will be a significant increase in collaboration between compliance teams, agencies and countries, helping to foster information sharing, cooperation and give the virtual world its own governing body. The more transparency achieved, the more data is shared, the more successful the regulation will be.
This is perhaps easier said than done, but the EU regulation outlines a model that could be developed and transferred into wider practice. And the committee report, despite triggering debate, also sets into motion discussions about how best to do this. Crypto needs the regulatory framework of a financial service, but fitted to a world that requires different regulation methods.
It is important to maintain innovation within crypto, but this ruling ensures that it is not done at the expense of the compliance industry. Facilitating open discussions between supervisory bodies about its policing and ways to create transparency will be central to regulating an unregulated world.
Bion Behdin is chief revenue officer at First AML