Facing the Risks of Crypto

Everyone knows that Blockchain technology can solve many problems we currently have in financial services.

Blockchains can help banks offer more competitive products, and also run their businesses more profitably.  Blockchain technology can bring banks savings on processing costs because this elegant new innovation can be adapted to make highly complex processes, simple again.

Despite all the benefits and potentials with blockchain technology, there are risks involved that new networks will not support established processes and regulation in the payments world. The existing processes in place in payments are sanctioned by governmental control and oversight. Although rules within the payments industry today do pose barriers of entry to many would be players, regulations against terror financing and money laundering remain a focus of regulators worldwide, for obvious reasons.

Concerns regarding quickly advancing technologies in the payments space is causing some alarm, which is why last week’s $700,000 penalty posed on Ripple Labs for anti-money-laundering violations sent a shock wave through the payments industry.  Ripple Labs, it seems, did not comply with the Financial Crimes Enforcement Network’s (Ficen) March 2013 issued guidance recognizing virtual currency businesses as money transmitters.  This ruling effectively subjected them to the full suite of existing anti-money-laundering regulations.  Despite the fact that Ripple eventually put AML protections in place, it failed to adhere quickly enough and facilitated transactions for months after the guidance was issued.

Ficen’s ruling made it perfectly clear to payment providers that the regulator has every intention of holding new players in this field wholly responsible for compliance, from the time they flip the switch on their new services.  The enforcement action sent a clear message to all digital currency startups that they must be hyper-vigilant about AML compliance.  Industry experts are debating what affect the ruling will have on banks’ future partnerships with digital currency startups. Traditionally, financial institutions have perceived the virtual currency field as high-risk, especially because of the potential for run-ins with regulators over AML and consumer compliance issues.  Perhaps, some demur, that the ruling will finally prove to banks that digital currency firms are not so different than any other money-services business.  New players will have to know their customers, file suspicious activity reports, and adopt written AML policies just like everyone else.

As part of the enforcement action, Ripple Labs agreed to make “enhancements” to its transaction analysis and risk monitoring protocol, but not to the protocol itself.  This came as a relief to players in digital currency who worried that regulators would overstep their bounds by mandating changes to Ripple software. Although the fine against Ripple Labs was the first, industry insiders do not expect it to be the last.  Apparently Fincen is only beginning its enforcement examination of MSBs in the digital currency space with this first round of compliance examinations.

Every implementation that is done in specific regulatory regimes should be equipped with standard processes for account verification, anti-money-laundering provisions, and even simple OFAC filters, to avoid substantial fines. We see a strong case for all innovators in this space to enhance their technology landscape to account for standard regulatory provisions when the data is available. Established wallet providers that can only receive/transmit currencies should aim for a trusted partner model that guarantees the identification of counterparties.  Cryptofinance in general must meet or exceed our current processing models related to compliance, anti-money laundering, and know-your-customer procedures. Responsible participation in the payments ecosystem requires as much.