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It's Time To Mitigate Cryptocurrency Risk with a Contextual KYC Approach
Analyzing cryptocurrency transaction data with specialized analytical tools.
Like the historic “Wild West,” the cryptocurrency market presents both great opportunities for wealth creation as well as significant risks.
Increasingly, traditional financial institutions across the globe are staking their own claims and beginning to offer cryptocurrency services, joining the ranks of money service businesses (MSBs), virtual asset service providers (VASPs), cryptocurrency exchanges and technology companies, which were key in creating this market. While the pedigrees and profiles of these disparate companies vary widely, they have a few things in common. They all want to play in this fast-growing new market, while understanding and managing their risks, and remaining compliant with the rapidly evolving regulations set by government agencies.
More than half of the world’s 100 largest banks have now made investments in cryptocurrency companies and/or hold cryptocurrency asset1. And it is not just a trend for the largest banks – in the U.S., small to mid-size “community banks” are entering the market as well. In late 2021, Oklahoma-based VastBank became the first federally-chartered U.S. bank to offer customers cryptocurrency transaction services, enabling them to purchase twelve types of cryptocurrencies when they open a new account, link their checking accounts to their crypto wallets, and move money from one to the other.
But effectively managing risks in this space is not easy.
How financial institutions can manage cryptocurrency risk
Several recent events have accelerated the movement of traditional financial institutions into more active phases of cryptocurrency market participation, including:
The invasion of Ukraine by Russia and the resulting cascade of sanctions on large numbers of individuals and organizations, with an expected increase in efforts by sanctioned entities to use cryptocurrencies to hide their assets;
The March 9th, 2022 Executive Order by U.S. President Joe Biden on “addressing the risks and harnessing the potential benefits of digital assets and their underlying technology.”
President Biden’s Executive Order is more a call to action than a specific policy declaration. Its most significant impacts are likely to be stimulating the further adoption of cryptocurrency by financial institutions and individual investors and savers, by giving symbolic recognition to cryptocurrency’s legitimacy, and by committing the U.S. government to evaluating the development of its own virtual currency, backed by the U.S. Treasury.
Regulated financial institutions must stay in compliance with Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations, including knowing the source of funding for deposits (above a defined threshold amount) to customer accounts. By its design, Blockchain keeps a permanent record of every transaction so any unit of Blockchain-based cryptocurrency can be traced. But at the same time, most cryptocurrency accounts are pseudonymous – the Blockchain record does not reflect the owner’s personal or business identity.
Bridge the gap between crypto transactions and real-world entities
Individual cryptocurrency values are volatile, moving up and down rapidly, but overall the cryptocurrency market is steadily gaining momentum and legitimacy. Financial institutions need new technology and data capabilities to manage their risks, meet KYC and AML requirements and see all of their customers’ activity in context.
Luckily, there are a variety of ways to link real-world identities to crypto transactions, such as using transaction and crypto wallet data from VASPs or using wallet account data shared on social media when transactions occur. Even if the wallet data is not shared with any identifiable details on social media, in many cases the same username would have been used elsewhere and would enable the connection to be made to a real-world identity.
Generate context using advanced technology
To maximize the value of this data, many leading financial institutions are introducing new technology and data capabilities that will both consolidate and generate intelligence from multiple sources in order to see all activity in context, such as:
Enriching a bank’s KYC and transactional data sets with additional third-party corporate registry data and/or intelligence from the virtual asset domain
Integrating intelligence from on-chain analytics companies
This will enable the financial institution to not only identify the exchanges and resolve them as entities but also to flag suspicious exchanges, or those with limited or no KYC programs, using transactional screening technology to overlay keywords and narrative indicators to build an improved risk profile of crypto usage.
The key to effectively managing crypto risks is by transitioning to a multi-dimensional view of risk and control by leveraging the power of innovative technologies, combining multiple data sources, and applying strong KYC and KYCC (Know Your Customer’s Customer) policies from the outset.
Amidst the rapid proliferation of cryptocurrencies, challenges will continue to arise for financial institutions. But one thing is clear – analyzing cryptocurrency transaction data and other relevant data to determine identities, manage risk and meet KYC and AML requirements demands specialized analytic tools that can handle large data volumes as high-risk actors are those most likely to obfuscate the tracing of their assets using multiple tactics.
