As cryptocurrencies become more widely used, regulators are grappling with how to balance innovation with the need to prevent financial crime. Cryptocurrency regulation has become particularly important because the anonymity associated with some digital assets can create opportunities for money laundering, terrorist financing, and other illicit activities. Governments in both Europe and the United States are responding by bringing cryptocurrency exchanges and related businesses more firmly within existing financial regulatory frameworks. While their approaches differ, the direction is increasingly clear: cryptocurrency businesses will face greater expectations around transparency, customer identification, and anti-money laundering compliance.
Cryptocurrencies have been in the news a lot lately, and there is a lot of debate about how they should be regulated. Some people believe that cryptocurrencies should be tightly regulated, in order to prevent money laundering and other illegal activities. Others believe that cryptocurrencies should be left unregulated, in order to allow for more innovation. There is no easy answer around cryptocurrency regulation, and the best approach may be to somewhere in between.
The EU has taken many steps in the last several years to reduce potential funding for terrorist activities and with the implementation of the Fifth Money Laundering Directive (“MLD5”) it has taken another step. MLD5 amends the Fourth Money Laundering Directive (“MLD4”) to include Cryptocurrency exchanges and custodian wallet providers.
“The new directive is of particular interest to the FinTech sector as, amongst other things, MLD5 includes measures to increase transparency around more recently developed instruments of payment — namely cryptocurrencies and prepaid cards. Both these instruments lend themselves to anonymity and raise concerns that they could be used to help fund terrorist activities.
The new legislation will also require virtual currency exchange platforms and custodian wallet providers to perform due diligence on their customers, including KYC checks. Such entities will also need to be registered for AML purposes. Consequently, these entities will be regulated for AML purposes in the same way as financial services firms (and subject to the same AML regulatory obligations). This will be a significant change for relevant businesses, and is likely to increase their regulatory compliance costs substantially.”
The US is moving in the same general direction as the EU, but is only just beginning get public attention and is currently regulated under numerous laws including the SEC, Fincen, the Bank Secrecy Act and Anti-Money Laundering regulations to name a few. There is also news that a “Virtual Commodity Association”, an industry non-profit focused on self-regulation amongst exchanges will be created which has precedent in the US. Typically the industry proposes limits and latitudes while the regulators gain a better understanding of the true product offerings and where the inherent risks are that require true government oversight. Either way regulation is coming, due to the volatility in cryptocurrency and initial coin offerings (ICO’s) as well as the anonymity associated with purchase, transfer or exchange of these currencies.
The debate over cryptocurrency regulation ultimately centers on finding the right balance between oversight and innovation. Excessive restrictions could make it more difficult for legitimate cryptocurrency businesses to develop new products and services, while insufficient oversight could leave significant gaps that criminals can exploit.
The European Union’s approach demonstrates how existing anti-money laundering frameworks can be extended to cryptocurrency exchanges and wallet providers, requiring these businesses to adopt many of the same customer due diligence and compliance practices expected of traditional financial institutions. In the United States, oversight has developed across multiple regulators and legal frameworks, while industry-led efforts have also sought to establish standards and encourage responsible practices.
As regulators gain a better understanding of cryptocurrencies, exchanges, and other digital asset products, the rules governing the industry will continue to evolve. The challenge will be creating cryptocurrency regulation that addresses legitimate risks without unnecessarily restricting technological development. Regardless of exactly where regulators ultimately draw that line, cryptocurrency companies should expect transparency, KYC, anti-money laundering controls, and regulatory compliance to become increasingly important parts of doing business.
Overview by Sue Brown, Director, Prepaid Advisory Service at Mercator Advisory Group
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