Who would have thought the Crypto world would have evolved so much and so fast since it's introduction to the world in 2009, and with that, that the ever-increasing need for effective measures to combat fraud and corruption, which has been a hot topic in recent years, especially surrounding the events that took place in 2022 starting with Terra USD and its sister token Luna all the way to the collapse of crypto giant FTX. As the industry has grown and the losses from fraud and lack of controls with it, regulators around the world have taken notice, with the U.S. leading the way and thus, many other countries following suit to introduce new crypto compliance regulations, with even at state level taking it upon themselves to introduce heavy compliance requirements. But what does this all mean for the future of companies in the crypto space?
CRYPTO REGULATIONS IN THE U.S.
Cryptocurrency regulation in the U.S. is still relatively new, but it is evolving, and very quickly. The U.S. Securities and Exchange Commission (SEC) has been the primary regulator of cryptocurrencies, with heavy push from other agencies, such as the Commodity Futures Trading Commission (CFTC) and the Financial Crimes Enforcement Network (FinCEN), which have also been involved in the regulatory process.
The SEC, in addition to its focus on protecting investors from potential scams and ensuring that they have access to accurate information, has also worked on creating a more comprehensive regulatory framework by issuing a series of guidance documents that outline the requirements for registering and operating token projects, as well as the requirements for financial intermediaries dealing with Cryptocurrency, while the CFTC has taken a handson approach, issuing guidance documents and providing advice on the legal and regulatory requirements for Cryptocurrency derivatives and taken action against companies that have violated these laws, and it does stop there, agencies at the state level such as the New York State Department of Financial Services (NYDFS) has aggressively started to enforce and fine several crypto related companies millions of dollars for BSA/AML and Compliance program deficiencies.
With all these agencies shifting much of their focus to cryptocurrencies, fraud must have come to a stop and with that money laundering and corruption...right? Well, not really.
There were multiple instances of companies that were fined by or settled with regulators in 2022 due to lack Anti-Money Laundering (AML) regulations, pervasive compliance deficiencies, lack of transaction monitoring and anti-fraud controls, cybersecurity deficiencies, insider abuse, and overall lack or regulatory governance, with fines to crypto financial institutions and its employees more than doubling compared to 2021, and the start of 2023 with a total of more than $100 million in fines before January ends. One of the events that caused the most controversy and damaged placed severe lack of trust on crypto financial institutions is the case of FTX. These events have further highlighted a need for enhanced regulation and scrutiny of cryptocurrency, segregation of duties, incorporation and enhancement of BSA/AML, registration, and licensing requirements and pushing for companies to start really doing their due diligence and take a proactive approach towards compliance and detecting fraud. The series of events the past year have shown that what was early on believed to be the technology to end corruption, insider abuse, fraud, and other financial crimes simply is not working and will not work unless agencies, auditor, banks, investors, and even customers are actively on the lookout. So, what now?
Well, with the losses that have taken place for companies and individuals, banks now have started de-risking, and those that have not, are surely trying to play catchup as they see the potential for financial penalties for not following regulatory guidance and having to react and rushing compliance measures, in addition to fines or settlements, the reputational damage, negative public perception, and difficulties raising capital. Sadly, much which could have been prevented were it not thanks to the historic mentality and approach from companies towards compliance as a last order of business since it is seen as a non-revenue generating business aspect.
WHAT HAVE WE LEARNED, AND CAN IT BE USED TO REBUILD?
I see this as a reboot of the system, it is a way to start fresh again and learn from the mistakes made in 2022 and prior years.
When Crypto discussions took place a decade ago, everyone talked about a decentralized currency, but then if that was the case, then what happened with FTX and Three Arrows Capital? These are core examples of centralization which resulted in millions turning into just smoke and mirrors under the control of fraudsters.
Regulatory oversight was something controversial and challenged constantly but had there been clear regulation in place and adequate programs, perhaps a lot of what happened would have either been come to light early on or been prevented, instead everyone was late to the show where millions were defrauded from investors and consumers.
Anyone can make blatant remarks, offer products that make no sense, offering beyond incredible interest rates, or promise gains, but as with all reasonable and safe investments, and people forgot that if something sounds too good to be true, it usually is.
From all of these comes the learning part, and most importantly learning from a crypto finance company and compliance perspective how to prevent these events from repeating themselves.
Companies will need to challenge themselves and rise to the expectations of consumers, the regulators, and potential sponsor banks which are now going to be paying close attention as they too become responsible for compliance deficiencies.
STARTING WITH A STRONG FOUNDATION
Companies entering or currently in the crypto market should look at their program to determine if at minimum they have the following:
- Strong risk management: Implement robust risk management systems and procedures to identify and mitigate potential issues before they become a problem
- Adequate compliance: Ensure that the company follows all relevant laws and regulations in the countries where it operates, including anti-money laundering (AML) and know-your-customer (KYC) requirements and that your compliance department is well qualified in these areas
- Robust security measures: Implement strong security measures to protect against hacking, theft, and other cyber threats. This can include things like two-factor authentication, multi-signature wallets, and regular security audits
- Transparency: Be open and transparent with customers, partners and regulators about the company's business practices, and provide clear and accurate information about the company's products and services
Strong governance: Ensure that the company has strong governance and internal controls in place, including a Board of Directors that is independent and has the necessary expertise to oversee the company's operations.
Strong customer support: Provide strong customer support to help customers navigate any issues and to build trust and loyalty.
Continuous review and improvements: Regularly review the company's policies and procedures and make improvements as necessary to ensure they align with the industry standards, regulations, and best practices.
"Regulatory oversight was something controversial and challenged constantly but had there been clear regulation in place and adequate programs, perhaps a lot of what happened would have either been come to light early on or been prevented"
In addition, here are a few of the cryptocurrency fraud trends that companies need to ensure they have adequate systems and controls in place to detect and prevent:
- Money Transfer Scams: Scammers often trick victims into transferring money to their own wallet. This is often done through convincing individuals to change their bank details or through fake payment services
- Phishing Attacks: Phishing attacks involve sending emails or messages that contain malicious links or attachments. If clicked, these links or attachments can install malicious software (Malware) and/or steal personal information
- Fake ICOs: Initial coin offerings (ICO) are becoming increasingly popular, but unfortunately, so are fake ICOs. Fake ICOs often have websites that look legitimate but are instead designed to steal investors' money by luring them to invest into these ICOs which promise outlandish returns but are usually nothing more than a Ponzi scheme or fraudulent investment
- Pyramid and Ponzi Schemes: Pyramid and Ponzi schemes involve paying higher members of the pyramid with money from lower members. Such schemes are illegal and can lead to financial losses for members involved
Pump and Dump schemes: These schemes involve bad actors buying a large number of low-priced cryptocurrencies and then artificially inflating the price through social media marketing and other tactics. When the price has gone up, the bad actors then sell their holdings at a large profit, leaving the investors with worthless coins.
Pig Butchering: - includes a sophisticated new twist that combines a romance scam with an investment spin. According to the Federal Bureau of Investigation (FBI), the term "pig butchering" refers to a time-tested, heavily scripted, and contact intensive process to fatten up the prey before slaughter. This scam is predominately executed by a ring of cryptocurrency scammers on dating apps and social media sites in search of victims as an evolved version or romance scams that gets the victim to invest in crypto.
Market manipulation: Bad actors may use malicious bots to artificially manipulate the price of cryptocurrencies, or even to spread false news about certain coins to manipulate their prices.
Fake cryptocurrency wallets: Cybercriminals may design fake cryptocurrency wallets that look like the real thing but contain malicious code. Victims may end up downloading malware or giving away their private keys, which can lead to loss of funds or a compromised security system.
These are just the tip of the iceberg on list of things that partner, or sponsor banks and investors will start to look at more closely as everyone realizes the array of risks that come with crypto. What was once early on believed to be safe, due to the decentralized, self-compliant currency in a way due its undisturbed audit trail that would force everyone to play by the rules, has turned out to be just as if not riskier than fiat currency without the proper technology and programs in place to supervise. Banks, regulatory authorities, and individual investors have realized there is plenty of work to be done before being able to trust crypto businesses and ensuring everyone involved is doing the right thing and being held accountable.
With innovation come risks and learning, and 2022 proved there are still plenty of risks from an operational standpoint with cryptocurrencies and banks may take some time to regain trust in how companies are operating and managing risks and for public perception to change
CRYPTOCURRENCIES: "What was once early on believed to be safe, due to the decentralized, self-compliant currency in a way due its undisturbed audit trail that would force everyone to play by the rules, has turned out to be just as, if not riskier than fiat currency without the proper technology and programs in place to supervise. "
HELPING YOU PREPARE FOR A COMPLIANT FUTURE
Cryptocurrency regulation is an ever-evolving landscape, and it is important for companies to stay up to date on the latest developments. Our team provides is an organization that promotes regulatory compliance and has the expertise to prepare new and existing companies, to stay informed, keep up to date with the latest developments in virtual currency regulations by monitoring relevant government websites, industry associations, and legal publications. We work every day to develop a compliance program to aid investor protection, KYC/AML compliance, and anti-fraud measures by assisting with creation and implementation of policies, procedures, and controls to ensure compliance with existing and future regulations. This can include things like conducting regular internal audits, training employees on compliance policies, establishing cross company relationships to ensure you have the appropriate technology, vendors, and systems necessary and develop contingency plans in case of regulatory enforcement actions or other legal challenges.
It is worth noting that regulations and compliance requirements can vary widely depending on the jurisdiction, so it is important for virtual currency companies to become aware of the specific regulations and changes to come in the countries or regions where they intend to operate and help prevent another year like 2022 for the crypto markets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.