Is the regulation that threatens the free-spirited nature of cryptocurrency actually the key to its future?

Cryptocurrencies’ lack of regulation has always been key to their appeal. It allows transactions to be ‘light on their feet’, without the delays and red tape imposed by banks, financial institutions and regulators. And the ability it gives to move money across borders cheaply is highly valued, particularly as some banks charge £25 for international transfers.

But this lack of compliance is why most banks worldwide refuse to work with cryptocurrency exchanges - the level of risk is too high. Know Your Customer (KYC) compliance is crucial in helping banks and companies avoid being defrauded or becoming victims of other financial crimes, such as money laundering or organized crime.

Why don’t cryptocurrencies take compliance seriously?

Competitive edge

There are 1,500 cryptocurrencies operating worldwide and their customers aren’t generally fans of KYC procedures. It takes 24 days, on average, for a commercial bank customer to pass the entire compliance process. This delay isn’t attractive to crypto traders and investors who may simply use a platform with less scrupulous checks.

Cost

Banks are already spending c.$550m a year on KYC which is significantly increasing the cost of adding new clients. If large banks are finding these compliance costs onerous, they could be fatal for cryptocurrency exchanges, particularly new entrants to the market.

The rise of cryptocurrency

There has been a surge in cryptocurrency development and media interest over the last year.

• There are now over 1,500 cryptocurrencies in the market.
• Bitcoin has had a dramatic renaissance in its 10th year and its price is up 220%. It has followed this trend since mid-February and breached yearly highs at least once every month. Bitcoin broke above its upper band limit for the first time this year in early February.
• Facebook’s ‘revolutionary new global currency’ Libra is already courting controversy before its launch. Facebook wants it to be usable for day-to-day transactions as well as a cheap, convenient way to store, spend and transfer money with low fees. Investors include Uber, Lyft and Spotify. But critics say Facebook’s track record with data security is cause for alarm.
• Innovative brewer, Brewdog, is now offering shares through its Equity for Punks crowdfunding initiative in exchange for a range of cryptocurrencies, including bitcoin, Ethereum, Litecoin, Augur and XRP.
• JP Morgan Chase is preparing to launch its own digital coin, the JPM coin. The idea is to give bankers and corporate clients a way to make payments to each other in real time as part of the company’s corporate payments business.

Global concerns

The resurgence of cryptocurrency has caught the attention of governments globally – and prompted some strong reactions. On 11 July, Donald Trump tweeted: “I am not a fan of bitcoin and other cryptocurrencies, which are not money, and whose value is highly volatile and based on thin air. Unregulated crypto-assets can facilitate unlawful behavior, including drug trade and other illegal activity.” US Treasury Secretary Steven Mnuchin joined the assault on bitcoin, Libra and other cryptocurrencies warning that they pose a “national security” risk to the US.

Elsewhere, India has threatened to ban cryptocurrencies altogether, while French finance minister, Bruno Le Maire, said Libra “can’t and…must not happen”. Also discussing high-profile Libra, Mark Carney, governor of the Bank of England, said: “Anything that works in this world will become instantly systemic and will have to be subject to the highest standards of regulation.”

Is regulation the answer?

The cryptocurrency market has now grabbed the serious attention of regulators. While regulation and cryptocurrencies may not seem a natural fit, the only way cryptocurrency can thrive is if the global establishment has confidence in it.

“To gain respect and empathy from regulators, crypto exchanges need to be proactive about compliance. At the minimum, you want to get the on-boarding stage right, even if the crypto-market is currently under-regulated. You also want to ensure that your user registration system can detect and deter criminal activities, using the expertise of best-in-class KYC/AML providers.”

Tony Mackay, who recently launched the Krypto-X exchange.

While the current compliance situation for cryptocurrencies is far from ideal, there are welcome improvements and changes underway.

Binance, one of the world’s largest crypto exchanges, is an interesting example. It has partnered with Chainalysis, a software solution provider that helps law enforcement agencies track the movement of bitcoin and other top cryptocurrencies. The platform uses statistical techniques to identify when a transaction is likely to be tied up with criminal activity and generates a warning alert.

Binance is a trendsetter in the market and other crypto exchanges are likely to follow its lead. While the costs of implementing proper compliance measures can be off-puttingly high, this can be solved by using an effective third party KYC solution; access to other company data resources should also play a key role in due diligence onboarding and other compliance processes.

Blockchain forensics company, Elliptic, says: “We find that the most successful crypto businesses are those that make compliance a top priority. By taking a proactive stance towards risk management, conducting meaningful KYC, and ensuring they are equipped with the right tools, people and expertise, exchanges and other crypto service providers can navigate regulatory change…We’ve seen that where responsible cryptocurrency businesses embrace successful compliance, it’s a differentiator that can help them achieve their broader goals of building trusted products and services that can drive the future of finance.”

Cryptocurrency is a rapidly evolving industry. But it’s clear that it can only continue its impressive growth by taking compliance seriously, rather than treating it as an afterthought or inconvenience.

You might also be interested in Compliance Catalyst.