Cryptocurrency, money laundering and KYC: why are regulations important?



Cryptocurrency has come a long way since the very first Bitcoin in the world was mined back in 2009. Almost 12 years on, it’s safe to say that cryptocurrency has well and truly emerged from the shadows and come into the mainstream.


But with cryptocurrency’s widespread interest and adoption comes another issue: how do we ensure that this innovation begets more good than harm? That’s the sentiment underpinning the numerous regulatory frameworks that are just beginning to emerge.


“Crypto’s outlaw days are over,” write the authors of this TechCrunch article, “but it’s gained an unprecedented level of legitimacy that can only be preserved and bolstered by abiding with regulatory oversight.”


What are cryptocurrency regulators concerned about?


Cryptocurrency regulations around the world vary very widely — one might even remark that the guidelines are almost as diverse as cryptocurrencies themselves.


Some governments ban cryptocurrency mining and trading outright. Others embrace cryptocurrency in the hopes of benefitting from its economic potential.


But most countries fall somewhere in between, wanting to adopt the technology while at the same time being wary of its risks.


Being a decentralised form of money, cryptocurrency changes hands without passing through a central authority or institution that can be held accountable by laws and regulations. That makes it particularly susceptible to criminal uses such as money laundering and terrorism financing.


Most governments’ guidelines address these risks in some fashion. Below, we’ll take a look at what crypto regulatory frameworks may comprise.


Read more: Guide to Cryptocurrency Part 1: What it is & Why it Matters


What does a typical cryptocurrency compliance framework look like?


Given that governments around the world are still working out how best to deal with cryptocurrencies, there is currently no such thing as a “typical” regulatory framework. However, we can take a closer look at Singapore’s regulations as an example.


The city-state is known to be fairly progressive when it comes to cryptocurrency. Its Payment Services Act, which governs crypto exchanges and digital payment providers, was updated in 2020 following a consultation with the various players on the scene.


Singapore also granted formal licenses to two crypto exchanges in late 2021, an apparently crypto-friendly move. Meanwhile, other crypto businesses continue to operate in Singapore on temporary licenses or exemptions as they await formal licenses.


In addition, the Monetary Authority of Singapore (MAS) has a very robust set of anti-money laundering (AML) and combating the financing of terrorism (CFT) guidelines, summarised in the following infographic.


Source: MAS infographic on AML/CFT controls


These guidelines can be roughly grouped into two main thrusts: KYC (Know Your Customer) guidelines, and monitoring & verifying transactions.


Part 1: KYC, or Know Your Customer


In the MAS’ regulatory guidelines, there are a slew of measures around screening and assessing customers. The idea is that businesses should know who their customers are, and who are at higher risks of criminal activity.


Called KYC (Know Your Customer), this is a common expectation among financial institutions around the world. It is easy to see why some governments extend it to players in the crypto space too.


To comply with KYC requirements, a licensed crypto exchange must first conduct extensive background checks on customers to verify their identities and determine their risk levels.


This process is meant to weed out undesirable customers, such as those with criminal track records and known association with terrorist groups.


The other important aspect of KYC is Customer Due Diligence, or CDD. Having done its background screening and identity verification, the exchange is obliged to flag high-risk customers and build additional safeguards into any existing Customer Due Diligence (CDD) protocols.


For example, a customer with political connections is regarded as at higher risk for bribery or money laundering than someone from an ordinary background. The exchange must implement stricter measures on the former to minimise the risk of abuses.


Part 2: Monitoring & verifying transactions


The second part of the crypto compliance framework relates to monitoring transactions and account activity on an ongoing basis. Exchanges are obliged to maintain records of these activities, scrutinise them for any suspicious activity and report them to the relevant authorities.


There may be differentiated measures for customers of different risk levels too. Higher-risk customers are typically watched more carefully, and may have to go through further rounds of verification or safeguards.


For instance, if a high-risk customer funds her crypto exchange account with a sum of fiat currency, the business may need to verify her source of funds to determine if the money comes from a legitimate source (for example, a bank account in her own name).


If she funds her account with a large amount of Bitcoin, the exchange must also verify where the Bitcoin came from, and whether it was legitimate.


The customer may be asked to furnish documentation, such as screenshots or email confirmation as proof of the Bitcoin purchase on another crypto platform.


In cases requiring further investigation, the exchange may need to establish her source of wealth, which explains how the customer’s funds were derived (e.g. income from work, inheritance, sale of assets).


Proving source of wealth is obviously much more onerous than source of funds, especially given the anonymous nature of crypto transactions.


Read more: What investors should know about security, hacking and cryptocurrencies


Regulations: the end of cryptocurrency’s “outlaw era”?


”Regulation” may be a dirty word in some other industries, but we believe it is beneficial in the case of cryptocurrency.


Looking at the state of crypto regulations around the world today, it’s apparent that most governments are more interested in compliance and risk management — more so than limiting the use and trade of cryptocurrency.


For the long-term investor, this focus is definitely a good sign. The fact that authorities seek to clean up rather than stifle the cryptocurrency ecosystem shows us that they have already granted crypto a fairly high level of legitimacy.


As crypto regulations mature, we expect greater awareness of and adherence to crypto compliance guidelines. This can only be a good thing for serious investors. After all, no sane investor would want their asset class to be tainted by money laundering and terrorist financing.



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