AML and the Blockchain: The (R)evolution of Regulatory Compliance

The early days…

The Bitcoin industry has come a long way from its early days where Customer Due Diligence (CDD), Know-Your-Customer (KYC) policies, and transaction monitoring were not a priority for most companies. It was typical for companies that operated Bitcoin exchanges to approach compliance with a lax attitude. The pseudonymous nature of Bitcoin transactions made the platform attractive for two types of early adopters; some of whom were in it for curiosity – and some to exploited it for illegal activity.

As can be expected, non-compliance with traditional finance standards hindered early Bitcoin companies from reaching a wider market. This lack of adherence to traditional finance standards also meant that these Bitcoin companies operated without sufficient consumer protection policies in place; resulting in a vigorous swarm of media scandals about the Bitcoin industry.

Mark Karpeles, the former CEO of the now infamous company Mt. Gox, was charged for embezzling client bitcoins. This event highlighted the need for independent oversight of Fintech companies. There is also the case of Charlie Shrem who was also jailed for two years for facilitating transactions for Silk Road – an online black market – through his company, BitInstant.

And very recently, Ripple – a company offering blockchain-based financial services – and one of its subsidiaries, was fined $700,000 in 2015 by Financial Crimes Enforcement Network (FinCEN) in the USA. FinCEN stated that Ripple “willfully violated” the Banking Secrecy Act; failed to register as a Money Services Business (MSB); and, failed to implement appropriate anti-money laundering (AML) policies.

Where are we now…

New Regulations

As with any new technology that marks a dramatic departure from the status quo, Bitcoin initially incited two broad regulatory responses – either dissent or silence. But over a short time the regulatory sentiment reoriented into more favorable approaches in general.

So far, the state of New York in the USA has had the most stringent approach to regulation. Other countries such as Canada and the UK have begun the process of investigating Bitcoin and Blockchain with the view to draft future regulations for this new financial tool, while currently approaching it with a “light touch”.

Due diligence requirements and software

It is a common misconception that Bitcoin means ‘perfect anonymity’ and therefore leads to money laundering. Bitcoin transactions are pseudonymous; knowing the identity of a party involved in one transaction can uncover many other transactions they were involved in.

Companies like Coinalytics have begun to leverage machine learning and graph theory to design software that analyses the Bitcoin blockchain and provides compliance insights far beyond the current capabilities of financial industry. Rather than the Bitcoin blockchain signalling a lapse in compliance, it spurs the necessary progression.

Additionally, Elliptic – a company specializing in bitcoin related risk management services – has developed software called the the Bitcoin Big Bang which is an interactive visualisation that plots the emergence and interconnectivity of the key players in bitcoin since its genesis in 2009.


Visualization of the Elliptic Software

In traditional financial compliance processes it is not possible for the company to track the movement of suspicious transactions in a meaningful way. Compared to traditional banking, this opens up a new monitoring method that could have never been realized due to jurisdictional privacy laws, correspondent banking, private banking services and other forms of complicated financial relationships and transactions within the traditional financial system.

IdentityMind now offers KYC document verification as a service, whereby it is no longer necessary to be face to face to confirm the legitimacy of photo ID. It is now as easy as uploading your documents and the software can confirm if the ID is a valid document. This not only makes the client onboarding process a more seamless and convenient experience for the customer but also affords the company a higher level of certainty regarding KYC validity.

Where we are going…

Blockchain technology and big data analytics now provide the opportunity for a level of transaction analysis that has not been available in the financial services industry in the past.

Overall, Bitcoin companies have learned from the mistakes of the early days of weak money laundering oversight. Now, companies like Bitt  not only meet the regulatory requirements like other financial institutions, but are set to surpass them due to the unique characteristics that bitcoin and the blockchain possess.