Satoshi Nakamoto (the creator of Bitcoin) was motivated by the economic chaos created by over-exuberant lending practices in the banking sector and the subsequent burst of housing bubbles in many other countries.
“And who do think picked up the pieces after all the chaos?” Durgham Mushtaha (business development manager at Coinfirm), spoke exclusively to Cointelegraph about the fallout of the cryptocurrency explosion.
Satoshi saw the need to create a new monetary system that is fair and equitable. A system that puts power back in the hands of the people. An anonymous system that is trustless and allows transactions to be done peer-to-peer without the use of a central entity.
A snippet from the Bitcoin whitepaper. Source: bitcoin.org
The crypto industry realized the importance of working with legislators and regulators to establish credibility and authority. Get Anti-Money Laundering and Know Your Customers (KYC), procedures.
Mushtaha began the discussion by explaining that unlike fiat currency transactions, coins and tokens made on blockchain technology can be traced using AML tools and on-chain analytics. In addition, KYC procedures were introduced to identify and legitimize users on major crypto exchanges. This made the financial system more secure and less susceptible to money laundering.
It helped to boost the sector’s reputation and attracted more people to invest their hard-earned cash in crypto. He said that he sees the next bull market as a turning point, when the masses will dive into crypto as their fears subside and the sector expands exponentially.
The evolution of finance: Impact of KYC/AML
Five decades ago, the first discussions and implementations of global AML/KYC legislation began. These were marked by the creation of the Bank Secrecy (BSA), in 1970, and the global Financial Action Task Force in 1989. Mushtaha said that the risk scenario indicators from traditional finance have been adopted in crypto and other niche sectors of the sector, as well as decentralized finance.
Our on-chain analysis processes are what sets us apart from traditional finance. Traditional finance does not have blockchains, so traditional financial institutions are missing a large part of the puzzle. The blockchain sector is not separable.
Mushtaha shared insights on how today’s KYC/AML implementation looks from a provider perspective. He revealed that Coinfirm has more than 350 risk scenario indicators. These include money laundering, financing terrorism, sanctions and ransomware.
AML is becoming more sophisticated in the space of decentralized finance (DeFi). “We can now tell if your wallet was directly involved in illicit activities or inherited risk from an address by receiving assets with ill-gotten gains.” Technology has also evolved to provide risk profiles for wallet addresses and transactions based upon on-chain analysis.
The decline in cryptocurrency use for money laundering
Numerous reports show a steady decline in money laundering year after year. In 2021, transactions involving illegal addresses accounted for just 0.1% of the cryptocurrency transaction volume. Mushtaha believes this is a valid finding.
“Those involved with illicit activity should avoid blockchain-related assets. Instead, they should stick to the tried-and-true dollar. He said that the United States dollar was still the preferred currency for money laundering. However, he added that once a wallet address is identified as being holding illegally earned assets, there are very few things that a criminal can do in crypto.
99.85% of blockchain activity is not considered criminal. This is something to keep in mind as you review the next tough regulation proposal. Crypto Crime Trends for 2022: Illicit Transaction Activity Reaches All-Time Low in Share of All Cryptocurrency Activity https://t.co/94VB7FiyZb
— Sten Tamkivi, @seikatsu, January 16, 2022
Bad actors will find it difficult to convert crypto assets into fiat, or use them in open markets. Crypto exchanges must be subject to current regulatory scrutiny. Mushtaha spoke out about the most common methods of transferring illicit funds.
They can use anonymizing techniques like mixers, tumblers or privacy coins but their assets will be flagged for this.
Criminals will use a black market to sell illicit assets as cryptocurrencies become more widely accepted and common worldwide. Future law enforcement agencies will have to crackdown on these marketplaces, given the ease with which money can be spent even without KYC.
AML and KYC tools now allow you to correlate IP addresses with wallet address. Clustering algorithms are amazing at identifying the associated addresses. Even for state-level actors, such measures make it difficult to launder money through foreign exchanges. Mushtaha said, “The Office of Foreign Assets Control” (OFAC), has lists of addresses that belong to sanctioned entities and persons. These assets are too valuable to be handled by anyone.
CBDCs’ role in fighting money laundering
CBDCs, central bank digital currencies, could give central banks a level control not possible with fiat currency. Imagine all the problems associated with fiat currency, such as government manipulation and inflation. But now, with the power of onchain analytics, you can see the solutions. CBDCs will enable more detailed scrutiny of users’ spending habits. Central banks can freeze, limit, expire, tax every transaction, and even set expiry dates for their holdings. Mushtaha stated that KYC would be required for every merchant, financial institution, and retail customer to prevent money laundering.
Libra, a permissioned, blockchain-based stablecoin, was not successful in gaining traction after it was launched by Meta, Facebook’s parent company. Meta’s crypto projects were a topic of conversation in mainstream media, and many governments started to explore CBDCs. China was the first to do so.
Worldwide CBDC initiative overview. Source: atlanticcouncil.org
This wave of government-sponsored innovation is not just motivated by the possibility of currency control. Mushtaha pointed out that governments don’t follow the gold standard anymore, but he also highlighted current inflation as a result of central and federal agencies printing money whenever they want.
“The United States printed more money than any time before. The result is rampant inflation that’s unimaginable.
Mushtaha also argued that raising interest rates too fast would lead to a collapse of financial institutions with excessive debt. CBDCs are a solution to central banks. Mushtaha also stated that central banks could create and destroy money for the first time.
Evolution of AML, KYC, and technological advances
Mushtaha’s extensive knowledge in the AML/KYC industry has shown that technology evolves with regulations. AML-integrated trading platforms can apply for virtual asset service providers (VASP) or securities licenses. Compliant means that you have access to a wide range of opportunities. This space can only be funded by those who are focused on compliance. AML solution providers have to bridge the gap between the crypto world, and the compliant financial sector.
Mushtaha shared a case where he was working with a startup to develop a nonfungible token (NFT-based KYC solution) using zero-knowledge proofs. “The genius comes from their recognition of the fact that NFTs used to KYC don’t have to solve the double-spend problem and can be disconnected from the blockchain completely. This allows private biometric data to remain on the NFT, and a zkProof can be sent to every platform where an individual wishes to open an account.
The solution was created to be a centralized entity to store NFT information, but Mushtaha says it is a positive step. NFTs will continue to serve KYC purposes over the next decade as digitization continues to spread across all industries.
AML technology is constantly evolving and new tools are being developed. Mushtaha says that Coinfirm has an in-house tool that allows it to analyze each wallet address that contributes assets into a smart contract-controlled liquidity pools. He also said that they can “provide risk profiles for tens to thousands of addresses at once.”
AI innovations that focus on pattern recognition based on algorithmically generated transactions will be a major trend. Mushtaha explained that the blockchain contains a wealth behavior-related data that can be used to analyze money laundering patterns and extrapolate risk profiles from wallet addresses that behave in such a way.
Machine learning tools that have accumulated large data sets over time across the crypto landscape will be used to predict possible trade outcomes.
Cross-border crypto transactions are being monitored by governments
In October 2013, the FATF released revised guidance. It categorized every crypto asset that protects privacy or doesn’t involve intermediaries of any kind as high-risk. It is not surprising, as the FATF has an explicit mandate to eliminate all threats to the integrity and functioning of the international financial systems. Cryptocurrencies are one of these threats. The Travel Rule, which was introduced in 2019, requires VASPs to provide certain information to the next financial institution involved in a transaction.
Mushtaha said that the rule will be applied to un-hosted wallet addresses owned by private individuals.
Mushtaha believes that a more prudent approach would be to harmonize fragmented implementation methods of the Travel Rule across jurisdictions. This would make cross-border transactions easier and more simple while focusing on VASP compliance.
The role of crypto entrepreneurs in fighting money laundering
Mushtaha feels that compliance is possible with the wide range of AML solutions available. As the world prepares for frictionless mass adoption, VASPs must also create comprehensive education materials for their users.
#Binance collaborates closely with regulators around the world, in order to make Web3 mainstream. James Rothwell, Binance VP of Global Marketing, discusses the importance regulation plays in establishing a Web3-world. pic.twitter.com/ZaJfLQPX35
— August 2, 2022, Binance (@binance).
Mushtaha believes crypto entrepreneurs have a unique opportunity to write the next chapter in the global financial system. They should also understand that AML compliance shouldn’t be a hindrance to their success, but an enabler. He said that most retail investors want to be able to navigate the space safely and manage their risks while transacting. VASPs should give these investors peace-of-mind.
Moving towards a regulatory future
AML and KYC are essential elements of today’s macro-economy and important components of crypto space. Mushtaha disapproves of the notion that regulations can reduce anonymity.
“Regulations are going to drive mass adoption. But it is incumbent upon the players in the space to actively put forward the framework of regulation that encourages innovation and disincentivizes illicit activity. It is important to find a balance between monitoring money laundering and protecting privacy. Both of these goals are possible.
Mushtaha also advised investors to use the age-old saying, “Do your own research.”