Why the crypto economy needs stricter anti-fraud protocols and other regulations

The use of digital or cryptocurrencies as a medium of exchange has grown so big, so fast that both crypto-based companies and mainstream financial institutions have reached a regulatory tipping point

To assert their legitimacy and expand their market reach, cryptocurrency exchanges and crypto-based business platforms need access to mainstream financial institutions. In order for traditional banks and other institutions to feel comfortable doing business with crypto-based entities, those entities must follow the same compliance rules as other financial institutions and companies. At a minimum, that means adhering to the same anti-money laundering (AML) protocols and customer due diligence (CDD) or know-your-customer (KYC) requirements as any other company.

Transparency and trust are the issues, and in the eyes of many opponents, the current infrastructure for digital currencies is not enough either.

The pros and cons of regulating crypto

Until recently, however, the whole idea of ​​regulating the crypto market was considered to contradict the ethos of anonymity and decentralization that made digital currencies so attractive in the first place. When Bitcoin was created in 2009, the whole point was to create a medium of exchange that worked outside the mainstream economic ecosystem of major banks and corporations.

However, now major factions in both the crypto industry and the mainstream financial community see stricter government regulation as necessary and beneficial. A better public policy framework is the best way to create an economic infrastructure in which both digital currencies and traditional fiat currencies can coexist, the argument goes. And this will help to create the foundation of trust necessary for the long-term viability of the cryptocurrency industry.

However, the main part of the problem is that while most major crypto exchanges now require customers to provide at least some basic personal information (name, address, date of birth), many still do not. Further, most don’t bother to establish proof of life, for example by comparing personal data with government databases and other publicly available information, or even by establishing a risk score. There is also no established method (or ethos) for sharing crypto client information with authorities or law enforcement.

For more information on the status of crypto regulation worldwide, visit the full digital version of the Cryptos on the Rise 2022 report from Thomson Reuters Institute and Thomson Reuters Regulatory Intelligence

The other part of the problem? Like the casino industry in the 1990s, the crypto industry needs to purge itself of the stench of crime. Crypto’s anonymity – once its biggest selling point – is now its biggest liability. The ability to exchange money anonymously is precisely why cryptocurrencies are so popular with drug dealers, human traffickers, arms dealers, terrorists, money launderers and other criminals. For example, when ransomware hackers take a company hostage, there is a reason why they want to be paid in crypto.

Crypto-based criminal activity also makes it difficult for genuine crypto platforms to establish the legitimacy and trust they so desperately need to expand. In fact, so many people playing digital currencies have been scammed for so much money lately that traditional financial institutions are understandably wary. According to the Federal Trade Commission, 46,000 people lost more than $1 billion to crypto scams between Q1 2021 and Q1 2022, and currently crypto scams account for 40% of all dollars lost to social media fraud.

Those in the pro-regulation camp argue that implementing more robust customer identification verification procedures – such as CDD and KYC processes and AML requirements – would go a long way in deterring the criminal element. This would also help establish the credibility and stability necessary for the long-term viability of the crypto industry.

Mainstream financial institutions want the same safeguards, not only to mitigate risk and meet AML requirements stated in the existing Bank Secrecy Act (BSA), but also to create a safe ramp into a potentially huge new market .

How regulators are cracking down

Moving from Why the crypto industry needs more regulation How it must be done is the challenge legislators and financial regulators are currently grappling with.

After all, there are many different types of so-called “virtual asset service providers”, and new ones are being invented all the time. In addition to well-known cryptocurrency exchanges such as Binance, Kraken, and Coinbase, where most people buy or trade digital assets; there are also stablecoin issuers, marketplaces for non-fungible tokens (NFTs), and decentralized finance (DeFi) protocols, the latter of which uses blockchain technology to create self-executing “smart contracts” that require no human intervention at all.

Establishing regulatory guardrails to keep up with the proliferation and popularity of all these digital assets has become a global challenge. Currently, the United States is lagging behind the European Union, the United Kingdom and some other countries in passing legislation to regulate digital assets, but the Biden administration is doing its best to catch up.

Currently, cryptocurrency exchanges (but not other forms of digital assets) in the United States should be regulated under the BSA, but the law has yet to be amended to apply specifically to digital asset service providers, so enforcement is irregular.

The New American Framework

To resolve that, the Biden White House recently released a framework for US crypto regulation based on six months of research and input from all relevant agencies and stakeholders, including the US Treasury Department, the Securities and Exchange Commission and the Federal Reserve .

Dubbed with the First ever comprehensive framework for responsible development of digital assetsthe document outlines a variety of policy recommendations intended to represent a “government-wide” approach to the regulation of all digital assets, including stablecoins and NFTs.

The framework addresses a wide range of issues related to consumer protection, national security concerns, environmental sustainability (mining of cryptocurrencies requires a lot of electricity), and law enforcement. It also proposes opportunities for international cooperation through organizations such as the Organization for Economic Co-operation and Development and the Financial Stability Board. The framework even includes suggestions for how the Federal Reserve could release its own government-backed digital dollar, which Fed Chairman Jerome Powell has said could eliminate the need for cryptocurrencies altogether, bringing the whole digital asset argument full circle. .

Nothing in the framework has been enacted yet, but it’s only a matter of time. Tighter regulation of the cryptocurrency market may tear away the cloak of anonymity that criminals and true believers so cherish, but if the goal is to make all digital assets safer and more useful for everyone, then the cloak must be removed.

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