12 April 2019

AML & KYC for Crypto Assets: Market Commentary for April 12, 2019

Patrick Heusser

Patrick Heusser

Senior Trader at Crypto Broker AG

About the author

Today, from our daily market commentary, we have some food for thought to share: a little weekend reading, in case you get bored.

Due to increasing pressure from regulators around the world, both crypto exchanges and financial intermediaries are in need of professionalised KYC (know-your-customer) and AML (anti-money laundering) procedures.

On the AML side, the number of companies that offer this service is rising quickly. Here are just a few:

Neutrino, Coinfirm, Chainalysis, and Elliptic.

Here is our concern with this development: currently, there is quite a difference in the results that each of these service providers display to users for a check request. Since they are all using the same underlying data, it is obvious that the interpretation is causing the difference. This appears to be a systemic issue.

Since regulators have begun requiring AML checks, it has become an increased risk or liability for companies involved in trading crypto assets. A company could do this check in-house, as the data is publicly available on the blockchain, but then the company runs the risk of facing the full consequences if they miss a tainted coin or address. As a result, it is more convenient to outsource it to a company specialised in this to mitigate some risk and liabilities.

As the industry grows, more financial intermediaries will use these services, and due to the nature of efficiency, the market for these AML services will consolidate: only a handful of specialist companies will split the market between each other. You may already see where this is going. But before we continue, it is worth making a comparison to the traditional financial industry, which may have a similar problem.

Rating agencies, Moody’s or S&P for example, have provided rating scores for many financial products. Understandably, banks and financial intermediaries were required to outsource this service due to a conflict of interest. It is the same for the AML checks, since it also involves some risk, and liability mitigation is needed for financial intermediaries.

Both of these service companies (for AML checks and for rating financial products) want to produce the most business-friendly outcome for their customers. If they are too conservative, the customer will go to another service provider. Hence, there is a hidden conflict of interest. One real-life example is the subprime crisis, where – in hindsight – obvious junk assets were rated as AAA investments, and we all know where that ended up. Let’s hope that history can provide a helpful lesson.

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