Napier and RegTech Associates co-hosted a webinar around the financial crime risks and compliance challenges of Web3 and digital assets.
Moderated by Dr Sian Lewin, Co-Founder & Head of Client Delivery at RegTech Associates, the webinar included as expert speakers:
- Ian Taylor, Executive Director of Crypto UK
- Robin Lee, Head of APAC, Napier
- Jessica Chuah, Country Manager (Malaysia), Chainalysis
- Artie McConnell, Assistant United States Attorney at the U.S Attorney’s Office
The lure of digital assets
To set the scene, Ian Taylor explained that the lure of digital assets over cash-based methods for money laundering stems largely from their digital nature and growth potential. Blockchain technology allows for the pseudonymity of crypto wallets, which presents a challenge as law enforcement cannot always identify who owns the wallet addresses.
Criminals have been able to exploit the innovative state of digital assets and largely keep one step ahead of regulators and law enforcement. Ian described how regulatory frameworks have not kept pace with the expansion of the sector, meaning criminals have been able to infiltrate with relatively little restriction.
Regulatory challenges
The decentralised nature of the underlying technology means that digital asset firms’ operations cross borders.
While a coherent, global approach to regulating the digital assets space is preferable, and the Financial Action Task Force (FATF) has made a start in setting some standards, jurisdictional differences are emerging as to the legitimacy of digital assets and no consensus has yet emerged as to how to regulate this space.
A lack of sufficient technological knowledge within the regulatory bodies is hampering both policymaking and enforcement, as there’s a shortage of people equipped with the combination of both regulatory and blockchain expertise.
The panel agreed that further guidance from global regulators would be welcome as the current divergence in approach between jurisdictions makes compliance challenging.
For an effective digital assets regulatory regime, old processes will need updating in line with the pace of technological innovation. A good example of regulatory progress is the FATF Travel Rule, which is being rolled out in 2023 and will require Virtual Asset Service Providers (VASPs) and other financial institutions to capture data when they send transactions through different exchanges.
Law enforcement challenges
Artie described how enforcing law across digital assets is more challenging than in traditional finance.
Illicit behaviour such as money laundering is already challenging for law enforcement, because of the difficulty in following an audit trail. But, in the digital asset space, this is compounded by the anonymous nature of the ledger. However, Artie explained that the publicly accessible nature of blockchain technology can actually support law enforcement as, once the owner of the wallet has been identified, the trail becomes much easier to follow.
A further challenge is that results of investigations using blockchain analytics are a new type of evidence, for which Jessica emphasised the judiciary need to be educated about this type of data for it to be of an evidentiary standard for use in court.
The rapidly evolving pace of innovation in the digital assets space also poses difficulties for both regulators and regulated firms alike. Robin highlighted the development of privacy coins as an example, as their sophisticated layers of encryption make it difficult for law enforcement to unravel.
The panel agreed that RegTech is constantly playing catch up with the innovative behaviour of criminal actors, who are too often that one step ahead. Law enforcement and RegTech firms must get ahead of criminals in order to stop illicit financial behaviour using digital assets.
Overcoming these challenges
The panel agreed that ‘fair, balanced, and proportionate’ regulation would help mitigate the activities of criminals with digital assets, but were keen to add this regulation must not stifle market innovation.
Ian spoke to the misconceptions many policymakers have about digital assets. Often, digital assets and blockchain are blamed for increases in ransomware and fraud when, the true cause is lapses in cybersecurity.
Increasing collaboration between the public and private sectors would also help to build understanding about issues and to share typologies of illicit financial behaviour. Privacy enhancing technologies such as zero-knowledge proofs and homomorphic encryption could be significant in the future to support such information sharing.
For law enforcement, it has been critical to ensure that those in the legal system are properly educated on crypto. In New York, briefing judges and juries about crypto in advance has proved effective in helping generate a greater understanding of criminal activity within the digital assets space.
Technology also plays a big part in overcoming compliance challenges, such as the Travel Rule. Ian suggested that blockchain analytics providers could prove effective in this space, as they support both the private and public sectors. Jessica additionally highlighted the immutability nature of public blockchain ledgers, which are accessible for all to see and allow transaction monitoring to be undertaken across them.
How to effectively manage the financial crime risks around digital assets
Finally, in order to manage compliance in this space effectively, firms dealing in digital assets need to build a risk-led culture internally.
According to Jessica, this is often led by compliance officers in the crypto industry acting as ‘change catalysts’ to help embed this culture which is not as well established as it tends to be in traditional financial spaces.
Compliance teams at crypto companies must also assess the technological support they need to fulfil their responsibilities and keep track of changes to laws and regulations. Unlike in more traditional finance, compliance teams in the digital assets space likely to more actively seek technology solutions and therefore these roles require a different set of skills than is us.
Robin added that this was reflective of industry trends as those with technology backrounds moving into compliance have an understanding understanding of data and technology that is now vital to fulfil compliance responsibilities.
The Web3 and digital assets spaces are constantly evolving, driven by technological innovation. As this trend continues, criminal activity will also continually expand and become increasingly sophisticated. More than ever, regulators and law enforcement must adopt technology into their processes if they are to keep pace with criminals.
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Photo by Steve Johnson on Unsplash
