Lynn Johannson, Advisor, Sustainability and ESG
January 4th, 2024
Lynn Johannson, President of E2 Management Corporation and Catalyst for THE Collaboration
In a care[...]
Unstable coins: cryptoassets, financial regulation and preventing financial crime in the emerging market for digital assets
FCA | Speech: Therese Chambers | March 6, 2020
Speaker: Therese Chambers, Director of Retail and Regulatory Investigations
Event: The Advancement of Digital Assets and Addressing Financial Crime Risk, New York University School of Law
Delivered: 5 March 2020
Note: this is the speech as drafted and may differ from delivered version
Highlights
- Cryptoassets such as Bitcoin, present different financial crime risks from traditional FinTech apps, as they enable digital value transfer without a financial intermediary.
- Money laundering using cryptoassets is a real danger, but the application of robust AML controls combined with international cooperation can help reduce the risk.
- Robust regulation to prevent financial crime supports financial innovation in new markets such as cryptoassets.
- The FCA’s AML regime for cryptoassets presents the FCA with unique supervisory and enforcement powers that are tailored to meet international standards.
See: South Korea Passes One of the World’s First Comprehensive Crypto Laws
How we enable innovation while cracking down on financial crime
Sometimes the relationship between promoting financial innovation and tackling financial crime is posed as a zero-sum game. However, at the FCA, we believe that the relationship between taking a tough stance on financial crime and enabling world-leading financial innovation to benefit consumers, is complementary. This is because it is hard to see how any financial innovation can achieve scale without tackling illicit use cases – if an innovation’s only use is to launder the proceeds of crime, then it’s difficult to see a pathway forward for mainstream adoption.
Without the right checks in place the open, public access of cryptoassets can lead them to become vehicles for global money laundering.
Criminals are generally the earliest adopters of new technology. From the initial use case of automobiles as 'getaway cars' or malware to steal personal information in the early days of the internet, criminals were there first. This is because they are always on the hunt for new ways to commit old crimes and evade regulatory authorities using a new technology or methodology. However, this 'catch me if you can' phase of any technological development, where many of use cases are nefarious, is hindered once a comprehensive regulatory framework to tackle the risks is implemented.
It has been over a decade since Satoshi Nakamoto published the Bitcoin Whitepaper, and today the cryptoasset market and the regulation around it looks quite different. First of all, there are many more cryptoassets, exchanges and businesses operating in this space, which has grown into an industry measured in billions, rather than millions.
See: An IOSCO report highlights crypto trading issues, but stops short of setting standards
As the value and use of cryptoassets have grown, so have the risks for financial crime. As cryptoassets enable digital value transfer across the globe, they enable a unique set of potential money laundering risks. As such, in HM Treasury’s three-year Economic Crime Plan, cryptoassets are identified as a growing conduit for global money laundering alongside the UK’s National Risk Assessment (NRA) and widespread concern about this typology among our Law Enforcement Agencies (LEAs).
Working hands-on with firms via the Regulatory Sandbox
When discussing financial innovation, regulation and cryptoassets it’s difficult not to mention an area in which we are different to every other financial services regulator. The FCA was the first to launch a 'Regulatory Sandbox'. Provided that firms are able to satisfy us that they meet several eligibility criteria, which includes showing proposition has a clear 'benefit' and is a 'genuine innovation'. In practice, this means showing our team that users of the service stand to receive a benefit beyond what’s possible in the market today, by using new technology or a novel business model. If they are successful, they are admitted to a cohort to test it in a controlled environment. So far, cryptoassets in regulated financial activities have been used in around 40% of tests and are the single most popular technology for testing.
In the first few cohorts, firms would primarily use cryptoassets like Bitcoin and Ethereum as an intermediate currency for money remittance. They would transfer fiat currency for crypto and then back into fiat currency in another jurisdiction, thereby bypassing the restrictive fees currently in place for money remittance and processing it faster than when using traditional remittance services – sending payments in minutes rather than days.
However, as the cryptoasset networks struggled to scale and transaction fees increased without commensurate growth in performance, firms stopped using cryptoassets for money remittance. Instead, we found them utilising the technology to explore the issuance of securities – debt and equity instruments – using cryptoasset networks (such as Ethereum) and using their 'smart contract' functionality.
See: 3 Ways Digital Assets Will Reshape The World
For example, in the sandbox, a firm tested settling a short-term debt instrument using a cryptoasset network to potentially streamline the traditional approach by removing the need for registrars and nominees. The test demonstrated that it was possible to meet legal and regulatory requirements. Benefits we observed were that it was cheaper and more transparent for investors and issuers as information was stored on a public network.
However, the cost savings from automation can lead to immutable transactions which are impossible to reverse if there’s a problem creating a new kind of risk. Also, the transparency provided by most cryptoasset networks can lead to front-running and new forms of market abuse and risk. However, overall for a regulator, it’s helpful to see these tests up close as they help to identify the various benefits and risks of new technology and our broader regulatory approach, including enforcement activity.
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The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
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