Friday, February 23, 2024

How to be compliant & protect your crypto business from fraud

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The rapid rise of cryptocurrencies has disrupted the global financial landscape, creating both opportunities and risks for investors. With the entry of new and credible players in the crypto space and the possibilities of blockchain technology, cryptocurrencies have become significant growth drivers. However, the rising number of scams in the crypto space has become a concern for investors, with reports indicating that illicit addresses sent nearly $23.8 billion worth of cryptocurrency in 2022 alone.

As the crypto industry continues to grow, it is imperative for businesses to prioritise security and regulatory compliance of their operations to prevent any potentially questionable transactions.

The Finance Ministry’s recent announcement of including crypto businesses under the Prevention of Money-laundering Act, 2002 highlights the increasing importance of regulatory compliance in the crypto space. Any exchange involving virtual digital assets and fiat currencies, exchange between multiple forms of virtual digital assets, and transfer of digital assets will now be subject to the same anti-money laundering standards as other regulated entities.

These developments are not unique to India, as other regions such as the EU, US, and Singapore have also implemented similar laws and regulations, such as the Markets in Crypto-Assets (MiCA) provisional agreement, the Framework for International Engagement on Digital Assets, and guidelines by the Monetary Authority of Singapore’s Payment Service Act.

Why is compliance necessary?
Crypto, like any other financial infrastructure, relies on trust to function effectively. Trust is built upon the confidence that transactions are secure and the identity of recipients is verified. The absence of regulations in the crypto space leaves room for fraud, money laundering, and other criminal activities, leading to a lack of trust among potential investors.

To counter these challenges, the Finance Ministry is pushing for regulations with an emphasis on Anti-Money Laundering (AML) and Know Your Customer (KYC) policies. Regulatory compliance will ensure that crypto exchanges and other crypto-related businesses are accountable for their actions and adhere to the same standards as traditional financial institutions. This is essential in reassuring investors, governments, and customers that the crypto industry is not a haven for illegal activities.

Regulators and governments worldwide are already recognising the importance of crypto regulations and implementing KYC and AML guidelines to increase trust by reducing the chances of fraud. Know Your Customer (KYC), for instance, is an essential tool for businesses to mitigate legal risks, increase customer trust, and prevent scams and money laundering. Implementing robust KYC procedures can safeguard businesses from legal disputes or regulatory fines, increase user confidence and loyalty, and defend their reputations in the event of a hack or data breach. However, initiating KYC processes can cause legitimate consumers to become disengaged. Research reveals that at least 38% of customers drop out of the onboarding process due to frustration with the sheer number of touchpoints. This highlights the importance of creating reliable digital customer journeys for onboarding by gathering appropriate information with the least friction possible.

How can crypto companies protect themselves, then?
Crypto businesses are increasingly vulnerable to cyber-attacks and fraud. Despite blockchain’s reputation for impenetrability, cybercriminals have managed to siphon off funds from crypto accounts. It is highly recommended that financial institutions adopt a risk-based approach to AML/CFT compliance.

To effectively manage compliance risks, crypto firms must perform individual risk assessments by collecting and verifying relevant customer information and building risk profiles. They can leverage artificial intelligence and machine learning algorithms for these risk profiles that can be used to inform future compliance decisions, including the deployment of proportionate compliance measures. For instance, account opening and onboarding offerings can use AI and ML algorithms to create risk-gauged profiles for each user based on their inputs and other data. These algorithms can analyse large amounts of data to detect anomalies and patterns of suspicious behaviour that may indicate fraudulent activity. This way, businesses identify and flag suspicious activity, such as fraudulent account creation attempts.

In today’s world, our identity is not limited to our physical presence but extends to our digital footprint. Our digital identity represents ourselves in the virtual world, encompassing various aspects such as email addresses, phone numbers, social media profiles, and other online activities.

AI and ML algorithms are increasingly used in digital footprint solutions to establish a user’s online presence and behaviour. These algorithms can analyse a user’s email and phone number to identify the number of social media, e-commerce, and other associated accounts to identify patterns of suspicious behaviour, such as users with a high number of accounts linked to the same email or phone number. They can also be used to scan for criminal and illegal activities by utilising global Anti-Money Laundering (AML), Politically Exposed Persons (PEP), Office of Foreign Assets Control (OFAC), and other checklists.

Additionally, crypto businesses can use solutions like device intelligence and behavioural biometrics with AI and ML deployment to improve their effectiveness. Device intelligence can detect sophisticated attack techniques such as emulators, bots, cloned apps, tampered apps, and more, helping businesses mitigate the risks associated with these threats. Device intelligence can aid in managing hacks in DeFi protocols, risk categorisation, countering syndicated crime, and hybrid models to manage risk.

Behavioural biometrics, on the other hand, can provide an extra layer of security by analysing user behaviour on web or mobile devices and creating a unique user signature that serves as a highly secure authentication mechanism. Behavioural biometrics analyses keystroke movements, typing speed, copy-paste and touch screen behaviour, swiping patterns, and pressure on the screen, among others, to identify patterns and detect patterns associated with individuals and can help businesses protect their platforms and prevent fraudulent activities.

Key Takeaways
Compliance with KYC and AML regulations is crucial for businesses operating in the crypto industry. Implementing these measures is necessary to maintain trust and integrity in the marketplace, prevent fraud and money laundering, and promote long-term sustainability.

As the crypto industry continues to mature, it is essential for businesses to stay up-to-date with the latest regulatory requirements and adopt innovative solutions to manage risks effectively. By prioritising compliance and utilising advanced tools for risk management, businesses can build a strong foundation for growth and success in the evolving crypto landscape.

(Author is Anil Srinivas Tadimeti, Head of Strategy and Operations

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