Q&A: Cryptocurrency and financial crime

February 2023  |  SPECIAL REPORT: CORPORATE FRAUD & CORRUPTION

Financier Worldwide Magazine

February 2023 Issue

FW discusses cryptocurrency and financial crime with Hakob Stepanyan at BDO.

FW: Could you provide an overview of how the rising popularity of cryptocurrencies increases the potential for financial crime across the globe? How would you characterise this risk?

Stepanyan: Although an understanding of the technological and economic implications of cryptocurrencies has come a long way, a large subset of individuals, regulators, legislators and institutional players still have a hard time grasping the concept and its risks. While darknet markets, cyber crime and ransomware dominate the news cycle, scams, fraud and exploits like smart-contract and bridge hacks are by far the most common forms of financial crime related to digital assets. There is no doubt that illicit actors will continue to innovate and try to circumvent preventative safeguards, so all parties should remain vigilant as the industry continues to evolve.

FW: Drilling down, could you explain some of the common types of financial crime committed using cryptocurrencies?

Stepanyan: In the eyes of law enforcement and regulators, money laundering is the most common type of criminal activity involving cryptocurrencies. Digging deeper, the most egregious precursors to money laundering are sanctions evasion, ransomware theft and the facilitation of darknet market transactions. In 2022, hacks and exploits were the most common types of crypto-related financial crime, with funds stolen in hacks estimated at approximately $4.3bn as of November 2022, according to Privacy Affairs. Looking ahead, more traditional white-collar crime is expected to enter the cryptocurrency space. Because cryptocurrency transactions are complex and lack uniform accounting standards, criminal actors may attempt to manipulate financial statements.

“Governance, controls, compliance technology and employee competence at all levels are key to mitigating financial crime risk.”
— Hakob Stepanyan

FW: What trends are you seeing in the regulation of cryptocurrency? What key developments would you highlight in this area?

Stepanyan: Regulation in the digital assets space continues to evolve and expand at an incredibly fast pace. To date, 42 countries have adopted regulatory measures and guidance. On 16 September 2022, the White House released the first draft of a regulatory framework on digital assets. And on 10 October, the European Parliament passed the Markets in Crypto Assets (MiCA) bill. Both of those developments represented major steps toward regulatory clarity. With a new balance of power in the US House of Representatives, it will be interesting to track progress toward passing the bipartisan Responsible Financial Innovation Act (RFIA). Coming off an eventful 2022, regulators will continue to push for legal precedence through enforcement. Gary Gensler, chair of the Securities and Exchange Commission (SEC), has spoken about the need for centralised exchanges to segregate operations where conflicts exist – separating market-making activities from a brokerage and retail trading platform. To make this a reality, the SEC may call for exchanges to register as broker-dealers, which would bring additional safeguards for consumers.

FW: With many cryptocurrencies providing for anonymity, making it difficult to link transactions to specific individuals or entities, what steps can organisations take to avoid facilitating financial crime, such as fraud or money laundering?

Stepanyan: Today, there are over 90 privacy coins with varying privacy preservation techniques, the most popular being Monero. While they are not illegal, many have been delisted from regulated exchanges due to their popularity with darknet markets and illicit actors. While built-in obfuscation techniques make it difficult to trace Monero transactions, some blockchain analytics firms claim to have developed the capability to do so. Organisations concerned about anti-money laundering (AML) compliance should consider utilising blockchain investigation tools to monitor transactions and apply custom transaction risk attributions for transactions involving privacy coins. For example, organisations can use chain analytics software to help review transaction history and uncover a past conversion from Monero to Bitcoin. Some organisations may choose not to engage with customers with histories of using privacy coins, mixers or unregulated exchanges.

FW: In what ways is technology helping to reduce financial crime arising in connection with cryptocurrencies? How are RegTech solutions evolving?

Stepanyan: The key challenges in the digital assets space are AML, know your customer (KYC) requirements, custody and market manipulation. One of the main elements of AML regulation is continuous monitoring of cryptocurrency transactions. Although these transactions are transparent, analysing blockchain data can be costly and cumbersome. RegTech providers have developed user-friendly tools and dashboards to monitor transactions, trace through transaction history and identify counterparties. These tools help compliance professionals and investigators detect and investigate financial crime. The last few years have seen a dramatic increase in custody services for institutional clients looking to acquire cryptocurrencies. Some providers offer custody technology to help institutional clients take self-custody of assets and onramp to decentralised finance (DeFi) platforms while maintaining regulatory compliance. Market manipulation also is a growing issue in the digital assets space. Chain-analytics providers are proving invaluable in detecting anomalies as companies grow their attribution data and analytical capabilities.

FW: What essential advice would you offer to organisations on understanding financial crime risks in connection with cryptocurrencies, and managing and mitigating their exposure?

Stepanyan: Governance, controls, compliance technology and employee competence at all levels are key to mitigating financial crime risk. Prior to offering crypto-related products or services, transacting with cryptocurrencies or adding cryptocurrencies to the balance sheet, organisations should consider updating their policies, procedures and internal controls and educating their employees. Organisations should also consider implementing transaction monitoring tools and engaging custody solution providers or third-party custodians. These and other measures may help avoid internal threats such as asset misappropriation, bribery and corruption, and fraudulent accounting and reporting.

FW: What are your predictions for the cryptocurrency landscape in the months and years ahead? To what extent do you expect to see a continued escalation in financial crime risk?

Stepanyan: The digital assets space has experienced some catastrophic failures during a major bear market cycle. Some claim that institutional adoption has already peaked, or that more widespread adoption has been pushed back several years. However, from infrastructure to new products and services, there are many examples of entrepreneurs and project teams continuing to innovate using digital currency. As the size of the digital assets market continues to grow, so likely will the scope and frequency of financial crimes. If lawmakers, regulators and enforcement bodies become increasingly sophisticated in their approach, the share of illicit activity could remain proportional to the market opportunity. Increased compliance and regulatory clarity also will help mitigate illicit activities. Ultimately, it will be up to industry players to develop more robust code and implement safeguards to build confidence.

 

Hakob Stepanyan serves as a core team member of BDO forensics’ blockchain and digital assets initiative. Having worked with cryptocurrency-centric and adjacent companies since 2017, he helps the team enhance advisory services related to blockchain-based digital assets. While at BDO, Mr Stepanyan also has held a traditional forensic accounting role on a monitorship regarding export control compliance. A certified fraud examiner, he has assisted clients in a range of industries across multiple jurisdictions. He/She can be contacted on +1 (212) 515 5408 or by email: hstepanyan@bdo.com.

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THE RESPONDENT

 

Hakob Stepanyan

BDO

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