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Crypto Should Disrupt Current Anti-Money Laundering Practices, Not Adopt Them


youUntil the turn of the 20th century, highly respected physicians routinely indulged in bloodletting to treat ailments ranging from acne to tuberculosis. Although we have left behind the bloodshed, we still indulge in supposedly useful, but truly destructive practices.

Modern know-your-customer/anti-money laundering (KYC/AML) regulations are equivalent to financial bloodshed today: they do little good and can cause great harm. Yet, whether we like it or not, the KYC/AML nightmare is coming to crypto.

A few weeks ago, news broke that a consortium of US-based crypto firms had formed TRUST, a travel rules compliance platform that extends financial oversight.

Incorporated companies must comply with the law of their local jurisdiction. Yet crypto shouldn’t blindly follow AML rules inherited from the Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog group; it should disturb them.

A recent phenomenon

The idea of ​​money laundering is relatively recent. In 1970, Richard Nixon passed the euphemistically named Bank Secrecy Act, which required financial institutions to spy on their customers.

Remember that Al Capone and other American gangsters had already been successfully prosecuted for tax evasion 40 years before the passage of the Bank Secrecy Act! Since then, the scope of surveillance has grown exponentially. For example, in 1970, banks were required to report transactions over $10,000. Today, the limit remains $10,000, but $10,000 in 1970 equals $73,000 today!

It wasn’t until the 1990s that the rest of the world criminalized “money laundering,” largely because of American pressure after the 2001 terrorist attacks on the World Trade Center and Washington, DC.

What were the results of this political experiment?

According to financial crime expert Dr. Ron Pol, very little. Current AML rules do not stop the vast majority of money laundering. The United Nations estimates that less than 1% of all criminal assets are seized worldwide, meaning that over 99% of criminal assets are laundered with impunity.

Why would criminals use the relatively small cryptocurrency market to launder funds on a public record, when they can easily launder billions through the conventional financial system without a trace?

AML regulations also have a significant financial cost. Global spending on anti-money laundering and sanctions compliance by financial institutions is estimated at more than $180 billion a year, about 100 times more than the $1-2 billion in assets criminals seized each year.

The social costs are also high. Bureaucratic rules designed to keep criminals out disenfranchise millions of legitimate customers. More often than not, these are often marginalized groups.

If you live in a small or poor country, you may find it impossible to pass the arbitrary steps devised by a San Francisco product manager on the advice of a London lawyer. The author was personally deprived of accounts because a small document issued by the EU government was not accepted as proof of valid address. The company’s KYC department couldn’t figure out that there are places where people don’t use utility bills to prove residency.

The AML departments of financial services companies are more concerned with complying with AML legislation than stopping money laundering. A 2014 study found that “identity verification principles, guidelines, and practices have resulted in largely bureaucratic processes and do not ensure that identity fraud is effectively prevented.”

In other words, fraud has increased at astronomical rates around the world and KYC laws have helped a lot. People are now used to sharing their personal identity documents with a wide range of actors ranging from banks to telecommunications providers to porn sites. Is it any wonder that their information is compromised?

Crypto is well suited

How can cryptocurrency disrupt AML regulations? Cryptography-based systems are particularly well suited to prove the identity and source of funds. Moreover, they can do so in a transparent and privacy-preserving way. For example, you can open accounts in a centralized entity under a pseudonym, using a public key verified by a trusted authority.

This way, you only have to trust one entity with your details. A similar method of preserving privacy could be used in decentralized finance (DeFi) using zero-knowledge proofs. Indeed, there is evidence that crypto is beginning to disrupt sanctions enforcement.

Coinbase announced that it has limited access to its services in 25,000 wallets that can be linked to sanctioned Russians. Privacy-focused non-custodial wallet Wasabi has announced that it will block sanctioned addresses from its CoinJoin pools, meaning users can be sure they won’t mix funds with sanctioned individuals. These measures, while going against the censorship-resistant ethos of cryptocurrency, generate far less collateral damage than the blanket bans and rampant surveillance of the current regime.

Although medical bloodletting was probably well-intentioned, over the centuries it has caused a great deal of unnecessary suffering, cost society dearly, and done nothing to treat disease. The cryptocurrency industry was born out of the realization that the modern financial system makes individuals vulnerable to abuse by trusted third parties.

The current regulatory mishmash of FATF-driven KYC and AML regulations has spawned ineffective systems that do little to stop money laundering. Instead, they enable political censorship, financial surveillance, fraud and inequality. The cryptocurrency industry should lead by example by using new, innovative and effective anti-crime methods, instead of forcing old and ineffective ones.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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Eleon

"Writer. Coffee practitioner. Twitter specialist. Food trailblazer. Subtly charming analyst. Troublemaker. Unable to type with boxing gloves on."
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