Cryptoassets have begun to become more mainstream, favoured for their flexibility and security there is rising popularity among younger investors. This has led to a number of cryptoasset firms beginning operations within the UK under regulation from the Financial Conduct Authority. HM Treasury has defined cryptoassets as “cryptographically secured digital representation of value or contractual rights that uses some type of distributed ledger technology (DLT) and can be transferred, stored or traded electronically”. They are, in essence, digital currencies which operate beyond the scope of regulation from a traditional banking firm with added security, anonymity and management for the asset owner. However, while asset owners may see these as benefits and greater privacy for their assets, these aspects also make cryptocurrencies and cryptoassets the preferred vehicle for financial crime. This is achieved by making it easier to obscure the origins of proceeds of crime and mask them as originating from a legitimate source or individual. There has been an increase of 30% in crypto money laundering in 2021, according to a report made by Chainalysis. With such a significant increase, questions are raised regarding the suitability of current money laundering regulations to adequately and effectively confront and prevent crypto financial crime.
Presently, cryptoassets and cryptocurrencies are not regulated and are not recognised as legal tender in the United Kingdom, however they are still regulated for money laundering purposes and cryptoasset firms must also be regulated by the Financial Conduct Authority. The UK has elected to adopt the European Union’s Fifth Anti-Money Laundering Directive (5MLD) as retained EU law post-Brexit, which created provision for the current money laundering regulations to be applied to cryptoassets and was provided for in UK law by The Money Laundering and Terrorist Financing (Amendment) Regulations 2019. This ensures the current money laundering regulations, including a Customer Identification Program, registration of the most recent beneficial ownership information, the Know Your Client process, transaction monitoring and Suspicious Activity Reports must also be applied to cryptoassets and by regulated cryptoasset firms. These current AML regulations remove some of the anonymity that has become such an attractive feature of cryptoassets, however without them, financial criminals will have easier access to legitimate financial services and is a necessity in order to ensure effective AML prevention in the United Kingdom. There is also a possibility that these regulations are unsuitable for and do not resonate well with managing money laundering taking place through cryptoassets. The current regulations have been drafted to apply to traditional currencies and widely used digital currencies. Cryptoassets operate in a different way to traditional currencies and it may be the current ‘copy and paste’ approach is unsuitable to help manage financial crime, particularly since cryptoassets are so focused on maintaining anonymity of the owner and origins of transactions. With cryptoassets becoming the preferred method of conducting financial crime, ongoing monitoring and adaptation will be necessary to ensure AML regimes are robust and flexible enough to effectively manage crypto financial crime.
The FCA recognises the 5MLD will only assist in preventing money laundering rising out of anonymity and will not mitigate risks such as abusive trading or cyber-thefts of unregulated tokens. In its most recent consultation regarding regulation of cryptoassets, the FCA proposed some potential changes to current AML regulations in order to ensure the current regime is more effective in its regulation. To help facilitate development of robust domestic systems, the Treasury has decided to defer implementation of the FATF ‘travel rule’, requiring businesses to collect and share personal information gathered for a particular transaction. While bank transfers of fiat currencies are governed by the Funds Transfer Regulation, the decentralised nature of cryptoasset transfers renders some of these provisions inappropriate, so adaptation of these regulations will be necessary to ensure the regulations can be applied practically and effectively to cryptoasset transfers. However, because the FTR is retained EU law, amendments will need to take place through primary legislation. The current solution being proposed by the Treasury is amending the current Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) to consolidate current AML regulations for the cryptoasset sector in one place for easier navigation. Cryptoasset firms are already required to obtain originator and beneficiary information of the transfer as part of the MLRs. Like the FTR, the required information changes based on the value of the transfer. To prevent criminals attempting to avoid this by transferring funds below the threshold amount, the Treasury proposes ongoing monitoring of funds from a single originator appearing to be linked. When these amounts are accumulated together and exceed the threshold amount, the transfer is required to be accompanied by full originator and beneficiary information. What is clear is that applying AML regulations to cryptoasset exchanges and transfers will not be a simple ‘copy and paste’ exercise and some adaptation will need to be undertaken to ensure cryptoassets can be effectively regulated for AML purposes. The FCA maintains a position that cryptoassets are incredibly high risk investments and investors should be prepared to lose all their money, however on the 4th April 2022, the FCA did announce its intention to begin regulating ‘stablecoins’ as the determination of their value is against assets with a definite market value, such as gold, and are therefore less volatile than other cryptoassets.
To ensure cryptoassets are effectively regulated for money laundering purposes, it is clear ongoing regulation and adaptation of current regimes along with regulated crypto firms implementing their own robust AML systems is crucial to ensure their risk is mitigated. While crypto firms themselves may be a potential weak link due to their discretion in creating their own AML system, supervision from the FCA will ensure these firms are compliant with their obligations. The rising popularity of cryptoassets as a means for financial crime cannot be ignored, and on both an international and domestic scale has attracted the attention of regulators to prevent financial crime. While the existing AML regulations were not drafted with cryptoassets in mind, they still assist in mitigating a large portion of risk. However, they may require some adaption to address any possible weaknesses remaining in the regime.
Written by Charlotte Read