Rene Hendrikse, Managing Director EMEA, Mitek
The increasing popularity of cryptocurrencies has the potential to radically change how the world uses money.
Many see advantages in this digital money over the alternatives: fast settlement, secure transactions, and, depending on the coin used, a level of anonymity.
Anonymity can, of course, be both an advantage and a disadvantage—there are definitely two sides to this coin. In a world where people are worried more and more about how their data is being stored and tracked, a payment method that offers a certain level of privacy is attractive. But it also appeals to those who want to use that privacy to hide from the law. One survey, from the University of Sydney and the University of Technology Sydney, estimated that nearly half of all Bitcoin transactions were associated with illegal activity. Even with the high-profile Silk Road shuttered, people are finding ways to get illicit substances online, and using cryptocurrency to pay for it.
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Cryptocurrency is also indelibly linked with ransomware. A person or business confronted with a message that their PC has been hacked and their files encrypted will be given one way out. Pay a ransom to the perpetrator, and that ransom will be in a digital currency. If cryptocurrency is to gain widespread acceptance, it will need to shake off its reputation as the choice of criminals, hackers and other miscreants, and be seen as more than just the newest form of shadow banking.
Getting rid of cryptocurrency’s grubby reputation likely means the end of its anonymity. Regulators won’t be willing to accept cryptocurrency as a mainstream payment technology unless users are willing to accept the same rules.
Legitimate businesses have been using cryptocurrencies for some time, but they are now under pressure to adopt the same Know Your Customer (KYC) processes as they would for any other method of payment. If a business needs an audit trail for every other customer, then it needs one for those who use cryptocurrency.
In Europe this will soon be mandatory. The EU’s fifth anti money laundering directive(AMLD5) will bring cryptocurrency wallets and exchanges into line with bank accounts and similar products. This follows similar moves by regulators in Japan (Act on Prevention of Transfer of Criminal Proceeds) and Australia (AML and CFT Amendment Act). Regulators have decided that if cryptocurrencies are here to stay, then they need to follow the rules. China, on the other hand, has introduced measures to crack down on cryptocurrency trading, going as far as to ban its citizens from offshore trading. Either way, the message is clear: if cryptocurrency is to go mainstream, it needs to be regulated in much the same way as any other currency.
One result of this is that compliance firms have seen a surge in business as cryptocurrency wallets and exchanges look to get ahead of regulation. While they’ve made progress, they’re not quite there yet. A study by John Devlin of P.A.ID Strategies found that 68% of the 25 most prominent cryptocurrency exchanges and wallets in Europe and the US did not perform identity checks on their clients.
There are also calls by the cryptocurrency sector itself for better regulation. The trade association CryptoUK has been established to educate politicians and regulators about cryptocurrency, and promote higher standards of conduct. Their definition of a supportive operating environment includes “appropriate regulation”—unlike many other trade bodies, CryptoUK is in favour of more regulation, including introducing anti-money laundering practices to exchanges.
Cryptocurrencies are on the way to meeting regulatory demands and “going straight”, but is there a risk that doing so undermines the very ethos of the crypto movement?
The need for transparency
Fundamentally, cryptocurrency needs to gain the trust of regulators and the public. Its short history has left it with a reputation as the currency of choice for criminals and money launderers. Long-term success will rely on wallets and exchanges to comply with regulation, which demands stricter identity verification.
The KYC requirements to meet Anti-Money Laundering regulation gives law enforcement an audit trail to follow if money laundering is suspected—they can tell who made particular transactions and identify if a transaction was an attempt to hide the origin of money that was the result of crime. It’s undeniable that cryptocurrency will lose one of its main features in order to gain mainstream acceptance, but it’s necessary.
This is only a problem if anonymity is the only advantage of cryptocurrency. It isn’t, it’s just the one that gave it notoriety. Cryptocurrencies are decentralised, meaning there is no single point of failure that a hacker could attack. As a peer-to-peer system, settlement doesn’t rely on business hours, making trading on weekends and holidays possible. And while it remains controversial whether this is an advantage or not, it retains its unique feature of having no central bank or government control.
The push for transparency by regulators will, ultimately, undermine the anonymity of cryptocurrency. What remains to be seen is if the unique features of cryptocurrency are enough to sustain its growth as a way to transact.