4th AMLD and cryptocurrencies: towards a possible regulation?

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Introduction

In less than a decade since Satoshi Nakamoto presented Bitcoin to the world, the introduction of cryptocurrencies in global economy have revolutionized the business ecosystem. 

Today it is a reality that cryptocurrencies caused great disruptions in the financial sector: there is a growing number of entrepreneurs who create ICO campaigns, sell tokens to the public and raise hundreds of millions of dollars.

The use of cryptocurrencies gives to retailers, payment processors, and banks advantages like speed of transactions, traceability, and transparency.

But despite the popularity of this new economic system, since the middle of 2017, there have been renewed government efforts to regulate the market. Most of these efforts have been centered on KYC and AML regulations: identifying and understanding the compliance linkages between banks, exchanges, and consumers will be a protracted process, but remains important to crypto industry growth.

Impact of cryptocurrencies on financial market

Cryptocurrencies are having a massive impact on the way conventional business methods: they are changing the political and economic environment.

Bitcoin, Ethereum, Ripples, Litecoin and many other cryptocurrencies continue to experience massive growth in price, market capitalization, and mainstream adoption. In fact, they are considered as a way of providing people with the power to control money and ensure that government does not abuse its powers. Since cryptocurrencies are not bound by the exchange rates, interest rates, transactions charges or other charges of any country, they can operate at the universal level without experiencing any problems and hence make transactions quite easy.

The most significant advantages of the cryptocurrencies use are :

•           Decentralization. All cryptocurrencies are not controlled or governed by central authority, both locally and globally. Decentralized cryptocurrencies like Bitcoin and Ethereum have strong advantages over centralized financial systems, because of their ability to function and operate without a single point of failure, which hackers and bad actors can target.

•           Easy and fast payments. Cryptocurrencies will replace the conventional methods of payment: they do not require third parties, eliminate the user logistic issues and are secure and free from fraud and corruption. In this way transaction happen quickly and receivers receive it in a couple of minutes.

•           Transaction security. The use of military grade cryptography ensures that transactions remain secure, no one except the owner of a wallet can make transfers or payments from a wallet and the chance of fraud is very less because there are no chargebacks.

•           Low or no transaction fees and no set up costs. Cryptocurrencies have lowered the cost of the online transaction. A good example is Bitcoin which unlike banks, it does not require the user to pay transaction costs reducing the cost of exchanging Bitcoins. Additionally, cryptocurrencies do not need considerable costs to set up: it is only required to have a computer or a smartphone and cryptocurrency wallet can be installed at no fees.

•           No Identity theft. The use the digital money makes possible to send precise amounts to the specific client, without fright of identity theft.

•           Accessibility. In the cryptocurrencies world a person who have the ‘know how’ can make a breakthrough, regardless of external circumstances: there is no need to trust a bank or any third-party service providers. There are approximately 2.2 billion individuals with access to the Internet or mobile phones who don’t currently have access to traditional exchange, these people are primed for the Cryptocurrency market.

However, all advantages of digital currencies can also be interpreted as some sort of shortcoming.

In termed of accessibility, it is important to underline that not many websites and companies accept digital currencies yet and a very few countries have legalized the use of cryptocurrencies. Even if cryptocurrency such as bitcoin is currently being used in different ways, in most of the cases its use does not concern yet commerce, international bank transfers as well as electronic payments.

Additionally, the information about cryptocurrencies is often difficult to achieve in a comprehensive and exhaustive way and it is very hard to determine the credibility of the sources. In fact, having cryptocurrencies enormous fluctuations, it is very important to monitor the situation constantly: the value of cryptocurrencies can increase or decrease by 5% or 10% in a matter of hours.

The decentralization gives a lot of advantages, but on the other side there is not investors protection: as cryptocurrencies are not subject to official regulations means that investors are not protected from potential frauds and scams.

In the end, in terms of anonymity, it is important to underline that this can enables criminals to finance illegal activities using cryptocurrencies. There are currently several cases of criminals that used Bitcoins for drug-related transactions, money laundering, and other illegal undertakings.

Impact of the EU’s 4AMLD on cryptocurrency exchanges and their users

The 4AML directive has for sure enhanced the rules in terms of customer due diligence and risk assessment, especially when the Professionals (as defined in the 4AMLD) have to perform a due diligence on their clients or they have to identify and verify the identity of beneficial owners or underlying entities.

On the one hand, the force of the cryptocurrencies is also related to their anonymity and it has landed to present several opportunities for criminal activities, such as, money laundering or tax evasion (which, since the adoption of the 4AMLD is considered as an AML crime). On the other hand, their success has represented one of the most complex challenge to the Professionals in terms of timing of adoption of the directive itself and of the implementation of procedures and guidelines for the users.

Furthermore, the evolution of the cryptocurrencies and the implementation of the directive give no choice to the Professionals to adapt their procedures to keep up to date and, most important, to be compliant with the regulation.

We need to consider the fact that when the directive has been written, the cryptocurrencies were not as common as nowadays, and for this reason the 4AMLD does not explore the subject as it should. It is for this reason that, the Council of the EU has reached a consensus to amend the 4AMLD by introducing the definition of “virtual currencies”. The suggested amendment of the Council defines the “virtual currencies” as a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency, and does not possess a legal status of currency, but is accepted by a natural or legal persons, as a means of exchange, and which can be transferred, stored and traded electronically.[1]

Furthermore, the new directive imposes to an exchange provider to be registered to the controlling authority of the country which does not mean that this authority has the same power on these entities than it has on “regular entities”. Nevertheless, virtual currency exchange entities and virtual wallets will be subject to the beneficial ownership reporting requirements.

In order to comply with these new demands, one solution which was suggested was to ban and subsequently to denounce certain cryptocurrencies following compliance rules such as violation of embargos or international laws (as, for example, a new Venezuelan cryptocurrency). The question is not to accept or not cryptocurrencies, because they represent a huge part of a new way of investing, but to establish controls on the kind of cryptocurrency an institution can actually accept.

Another solution adapted by the Professionals, which is not really a new one, is the transactions’ monitoring.

Of course, these solutions are not well adapted to the ongoing growth of these currencies and that’s why the European commissioners are pushing for an amended version of the 4AMLD.

After the amendment will come to force, the Professionals and especially the exchange services between virtual and fiat currencies and the custodian wallet providers will have to comply with it and, of course, with the regulation of their country of incorporation.

Furthermore, all the services linked to cryptocurrencies need to be registered to the AML authority of their jurisdiction.

In addition to this, the European Commission announced its Action Plan on Financial Technology for the spring 2018. This Action Plan will release several recommendations on issues like blockchain and it is expected to adjust all the supervisory practices (especially the standardization practices) for all the Member States. This show a considerable change on the laissez-faire approach adopted by the EU so far.

It is evident that we are in front of some AML contradictions. The current AML procedures dictated by the directive cannot keep up with a “special financial system” based on anonymity.

Governments persevere with regulating cryptocurrencies and with updating and developing broader financial crime regulations.[2]

Until the adoption of the amendment to the 4AMLD, what the Professional can do is to change their perspective and try to reduce AML risks.

In most countries, in order to open a digital wallet and to buy cryptocurrencies, clients need to pass the “KYC exam” which, obviously compromise the anonymity side of them. It is important to note the use of the expression “in most countries”, because nowadays in other countries you can easily open a digital wallet and trade with cryptocurrencies in absolute anonymity. Is the spread of the KYC policy worldwide a real possibility? If we want to comply with the current regulations, it should be.

Finally, the spread of the FinTech is actually helping Professionals to reduce AML risks. Thanks to the Blockchain technology, AML requirements and controls could be better served than the normal existing monitoring supervision (entry/exit monitoring).

First steps on a cryptocurrency’s regulation

Combining business needs and compliance needs is an old history. The question has always been the same: how compliance needs and regulations could comply with the needs of a more business perspective? How can these two worlds combine?

The market has his rules, as much as compliance has its owns.

However, all these debates on AML regulation on cryptocurrencies seems not to influence the ICO companies. They continue to trade normally but since most ICO companies exchange the cryptocurrencies to fiat money, they need to resort to ordinary ways, which means for example, opening an ordinary bank account for their operational needs. It is clear in this case that AMLD could be effective because several crypto exchange entities and banks refuse to work with ICO companies due to the fact that they do not identify their users. This “block” against them forces them to comply more and more with the AML regulation in place, at least when it comes to KYC processes.

For sure, the impressive growth of cryptocurrencies gave them a scent of forbidden excitement, but compliance programs should be adapted with this evolution.

Banks and the other financial institutions should foster cryptocurrencies exchanges in order to facilitate the adoption of the cryptocurrencies. A broader adoption of these currencies and blockchain KYC processes can prevent and detect more easily illicit transaction and can lead to a more stable cryptocurrency market.

In cryptocurrency’s regulation, some progress has been made, for example with the creation of the first 100% AML/CTF compliant cryptocurrency: AMLBitcoin by NAC. Thanks to a biometric identification system, it is possible to identify the owner of the wallets holding this kind of cryptocurrencies, and it allows to monitor every transaction by analyzing individual AMLBitcoin users’ track records.

Additionally, in Luxembourg, bitFlyer has been the first cryptocurrencies’ platform to receive the approval of the CSSF, the Luxemburgish regulation authority. This approval allows it to trade across Europe fully respecting Compliance regulations.

Furthermore, the New York Department of Financial Services introduced the notion of “BitLicense” for crypto-exchanges that could comply with current regulatory standards. This kind of license can encourage the establishment of crypto-banking relationships because once cryptocurrencies are registered and certified they are as compliant as conventional currencies.

This is a real progress and, even if it is maybe too early to say, it could actually grant the continuity of the cryptocurrencies.

[1] NOVAK, Nejc « EU Introduces Crypto Anti-Money Laudering Regulation »,

[2] CRABTREE Rachel, The compliance and KYC link between banks, bitcoin and exchanges

The Authors

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Martina Giuffrida graduated in Political science and International Relations with a specialization in Security, Peace and Conflicts studies. After a first experience in a NGO dealing with monitoring of International cooperation projects, she worked at BNP Paribas Fortis and KBL Private Bankers in Luxembourg as Compliance Process Officer and Business Analyst. Martina joined Initio in 2017.

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Diana Cutolo hold a master in Political Sciences, a master in International Business and a doctorate in International Relationship. She started her career in banking industry in 2008, where she developed a transversal knowledge of the different activities: Fund Industry, forex, money market and securities deals, cash and securities flow, investor services and client relationship.

After 9 years of experience in Luxembourg financial sector, Diana joined Initio in 2016, as consultant and business line manager for Fund services.