How Compliance Might Become Crypto’s Greatest Ally

Compliance. It’s the secret ingredient to ensure that traditional finance players not only give crypto platforms access to payment rails they need, but also prove to regulators and the general public that web3 is mature enough and here to stay.

The high-profile collapses of FTX, Terra and Silvergate shook institutional and consumer confidence, however the crypto industry is certainly looking more stable in recent months. It’s far from a renaissance, but it seems that attention is fully turned to steadying the ship; a recent Bloomberg report detailed how European financial firms are now competing for top compliance staff, and there is hope that those in crypto are more committed to doing things right.

Compliance At The Core

While the outlook for crypto is growing ever more positive, we can’t ignore the fact that crypto firms are typically behind their TradFi counterparts in terms of tech capability and resources reserved for compliance. Newly established firms in crypto often under-resource their compliance programs and have a knowledge gap on regulatory developments, and can lack an effective governance and oversight structure, particularly at senior leadership and board levels.

There is also a lack of understanding of the importance of regulatory compliance and why companies need to follow a rigid compliance program. The FTX debacle is a case in point and a reminder of why crypto founders should maintain a big-picture view of regulatory requirements. Compliance needs to be at the core of the way a firm operates. It can’t be an afterthought — and needs to be embedded into an organisation’s systems and processes in a way that is both scalable and cares for the clients it looks after.

Founders also need to embed compliance fitness early on. Startups that involve compliance professionals only when the product is finished are unlikely to pass compliance standards, creating headwinds. If compliance is involved in the ideation phase and not considered a separate strategy from the company strategy, products can be both innovative and compliant, particularly important if it involves interactions with TradFi banking partners.

An example of applying innovation to crypto through compliance would be utilising the data collected via blockchain analytics to complement KYC and transaction monitoring processes. That could mean that risk-based and bespoke processes would be created if compliance is involved early on.

Transparency in Crypto

Cryptocurrencies have often been misunderstood and associated with illicit activities, partly due to unfortunate episodes like the downfall of the exchange FTX. However, these incidents don’t fully represent the essence of the crypto industry or its potential.

One of the significant strengths of cryptocurrencies is the inherent transparency of blockchain technology. It allows an unprecedented level of precision in tracking transactions. This feature was evident when Chainalysis reported that $23.8 billion worth of crypto was laundered in 2022. Rather than viewing this negatively, it should be seen as a demonstration of blockchain’s potential to monitor and report on financial activities, a capability often lacking in traditional financial systems.

Indeed, money laundering is a universal issue, not just in the crypto world. The UN Office of Drugs and Crime estimates that total money laundering transactions globally amount to $800 billion to $2 trillion annually. This perspective helps us realise that the crypto industry is a microcosm of the broader financial world.

Compliance, in this scenario, plays a vital role in changing the perception of cryptocurrencies. It will be transformative if the industry can successfully adopt regulations focusing on Anti-Money Laundering (AML) and consumer protection strategies.

A critical example here is the use of crypto mixers, which offer users enhanced privacy by blending the funds of multiple users. Despite their misuse by some individuals, the US Treasury’s sanctioning of mixers like Tornado Cash signifies the regulator’s recognition of their potential. These tools can indeed be a lifeline for individuals in oppressive regimes, demonstrating the socially beneficial aspect of crypto technologies. If compliance officials increase their engagement with these tools, we can further minimise misuse and maximise their positive potential.

So, instead of focusing on the challenges, let’s embrace the potential of the crypto industry. By highlighting its capacity to improve compliance and secure financial transactions, we can shift the narrative away from the notion of cryptocurrencies as a tool for illegal activities and towards a more accurate depiction of its immense potential to revolutionise finance.

Regulatory Speak

The future of the crypto industry hinges on constructive collaboration between crypto providers and regulatory bodies. Embracing this cooperative spirit, the industry can learn from past episodes such as the FTX incident, where a close relationship with regulators did not reflect the internal turmoil of the exchange.

The key to a brighter future lies in fostering trust between industry stakeholders and regulators, moving past previous disconnects and suspicions. The landscape is not entirely bleak, as seen in the way the SEC interacts with major players like Coinbase. Although the SEC recently warned Coinbase about potential enforcement actions, such a move signifies an active regulatory environment where compliance is valued. Furthermore, regulatory clarity is progressively emerging in various jurisdictions, including the EU, UK, Bermuda, and Hong Kong, as seen with developments like the forthcoming MiCA regulations.

The industry’s dynamic nature can be challenging for regulators to grasp completely, but it’s important to view this not as a hurdle, but as an opportunity for crypto firms to educate regulators about their evolving field. Regulators, being human, are prone to errors, either by over-regulating or not being stringent enough. At times, resource limitations can cause lapses in response, as was the case with the UK’s Financial Conduct Authority last year.

Recognising these challenges, it becomes more crucial for crypto firms to initiate early conversations with regulators. This proactive approach not only helps to address potential issues head-on but also creates a platform for regulators to learn more about the crypto industry.

While it’s true that the terms "compliance" and "crypto" have seldom been linked, the landscape is changing. Recent crises in the sector have indeed caused upheaval, and coupled with the lack of industry expertise among regulators, crypto has often leaned towards rapid innovation at the expense of compliance.

The formation of advocacy groups that represent crypto interests to both the market and regulators can play a pivotal role in bridging this gap. Such consortiums, comprising users, regulators, and both traditional and crypto players, are steps in this direction.

This newfound focus on compliance signifies the crypto industry’s commitment to learn from the turbulent events of 2022. It shows a clear shift towards not just moving on, but incorporating vital lessons from past incidents.

As we look ahead, it’s important to note that the relationship between compliance and crypto is undergoing a fundamental shift. In certain jurisdictions, the implementation of new regulations and a willingness to work alongside crypto companies suggest a positive turn in this direction. These developments signal a future where compliance and crypto coexist harmoniously, reshaping the industry and reinforcing its legitimacy.

About The Author

	Paula Steiner is Group Head of Compliance at Fiat Republic. She has more than 8 years of Regulatory Compliance and FinCrime experience in financial institutions and Fintechs. Her previous roles include Senior Consultant at Deloitte and Compliance Officer at Mollie Payments.

Editorial Note: This Press Release is made possible by MVPR.