Cryptocurrency ICOs Must Stop Flying Blind On Money-Laundering Risks

Companies have raised as much as $4 billion this year through token crowd sales, or Initial Coin Offerings, a new mechanism that many startups using blockchain technology in some way have used to bypass traditional venture capital funding routes. That is a lot of money flowing to entities to fund their ideas and develop their products. It is also a lot of money originating from unknown sources, some of them also high risk or illegal.

While many of these startups will inevitably fail, hopefully many more will succeed. We may soon see new Amazon- or Facebook-like successes in this space. But will the next market winner end up regretting where their funding came from? Will they ever even know who was really behind the money that launched their business? How will it impact their valuation? Would competitors point this out in the future to weaken the challenger?

Typically, the startups use the Ethereum blockchain platform to issue tokens to hundreds if not thousands of buyers dispersed across the globe in the ICO phenomenon. But they have had little or no way of answering with confidence the following: Is their backers’ money flowing from savings, inheritance and asset sales — or from ransomware, drug-trafficking or other nefarious sources? Does the profile of the entity providing the funds match the profiles of their transaction?

Unfortunately, the companies raising the funds have generally lacked the tools to analyze and structure data based on Ethereum for anti-money laundering and counter-terrorism financing compliance purposes. This has also blocked countless entities who have raised funds through the ICO process from being able to use those funds or functionally interact with the traditional economy and its regulatory structure. Why? Precisely, because they cannot prove the anti-money laundering (AML) and counter-terrorist financing (CFT) risk related to the source of funds.

Regulators, though, are increasingly scrutinizing ICOs from the AML perspective, and so they should. If you’d like to, for instance, transfer wealth out of Russia abroad, an ICO would be a perfect tool — not only to do that but also potentially to earn on this.

The ICO surge needs robust ways of safeguarding against illegal movement of money just as much, if not more than, the traditional financial sector. This now sits at the heart of the future of ICOs and cryptocurrencies in general. It is arguably the biggest roadblock to adoption by the traditional and mass market. With mainstream investors now attracted to digital currencies as the prices of Bitcoin and Ether soar, these new buyers need reassuring over where the money they hold has come from.

Most people enter into the space by buying Bitcoin and then branching out into Ether.

Typically, startups accept Ether when they sell their coins. So, by the time somebody wants to use Ether to buy into an ICO, there is a complex history of the source of the funds. The proper application and execution of AML/CFT rules and regulations is a barrier virtual currency businesses need to overcome. It is a growing burden limiting the speed and scale of market growth as entities operating in this new space are required to apply the same stringent standards as long-established banks and other financial institutions.

Besides, blockchain and virtual currencies — in relation to AML/CFT compliance — are also a challenge for traditional financial institutions. More and more of their clients are expanding into this rapidly growing market, and the business generated by this new ecosystem cannot be ignored. The market capitalization of cryptoassets has surpassed $500 billion.

As companies, financial institutions and major players around the world lack the proper standards, tools or data, they are technically “blind.” They are unable to efficiently determine the potential risk associated with virtual currency or blockchain asset related entities and, therefore, they are unable to provide services to them.

Many startups satisfy themselves with simple know-your-customer (KYC) efforts for their ICOs. Take some info from the client, screen this via external source, check if ID matches face. They may believe it is sufficient to exclude investors from stricter regulatory jurisdictions such as the United States.

But real compliance needs to go further and actually mitigate money-laundering and terrorist financing risks. KYC/AML is a much more complex process to do this right. Otherwise, it is false assurance that you are compliant, that all is good. It is not. Full processes are needed to be compliant, with policy, procedure, trained and experienced staff that makes decisions and can categorize the low, medium, high risks.

The solution is for the innovative, creative and dynamic blockchain industry to develop more sophisticated capabilities to help companies be compliant. Streamlining and automating the process with an AML/CTF platform is the best way to prevent the up-and-coming Googles from falling down on money-laundering rules and protect them from penalties and worse.

Pawel Kuskowski is the CEO of Coinfirm, a blockchain regulatory technology company providing cryptoasset compliance services.