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Five Steps Banks Can Take to Ensure Effective Cryptocurrency Compliance Now

By Michael Ross. Originally published at ValueWalk.

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The contentious Senate debate over new cryptocurrency regulation, which resulted in the delay of a $1.2 trillion infrastructure bill, is finally over. The fact that this dispute even occurred shows just how mainstream digital assets have become over the past few years.


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Today, America’s most popular cryptocurrency exchange, Coinbase, is a publicly traded company, and traditional banks and institutional investors are scrambling to increase exposure to digital assets. With cryptocurrency’s fast upward trajectory into the sphere of traditional banks and investors, compliance departments must educate and protect their firms as they move into uncharted waters.

Complexity And Risk

Many industry leaders continue to view cryptocurrencies and digital assets in the same way they view traditional fiat currencies or securities. But they shouldn’t. In reality, the technology behind cryptocurrency makes it unique and gives rise to several significant challenges that banks will have to confront.

First, there’s the relative lack of a settlement cycle that comes with exchanging cryptocurrencies. Traditional securities have a T Plus (i.e., T+1, T+2, T+3) to account for necessary activities after a given security is bought or sold—such as confirming trades, sending duplicates to employers, or other required correspondence before a transaction can settle in a trader’s account. Whereas the settlement date for a stock transaction is T+2, or two business days after the transaction date, a cryptocurrency trade can settle on a trader’s phone in a matter of minutes.

Additionally, the cryptocurrency market is inherently fragmented. The SEC implemented the Regulation National Market System (NMS) in 2005 to ensure that equities traders can see the best bid and ask prices for a given stock before executing a trade. Essentially, while NMS has created a more fragmented U.S. equities market structure, it has also required market participants to invest in market-making and order-routing technology, which has ultimately provided transparency across exchanges, alternative trading systems, dark pools, and even adjacent markets such as futures and options. But no such regulation exists in decentralized finance, also known as DeFi. It will take years of investments in technology and regulatory rule-making to achieve a similar level of integration, interoperability, and transparency.

Moreover, traders who want to buy and sell digital assets must do so from pre-funded accounts. The lack of a cohesive infrastructure means that cryptocurrency traders often have funds dispersed across multiple online exchanges as they seek the best execution prices. In the process, they’re elevating their exposure to market risks as well as risks associated with hackers and technical malfunctions, both of which have historically plagued cryptocurrency exchanges.

These are just a few of the challenges facing compliance departments as firms plunge into the DeFi and digital asset space. Until cryptocurrency regulation matures substantially, solving these challenges will be anything but straightforward.

In Search Of Clarity

In the U.S., regulators like the SEC and FINRA have made investor protection a top priority. Banks offering cryptocurrency-related services have fiduciary responsibilities, disclosure requirements, and the obligation to avoid conflicts of interest. But a cohesive regulatory framework is still largely absent.

Meanwhile, in the U.K., regulators have serious concerns about the potential role of digital assets in money laundering and fraud. Firms have taken actions to better monitor the space, including restricting certain cryptocurrency exchanges from engaging in even regulated activity. For instance, this June, the Financial Conduct Authority barred Binance Markets Ltd., a U.K. holding of the world’s largest cryptocurrency exchange, from undertaking any regulated activity. It has also required all organizations offering cryptocurrency-related services to demonstrate compliance with anti-money laundering rules.

In the EU, legislators recently proposed the “Markets in Crypto-Assets Regulation” (MiCA) to crack down on insider trading and market manipulation on cryptocurrency exchanges. The emergence of this new legal framework should eventually lead to more institutional investment in the space. Unfortunately, there’s still no concrete timetable for its implementation.

Addressing Cryptocurrency Compliance

The undeniable growth in the popularity of digital assets combined with the pervasive ambiguity of cryptocurrency regulation leaves banks in a precarious position. So how should compliance departments address cryptocurrency compliance moving forward? Here are five recommendations:

  1. Develop A Foundational Understanding

It might seem obvious, but the first step for compliance officers should be to understand cryptocurrencies and crypto-assets. Host an expert to explain the basics of distributed ledger technology, blockchains, and various cryptocurrency assets (e.g., stable coins, utility tokens, etc.). Make the meeting mandatory for all compliance and legal personnel.

  1. Extend Education Beyond The Compliance Team

It’s likely that many of your firm’s associates already have experience in the cryptocurrency space, but that doesn’t mean they fully understand the complexities associated with trading digital assets. For instance, a trader might assume that they’re exchanging Bitcoin when they’re actually trading a derivative. Suddenly, they’ve executed a security transaction that goes unreported. As your firm’s cryptocurrency-related policies mature, implement a quarterly or biannual certification program that requires employees to confirm they’re aware of current policies and will abide by them.

  1. Understand The Risks Specific To Your Business

Examine policies and procedures in light of your current business lines and how they could change in the future. Identify retail trends that will shape the institutional business and then proactively implement thoughtful policies to protect the company as these trends unfold. Work with the executive team to understand your organization’s strategy and analyze cryptocurrency developments through that lens.

  1. Assess Current Measures

Plenty of firms will be missing the mechanisms needed to design and implement robust cryptocurrency compliance protocols. As a compliance officer, it’s up to you to identify where gaps exist and figure out what you need to do to fill them. Do you have a system you could use to facilitate and monitor employee disclosures regarding investments in Bitcoin, Ethereum, or other DeFi or digital assets? If such a system doesn’t exist, how could you create one?

Ideally, your firm will have a technology solution that allows employees to submit requests easily and gives compliance teams ongoing visibility into relevant trading activity. If that’s not currently feasible, you could create a simple standard form that employees can complete manually using a digital tool like Adobe Sign. A lack of processes and mechanisms might be an obstacle, but sooner or later, your firm will need them. Start developing them now, no matter how rudimentary they might seem, and gradually build upon them as needed.

  1. Prepare For Change

Continually reassess your firm’s cryptocurrency-related services and policies. As potential new cryptocurrency regulations surface, think about their possible outcomes and the likely impact on your organization. By planning for many potential scenarios, you’ll empower your leadership team to make decisions faster and take more decisive action when the need arises.

Moreover, fostering a culture of compliance will give your organization the conviction required to introduce new products and services quickly: positioning you to capture more market share from less agile competitors. Although not often recognized, this is one critical way that compliance is accretive to a bank’s bottom line (not to mention the service provided to society through safer, fairer markets).

Though its regulation remains largely undefined for banks, there is no question that cryptocurrency is here to stay. Compliance officers must stay curious, thoughtful, and informed to help their firms adapt swiftly and keep a competitive edge as the future unfolds.


About the Author

Michael Ross is Director and Senior Sales Manager at StarCompliance, a global leader in financial compliance software. He is an expert on the capital markets ecosystem and is passionate about market structure and technology.

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