Tag: crypto exchanges

KYC & AML: Designed to Resuscitate the Crypto Market

Crypto market stagnated. And let there be no obscuring of that. We are now in a ‘buffer crypto-zone’, waiting for turning points to occur. The entire 2018 was mostly bearish, and today, everyone, including investors and crypto-related business initiators, is expecting the year 2019 to be more crypto-friendly.  New regulations, combined with KYC and AML procedures, are designed to contribute to the flourishing future of the crypto world.  Many critics say that abovementioned ‘duo’, besides being a calling card of company’s credibility, also acts as a ‘double edge sword’ and kills users’ anonymity.  But we have something to say in return: the absence of KYC and AML can kill the entire crypto space. Illustrative statistics of 2017 demonstrates a pretty obvious thing. 2 years ago, when KYC and AML were in their infancy, only 24% of ICOs worldwide had an official legal status. And one more study prepared by Statis Group shows that more than 80% of ICOs conducted in 2017 were identified as scams.  This leads to the conclusion that the appropriate legal support does not protect investors, and does not allow ICO initiators to carry out an ‘exit scam’ scenario.  We must admit that we live in a harsh world, and it’s far from utopian. Users with contrived and malicious intentions have always tortured the crypto world. That’s why regulatory measures must not be neglected. Crypto field has been and, actually, is the great ‘bait’ for fraudsters and criminals, especially when this bait is not essentially regulated.  Let us take, for example, an ICO model, where the money laundering is deplorably flourishing. In simple terms, an ICO takes one’s asset and redeems it for another - a token. These tokens can be freely traded for other crypto or fiat currencies on exchanges worldwide. This system presents a major risk for ICOs. They could easily be used for laundering proceeds of crime.  Many within the industry believe that the future of ICOs may instead lie in security token offerings (STOs). In a nutshell, the STO is an ICO-like investment model. The key advantage of using this route is that token holders are fully protected by the very same financial regulations as used in traditional security-based projects. Self-regulation is needed, but is still hard to be implemented. Max Grain, a Product Management Executive of company Bitlish, explains:  “Scaling brings its own changes and challenges, and a company’s team has to be ready to adapt. Procedures that worked well when you were small may have to give way to a more defined systems and procedures over time as the company grows” Hopefully, not only self-regulations are coming to the crypto market. For instance, in March 2018 the US Department of the Treasury published a letter summarizing its interpretation of the Bank Secrecy Act as it pertains to ICOs. The letter stated that: “Generally, under existing regulations and interpretations, a developer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply with AML/CFT requirements” Last year, European Union also introduced crypto anti-money laundering regulation. Here the regulation applies not to ICOs, but to exchange services between virtual and fiat currencies, and custodian wallet providers which don’t comply with the AML directive.  These businesses become “obliged entities” under the new AML/CTF legislation, similar to traditional financial institutions such as banks. They are obligated to implement measures to counter money laundering and terrorist fundraising, such as customer due diligence (including KYC) and transaction monitoring. They are also required to maintain comprehensive records and report suspicious transactions. The only problem which these regulations entail is that they are not standardized. Andrei Popescu, a Co-Founder of COSS.IO, says AML should be harmonised worldwide: “Despite calls for the adoption of global AML standards for crypto assets trading, no such uniform rules have yet emerged. Differences in national regulations include the existence of special licensing requirements for Crypto Exchanges, the extent to which AML rules also cover administrators and wallet services, the extent to which ICOs are covered by securities laws or equivalent regulations with AML regulatory implications, and the extent to which a crypto-to-crypto exchange is treated differently from crypto-to-fiat exchange. In many cases, the regulatory status of these activities is either ambiguous or case-specific, or is otherwise subject to pending changes in law and regulation” The other side of the crypto-coin is trust. Market needs some time until community will get accustomed to every new regulation and legal improvement. Srdjan Mahmutovich, Kriptomat CEO, states on the issue:  “Crypto space is so fresh and new that no one knows where it all finishes, as we are at the beginning stage. One thing is clear - we do need to put in place more regulation; otherwise we won’t be able to attract all the masses of users to come here. People trust banks. Generally speaking, they do because they use their services on a daily basis. Time will show how much regulation should be put in place in order to secure the user and prevent abuse. Some people, if there`s no KYC, are actually worried, asking whether their assets secured. And that’s what KYC and AML will solve” Evolution is a long-term process, and the crypto market is no exception. We are standing on the verge of a new era – ‘Era of Regulation’ – a crucial period for the crypto world. Backed by harmonized regulation, cryptocurrency will be a great instrument for those who are keeping the interest of the society in mind as a top priority. AML and KYC will help keep it, and what’s more – will help meet it in a fully secure and trustworthy manner.  * This article is based on the exclusive interviews with top-managers of several crypto exchanges. Cryptonomos is most grateful to Andrei Popescu, Co-Founder of COSS.IO, Srdjan Mahmutovich, Kriptomat CEO, and Max Grain, a Product Management Executive of Bitlish.

Articles/January 24, 2019
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Exchange vs. Over-the-Counter Markets: Eternal War

Financial markets are complex environments with their own conjunctures and institutional structures. Historically, there are two basic ways to organize financial markets—exchange and over the counter (OTC).  The cryptocurrency is no exception. Today we’ll focus on the latter, OTC market, which is now gaining momentum in the crypto world.   What’s its nature? Over-the-counter trading is considered as one of the principal ways to trade crypto for those who want to buy or sell a large portion of digital assets. OTC trades are often placed by high-volume players – ‘crypto-whales’, such as hedge funds, private wealth managers and high-net-worth individuals. Despite the fact that OTC trading is not available for every crypto investor, the Bitcoin market here is roughly three times larger than the exchange one. As a rule, a minimum of $75,000 must be on the table before the discussion between parties can even begin. On average, the game for an institutional player in the OTC market usually starts in $50,000-and-up arena, depending on a company’s policy or individual’s preferences. Some centralized exchanges have already started offering OTC services. In summer, U.S. crypto exchange Bittrex launched an over-the-counter (OTC) trading desk. The new service allows approved clients to “quickly and conveniently trade assets”, and supports nearly 200 cryptocurrencies already offered by the exchange.  One of the latest to join the ‘OTC wave’ is U.S.-based crypto exchange Coinbase which opened its over-the-counter (OTC) crypto trading desk in November, 2018. In his latest interview, the company’s Head of Sales Christine Sandler said why the firm had resorted to the OTC trading: “We launched our OTC business as a complement to our exchange business because we found a lot of institutions were using OTC as an on-ramp for crypto trading” Why ‘whales’ only? It’s no secret that the rich do things differently.  That’s why they are the rich, though. Here ‘big boys’ could avoid excessive commission fees and, in a manner of speaking, feel more decentralized. When compared to exchanges, there transactions are completed through a centralized source. In simple terms, there’s a third party acting as the mediator between buyers and sellers.  If you have some extra millions of dollars, it will be extremely inconvenient to place such an order via crypto exchange due to the hassle with continuous verifications and big commission fees. Plus, the order can move the entire market down and hence will make a negative impact on your fortune. Over-the-counter markets are generally decentralized and have no centralized trading facility. This promotes heavy competition between counterparties and lower transaction costs. Here, there are many mediators who compete to link buyers to sellers. The advantage is that such rivalry ensures that costs for intermediary services are as low as possible. The big crypto OTC providers are Cumberland, Jump, and Circle. But it’s hard to rank them because their transactions and earnings are necessarily kept private. OTC market is not entered unreasonably. One of the principle advantages of OTC trading is that clients can trade with each other via broker without anyone else knowing about their interacting. It’s like you are the only one in restaurant, and brokers are the waitresses who compete in order to serve you.  The trendiest OTC instrument to have arrived on the scene is ICO investing. In most cases the ICO model allows investors to support their favorite projects and receive tokens directly without strict oversight from authorities.  However, where there’s a profit to be made, big brother (regulator) will be watching. Since OTC trading provides the possibility of avoiding official records, the regulators started watching quite thoroughly. That’s why traders and brokers even in OTC market may also need to complete KYC and AML procedures on each other to make sure they satisfy legal requirements. 

Articles/January 17, 2019
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Biggest Risks for Crypto Exchanges: Internal Errors, Hacker Attacks, and Money Laundering

Invest in reliable assets, diversify your portfolio and choose a good crypto exchange, says a well-known maximum for investors. But as it often happens it is more easily said than done. Today we will talk about crypto exchanges and the risks related to them. This article is based on the exclusive interviews with top-managers of several crypto exchanges. Cryptonomos is most grateful to Andrei Popescu, Co-Founder of COSS.IO; Johnny Lyu, KuCoin VP; Srdjan Mahmutovich, Kriptomat CEO; Jason Wang, CHAOEX CEO; Max Grain, Product Management Executive of Bitlish, and Alex Strześniewski, Business Development Director at CoinDeal. Hacker attacks, money laundering and internal errors are the biggest risks that crypto exchanges face, analysts and market participants agree There are several hundred crypto exchanges in the world (from 200 to 600+, by different estimates), and many of them know what a hacker attack is. ‘Especially lucky’ exchanges, including Mt.Gox, Bitcoinica, PicoStocks, and Bitcurex have been attacked several times. In the three biggest hacker attacks crypto exchanges and their investors lost more than $1.3 bn. In January 2018 hackers stole $500 million worth of NEM coins from Coincheck, in February 2014 - $460 million worth in Bitcoin from Mt Gox, and in February, 2018 - $187 million worth in Nano from BitGrail. Investors certainly do not like to lose money, especially when it happens through the fault of exchanges.   According to the ICORating’s Exchange Security Report, $1.3 bn has been stolen over the past eight years from just 30 crypto exchanges. The research showed that 32% of exchanges have bad code errors. Only 46% of exchanges protect their users’ personal details properly and have sound requirements to passwords. And only 4 percent of exchanges answer all safety requirements. However, crypto exchanges’ lack of security is not always their fault The crypto space is becoming more mature with the inflow of institutional money, says Andrei Popescu, Co-Founder of COSS.IO and SCX Holdings. “As soon as more institutional investors enter the space, the market will be less concentrated”, he says. Institutional money needs enterprise-grade infrastructure, and it is already there, offered by the most renowned brokers, including Goldman Sachs, JPMorgan, Bank of New York Mellon, Northern Trust, Mitsubishi UFJ Financial Group, etc. Institutional investors are also looking for more regulatory clarity, but this is something the market is only expecting to get. May be as soon, as this or next year.  Improved regulation is something that has not emerged yet. This is especially true about Anti-Money Laundering (AML) Regulation of cryptocurrency. At present AML policies in different countries are not consistent and sometimes misleading, Allen & Overy consulting firm says. For example, in the US “a given cryptocurrency may variously be considered a currency, a security, or a commodity (and potentially more than one of these at once) under overlapping US regulatory regimes”, while in China, that boasts the strictest approach to cryptocurrency, all issuance and exchange services for cryptocurrency is effectively prohibited. Allen & Overy defines AML Risks in cryptocurrency as ‘elevated’. Such risks include: trafficking in illicit goods, hacking and identity theft, market manipulation and fraud, and facilitating unlicensed businesses. “Anonymity, liquidity, and borderless nature of cryptocurrencies makes them highly attractive to potential money launderers”, Allen & Overy concludes.  Banks do not know how to work with crypto exchanges According to Srdjan Mahmutovich, Kriptomat CEO, two years ago in Europe the crypto regulation was quite loose, it was quite easy to get a payment processor, or to get bank accounts. The banks did not know anything about this industry, so it was open field for all these things”, he says.  Now this has changed. “Some banks don`t want to open account, and I understand why: because of ICOs, scam, they don`t have enough knowledge to assess this. But many of them are unwilling to open accounts for exchanges. Why? Because of potentially negative PR they might get”, Srdjan Mahmutovich adds.  Banks know that cryptocurrencies are involved in 10% of the total of the $2 trillion of dirty money that is washed annually, but many of them are in no hurry to adjust their AML programs to catch cryptocurrency criminals. “Some banks are not accepting accounts related to cryptocurrency because they do not know how to handle them”, said Natasha Taft, an AML expert compliance consultant in New York, to finops.co. Little surprise that bank AML specialists recommend that all cryptocurrency transactions made by customers from certain countries, including Russia, Venezuela, Lebanon, Iran, North Korea, the Ukraine and Turkey should be flagged as high risk. It means that banks will avoid transactions with all citizens from those countries, without looking if their money is ‘clean’ or ‘dirty’. KYC procedure: cure-all solution or not? To avoid the Mt.Gox situation, crypto exchanges use AML and KYC (Know Your Customer) procedures to monitor customer behavior, says Jason Wang, CHAOEX CEO. Both AML and KYC are easy for users who need only to upload certain scans of documents to do certification. Some exchanges seem to exist only because they do not comply with AML requirements, says Max Grain, Bitlish’s Product Management Executive. However, such players will eventually close or be shut down as new restrictions clean up the market. There are bound to be regulatory challenges or changes, personnel, personality, and product issues along the way that will challenge how your AML operations takes place, he adds. This is especially important for a growing company because larger volume brings more AML related tasks.  In terms of regulation, there are a lot of crypto companies that are breaking the law, says Alex Strześniewski, Business Development Director at CoinDeal. For example, some exchanges want to add fiat currencies and allow their users to trade without undergoing KYC. “Even if there's a limit within which you can trade (without KYC), you still break the law”, says Alex Strześniewski. Regulation is good, he says, although it will be much more difficult to acquire new clients.  “You can probably look at that like Forex, where you have to go through KYC, and I think some of the biggest exchanges are going to be basically chased for their users: user profiles, who's trading on that platform, and I think we are going to see a really big decrease in the biggest exchanges' trading volumes, because they'll maybe make them go through KYC and then just cut off half the countries, which are troublesome”, says Alex Strześniewski. KYC that is supposed to protect both crypto exchanges and investors turned out to be only a half-measure, because it also created a thriving black market for fake IDs. On Internet, including specialized Telegram channels, it is possible to buy (and sell) fake IDs, necessary to pass KYC: passport scan, selfie, scanned bank statement. These documents can be bought for as little $50; and investors snap up fake IDs as a means of protecting their own identity. Investors have good reasons for being frustrated. If the mailing list gets leaked, there will be attempts to socially engineer them, sell the addresses on the black market or even blackmail their owners, claiming to have filmed the victim watching online porn and threatening to send the video to their friends and family. It is little wonder that people prefer to pay $50 for fake ID to avoid all this, which makes KYC a useless tool.  “Exchanges need more database from different countries and authorities (terrorists, people under sanctions, etc.) to verify each user and make sure all data is trackable”, says Jason Wang.  Crypto exchanges still have to do some homework and close loopholes to ensure security of investor money. However, regulators from different countries are also expected to do some homework to make the crypto space safer. The market needs some technical tools for AML and CTF monitoring to become more mature and ‘enterprise-grade’ to answer interests of ‘big money’ and institutional investors.

Articles/January 16, 2019
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