Five Steps Banks Can Take to Ensure Effective Cryptocurrency Compliance Now

Controversial Senate debate over new crypto regulation, which has delayed a $1.2 trillion infrastructure bill, has finally come to an end. The fact that this conflict occurred shows how mainstream digital assets have become over the past few years.

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Today, Coinbase, America’s most popular cryptocurrency exchange, is a publicly traded company, and traditional banks and institutional investors are increasing exposure to digital assets. With the rapid upward trajectory of cryptocurrency among banks and traditional investors, compliance departments must educate and protect their companies as they move into uncharted territory.

Complexity and risk

Many industry leaders continue to view cryptocurrencies and digital assets in the same way they view traditional currencies or securities. But they shouldn’t. In fact, the technology behind the cryptocurrency makes it unique and leads to many important challenges that banks have to face.

First, there is a relative lack of the settlement cycle that comes with cryptocurrency exchange. Traditional securities have a T Plus (for example, T+1, T+2, T+3) to account for the necessary activities after a particular security is purchased or sold – such as confirming deals, sending duplicates to employers, or other required correspondence. Before the transaction can be settled in the trader’s account. While the settlement date of a stock transaction is T+2, or two business days after the transaction date, cryptocurrency trading can settle on a trader’s phone in a matter of minutes.

In addition, the cryptocurrency market is fragmented in nature. The Securities and Exchange Commission (SEC) implemented the National Market Regulation System (NMS) in 2005 to ensure that stock traders can see the best bid and ask prices for a particular stock before executing any trade. Essentially, while NMS has created a more segmented structure for the US stock market, it has also wanted Market participants invest in market-making and order-routing technology, which ultimately provided transparency across exchanges, alternative trading systems, dark pools, and even neighboring markets such as futures and options. But there is no such regulation in decentralized finance, also known as DeFi. It will take years of investment in technology and regulation to achieve a similar level of integration, interoperability and transparency.

Furthermore, traders who want to buy and sell digital assets must do so from pre-funded accounts. The lack of a coherent infrastructure means that cryptocurrency traders often have funds spread across numerous online exchanges as they seek the best execution prices. In the process, they are increasing their exposure to market risk as well as the risks associated with hacks and technical failures, both of which have historically plagued cryptocurrency exchanges.

These are just a few of the challenges facing compliance departments as companies plunge into the DeFi and digital asset space. Until cryptocurrency regulation matures considerably, solving these challenges will not be easy.

In search of clarity

In the United States, regulators such as the SEC and FINRA have made protecting investors a top priority. Banks that provide cryptocurrency-related services have fiduciary responsibilities, disclosure requirements, and an obligation to avoid conflicts of interest. But a coherent regulatory framework is still largely absent.

Meanwhile, in the UK, regulators have serious concerns about the potential role of digital assets in money laundering and fraud. Companies have taken measures to better monitor the space, including restricting some cryptocurrency exchanges from engaging in regulated activity. For example, in June of this year, the Financial Conduct Authority banned Binance Markets Ltd, a British company that owns the world’s largest cryptocurrency exchange, from conducting any regulated activity. It also required all organizations that provide cryptocurrency-related services to demonstrate compliance with anti-money laundering rules.

In the European Union, lawmakers recently proposed the Markets in Crypto Asset Regulation (MiCA) to eliminate 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 is still no set timetable for its implementation.

Cryptocurrency compliance processing

The undeniable growth in the popularity of digital assets combined with the prevailing ambiguity in crypto-regulation is leaving banks in a precarious position. So how should compliance departments handle crypto-compliance? Here are five recommendations:

  1. Develop a foundational understanding

It may seem obvious, but the first step for compliance officials should be to understand cryptocurrencies and crypto assets. Host an expert to explain the basics of distributed ledger technology, blockchain, and various crypto assets (eg stablecoins, utility tokens, etc.). Make the meeting mandatory for all compliance and legal staff.

  1. Expand education beyond the compliance team

It is possible that many of your company’s partners already have experience with cryptocurrencies, but this does not mean that they fully understand the intricacies associated with trading digital assets. For example, a trader might assume that they are exchanging Bitcoin when they are actually trading a derivative. Suddenly, they executed a security transaction that was not reported. As your company’s crypto-related policies mature, implement a quarterly or semi-annual certification program that requires employees to confirm that they are aware of current policies and will adhere to them.

  1. Understand the risks of your business

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

  1. Evaluation of current measures

Many companies will lose the mechanisms needed to design and implement robust compliance protocols for cryptocurrencies. As the compliance officer, it is up to you to determine where the gaps are and what you need to do to fill them. Do you have a system that you can use to facilitate and monitor employee disclosures regarding investments in Bitcoin, Ethereum, DeFi, or other digital assets? If such a system does not exist, how can you create one?

Ideally, your company will have a technology solution that allows employees to easily submit orders and gives compliance teams an ongoing view of relevant trading activity. If this is not currently possible, you can create a simple standard form that employees can complete manually using a digital tool such as Adobe Sign. Lack of processes and mechanisms can be an obstacle, but sooner or later your company will need them. Start developing it now, no matter how primitive it may seem, and build on it gradually as needed.

  1. Get ready for change

Constantly reevaluate your company’s cryptocurrency-related services and policies. As potential new regulations for cryptocurrency emerge, consider their potential outcomes and potential impact on your organization. By planning for many possible scenarios, you will enable your leadership team to make decisions faster and take more decisive action when needed.

Moreover, fostering a culture of compliance will give your organization the conviction needed to quickly introduce new products and services: putting you in a position to capture a greater market share than less flexible competitors. Although this method is not often recognized, it is one of the critical ways that compliance builds up with the bank’s bottom line (not to mention service to society through safer and fairer markets).

Although its regulations remain largely undefined for banks, there is no doubt that cryptocurrency is here to stay. Compliance officers must remain curious, thoughtful and informed to help their companies adapt quickly and maintain a competitive advantage as the future evolves.


About the author

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

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