Balancing the Risks and Rewards of Cryptocurrency Adoption: Can growing regulatory rails, fincrime compliance controls bring validity, stability to volatile, at-times vilified virtual asset sector?

By Joseph Blanka
A second-year law student (2L) at the Benjamin N. Cardozo School of Law
November 25, 2024
jblanka@law.cardozo.yu.edu

With editing and content contributions from ACFCS VP of Content, Brian Monroe

Cryptocurrencies have gained traction as digital economic assets that promise speed and decentralization, where control and decision-making are distributed across a network of participants rather than being held by a central authority.

Major corporations like Tesla and PayPal have dipped their toes into crypto waters by accepting crypto as a payment method for their products and allowing customers to buy, sell, and hold cryptos in their digital wallets.

Similarly, financial firms like JPMorgan and Goldman Sachs are exploring blockchain technologies to enhance transaction efficiency, transparency, and security, while also exploring asset tokenization, smart contracts, and digital currencies to stay competitive in modern finance.

But crypto’s decentralized, pseudo-anonymous nature can also foster fraud and criminal activity.

The anonymity of some transactions, lack of regulatory oversight, and global accessibility make any businesses heavily involved in cryptocurrency ripe for malicious actors.

An FBI report noted that cryptocurrency is a favored tool for cross-border money laundering.

It emphasized that criminal enterprises can exploit the lack of oversight to “...facilitate large-scale, nearly instantaneous cross-border transactions without traditional financial intermediaries that employ anti-money laundering programs.”

Even so, large and small businesses are drawn to the cost-saving potential of streamlined, cross-border transactions.

Traditional financial systems, weighed down by fees and delays, can be outpaced by crypto’s fast, low-cost transfers.

As the adoption of cryptocurrency continues to increase, efforts to regulate and address its associated risks are also intensifying.

Law enforcement agencies have recently taken strong action against cryptocurrency scams, including the infamous "pig butchering" scheme.

This scam involves fraudsters creating fake relationships to persuade victims to invest in fraudulent crypto platforms – a soaring cyber-enabled fraud vector reaping tens of billions of dollars a year, in some cases fueled by trafficked victims trapped on pig butchering scam compounds.

In a rare win against typically insulated and entrenched foreign adversaries, investigators have begun tracking and seizing funds from these scams, as demonstrated by the Department of Justice’s recent seizure of over $112 million tied to crypto investment schemes.
 
This proactive approach marks a new phase in regulatory enforcement, where authorities are not only monitoring illicit activities but also actively recovering stolen funds in an effort to combat crypto-related fraud at its sour.

The divine duality of crypto: Rising values, broader acceptance - and historic flashes, crashes

Criminals like to use crypto because it is fast, international and typically irrevocable. It can also be more difficult to trace for the uninitiated and at first blush does not immediately tie back to the flesh-and-blood users behind the cryptographic keys.

But for individuals and corporates, the reasons to get into crypto – either as an investment or simply accept it as a form of payment – are more mundane.

Consumers want to have more options to move money and buy products. Corporates want to be viewed as the advanced, innovative and future-facing companies allowing current and potential customers to do just that.

In a June 2023 report, Deloitte emphasized that the increasing global acceptance of crypto is driving businesses to reconsider their payment options and operational structures.

Companies are more likely to attract tech-savvy customers by offering crypto as a payment option, diversifying their asset portfolios, and staying clear of technological disruptions.

According to the report, a survey of 2000 US executives found that “...merchants are embracing digital currency payments with the hope of gaining a competitive advantage in the market and in the belief that the use of digital currency will continue to expand.”

But it is indeed a cautionary tale, as the report also counsels that “...with any new frontier, there are both strong incentives and unknown dangers. That’s why companies intent on using crypto in their businesses should have two things: a clear understanding of why they are undertaking that action and a list of the questions they should consider.”

As such, while these economic innovations can offer significant advantages, companies must also weigh the substantial risks associated with this emerging financial system.

High-profile cases like FTX and Binance illustrate the profound impact of inadequate regulatory controls within crypto operations.

FTX's collapse, which involved mismanagement of customer funds and alleged insider dealings, shows how opaque governance and misuse of customer assets can bring down even the most prominent players.

In comparison, Binance’s ongoing regulatory challenges underscore the importance of compliance with Anti-Money Laundering (AML) and Know-Your-Customer (KYC) regulations to prevent money laundering.

Together, these cases reveal that without robust internal controls and clear accountability, even large crypto exchanges face severe reputational and operational risks.

These examples should serve as cautionary tales for both new and established players in the crypto industry.

Clearly, cryptocurrencies offer significant benefits and risks for businesses.

They provide access to new customer bases (particularly among underbanked populations or regions with unreliable financial systems) and offer a more accessible alternative for individuals and businesses seeking quick, low-cost transactions.

Crypto payments help companies expand into developing markets with limited banking access.

Even with peaks, valleys, retreats, rallies - more countries embracing crypto rules, not bans

But with the rewards come the risks.

Cryptocurrencies can (and have) been used to facilitate illicit transactions (e.g., money laundering, ransomware payments, financing of illegal activities).

Suppose a business unknowingly transacts with a party involved in such activities. In that case, the company can be implicated in regulatory violations, resulting in significant sanctions, fines, and, perhaps most critically, reputational damage.

Of course, cryptocurrency's inherent uncertainty sometimes leads to extreme price swings, mainly because it is not backed by any government or central authority.

Cryptocurrencies derive their value solely from market demand and speculative interest, making their prices highly susceptible to fluctuations.

Critics of cryptocurrency often point to this volatility as evidence that crypto is inherently unstable and unreliable as an authentic financial alternative, arguing that without the backing of a government or financial institution, cryptocurrency has no real intrinsic value.

Detractors say this makes crypto prone to bubbles and crashes.

Eswar Prasad, in a New York Times essay, expresses these concerns. Some critics believe that cryptocurrency is just a fad.

They argue that cryptocurrency is a speculative investment for risk-takers or the uninformed, unlike traditional currencies.

They point to its extreme price fluctuations and lack of inherent value, warning that small investors will likely suffer significant losses. Some even suggest that cryptocurrency should be banned altogether.

Additionally, they emphasize the environmental harm caused by the energy-intensive process of cryptocurrency mining. Nikita Tambe highlighted these advantages and disadvantages in an investing piece for Forbes India.

Understanding the regulatory landscape is crucial for businesses considering crypto adoption.

Countries like the United States are moving toward more crypto regulations.

However, these efforts are still in their infancy, and given the uncertainty of how governing bodies like the SEC or IRS will ultimately regulate the crypto market, it adds a new dimension of complexity to crafting what would be considered “reasonable” compliance programs.

These selfsame compliance programs are, ostensibly, the new frontline defenses against determined, aggressive and creative global threat actor groups.

The result for banks, corporates and exchanges intersecting the virtual asset sector?

It is incumbent upon these companies to be fully aware of relevant compliance parameters to mitigate legal risks and to avoid the pitfalls of the hundreds of corporate failures which, according to Deloitte, “...have neglected to prioritize the development of a culture of integrity.”

Former President Trump has recently expressed his support for cryptocurrencies.

Thomas B. Edsall discusses the Republican party's change in policy considerations as a strategy to gain support from crypto enthusiasts. However, Edsall also noted that Vice President Harris has recently shown her support, indicating a shift in the view of the current Biden administration.

Take a step back to look at the big picture, the global cryptocurrency regulatory environment has undergone significant transformations in recent years, with regions adopting increasingly stringent anti-money laundering (AML) measures.

The European Union's Markets in Crypto-Assets (MiCA) regulation represents a landmark approach, establishing a comprehensive framework for crypto-asset markets that mandates strict customer due diligence, transaction reporting, and robust AML protocols for crypto service providers.

In the United States, the Financial Crimes Enforcement Network (FinCEN) has progressively tightened cryptocurrency regulations, particularly through the implementation of the Crypto Travel Rule.

This rule requires virtual asset service providers to collect and share sender and recipient information for transactions exceeding $3,000, mirroring traditional banking compliance standards and creating more transparent transaction pathways.

The United Kingdom has similarly intensified its cryptocurrency regulatory oversight, with the Financial Conduct Authority (FCA) requiring all crypto businesses to register and comply with AML regulations since January 2021.

These regulations mandate comprehensive customer verification processes, suspicious activity reporting, and strict governance frameworks that align with broader financial services compliance standards.

These regional approaches reflect a growing global consensus that cryptocurrencies require sophisticated, adaptive regulatory frameworks to mitigate financial crime risks.

While approaches vary, the trend is toward increased transparency, enhanced due diligence, and closer alignment between traditional financial regulatory mechanisms and emerging digital asset ecosystems.

An ounce of Crypto Compliance now is worth a pound of penalties later

Compliance regulations, compliance officers, and compliance departments offer protection against these types of reputational, operational, and financial risks, offering navigational strategies while leveraging the benefits.

Implementing safeguards such as Anti-Money Laundering (AML) and Know-Your-Customer (KYC) procedures would surely help prevent illicit activities (e.g., money laundering or fraud), as would security protocols (encryption), strict governance controls (whistleblower programs), and real-time monitoring tools.

Companies should invest in compliance frameworks tailored to digital currencies.

Regular audits, transaction monitoring, and partnerships with cryptocurrency analytics firms can help businesses detect suspicious activities early and mitigate risks before it is too late.

Additionally, businesses must stay informed about evolving regulations to comply with local and international laws. By implementing these measures, companies can be expected to responsibly (and safely) incorporate cryptocurrencies into their operations while minimizing legal and reputational risks.

It should be noted that instituting these regulations and formal compliance controls is within the norm.

Major crypto exchanges like Coinbase and Crypto.com in the United States already comply with federal and state AML laws and licensing requirements.

This demonstrates that regulation in the crypto space is not a radical shift but an extension of the existing financial regulatory framework and aligns with well-established domestic norms.

A recent case highlights how scammers exploit the inherent anonymity of cryptocurrency to launder money.

In September 2024, two individuals allegedly carried out a phishing attack that resulted in the theft of $230 million in cryptocurrency, which they subsequently laundered through a complex series of transactions.

This laundering process involved using cryptocurrency mixing services, converting the stolen crypto to fiat currency, and conducting international fund transfers, all designed to obscure the origin of the funds.

This case underscores how cybercriminals take advantage of the unique features of cryptocurrency, emphasizing the need for companies to enhance their anti-money laundering (AML) and transaction monitoring efforts to detect and prevent such tactics.
The fact is that the relevant question for businesses today is not whether they should engage with cryptocurrency but rather how and when they should do so.

While cryptocurrency offers enormous potential, businesses must carefully navigate the complex and evolving space.
 
Success in the crypto world will depend on the ability of a business to strike a balance between financial advancements and cynical cautiousness, ensuring that they capitalize on potentially profitable opportunities without falling victim to the significant risks accompanying such uncharted territory.