Key takeaways
In recent years, the digital assets industry has made huge strides in compliance. As an industry leader, Binance prioritizes maintaining a robust and comprehensive compliance program.
We're launching a new blog series, Playing by the Rules, to raise awareness of the role of compliance in the cryptocurrency industry and highlight the impressive work our Compliance team does every day.
In the first article in this series, we examine the components of compliance, the differences between traditional and crypto financial organizations with respect to this function, and the current compliance framework applicable to cryptocurrencies.
Some people who are not yet familiar with the digital asset sector tend to view it as an environment where the rules and laws that govern other sectors of financial activity do not apply. Exposed to various anecdotes from the earliest days of cryptocurrency, when many early adopters considered trading digital tokens to be more like trading baseball cards than trading financial assets , and facts from some high-profile cases of cryptocurrency fraud, such as FTX, these individuals may be led to believe that cryptocurrency businesses are inherently incapable of being regulated and complying with regulations. .
The reality of the cryptocurrency compliance framework is very different from this misperception. Just a few years after the first centralized cryptocurrency exchanges appeared, the digital assets industry has greatly improved its compliance capabilities. In recent years, Binance has invested significantly in building a cutting-edge compliance program whose complexity and technological robustness have nothing to envy of those of the giants of traditional finance.
To highlight the fascinating work of our compliance professionals, we are launching Playing by the Rules, a blog series exploring the state of the compliance framework in the cryptocurrency industry and delving into different areas monitored by the compliance team from Binance. In this introduction, we will look at what we mean by compliance in general and how compliance in the field of cryptocurrencies is different from traditional finance.
Compliance in financial organizations
When people think of compliance in the context of finance, the acronyms KYC (Know Your Customer) or AML (Anti-Money Laundering or AML) are usually the first that come to mind. come to mind. Both are important components of any compliance program, but the areas where the compliance function impacts a mature financial services company, traditional or crypto, are not limited to KYC and AML.
Simplifying for clarity, we could describe compliance as comprising three main areas: AML, consumer protection and regulatory compliance (i.e. licensing). Beneath these broad, often complementary categories lie a large number of disciplines that underpin the compliance work of financial organizations and which we will cover in this blog series.
Consider the category of AML, which can be subdivided into areas such as customer identification programs (CIP), know your customer (KYC), customer due diligence (CDD), Enhanced Due Diligence (EDD), customer screening (including those subject to sanctions or designated as politically exposed persons, or PEPs), transaction monitoring, reporting of suspicious activities/transactions/subjects (e)s (SAR/STR/SMR), risk assessment, audits, anti-corruption (ABC), travel rule, and many more.
In addition to the many aspects mentioned above, consumer protection includes data privacy measures, terms of service, customer disclosures, asset segregation, UDAAP (unfair, deceptive or abusive acts or practices: a term specific to the United States which has equivalents in most countries), as well as anti-scam and anti-fraud controls.
On the regulatory side, compliance officers ensure that their company has the necessary processes and controls in place to comply with the regulations of the jurisdictions in which it operates. This also includes applications for approval, maintaining relationships with regulatory bodies, managing external auditors as appropriate, managing regulatory reviews and implementing any corrective action required following the review. or audit.
In many jurisdictions, it is the compliance officer who has primary responsibility for ensuring that a company's operations comply with applicable regulations, and who takes personal responsibility for any failures that occur during his or her tenure. Although other leaders may share some level of responsibility, the compliance officer is expected to have the autonomy and authority to act independently to ensure that the company complies its regulatory obligations.
A compliance program can directly manage these areas of responsibility or provide oversight, governance support, and quality assurance testing.
Compliance in the Cryptocurrency Industry: Unique Challenges
Implementing a compliance program for a digital asset services company involves covering the same bases as in traditional finance, and also facing a series of new challenges.
The biggest difference between TradFi (conventional finance) and cryptocurrencies relates to the maturity of the regulatory environment, the rules governing the sector and the lack of consistency between jurisdictions. On the one hand, the definitions of different cryptoassets vary considerably from country to country, which has enormous implications for compliance work.
Another major difference lies in the very nature of digital assets. Most cryptocurrencies were designed to operate on decentralized, distributed, permissionless networks that operate without a central governing body. This is the epitome of the principle that “code is law”. In a permissionless network such as Bitcoin, there is no central body that can prevent a transaction from occurring. There are no transaction cancellations. No transfer reminders. Transactions are permanent and without recourse for the originator. This can pose problems for centralized service providers such as cryptocurrency exchanges which are fundamentally different from the traditional finance sector.
Traditional finance is dominated by highly centralized payment networks where transactions are slow (processing times are typically measured in days rather than minutes or seconds), can be canceled, blocked by outside parties, or even seized. In many countries, consumer protection laws allow individuals to dispute charges taken from their accounts, sometimes up to six months after the fact, and the underlying service provider is required to reimburse the user.
This means that many of the traditional controls put in place in traditional finance will not work well, if at all, in the context of cryptocurrencies. This justifies considering consumer protection differently. For example, if a user shares their password or private keys with someone and that third party liquidates a wallet, there is no way to recover the assets that have been moved and no centralized authority can “refund” the customer’s funds.
This is why centralized exchanges often provide their customers with advanced account security tools, perform more analytics and device fingerprinting, and flag withdrawals that appear to be going to risky wallet addresses. and conduct customer suitability testing to assess users' level of understanding of the risks associated with certain products or services.
Transparency and speed
In the world of distributed ledgers, transparency makes all the difference. Today, the financial services industry is an opaque and secretive network of different payment and settlement networks, where only a privileged few can have access to essential pieces of information.
Think about the SWIFT network. Only member banks and financial institutions will have access to the SWIFT messaging system, and this access will be limited to transactions processed by the relevant institution. This ensures a certain level of financial privacy, but also allows institutions to operate surreptitiously.
Public blockchains, on the other hand, are very transparent, sometimes almost excessively so. Each transaction is published for everyone to see. While the names of the people and companies that originate and benefit from these transactions are not easily accessible to an outside observer, most blockchains are pseudonymous. This means that there are key pieces of information that can be used by the public or blockchain analytics service providers to identify initiators, beneficiaries, transaction patterns and wallet balances.
Using social engineering techniques, these wallet addresses can often be traced to the actual people or companies that own or control the wallets. Returning to the SWIFT example, it’s as if every person in the world has a front-row seat to see every SWIFT transaction and associated bank account details processed.
This level of transparency raises many concerns around data privacy and individual security that the cryptocurrency industry must address. On the other hand, exchange platforms and other industry players have enormous opportunities to create tools to better understand what is happening in blockchain networks globally, and to lift the veil of transactions that could have several layers to avoid detection. This provides crime-fighting agencies around the world with an effective means of investigating illicit activities, while minimizing the need to obtain court orders, subpoenas or rely on mutual legal assistance treaties (MLAT) to investigate cross-border movements of funds.
Finally, speed is a key factor of value for the cryptocurrency sector. In the world of traditional finance, settlement of transactions generally takes several days. Digital assets promise, among other things, to be able to make settlements almost in real time. Applying regulatory expectations and compliance controls and processes identical to those used by traditional finance platforms to the cryptocurrency industry threatens to destroy the value and efficiency of cryptocurrency transactions.
How do cryptocurrency companies approach compliance?
Given the complexity of the task at hand, the level of compliance practices and processes that the digital assets industry has achieved today is impressive. Additionally, given the speed at which major cryptocurrency companies continue to advance in this area, we can expect industry compliance standards to become even stricter.
Anti-money laundering (AML) has been the headline act for cryptocurrencies over the past few years, and will continue to be so in the future. Strict AML laws have been enacted in most developed countries over the past two decades, and are largely technology agnostic. This means that the anti-money laundering rules applicable to cryptocurrency companies (especially those that also support fiat currencies) are well established and understood by the industry.
Basic things like obtaining customer credentials (KYC) or monitoring transactions for possible suspicious activity and complying with international sanctions are nothing new for cryptocurrency companies because they represent the essential elements of any compliance program.
The pace of adoption of a compliance philosophy in the cryptocurrency sector has accelerated in recent years with the emergence of greater regulatory clarity and common acceptance of AML laws in most jurisdictions. apply to the cryptocurrency sector. Additionally, strategic partnerships with mainstream banking and payment networks have helped accelerate the adoption of a more compliant approach, as having fiat currency channels is a clear differentiator in today's asset market. digital. Traditional financial institutions require the exchanges they support to meet their standards for compliance, AML, sanctions and anti-fraud measures.
There is also a high level of collaboration between compliance officers within the cryptocurrency industry. We accept that another major FTX-style scandal could cause irreparable damage to the entire industry, and it is in everyone's best interest to collaborate on emerging trends, risks, and solutions to issues and challenges facing cryptocurrency compliance.
Binance: At the forefront of cryptocurrency compliance
For Binance, compliance is the number one strategic priority, and a compliance mindset is embedded in everything we do. We have come a long way since our beginnings in how we approach this key aspect of our operations, and have realized that advancing cryptocurrency adoption and financial freedom is only possible by working closely with regulators and strictly respecting all applicable rules.
Binance has invested heavily in finding the best KYC providers and data sources in each of the jurisdictions we support. This allows us to provide the best possible user experience while remaining fully compliant with local and international laws and regulations. The localization of our controls also demonstrates our commitment to understanding our customers and adapting our solutions to their needs.
Across the industry, the level of compliance among participants varies widely. This is mainly because compliance is difficult, expensive and causes friction with customers. Larger cryptocurrency companies, such as industry leader Binance, have more resources and are therefore better equipped to implement the many vendor solutions and build the internal tools necessary for a robust compliance program.
Cryptocurrency compliance is becoming more and more similar to the organization of a traditional financial services company over time. However, with the many new challenges they face every day, cryptocurrency businesses will develop, and in some cases have already developed, more sophisticated tools, better data, and a better understanding of how individual transactions fit together. to the environment as a whole.
To delve deeper into the different aspects of Binance's compliance program, stay tuned for future articles in our Playing by the Rules series.
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