Blockchain Monitoring: A Pillar of AML/CFT Compliance for Crypto

Global Digital Finance
Oct 7 · 5 min read

Cryptocurrencies are often portrayed as the perfect safe haven for criminals seeking to hide their illicit funds.

However, by analyzing data on transparent public blockchains, it’s possible to lift the veil on the flow of criminal funds through cryptocurrency ecosystems.

Blockchain monitoring solutions have become an essential component of regulatory compliance in the crypto space, enabling cryptocurrency businesses, banks, and other regulated financial institutions to mitigate risks and satisfy AML/CFT requirements.

In this blog post, we look at the role of blockchain monitoring solutions in AML risk management and explain why regulators increasingly see them as a key component of AML/CFT compliance for the crypto space.

The Role of Blockchain Monitoring Solutions in Risk Mitigation

In the world of fiat currencies, automated transaction monitoring solutions that scrutinize customer behaviours are an effective way for financial institutions to satisfy AML/CFT requirements.

Despite the common misperception that cryptocurrency transactions are indecipherable, blockchain monitoring solutions allow regulated businesses to achieve these same ends when it comes to handling cryptocurrencies — but with some important technical distinctions from traditional fiat transaction monitoring techniques.

As Diagram 1 below shows, traditional fiat transaction monitoring techniques focus on identifying anomalies in behaviour at the immediate point where customer funds are deposited or withdrawn from a financial institution.

The reason for this is simple: a financial institution cannot view the entire history of fiat funds flows from or to their ultimate source or destination, and so must look to patterns or characteristics of the immediate transaction to determine if the activity in question presents any unacceptable risks, or is suspicious.

Where financial institutions facilitate fiat currency transactions, they will always know who is sending or receiving those funds, but they generally will not have further information about the flow of funds that precedes or follows their direct interactions with their customers.

In the world of crypto, this situation is different.

As Diagram 2 below demonstrates, a cryptocurrency exchange may not always know the identity of the individual or entity that is behind the immediate transaction with its customers. However, the transparency of public blockchains makes it possible for the exchange to view the history of the flow of funds to or from its ultimate source or destination, revealing further information that can provide an informed view of risk.

Customer activity monitoring in the crypto space, therefore, can entail scrutinizing not only information about the immediate interaction between a business and its customers, but obtaining further information about the flow of funds to determine if its customers are engaged in activity that is high risk or suspicious.

This allows for a level of scrutiny that is not possible in the fiat currency world, and that allows crypto companies to mitigate their exposure to risks.

Blockchain Monitoring is a Regulatory Standard

Regulators around the world are working fast to ensure that cryptocurrency services can operate in line with high AML/CFT standards.

As part of those efforts, regulators have begun to clarify that blockchain monitoring plays a critical role.

In May 2019, the US Treasury’s Financial Crimes Enforcement Network (FinCEN) noted in guidance that regulated businesses can comply with their AML requirements “by incorporating procedures into their AML Programs that allow them to track and monitor the transaction history of a [cryptocurrency] through publicly visible ledgers.”

The Hong Kong Securities and Futures Commission has stated that it expects cryptocurrency exchanges to “employ technology solutions which enable the tracking of virtual assets through multiple transactions to more accurately identify the source and destination of these virtual assets.”

In Abu Dhabi, the Financial Services Regulatory Authority has stated that crypto businesses, “should be able to assess the ultimate beneficiaries’ wallet addresses and their source or destination of funds as appropriate.”

What’s more, in its June crypto guidance, the global standard-setting Financial Action Task Force (FATF) underscored that to mitigate the risks associated with pseudonymous transactions, cryptocurrency businesses should have the ability to conduct monitoring “beyond the immediate transaction between the VASP or its customer or counterparty.”

Blockchain Monitoring Fosters Trust and Reduces Criminality

Blockchain monitoring is about far more than just ticking a box off the regulatory compliance checklist.

Blockchain monitoring enables cryptocurrency businesses to make informed decisions about risk, and to offer new, innovative products and services with confidence, fostering greater trust in the cryptocurrency space.

New analytic techniques are allowing us to refine monitoring approaches, offering the promise that blockchain monitoring will only become even more sophisticated at enabling effective AML risk management over time.

What’s more, blockchain monitoring contributes to a broader culture of transparency in the cryptocurrency world that ultimately reduces its attractiveness to criminals.

As Ellliptic’s research has shown, illicit activity accounts for less than 0.5% of all transactional activity involving bitcoin — a fact that we believe is at least partially attributable to the availability of monitoring solutions that enable crypto businesses to prevent illicit activity from occurring in the first place.

Global policymakers are right to draw attention to the risks that cryptocurrencies pose, and to demand accountability and AML/CFT compliance.

Fortunately, blockchain monitoring solutions are already here that enable financial institutions to meet those emerging standards.

About Elliptic

Elliptic empowers financial institutions and cryptocurrency businesses across the world to confidently manage AML risk and detect criminal activity on the blockchain. To date, Elliptic clients have used our products to assess risk on several trillion dollars worth of transactions, and uncover activity relating to money laundering, terrorist fundraising, fraud and other financial crimes. Our software is recognized as the global standard for regulatory compliance in the cryptocurrency industry.

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