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What CPAs Should Know About Cryptocurrency and Money Laundering

Practitioners interested in providing assurance and advisory services in the cryptocurrency space are drawn to a seemingly simple model. 

Oct 31st 2019
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Bitcoin Profit

Those with limited experience in the financial services sector may be unaware of the reporting requirements and risks.

Stablecoins continue to capture headlines, most notably through Facebook’s announcement of Libra. At its core, a stablecoin is a digital representation of one unit of an existing, tangible asset. Practitioners are well equipped to verify a liability does not exceed an asset.

There is a growing global concern by numerous oversight and regulatory bodies that these emerging assets pose a significant threat to efforts in combating money laundering and terrorist financing.  Cavalier reactions from many that scoff at this concern speaks to the underlying issue, most well-intentioned people do not understand the basics of money laundering.

Technology continues to blur boarders and reduces the friction of transacting globally. This provides opportunities for clients and their service providers to grow and compete. This benefit does not discriminate based on intention. Those seeking to conceal the fruits of their illicit activity are taking advantage of the speed and oversight disconnects that currently exist.

Chain analytic companies are continuing to advance their detection tools and are exceedingly helpful in assisting law enforcement. Tools are not a substitute for knowledge, nor are they immune to related party interests and collusion. Waiting for technology to solve a problem is unnecessary and unreasonable.

Accountants are tasked with assessing risks and designing preventive measures to mitigate them. What can a well-intentioned practitioner do to assess laundering risks to prevent clients and themselves from becoming unwitting participants?

Laundering 101

Separate the crimes. Laundering effectively combines two crimes:

  1. The activity that generated the funds (usually illicit)
  2. The act of concealing those funds. Concentrating on the activity and stereotypical persona that generates the original funds restricts the ability to recognize potential warning signs of laundering

The goal of laundering is to conceal funds in a way that appears legitimate. The process usually is examined in three stages:

  • Placement – entry of the funds into a legitimate enterprise, (e.g. a bank, investment firm, or other asset)
  • Layering – moving the funds to obscure the trail (e.g. moving between accounts, in and out of various assets, or between trusted parties and shell companies)
  • Integration – a return of the funds to the perpetrator through a seemingly accepted transaction (e.g. borrowing the money, purchases from front companies, or withdrawals from companies set up in the previous stages)

Understand how and why the instruments and organizational types assist in the process. Entities and individuals are often used as conduits. The impact of laundering often does not appear to impact the financial statements.

Being a Bank is Hard

There is a bit more to banking than a private key and a wireless phone. Beyond the shortcomings of regulation and socio-economic debates of how to best serve the unbanked, the banking sector faces challenges that are not solved by exempting well-intentioned innovators. Participation in this space requires an understanding of the applicable regulations, reporting requirements, and challenges.

Become familiar with existing risks and challenges that are exacerbated in a decentralized, selectively transparent ecosystem. Understand how previously successful schemes can be replicated. It is not difficult to imagine how a mirror trading scheme similar to the one used in the Deutsche Bank scandal could be replicated between OTC desks and exchanges.

Transaction laundering remains a challenge for the banking and credit card industries yet is alarmingly unacknowledged by cryptocurrency enthusiasts. Microtransaction laundering with in-game purchases is accelerating. Valve recently announced nearly all microtransactions on its platform are being used to launder.

Think as if

If the technology is intimidating, remove it from the initial analysis. Recreate a client’s business model as if it were 1980 and ask, “If I wanted to use this product to hide money from: the law, a significant other, an employer, a vendor, etc., how would I do it?”

Gain an understanding of how bearer instruments are a criminal’s best friend. Despite the public nature of the blockchain, “Not your keys, not your crypto,” has the hallmark of a bearer instrument. The ill intentioned have merely two concerns, how to circumvent existing controls and not get caught. Be aware of social engineering and affinity fraud tactics.

Current crypto AML/KYC compliance is largely focused on the end-user level. When considering potential threats, look up and out. It is important to consider the organizational structure, sources of funding and related party interests.

Start-ups in this sector have enjoyed access to large amounts of speculative funds. It is important to consider the source of these funds and how one may be able to use exchanges and organizations resembling traditional companies as vehicles to place, layer and integrate funds.

Ask Questions

In the end, simplicity is generally rewarded in the market. When looking at cryptocurrency transactions, it is sometimes anything but simple. This is an advantage to those wanting to obfuscate transactions and create layers.

Inquire about the intended result. Many talented innovators are inexperienced in business. Complicated structures could be the result of ignorance or perceived compliance restraints. Questions in assessing risk may also lead to assisting a client in establishing a sustainable business model.

Remember, the intent of many stablecoin creators may be pure, but they remain vulnerable to those with other intentions.

Additional Resources

Disclosure: I bought at the top, sold at the bottom, and lost the keys to the remaining alt coins that I obtained exploring other blockchain projects and refused to dump on the market when I ran away from home. I am not a journalist. I am a former practitioner passionate about preserving the integrity of the profession. I currently serve as a consultant to an organization determined to extend the useful life of legacy systems. I wrote this article myself and the views expressed herein are my own. 

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