Crypto Firms Are Ready to Spend More on Compliance

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Illustration: Ada Amer/Axios

Crypto shops tired of last year’s unfortunate sequence of events likely have arduous regulatory gymnastics ahead of them, and executives see compliance costs rising across the board.

Why it matters: Regulators’ hawkish stance on the industry signals a torrent of enforcement action to come that major exchanges may be able to endure, but which could stifle smaller companies, their products or reduce numbers jurisdictions in which they operate.

State of the art: Major exchanges are already building their own systems or increasing their dedicated compliance staff, even in the face of company-wide layoffs.

And state and federal regulators are going in circles. The Department of Justice, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Treasury Department all focus on digital asset companies and their practices in the United States.

Leading the news: Coinbase Global, the largest centralized crypto exchange in the United States, last week agreed to a $100 million settlement with New York state regulators over accusations that it did not would not have performed sufficient background checks for new client account applications.

$50 million has been paid in fines and another $50 million has been pledged to boost compliance.

Be smart: the crypto industry doesn’t have a regulatory framework to follow, but it had to follow some rules.

The Financial Crimes Enforcement Network in 2013, for example, was among the first to rein in digital asset firms by requiring them to adhere to the Bank Secrecy Act. Crypto exchanges follow Anti-Money Laundering (AML) rules, which require them to perform, among other things, a Know Your Customer (KYC) check.

Zooming in: Crypto exchange Kraken says it has increased its compliance workforce by 55% over the past 12 months, even as the firm downsized in November.

“For 2023, we are focused on improving our use of technology to further strengthen our robust compliance program,” David Zacks, senior director of corporate compliance, told Axios. “These additional investments in our risk-based program will continue to increase our overall compliance budget.

Between the Lines: Crypto exchanges use regulatory technology to automate some of the processes of verifying customer and transaction identities for suspicious activity, much like banks and other service companies do traditional finance.

And some will build their own “reg-tech”, which would allow them to avoid sending customer data to third-party service providers.

However, they also require teams of compliance experts who can also analyze and investigate transactions that occur on blockchains. And the need for these experts fluctuates depending on the workload.

Note: NYDFS has fined Robinhood and Coinbase for their backlog of unaddressed suspicious activity alerts.

Meanwhile, following the collapse of FTX and the blowout of Chapter 11 crypto lender filings, the biggest crypto stores are trying to consolidate or maintain a certain level of professionalism that shows their good reputation.

“Compliance is key to building trust between industry, regulators and customers.” Paul Grewal, Chief Legal Officer of Coinbase, told Axios, “Maintaining high compliance standards can also be a competitive advantage, allowing companies like Coinbase to obtain licenses and operate in highly regulated markets that do not are not open to our competitors.”

Nowhere to hide: “If there is enforcement action, it will cost more than you spend,” Tim Byun, head of government relations for crypto exchange OKX, told Axios.

“If you get enforcement action, even to fix it, it’s going to take significant resources. It’s hard to manage the influx of an army. Your costs can easily triple or quadruple.”

The Other Side: Investing in compliance isn’t immune to economic realities, however. There is always a trade-off in compliance resources, BitGo Chief Compliance Officer Jeff Horowitz tells Axios.

“In good times there are more resources and in tougher times cuts across the board,” he says. [anti-money laundering] is a large umbrella. There are general standards regardless of the type of license you have and it comes at a cost: people or resources, case management and report management. It’s a cost of doing business.”

Reality check: Crypto firms that spent the last bull run launching new products and lines of business willy-nilly from the US to Japan and everywhere in between will have to reconsider, compliance officials say .

There is the threat of enforcement action, but also licensing reviews, requirements and processes, and fees.

Our thought bubble: Maybe the threat of law enforcement cuts the fat out of the industry.

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