Crypto Enforcers Dive Deep into Platform Fraud Activity

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After a tumultuous year in digital assets, blockchain-based financial service providers should have an eye on the app landscape. Governments’ fight against financial crime and money laundering is squarely focused on the digital asset space, and law enforcement has something to prove.

Criminal prosecutors and financial regulators have long warned that cryptocurrency is popular among criminals, money launderers, hackers and illicit dark web markets. Before some of the cryptocurrency market’s most spectacular failures, there was a real debate about whether cryptocurrency transactions really involved a greater risk of illicit conduct than the fiat market.

It’s hard to argue that digital assets don’t involve a higher overall level of risk, thus shining a spotlight on law enforcement on every cryptocurrency platform.

Borders don’t matter

On January 18, the Department of Justice and the Financial Crimes Enforcement Network took simultaneous action against Bitzlato, a Hong Kong-registered digital asset exchange operated by a Russian national suspected of handling $700 million illicit funds, including in relation to the notorious Hydra darknet market.

The DOJ arrested the owner of the exchange and seized its website, saying: Whether you are breaking our laws in China or Europe or abusing our financial system from a tropical island, you can expect to be held accountable for your crimes in a courtroom in the United States.

Additionally, under a new authority designed to target cryptocurrency, FinCEN has identified Bitzlato as a primary money laundering concern in relation to illicit Russian finance and has blocked U.S. institutions from transacting. with Bitzlato and its successor entities.

Bitzlato’s action, along with the DOJ’s recent seizure of $3.6 billion related to the Bitfinex hack and multiple seizures of accounts and funds related to North Korean hacks, reflect substantial successful cooperation between the National Cryptocurrency Enforcement Team and the Federal Bureau of Investigations Virtual Asset Exploitation. Unity with foreign counterparts.

Digital exchanges located overseas are subject to US extraterritorial enforcement tools, and blockchain analysis allows the US government to investigate digital exchanges located overseas without going through a lengthy cross-border process. -jurisdictional.

Therefore, even outside of US supervision, digital exchanges should monitor their exposure to illicit activity to ensure that their exposure remains within market norms.

Risky Ransomware Links

The US government is particularly focused on the use of cryptocurrency in ransomware attacks. Bitzlato’s recent action underscored the relationship between the exchange and Russian state actors who carry out ransomware attacks against American people. It highlights two reasons why the U.S. government will continue to prioritize action against ransomware enablers: the use of ransomware by state actors is a matter of national security, and ransomware represents the use of crypto -currency to facilitate crime against consumers.

The focus on ransomware attacks demonstrates that real-time ransomware monitoring is critical to avoiding regulatory scrutiny. FinCEN’s ransomware studies of statistical analysis and reporting systems and blockchain analytics have revealed that foreign exchanges are the main withdrawal points for ransomware actors. Therefore, US exchanges should limit their exposure to foreign counterparty exchanges, such as Bitzlato, which are hubs for ransomware activity.

Compliance Program Risks

Very few criminal actions have focused on consumer digital asset platforms. Rather, the DOJ has prosecuted a seemingly endless number of egregious criminal actors using cryptocurrency to facilitate overt and notorious illegal conduct, as well as to launder the proceeds of less egregious criminal activity.

We are aware of only one criminal case for anti-money laundering compliance violation, the BitMex lawsuit in 2020.

US cryptocurrency platforms are at greatest risk due to their regulators’ findings of compliance program failures. Recent enforcement actions by the Office of Foreign Assets Control, FinCEN and the New York Department of Financial Services highlight themes of alleged failures: business growth outpaces compliance spending, oversight gaps transactions, unqualified and inexperienced compliance staff, insufficient assessment of crypto-specific risks, problematic relationships with third parties, and insufficient commitment to compliance on the part of executives and board members.

Cryptocurrency products and services require brand new policies, processes and tools. Law enforcement and government regulators seek evidence policies, testing, records, sophisticated and properly tuned technology resources, and robust suspicious transaction reporting for a cryptocurrency platform to know what she must do and does.

Relationships under surveillance

The government is also paying close attention to how digital asset companies manage risks with their partners and service providers. FinCEN has repeatedly cited institutions for transacting with high-risk exchanges, such as BTC-e, and for not filing suspicious activity reports. FinCEN’s message is clear: it will hold U.S. persons accountable for their activity with foreign exchanges outside of U.S. jurisdiction.

The focus on third-party relationships is a priority for many regulators. The Office of the Comptroller of the Currency has repeatedly included third-party relationships at the top of its oversight areas, and FinCEN, OCC, and New York’s DFS have cited failures to mitigate relationship risk. with third parties in many recent enforcement actions. .

Compliant exchanges should review the exposure of their relationships with third parties and have confidence in their partners’ compliance program and processes. Facilitating transactions with risky third parties could draw attention to an institution’s third party management policies and procedures.

Regulators look for an up-to-date risk assessment of the relationship, clear roles and responsibilities in writing, real-time and periodic monitoring processes, and plans to address weaknesses, including an exit strategy if necessary.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Laurel Loomis Rimon is a partner at the fintech and payments firm of Paul Hastings. A former federal prosecutor, she advises financial institutions, fintech companies, and government entities on compliance matters, enforcement actions, and internal and governmental investigations.

Braddock Stevenson is a financial technology and payments practices and white collar investigations and defense attorney at Paul Hastings. He spent more than a decade at FinCEN, most recently serving as deputy associate director of its law enforcement division.

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