WASHINGTON — As cryptocurrency’s popularity has grown, so have flags for potential money laundering and fraud.
As the Biden administration grapples with cryptocurrency and its regulation, cryptocurrency’s potential to be used for illicit purposes has come to the forefront of the conversation. President Biden’s executive order on crypto in March specifically mandated the Treasury Department and other federal agencies to find better ways to investigate digital assets and the extent to which they are used for money laundering and fraud.
But that’s a big, complicated task — and it’s not made any easier by the growing body of cryptocurrency-related reports designed to identify this activity.
According to the Financial Crimes Enforcement Network (Fincen), the number of reports of suspicious activity related to cryptocurrencies reached around 92,000 in 2021. That number is more than double the 42,782 crypto-related SARs the agency received in 2020, which in turn was four times the 10,377 SARs mentioning crypto in 2017.
It’s something the Biden administration and the government are trying to figure out how to address. Fincen, the Department of Treasury’s anti-money laundering division, faces a rapidly evolving landscape that requires specialists and resources that the office may not have.
“[Fincen’s budget] limits our ability to hire analysts, particularly in the cryptocurrency space, to conduct the type of analysis needed to understand how cryptocurrencies flow and contribute to illicit finance,” acting director Himamauli told Das last week the congress. “Our team is incredibly talented, but it’s also incredibly small, and it just doesn’t outperform the challenge in terms of skill, it just outperforms it in terms of resources alone.”
Follow the breadcrumbs
The 92,000 crypto-related SARs are a large number, and they are larger than the number of SARs issued by securities and futures companies and by casino/card club companies.
It takes some educated guesswork to figure out where these cryptocurrency-related SARs might have come from — there is no specific category in the SAR documentation that suggests the suspicious activity came from a digital asset company or whether it was crypto everything.
Most SARs filed by cryptocurrency exchanges (which are likely to involve digital assets) are classified as “money services firms,” experts said.
According to Fincen data, money services firms’ SARs increased by about 220,000 from 2020 to 2021, the highest of any category.
“When crypto companies file SARs, they are likely registered as a money services company,” said Alison Jimenez, president of Dynamic Securities Analytics, an anti-money laundering consultancy. “There’s a slim chance some of them are also registered as futures companies or broker-dealers.”
But “money service companies” or MSBs is a broad category that includes money transmitters like PayPal, providers and sellers of prepaid access like gift cards, and cryptocurrency exchanges, among others. Growth in the money services business category has also not been as strong as growth in other categories in recent years.
Breaking down the MSB category into types of suspicious activity reported provides further clues as to where this cryptocurrency jump may be coming from. According to Fincen data, there has been a huge increase in SARs filed by registered MOSs over unregistered MOSs. Jimenez wrote about them analyzing registered MSB SARs relative to their unregistered counterparts using Fincen data as of October 2021.
For the full year 2021, registered MSBs submitted almost 67,000 reports on unregistered MSBs, more than triple the number in the previous year.
So what could happen here?
Jimenez said what is likely going on is licensed crypto exchanges that are submitted under MSBs find and flag unlicensed businesses.
There are some reasons to believe that this jump is related to crypto activity. In 2019, Fincen “increased the need” for crypto exchanges to register as an MSB by issuing new guidance, Jimenez said, just ahead of the first major spike in SARs from this category of registered entities.
Most of the increase (65,397 of the 66,751 total SARs in 2021) can be attributed to San Francisco County, California, according to Fincen data. San Francisco County happens to be the legal address or headquarters of the largest cryptocurrency companies in the United States.
“There’s this vast world of unregistered, unlicensed exchanges or ATMs and other types of entities that operate outside of the regulatory system, and that’s something that identifies the licensed exchanges,” Jimenez said. “I’m not sure why they are detecting so many, but they are and they are reporting many.”
An example of what these licensed exchanges might report, Jimenez said, would be what they call a parasitic exchange, or an unlicensed exchange operating through a licensed exchange and using the larger company’s liquidity. It could also be an unlicensed crypto ATM considered MSBs by Fincen, she said.
“It’s pretty crazy,” she said. As a point of comparison, Jimenz said, “If you had a bank that said I noticed all these unregistered banks, that’s a worrying thing.”
“Come into the Herd”
While the potential presence of a large volume of unlicensed cryptocurrency operations is unlikely to be good news for regulators, some experts see the overall growth in crypto-related SARs as a sign that the cryptocurrency industry is maturing.
Although there have been high-profile cases of crypto firms, including banks, lacking robust anti-money laundering protections, the rise in cryptocurrency-related suspicious activity reports means institutions are becoming better at spotting suspicious activity, said Ian McGinley, a partner at law firm Akin Gump Strauss Hauer & Feld LLP.
“I generally see it as a sign that crypto is getting into the realm of traditional finance, and you’ll see the increase in these reports as some sort of a function of that,” said McGinley, a cryptocurrency fraud expert with more than a decade as an attorney the US Attorney’s Office for the Southern District of New York.
There are also more exchanges now, and more are required to report suspicious activity to Fincen, he said. As the cryptocurrency grows, there are simply more opportunities for nefarious activity, he added.
“Some of that probably has to do with how cryptocurrency has become mainstream and how many institutions are dealing with it, including institutions that may have reporting requirements, and also how many members of the public are now exposed to cryptocurrency,” McGinley said. “Also, exchanges and other players in this space have really increased their regulatory capabilities.”
And just because SARs are filed doesn’t mean anything resembling money laundering or fraud is actually happening, said Alma Angotti, partner and anti-money laundering expert at consultancy Guidehouse, which also serves on the Securities and Exchange Commission and the Securities and Exchange Commission worked Finzen.
“It’s important to remember that the standard for filing a SAR is very low,” she said. “Does the institution have a reasonable suspicion that the activity is related to something criminal or not typical of this client?”
With crypto, Angotti said it’s actually easier for financial institutions to trace, so there may be more opportunities for benign activity to be flagged as suspicious.
“You know a lot more about a crypto deposit than your bank does when you deposit $10,000 in cash,” she said. “They know where it came from, how long ago it was from a ransomware hack, they know if it was disassembled and reassembled in a different wallet, [and] they know if it came from a wallet associated with a risky exchange.”
Like a pack of dye in a pile of cash, Angotti said crypto’s traceability makes it an easy target for SAR reports, and she expects them to continue to rise.
“Because of this, there may be even more reasons for companies to apply,” Angotti said.
