Onboarding crypto investors with blockchain tools
Henry Burrows explains how professional services firms can overcome the challenge of carrying out due diligence and anti-money laundering checks on those who have accrued wealth as crypto investors
In 2021, the Financial Conduct Authority (FCA) estimated 4.4 per cent of UK adults hold crypto, up 0.5 per cent from 2020. In the US, that figure is closer to 16 per cent and climbing. Trading volumes on cryptocurrency exchanges – where most transactions take place – reached $14 trillion in 2021, a near 700 per cent increase on the year before, reflecting not just how big the cryptocurrency industry has become, but how much wealth is being generated as a result.
What the FCA’s study doesn’t mention is cryptocurrency’s rise is creating new wealth among younger generations. Hoptrail’s crypto audit work is predominantly on behalf of young professionals – teachers, nurses, and students in their 20s and 30s – who are generating large sums of money from small initial investments, often in short spaces of time.
Increasingly, those who have made fortunes in crypto are seeking to diversify their assets. Many are opting to place funds in lower-risk sectors – with wealth managers, or acquiring high value assets such as art, wine, or property – areas where they expect their wealth to be better protected.
The issue comes at the intersection of crypto and traditional services. Sharp price movements and unusually named token can make compliance officers wary. They also create challenges in explaining how wealth was accrued.
Volatility and risks
It is not unusual to see price increases of 10,000 per cent in weeks or months. Tokens such as HEX, Shiba Inu and Dogecoin are just three recent examples of this phenomenon. Purchasing Shiba Inu in March 2021 and selling eight months later would have netted gains of around 500,000 per cent. While these price rises are relatively common in cryptocurrency, they are almost unheard of in other asset classes.
For many in regulated services, crypto remains complex and fraught with risk. Where anti-money laundering (AML) checks are mandated by regulators – such as those for a property purchase – there is genuine concern risks pertaining to crypto are misinterpreted or missed altogether. Moreover, crypto investors tend to have little to no public footprint, making broader due diligence problematic.
So, how does one carry out due diligence on a crypto millionaire? And what is required when assessing crypto source of funds?
A big part of the answer lies in blockchain analytics. Using the right tools, it is possible to gather information on a prospect’s crypto assets: their sources and destinations of funds, any high-risk transactions, and known counterparties. The data is publicly available. It is also immutable, providing a trusted ledger from which to run sound analysis.
Rolling back the clock on someone’s transaction activity provides salient detail on their crypto journey, including which tokens they traded, which ones accrued the most, which venues were used, and any high-risk exposure. This approach answers not just the sources of funds question but deals with any financial crime concerns.
The crypto world is relatively well-mapped too. Take Bitcoin as an example: there are anywhere between 150 – 250 million tagged Bitcoin addresses (i.e., those tied to a known service, entity, or event).
These include exchanges and payment services, but also comprise high-risk categories such as darknet marketplaces, mixing services, hacks, scams, and addresses tied to sanctioned entities. Hoptrail estimates roughly 10 - 15 per cent of known Bitcoin addresses are tied to high-risk entities or events, but only around one per cent of transactions are linked to illicit activity. This is lower than the UN’s estimate two to three per cent of fiat currency is connected to money laundering.
Part of the broader challenge undoubtedly lies in providing analysis is concise without being complex. Knowing too much can be a hindrance to clear analysis. Crypto can be extremely, and unnecessarily, jargon heavy. This obsession with data often comes at the expense of nuance, context, and clarity – things critical for good due diligence.
Education is therefore essential. Making sure to explain what ‘staking’ or ‘mining’ is, examining the risks of lending protocols, or setting out the differences between centralised and decentralised exchanges, are key to building the knowledge bridge between crypto and traditional sectors.
Nonetheless, strides have been made towards crypto adoption in recent years. The successes of a new generation of entrepreneurs and investors have opened opportunities for new business in old sectors. This in turn is encouraging compliance to adapt.
And while it might seem a challenge at first, the solutions are already in place. From the creation of the blockchain came the tools to police the ecosystem. It is time to embrace them.
Henry Burrows is the founder and CEO of hoptrail hoptrail.io