Since the advent of Bitcoin, financial institutions have largely watched the growth of digital currencies from the sidelines.
Those attitudes – at least for some – seem to be making a shift into what had been uncharted waters as blockchain technologies develop and prove themselves.
For the proponents, JP Morgan Chase was one of the early banks to announce introduction of a mainstream blockchain project to settle remittances between institutional clients. But is not a cryptocurrency as it is a private network for internal inter-client payments.
The firm announced the JPM Coin in 2019 as the first product from a major international bank. Although it has not hit the market yet, the bank has been testing its technology.
Unlike Bitcoin, which has seen large fluctuations in its value since its introduction in 2009, each JPM Coin will be worth one US dollar, sheltering it from the market volatility. One of the main reasons for JP Morgan launching these coins is to offer large corporate clients a way of making payments between institutional clients in real time.
Recently, officials from the People’s Bank of China confirmed their country is also looking at a digital version of the yuan to help in fast moving international trades. The digital version of the yuan would trade in real time.
Banks forge crypto working group
Now, the Bank of England and others may be ready to get into the game with the announcement on Jan. 21, 2020 that they have formed a working group to address potential cases for central bank digital currencies.The group includes The Bank of Canada, the Bank of Japan, the European Central Bank, the Sveriges Riksbank, the Swiss National Bank and the Bank for International Settlements (BIS).
With the banks looking at a Central Bank Digital Currency, they would still be outside the cryptocurrency market as it does not necessarily use a distributed ledger or blockchain, and it is controlled by a central bank, not a settlement algorithm. This is just a database representation of physical currency.
Many governments have taken a cautious approach to dealing with cryptocurrencies. Indeed, regulators in some countries warn against cryptos and some have banned them altogether.
FIs trying to educate themselves about cryptocurrencies and their risks can be forgiven for any confusion they have had in the past as it has been hard to get a handle on exactly how many cryptos exist. According to CoinMarketCap, the total number of cryptocurrencies is just short of 3,000. The research platform Coinlore offers a similar count, listing a total of 2,817 cryptocurrencies. Investing.com is on the same page too, with 2,808 cryptos tracked on their website.
While those are significant numbers, the growth of digital currencies has seen its share of casualties over the years.
Virtual currency experts admit some have gone by the wayside were either parodies or scams, but thousands of cryptos exist and are still traded daily.
Compliance teams need to be aware of the types of cryptocurrencies and the different risks with each one in order to do a proper risk assessment. Here are the top trading cryptocurrencies that FIs may wish to consider for their portfolios:
Conventional cryptocurrencies, like Bitcoin, serve primarily as a means of holding and transmitting value, like fiat currency. Many, but not all, conventional coins split off (hard-forked) from Bitcoin or were modifications of the Bitcoin code.
- Bitcoin has many tools available to track and monitor transactions, helping to manage and mitigate risk
- Bitcoin is the most widely adopted, with an estimated 42 million wallet users, making it the most commonly used currency for both legal and illicit activity
Stablecoins are cryptocurrencies with value tied to a currency, basket of goods, commodities, or other stable asset to minimize price volatility.
Stablecoins are less volatile because they are pegged to an asset. However, investors could be stuck with something that is without value, so it is important to get reliable audits of the assets behind them.
- The real risk issue with stablecoins is that they can be used to get around CTR requirements. You can transact any amount in stablecoin user-to-user without any regulator knowing about it, making illicit transfers far easier.
- When tied to a fiat currency, users can transact without the volatility of other cryptocurrencies
Ethereum and subsequent Smart Contract (sometimes called dApps) cryptocurrencies enable code to run on the blockchain. This code can be used to store, process, and represent ticket sales, equity trades, game tokens, and many other real-world assets in addition to running as normal software code.
- Smart Contracts can be written and deployed by anyone. Because of this, there have been numerous hacks due to errors made by the creator of the Smart Contracts
- Smart Contract wallets can store both value and other assets, making it difficult to determine the nature of trades
The goal of settlement networks is to replace existing cross border payment networks that banks, MSBs, and people currently use. This is essentially what JPM Coin is doing. Currently, the two main players in this space are Ripple and Stellar. Ripple is focused on banks and MSBs, while Stellar is focused on individual exchanges of value.
- Both Ripple XRP and Stellar Lumens can be freely traded as a cryptocurrency, so the risk is similar to conventional cryptocurrencies.
Exchange tokens provide an easy mechanism to transact within an exchange and pay reduced exchange fees. The largest is the Binance Coin (BNB), which pose similar risks to conventional tokens.
- May be centralized and managed by the exchange, enabling the exchange to burn tokens and perform other currency management tasks
- Typically follows the same risk profile as other conventional tokens
Privacy coins use advanced cryptographic algorithms to ensure transactions are not linkable or traceable, thereby ensuring senders, receivers and transactions can be obfuscated from 3rd party observers.
- Privacy coins are the biggest area of risk from an AML/KYC perspective
- By obfuscating wallets and transactions, it can be difficult of impossible for a 3rd party to identify the nature and risk of a transaction
By combining the immutable ledger of cryptocurrencies with tagging devices such as RFID tags, supply chain cryptocurrencies provide full supply chain traceability and material authenticity for complete chain of custody for high-end goods.
- Represent a very small percentage of the market.
- While trading of supply chain cryptocurrencies is open to any user with a compatible wallet, these are used mainly by individuals investing in the projects or using the supply chain aspects.
For compliance teams who are evaluating cryptocurrencies, here are four things that they must do:
- Risk profile all cryptocurrencies used by clients as each cryptocurrency type presents a different type of risk
- Understand the nature of any cryptocurrency business you are engaging with, including their value and purpose to the market and their ability to run the business legally and securely
- Perform transaction monitoring for any currency (fiat or virtual asset) and rely on blockchain forensics for cryptocurrency accounts
- Keep screening against sanctions, politically exposed and adverse media lists
New coins and new types will continue to emerge as coins split (hard fork), new coins are developed, and new problems are solved through cryptocurrency. CaseWare RCM Inc. is the maker of Alessa, a financial crime detection, prevention and management solution. With deployments in more than 20 countries in banking, insurance, fintech, gaming, manufacturing, retail and more, Alessa is the only platform organizations need to identify high-risk activities and stay ahead of compliance.