The rise of cryptocurrency and the risk for fraudulent activities

– As a digital peer-to-peer global payment system that doesn’t rely on banks to verify transactions. Since then, cryptocurrency continues to gain popularity as an investment instrument.

However, the inherent characteristics of cryptocurrencies can increase the risk that cryptocurrency is used as a tool for money laundering, terrorism financing, fraud, and ransomware. If you do an online search of "fraud" and "cryptocurrency", you will find thousands of examples of fraud related to cryptocurrency, a few of which are discussed below. 

The Association of Certified Fraud Examiners determined that 8 percent of all global fraud cases involved the use of cryptocurrencies. Among these cases, 48 percent involved bribery and kickback payments and 43 percent converted misappropriated assets to cryptocurrencies[1]. For example, two Chinese intelligence officers were recently charged with obstructing justice for allegedly bribing a US double agent with US$61.000 in bitcoin.[2]

The Norwegian Tax Administration identified only 20 percent of those owning digital assets report that wealth on the Norwegian Tax Return in 2021[3]. We can only speculate about the reasons for why so few report owning digital assets. Possibilities include tax evasion through obfuscation of their wealth or efforts to conceal that the funds were obtained through criminal activities.

Cryptocurrency and blockchain is still considered to be a relatively new technology and thus vulnerable to cyberattacks. The blockchain analytics company Chainalysis[4] report record high cybercrime hacks in 2022. With a lack of regulations such as consumer and investor protections, the world of cryptocurrency may look like the Wild West. 

In other words, there is an elevated risk for cryptocurrency transactions being linked to illicit activity. Financial institutions are vital in helping to uncover fraudulent transactions before the proceeds become integrated into the legal economy. The question is, how can financial institutions stay compliant with the Anti-Money Laundering Act? 

The Financial Supervisory Authority has addressed the increased risks of money laundering by making cryptocurrency transactions subject to enhanced customer due diligence following the Anti-Money Laundering Act. Cryptocurrencies have a particularly dynamic characteristic beyond just price variations. Cryptocurrencies are characterized by constant evolutions in transactional patterns as well as technological and functional changes. This implies changes in risk exposure. To enable financial institutions to stay compliant, it’s important to create and implement a risk-based framework such as a parameter identification. The first line of defense should understand the fundamentals of cryptocurrency and be able to handle and manage their exposure in relation to their unique risk tolerance and regulatory requirements. 

Here are four guidelines to help mitigate fraud risk exposure:

• Cryptocurrency has a history of volatility and is not commonly used for paying for goods and services. Hence, financial intermediaries such as cryptocurrency exchanges are involved in converting cryptocurrency to fiat currency. While most exchanges operate under a license with AML/CFT programs, such as Know your Customer (KYC) and Know Your Transaction (KYT), others have engaged in nothing more than a play for the gallery, enabling criminals to launder their funds anonymously. The financial institutions' frameworks should include a due diligence of the cryptocurrency exchanges used to convert the money.

• With the right tools for blockchain analytics, it's possible to reduce anti-money laundering risks compared to those of fiat currencies. Transactions are maintained on an online public ledger, enabling the tracing of the funds to their source. As such, it can actually be an advantage for law enforcement to trace cryptocurrency on the blockchain. Compliance offers should also start using these tools to their advantage.

• While most cryptocurrencies are traceable, some conceal the senders, receivers, addresses and amounts (so-called "privacy coins"). As an example, the kidnappers of billionaire Tom Hagen’s wife, demanded ransom in the privacy coin "Monero"[5]. Financial institutions should stay alert or refrain altogether from facilitating transactions involving such coins.

• Certain patterns and behaviors may indicate money laundering schemes, such as customers' source of funds from cash-to-cash transactions, third-party service providers, international wire transfers, and inflows and outflows not related to the customer's known sources of funds. 

Financial institutions should have a risk-based compliance framework and compliance officers trained to detect and prevent fraud. Detection is essential in helping to uncover fraudulent transactions before they are integrated into the economy. With the right framework and understanding of the complexity of digital assets, maybe one day it’ll get to a point where it feels less like the Wild West.

[1] Occupational Fraud 2022: A Report to the nations, ACFE Association of Cerified Fraud Examiners, 2022. Source: https://legacy.acfe.com/report-to-the-nations/2022/

[2] “Two Chinese Intelligence Officers Charged with Obstruction of Justice in Scheme to Bribe U.S. Government Employee and Steal Documents Related to the Federal Prosecution of a PRC-Based Company”, The United States Attorney’s office, Eastern District of New York, October 2022. Source: https://www.justice.gov/usao-edny/pr/two-chinese-intelligence-officers-charged-obstruction-justice-scheme-bribe-us

[3] Flere oppgir kryptovaluta i skattemeldingen, The Norwegian Tax Administration, August 2022. Source: https://www.skatteetaten.no/presse/nyhetsrommet/flere-oppgir-kryptoverdier-i-skattemeldingen/

[4] Chainalysis “Public Key” podcast, January 2023. Source: Podcast Ep. 39 - 2023 Crypto Crime Report Preview (Part 1) (chainalysis.com)

[5] Etterforsker ID-tyveri i Hagen-saken: – Et svært sentralt spor, NRK, October 2021, Source: https://www.nrk.no/norge/etterforsker-id-tyveri-i-hagen-saken_-_-et-svaert-sentralt-spor-1.15701546