Crypto AML — What is happening now?

The proliferation of cryptocurrencies and virtual assets has reshaped global finance, bringing both opportunities and regulatory challenges. As Virtual Asset Service Providers (VASPs) increasingly fall under anti-money laundering (AML) supervisory frameworks, they are expected to adhere to Financial Action Task Force (FATF) standards, similar to traditional banks and financial institutions (FIs). However, overall AML capabilities in the crypto sector remain a significant challenge.

A common misconception among some VASPs is that implementing Know Your Transaction (KYT) blockchain tracking tools suffices for AML compliance. In reality, certain VASPs lack a comprehensive overall AML framework, particularly in certain key areas such as triggered customer due diligence (CDD), enhanced due diligence (EDD), risk-based monitoring and investigative expertise. These gaps make certain VASPs a target for financial criminals who exploit weaknesses in onboarding and transaction monitoring processes.

Over-Reliance on KYT Tools Without Comprehensive AML Controls

A critical flaw in certain VASPs’ AML practices is the over-reliance on KYT blockchain tracking tools. While KYT solutions help identify suspicious blockchain transactions, they do not replace CDD, EDD, transaction monitoring (TM) and comprehensive investigation methodologies. Some VASPs assume that transactions without KYT alerts require no further queries. This misconception creates compliance gaps, allowing criminals to circumvent additional due diligence.

Unlike banks, which scrutinize the source of funds (SoF) and source of wealth (SoW) of customers, some VASPs fail to verify whether the transaction volume aligns with a customer’s financial strength and business profile. This weakness has made certain VASPs attractive to money launderers, who can conduct large crypto transactions under minimal scrutiny.

Insufficient Investigation and Risk-Based Monitoring

VASPs, if lacking investigative capabilities, can further exacerbate AML risks. In traditional financial institutions, requests for information (RFIs), transaction justifications, and background checks are routine. These processes help identify shell companies, illicit funds, and high-risk transactions.

However, if a VASP does not effectively integrate blockchain tracking alerts with investigative efforts, missed red flags will result. A risk-based approach should require VASPs to assess whether transaction patterns align with customers’ backgrounds. Without this critical oversight, criminals can exploit the pseudonymity of blockchain transactions to obscure illicit activities.

High-Risk Industries and Crypto’s Vulnerability to Financial Crime

Cryptocurrency adoption in high-risk industries such as online gambling, precious metals trading, and offshore financial services adds another layer of complexity. These industries have long been associated with money laundering risks, and their integration with crypto transactions intensifies concerns.

Regulatory Gaps Between VASPs and Traditional Financial Institutions

Despite increasing regulatory oversight, VASPs in general still lag behind banks and traditional regulated FIs in holistic AML capabilities. While most jurisdictions require VASPs to register with regulatory authorities, enforcement may still be inconsistent. Some regulators may still lack sophisticated crypto-specific expertise, leading to uneven implementation of AML measures.

Additionally, regulatory fragmentation across jurisdictions allows criminals to exploit weaker compliance standards by moving funds through VASPs in regions with lax regulations. This regulatory arbitrage undermines global AML efforts and creates significant risks for the financial system.

Enhancing AML Standards for VASPs

There seems an urgent need for VASPs to strengthen overall holistic AML capabilities, particularly EDD, risk-based monitoring frameworks, and comprehensive investigative expertise. A more rigorous approach should include:

• Comprehensive SoF and SoW assessments for high-risk customers
• Enhanced transaction monitoring and investigative effort that goes beyond KYT alerts

Improving Investigation and RFI Capabilities

A major deficiency is the lack of structured investigations. Unlike banks, which conduct in-depth transaction reviews, some VASPs fail to implement sufficient and effective RFIs and follow-up inquiries. Strengthening internal investigative teams is essential to closing this gap:

• Implement RFI protocols that require customers to justify large transactions
• Train AML teams to identify and investigate unusual trading behaviors and red flags

Strengthening Regulatory Oversight and Global Cooperation

Regulators also need to work towards harmonizing AML laws across jurisdictions to prevent criminals from exploiting inconsistent regulations:

• Clear and consistent AML enforcement mechanisms to ensure VASPs comply with FATF standards
• Prompt enforcement action against specific VASPs that fail to implement reasonably adequate AML controls

Increasing AML Training and Awareness in the Crypto Industry

A well-trained AML workforce is essential for effective monitoring in the crypto sector. Some VASPs’ compliance teams may lack the expertise needed to detect complex financial crimes. They should invest in overall AML resources and specialized AML training focusing on:

• Blockchain forensics and transaction tracing
• Advanced investigative techniques for identifying suspicious activities

VASPs must not simply appoint a less experienced compliance professional as the AML Compliance Officer or Money Laundering Reporting Officer (MLRO) without thoroughly assessing their competence in handling the complex and evolving nature of crypto transactions. Doing so risks undermining AML oversight and shirking the responsibility of maintaining a robust and effective AML framework.

The ongoing monitoring of AML risks in the crypto industry demands a multi-layered approach. While KYT tools provide valuable insights, they must be complemented by robust KYC, EDD, and in-depth investigative frameworks. To effectively combat money laundering, fraud, and illicit financial activities, regulators, VASPs, and compliance professionals must align AML standards with those of traditional financial institutions. By enhancing due diligence, strengthening investigative capabilities, and fostering global regulatory cooperation, the industry can establish a more secure and transparent financial ecosystem that protects against criminal exploitation.