Digital Currency: New Opportunity for Financial Crime

Neil Katkov, PhD, is Senior Vice President, Asia, for Celent, a division of Oliver Wyman based in the firm’s Tokyo office. His areas of expertise include the Asian financial services industry, financial services distribution channels, and compliance issues including anti-money laundering and business continuity planning. He will be speaking at the NICE Actimize ENGAGE Client Forum in Hong Kong on November 7.

Readers of this blog may be most familiar with our work on compliance trends and technology, but in fact Celent looks at all things digital in financial services. We work on topics across the spectrum of innovation, including social media, big data, mobile financial services, alternative payments, personal financial management, high frequency trading and so on.

So naturally, I’ve been following with interest bitcoin, the virtual currency which bills itself as “open source P2P money.” In the world of alternative payments, bitcoin is seen as a pinnacle of innovation, the ultimate disintermediator. I’ve even toyed with the idea of investing in some bitcoins, after reading urban myth-like articles about early adopters who found themselves millionaires. (In fact, bitcoin’s value against other currencies fluctuates wildly.)

It gave me pause, then, that bitcoin has been implicated in some unsavory activities including money laundering and trade in illegal goods. Last week in the Netherlands, for example, a gang of phishers was arrested for allegedly laundering money (stolen from online bank accounts) through bitcoins. But then again, it makes perfect sense that a completely unregulated currency that can be exchanged for hard dollars would be an attractive medium of exchange for money launderers and other criminals.

Of course, bitcoin is still just a bit player in the world of money laundering, which ultimately relies on real currencies like the euro. Still, the virtual currency’s sometime-association with the underworld is a symbol of both the attractions and the risks of the digital economy and alternative payments. In a word, electronic channels make it easier for malefactors to hide their identities or assume other identities.

To the casual observer, this would suggest that electronic financial services should be closely regulated and monitored, to minimize this inherent risk. In fact, however, the opposite is frequently true. Regulation of alternative electronic payments, for example, is skeletal at best and for virtual currencies practically non-existent.

In March 2013, for example, FinCEN issued Guidance on virtual currencies which in effect exempted “de-centralized virtual currencies,” such as bitcoin, from AML regulations unless they have been traded for real currencies or goods. The US FIU, in other words, sees no need for monitoring a virtual currency while it is being traded among the countless virtual exchanges and marketplaces in cyberspace. Investigators and non-banks might breathe a sigh of relief that they are off the hook for monitoring transactions in this vast virtual world, but ex post facto investigations of a virtual money trail, after it has entered the real economy, would seem to create even more headaches.

No doubt regulation will eventually catch up with (virtual) reality. In the meantime, digital banks offering bitcoin accounts (yes, banks are offering bitcoin accounts) can take the reasonable step of monitoring these transactions as they would any other financial product.