Financial Watchdog FATF Examines Risks of Digital Currencies

The Financial Action Task Force has published a paper examining the money-laundering and terrorist-financing potential of cryptocurrencies.

AccessTimeIconJun 30, 2014 at 1:34 p.m. UTC
Updated Sep 11, 2021 at 10:55 a.m. UTC

The Financial Action Task Force (FATF) has published a paper looking into the money laundering and terrorism financing risks involved with digital currencies.

FATF is an independent intergovernmental organisation tasked with developing policies to combat money laundering (AML) and terrorism financing (CTF). The organisation further maintains a blacklist, which highlights jurisdictions that refuse to address these issues. In addition, the FATF issues recommendations for AML and CFT, which must be followed in order to stay off the blacklist.

The FATF paper, titled ‘Virtual Currencies – Key Definitions and Potential AML/CFT Risks’, offers a quick summary of the digital currency system, but, as implied by the title, also looks into the risks that could arise from the technology (see the full report at the bottom of this article).

Coincidentally, the paper was published just days after the OECD published a working paper on bitcoin, and was referenced by Russian officials earlier this month. The FATF secretariat is located in Paris, at the OECD headquarters.

Legitimate uses, ample potential

The paper points out that digital currency has legitimate uses, with prominent venture capital firms investing in start-ups, and clearly recognises the potential in the emerging technology:

“Virtual currency has the potential to improve payment efficiency and reduce transaction costs for payments and fund transfers. For example, Bitcoin functions as a global currency that can avoid exchange fees, is currently processed with lower fees/charges than traditional credit and debit cards, and may potentially provide benefit to existing online payment systems, like PayPal.”

FATF also points out that digital currencies could pave the way for viable microtransactions, allowing businesses and individuals to monetise very low-cost goods or services sold online.

It further states that digital currency could support financial inclusion in other ways, by offering services in under-banked and unbanked regions of the world. Remittances are discussed, too.

Overall, the FATF summary can be described as relatively optimistic, focusing as it does on real-world applications of the technology.

Not without risk

On the risk side, FATF concludes digital currencies are “potentially vulnerable to money laundering and terrorist finance abuse” for a number of reasons.

“First, they may allow greater anonymity than traditional non-cash payment methods. Virtual currency systems can be traded on the internet, are generally characterised by non-face-to-face customer relationships and may permit anonymous funding,” the paper states. “They may also permit anonymous transfers, if sender and recipient are not adequately identified.”

FATF points out that decentralised systems can be particularly vulnerable to anonymity risks, explaining:

“For example, by design, Bitcoin addresses, which function as accounts, have no names or other customer identification attached, and the system has no central server or service provider. The Bitcoin protocol does not require or provide identification and verification of participants or generate historical records of transactions that are necessarily associated with real world identity. There is no central oversight body, and no AML software currently available to monitor and identify suspicious transaction patterns. Law enforcement cannot target one central location or entity (administrator) for investigative or asset seizure purposes (although authorities can target individual exchangers for client information that the exchanger may collect). It thus offers a level of potential anonymity impossible with traditional credit and debit cards or older online payment systems, such as PayPal.”

Global reach

The global reach of digital currencies also increases their AML/CFT potential, facilitating international transfers and relying on a complex infrastructure spread across the globe.

This segmentation adds another layer of problems for law enforcement and compliance authorities, as responsibility for AML/CFT may be unclear and transaction records could be held by different entities in different jurisdictions.

“This problem is exacerbated by the rapidly evolving nature of decentralised virtual currency technology and business models, including the changing number and types/roles of participants providing services in virtual currency payments systems. And importantly, components of a virtual currency system may be located in jurisdictions that do not have adequate AML/CFT controls,” FATF concludes.

FATF warns that centralised virtual currency systems could be complicit in money laundering and could deliberately seek out jurisdictions with weak AML/CFT regimes. Decentralised convertible virtual currencies allowing anonymous person-to-person transactions can exist in a digital universe entirely outside the reach of any particular country.

Essentially FATF believes nefarious actors could use digital currency technology to effectively set up shop somewhere beyond the reach of law enforcement and regulators, all in an effort to elude law enforcement, international financial regulations or potentially even circumvent financial sanctions. That risk is merely hypothetical at this point.

Early days for law enforcement

FATF points out that law enforcement is already starting to see major criminal cases involving the use of digital currency.

In the report the organisation examines the Liberty Reserve money laundering case, the rise and fall of online drug bazaar Silk Road and the demise of Western Express International.

Of course, the latter had nothing to do with bitcoin, or cryptocurrencies inspired by bitcoin, as it involved e-gold and WebMoney.

The full report

Bitcoin image via Shutterstock


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