Crypto Financial Reporting and Compliance

A Guide To Crypto Compliance In The U.S.

Delve into crypto compliance with this guide, highlighting essential concepts, regulations, and best practices for American businesses.

July 18, 2023

Blockchain technology has ushered in a new era of financial possibilities across the globe. 

Yet, it has created opportunities for businesses to exploit regulatory gaps and engage in nefarious activities. Money laundering, terrorist financing, and other financial crimes have become concerns within the cryptocurrency ecosystem.

The volume of criminal transactions involving cryptocurrencies reached a record high of $20 billion last year, in which a substantial 44% of the total illicit activity are are transactions linked to sanctioned entities.

Compliance in crypto is now an imperative rather than a choice, as it ensures the safeguarding of your business, customers, and reputation.

In this guide, you’ll understand how crypto compliance works in the U.S., and learn some of the best practices to ensure your Web3 business is compliant, which include: 

  • 1) Understanding compliance in crypto
  • 2) Key elements of crypto compliance
  • 3) How U.S. regulations operate
  • 4) Best practices for ensuring crypto compliance

Understanding compliance in crypto

Compliance in crypto refers to the adherence to legal and regulatory requirements governing cryptocurrency transactions and operations. 

It encompasses key concepts such as Anti-Money Laundering (AML), Know Your Customer (KYC), and Counter-Terrorist Financing (CTF) measures. These protocols aim to combat illicit activities like money laundering, fraud, and terrorist financing.

Key elements of crypto compliance

Crypto compliance certification: A crypto compliance certification is a formal acknowledgment that an individual or a business has successfully adhered to specific regulatory norms within the cryptocurrency domain. 

If you’re looking to attain a crypto compliance certification, there are independent organizations or regulatory authorities that grant such certifications. 

For instance, CipherTrace, a blockchain analytics and intelligence company, offers a Cryptocurrency Investigator Certification Program. This program equips individuals with the skills to trace illicit cryptocurrency transactions and understand the regulatory environment.

AML/CTF: AML, or Anti-Money Laundering regulations, are established to inhibit the conversion of illegally obtained proceeds into seemingly legal assets, a process known as money laundering. 

Similarly, CTF, or Counter-Terrorism Financing measures, are implemented to obstruct the financing of terrorist activities. This involves tracking transactions and reporting any activity that could potentially be associated with terrorism.

According to research by the Financial Action Task Force (FATF), patterns of transactions that deviate from the norm, appear odd, or are infrequent can be indicative of illicit activities. This might be the case when:

  • - New clients deposit a substantial amount to establish a new relationship with a provider of virtual asset services, which is not in line with their customer profile.
  • - Transactions involve several virtual assets or numerous accounts, without a reasonable business justification.
  • - Repeated transfers within a specific timeframe to the same virtual asset account by multiple individuals, from the same place, or involving large sums.

To adhere to AML/CTF rules, make sure that your business is always scrutinizing transaction patterns and reporting any suspicious activities to the appropriate authorities. 

KYC: KYC, or Know Your Customer, is a procedure employed by businesses to authenticate the identity of their clients. This usually involves gathering and verifying documents such as driver's licenses, passports, or utility bills. The primary objective of KYC is to thwart identity theft, financial fraud, and the financing of terrorism.

KYB: KYB, or Know Your Business, is a procedure akin to KYC, but it is utilized for verifying the identity and evaluating the risk of businesses rather than individual customers.

KYB procedures form a part of the due diligence process that companies undertake to ensure they are conducting business with legitimate and reputable companies. This process typically involves verifying business registration documents, understanding the business's nature, and identifying the ultimate beneficial owners (UBOs) of the company.

A bank might conduct a KYB check before opening a business account for a new corporate customer. This could involve verifying the business's registration details with the relevant authorities, checking the identities of the directors and UBOs, and assessing the business's financial transactions to ensure they are consistent with their stated nature and size.

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How U.S. regulations operate 

In the United States, the regulatory framework for cryptocurrencies can be complex, with different jurisdictions having their unique focus and jurisdiction. These regulatory bodies work together to ensure compliance and address different facets of the crypto industry:

Securities and Exchange Commission (SEC): The SEC is charged with the oversight and enforcement of laws related to securities. It holds a significant role in determining if a cryptocurrency is classified as a security, regulating Initial Coin Offerings (ICOs), and enforcing the obligations of registration and disclosure.

A Web3 business aiming to raise funds through an ICO or a Security Token Offering (STO) must comply with SEC regulations. If the token is deemed a security, the business must register the offering with the SEC and provide comprehensive disclosures about the company and associated risks.

Given recent SEC lawsuits against Binance and Coinbase, the SEC now considers a wide range of tokens such as ADA, MATIC, NEAR, among others, as securities, potentially leading to strict regulatory requirements.

Failure to comply can result in severe penalties, as demonstrated by the case of Telegram, which was compelled to return $1.2 billion to investors and pay an $18.5 million fine for conducting an unregistered offering of their "Grams" token.

Financial Crimes Enforcement Network (FinCEN): FinCEN focuses on combating money laundering and terrorist financing activities. It mandates crypto businesses, including exchanges and money transmitters, to register and implement robust AML/KYC measures to prevent illegal financial transactions.

Web3 businesses, especially those involved in financial transactions like exchanges or wallets, must comply with FinCEN's AML and KYC regulations. This involves implementing systems to identify and verify customers, monitor transactions for suspicious activity, and report certain transactions. 

For example, in 2020, Larry Dean Harmon, the operator of Helix and Coin Ninja, was fined $60 million by FinCEN for violations of the Bank Secrecy Act related to his convertible virtual currency businesses.

Commodity Futures Trading Commission (CFTC): The CFTC is tasked with regulating commodities, including certain cryptocurrencies like Bitcoin. It focuses on ensuring fair trading practices and market integrity in derivative markets, such as futures and options trading.

If a Web3 business is involved in trading cryptocurrencies considered commodities, such as Bitcoin, it must comply with CFTC regulations. This includes ensuring fair trading practices and maintaining market integrity. 

Failure to comply can lead to substantial fines, legal repercussions, and the loss of trust from customers and partners. In 2021, BitMEX faced a $100 million charge from the U.S. Commodity Futures Trading Commission (CFTC) for unlawfully operating a crypto trading platform and violating AML regulations.

Internal Revenue Service (IRS): The IRS treats cryptocurrencies as property for tax purposes. Individuals and businesses involved in cryptocurrency transactions are required to report them and pay applicable taxes, including capital gains tax.

Web3 businesses must also comply with IRS regulations regarding the taxation of cryptocurrency transactions. This includes reporting all cryptocurrency transactions, calculating and paying any capital gains tax, and providing tax forms to customers. 

State-specific regulations: In addition to these federal regulations, some states have introduced their specific regulations for cryptocurrency businesses operating within their borders. Notably, the New York BitLicense imposes particular requirements on crypto businesses operating in New York.

Best practices for ensuring crypto compliance 

Given the heightened regulatory focus on the risk management practices of crypto firms, it's vital to prioritize the following best practices:

1) Leverage on crypto compliance solutions

If you’re a crypto exchange, wallet, custodian, or Web3 business that handles a large number of trading transactions, you must have AML and KYC solutions in place. 

Several companies provide AML, KYC, KYT, and KYB services to crypto businesses. They develop compliance solutions for cryptocurrency businesses in the form of AML software and identity management/monitoring services. 

It’s necessary to formalize crypto compliance measures by partnering with AML/KYC firms to simplify and stay compliant with your crypto transactions. 

With the growing number of institutional investors adopting DeFi platforms and increasing regulatory interest, DeFi platforms are also starting to use compliance services offered by KYC/AML providers.

Below is a list by Blockdata, of some of the leading companies that provide compliance solutions that you could take reference from: 

Source: Blockdata

2) Set up internal controls and reporting mechanisms

Maintaining a dynamic approach to risk management involves constant evaluation and reassessment of risks associated with customers, products, and geographical factors. This means developing comprehensive risk mitigation strategies and robust internal controls to effectively address identified risks.

For example, a holistic risk mitigation strategy could encompass a layered approach. On the customer front, this could involve stringent Know Your Customer (KYC) and Anti-Money Laundering (AML) checks to authenticate customer identities and scrutinize their transaction behaviors.

At the product level, it could involve routine audits and penetration testing to pinpoint potential vulnerabilities in your products and proactively address them. This could be supplemented by a solid cybersecurity framework to guard against external threats.

Internal controls could encompass the segregation of duties (ensuring more than one person is involved in critical processes), access controls (ensuring only authorized individuals can access sensitive information), and regular internal audits to evaluate the effectiveness of these controls.

To help with internal controls, crypto payment apps like Request Finance has features like roles and permissions that allow you to easily add team members and customize their access levels to ensure the security of sensitive information. 

3) Maintain proper record-keeping

Proper record-keeping sets the foundation for crypto accounting. 

By monitoring all your crypto transactions and maintaining proper documentation, it eases the auditing process and ensures adherence to regulatory standards. 

However, cryptocurrency transactions involve unique identifiers, multiple addresses, and can have varying transaction fees. Tracking and recording these manually can be time-consuming and prone to errors. The fluctuations in the value of cryptocurrencies further complicate the process of recording transactions and holdings accurately. 

With a dedicated crypto payment solution like Request Finance, you can maintain proper record-keeping of all your crypto transactions while ensuring crypto compliance. It offers a user-friendly interface where transactions can be completed with a single click, minimizing the risk of clipboard malware. 

For all invoices that are successfully generated, they automatically appear in your dashboard. An invoice entry consists of crucial information that’s needed for effective payment tracking for compliance, including:

  • - The date the invoice was issued
  • - A description of the transaction
  • - The payable amount (denominated in fiat)
  • - The payment status (whether it's Paid, Awaiting payment, Canceled, or Rejected)
  • - Other actions (such as Cancel invoice, Pay invoice, Download receipt)

In addition to a summary view of invoice payment statuses, the dashboard allows you to access each invoice individually for more detailed information. By clicking on any invoice, you can delve into granular details such as business information, discounts, taxes, and more.

Using Request Finance, all your data remains secure and confidential - just like how over 2,300 businesses that have already placed their trust in Request Finance to streamline their crypto invoicing processes and safeguard their financial operations.

Staying ahead in crypto compliance

The regulatory landscape is ever-changing, much like the world around us, and it's your responsibility to stay informed and adapt accordingly.

Make it a habit to regularly review and monitor changes in laws, regulations, and guidelines related to cryptocurrencies. Just as you would adjust your business strategy in response to market trends, you must continually fine-tune your compliance measures to align with the latest requirements.

Remember, crypto compliance isn't a one-time task, but an ongoing commitment. 

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