How to build confidence in crypto

Michael Ramsbacker, Chief Product Officer at Trulioo, a leader in global identity verification, considers what exchanges can do now to restore faith in the industry

FTX, one of the biggest crypto exchanges, crashed and burned last month (November), taking an estimated billion dollars in missing client funds with it. But, for the rest of the industry, the biggest loss was something of inestimable value: trust.

The FTX scandal was confirmation for crypto detractors that the so-called Wild West of finance would never be anything but a lawless frontier for cheats and scoundrels. Or, as Gilad G. Amir, digital operating partner at London private equity firm Pollen Street Capital, put it in a polarised debate on LinkedIn a few days later: “Crypto is arguably the biggest scam in the history of mankind. Hopefully, the recent events will wake regulators up to enforce more aggressively and put an end to this industry as we know it today.”

As the flames licked around FTX’s operations in the US, Europe (where it was only recently granted an investment licence), The Bahamas, Japan and Australia, other centralised exchanges rushed to reassure users, pledging to publish liquidity statements that proved they hold sufficient reserves to match their customer liabilities.

But the fact they felt that was necessary only serves to highlight how fragile is the reputation of a custodian service that is not protected by the same cloak of globally consistent regulation as banks. And that extends to customer identity verification, something that, admittedly, mainstream financial providers struggle to make with processes similar to those used for limiting financial crime in the mainstream banking industry – namely, those centred on KYC, anti-money laundering (AML) and combating the financing of terrorism (CFT). Eighty-seven per cent of them even agreed that identity verification needs to be a continuous process throughout the customer journey, rather than a single step during account creation.

“The majority of crypto transactions take place on the largest exchanges in the world, the exchanges that years ago were practising regulation arbitrage, locating in countries where maybe the regulations weren’t as advanced,” says Ramsbacker.

“Those days are gone. All of those exchanges are now really embracing the regulations and getting ahead of them. Even the segment of the industry closest to the roots of crypto, and the pseudo anonymisation that goes along with it – some of the lending, trading and derivatives, and speculation platforms – will, I think, have to adopt more KYC if they want to go mainstream.”

In fact, they may not have a choice. Many well-established crypto operators have argued for some time that the industry is well beyond self-regulation, that it can’t be expected to do the job of policymakers, who, by and large, have taken their time getting to grips with it. The global framework around cryptocurrency didn’t even make it onto the G20 agenda until 2018. But, under India’s G20 presidency in 2023 it will be a priority issue.

watertight, too, but is nevertheless legally required of them. The obligations of crypto firms that act as custodians of digital assets are patchy, and non-existent for pure play facilitators of decentralised, peer-to-peer trading where caveat emptor is usually the only rule that prevails – although decentralised exchanges like Uniswap, Curve and PancakeSwap might be precisely where retail crypto traders flee after the FTX debacle, of course.

“The regulations around banks and their onboarding processes are there to protect consumers. I think for crypto, onboarding processes and know-your-customer (KYC) should look more like traditional finance,” says Michael Ramsbacker, chief product officer at Trulioo, a leader in global identity verification (IDV) that only days before FTX hit the headlines, published a report that highlighted crypto customers’ growing demand for reassurance.

Arguing that IDV provides the ‘positive friction that consumers crave’ – even in an environment that originally attracted many precisely because of its anonymity – Trulioo reported that 62 per cent of consumers said security is more important to them when opening accounts than it was two years ago. And yet it found that 82 per cent of crypto companies find it difficult to adjust identity verification and onboarding approaches in response to shifting market conditions.

The vast majority of the crypto leaders Trulioo spoke to (79 per cent) believe building trust will require more agile and resilient onboarding and ID verification,

A Wild West?

Crypto providers themselves acknowledge the value of KYC

“There is an understanding that we need to have some kind of a regulation and that all the countries will have to do it together. No one country is going to be able to singularly handle it,” India’s finance minister Nirmala Sitharaman was quoted as saying. That will undoubtedly mean calls for truly universal rules around ID verification to combat what Europol and the independent inter-governmental body Financial Action Task Force (FATF), among others, identify as a growing threat of virtual asset crime.

As with any other financial crime, just how big a threat is hard to put a figure on. Private sector industry analysts estimated the unlawful use of cryptocurrencies to be 0.34 per cent of transactions (around US$10billion) in 2020, while academic research maintained it was more like 23 per cent. One senior legal officer at the United Nations Counter-Terrorism Committee Executive Directorate this year went so far as to say that up to 20 per cent of terrorist acts were financed that way.

While nowhere near the $800billion to $2trillion of fiat currency lost to money laundering each year, that still puts an obligation on crypto providers – whether or not they are subject to regulation – to build an accurate risk profile of individual customers in order to identify those who are misusing their services. Given that, by its nature, crypto is borderless, the international nature of that task is particularly challenging.

“The exchanges have recognised that there are centralised solutions that are necessary for their KYC and AML processes,” says Ramsbacker.

“Nevertheless, they look to keep those centralised solutions to a minimum by using vendors that can provide global coverage. That’s where Trulioo comes in, because Trulioo GlobalGateway covers 195 countries, all through a single API.”

IDENTIFYING THE THREAT

India’s pledge to clean up crypto follows a sustained effort since 2019 by the FATF to encourage states to embed its ‘travel rule’ – a global standard to counter cross-border money laundering through virtual assets – into domestic legislation.

Meanwhile, in July, the European Union agreed to adopt the Markets in Crypto Assets regulations, described as ‘the first comprehensive piece of crypto regulation in the world’, which is expected to take effect by 2024. New rules will subject cryptocurrency transfers to the same money-laundering controls as traditional banking transfers, meaning that information on both the source and the beneficiary of a transfer would have to be stored and handed over to investigators if they suspected criminal activity.

Already, in the UK, any virtual asset service provider, such as a cryptocurrency exchange, has to satisfy the Financial Conduct Authority (FCA) that it has

Pointing to the future:

Crypto providers are now under pressure to increase security

keys, and if it were to go out of business, those keys are potentially lost. The trade-off here is friction: as a customer, you may have to provide your name, your date of birth, perhaps your address and a government-issued identity document, or a biometric. That’s to protect the platform, but – ultimately – to protect that investor.” The Trulioo research uncovered how optimised identity verification can indeed create a ripple effect for consumer trust: it starts at a transactional level, then builds user confidence in the digital service or application, then the brand behind the service and, ultimately, the entire industry benefits, the report said. Eighty-three per cent of crypto users interviewed for the report said that when they encounter identity verification, it increases their trust in the brand, and 73 per cent say it increases their trust in the industry. “Crypto users notice when companies invest in the best identity verification approaches, with 85 per cent of them saying it demonstrates the company cares about its customers,” the authors wrote. “Crypto leaders… are evidently aware of the potential upside for businesses that successfully reset their identity verification to meet consumer needs… More than half (51 per cent) of crypto leaders report they will strive to harness identity verification as a driver of growth and It’s difficult to establish agility in the coming years.” Ramsbacker has already detected a ‘hardening’ of processes in place to trust in a fully views between ‘the 20 identify criminal or terrorist financing activity and that, currently, it can follow anonymous relationship per cent of the population that embraces crypto use cases – cryptocurrency, the European Union’s Fifth stablecoins, etc – and the Anti-money Laundering Directive. The FCA 80 per cent which are the detractors’, has shown it is not afraid to use its powers even before the events surrounding FTX. to suspend or cancel a firm’s crypto-asset And he fears that if the industry isn’t just registration. In 2021, it banned Binance submitting to, but also perceived to be Markets Limited, part of one of the world’s receiving, the same level of scrutiny as largest exchanges, because it was ‘not other providers, the beneficial use cases for capable of being effectively supervised’. alternative finance will be undermined.

As the issue of crypto regulation gains “For example, using stablecoins as urgency at governmental level, a way to transfer money from country to Ramsbacker says providers themselves country, quickly and easily, is a great use acknowledge the upside for the industry. case,” he says. “As crypto evolves, more

“Identity verification is important to uses like that will come to the surface, providers, because it creates trust and but it requires trust and safety. And safety on their platform. If someone is going it’s difficult to establish trust in a fully to host their wallet with an exchange, they anonymous relationship. That’s why identity want to know it’s a reputable company, is so important, not just for crypto, but because the exchange holds their private for the broader digital economy.”