Balancing Risk and Opportunity: Operational Challenges and Internal Controls in Small and Large Cryptocurrency Institutions

Posted in Crypto Asset Compliance on January 19, 2024
Balancing Risk And Opportunity

Balancing risk and opportunity in the evolving landscape of cryptocurrency institutions, both small and large, necessitates robust internal controls, strategic planning, and a diligent approach to regulatory compliance.

Every cryptocurrency institution has unique risks and challenges with opportunities. Small institutions may face a lesser number of challenges as compared to large corporate institutions. 

Small institutions usually run on a limited scale and have a small cryptocurrency portfolio, simple operations, a limited customer base, and limited use of technology. 

Smaller institutions such as sole proprietorships are usually owner-managed, where owners are directly involved in the daily execution of cryptocurrency transactions, monitoring cryptocurrency operations and related activities. Due to owner management, a smaller institution requires a simple business hierarchy and processes to be managed by limited human resources. The focus of smaller institutions is to increase the market share and reduce the costs of running the cryptocurrency business and its operations.   

On the other hand, large institutions are involved in significant cryptocurrency investments and trading and deal with diversified customers from different jurisdictions. Large institutions have diversified shareholding structures, complex business operations, dependency on a large number of skilled human resources, and complex laws and regulations, to comply with.

To operate on a large scale large institutions deploy specialist knowledge in the form of skilled human resources, technology, machinery, and large infrastructure. These factors cause business and its operations to be complex.

Balancing Risk And Opportunity

Balancing Risk and Opportunity

To remain competitive and in business, both small and large institutions have to design, develop and implement the relevant cryptocurrency business and operations controls, in the form of hierarchy, processes, policies, cryptocurrency transaction limits, stop-loss limits, monitoring, and risk management procedures. 

Institutions need to develop robust mechanisms to regularly review and monitor internal controls, compliance, and risk management activities.

To identify, and understand regulatory requirements, and update the internal regulatory controls there is a need for management to develop a dedicated compliance function. Developing a dedicated compliance function is control in itself to protect the overall compliance environment of the organizations, however, the board and management build strong compliance culture by hiring compliance subject matter experts, to ensure regulatory compliance.

The compliance function regularly performs reviews of cryptocurrency business and operations, to identify the issues and weaknesses in the overall internal control environment that may be significant enough and lead to penalties. The compliance department ensures that issues and breaches identified during the periodic compliance reviews are reported to management and recommended for mitigation.

Management needs to ensure that all identified breaches and risk incidents are addressed through the development of appropriate internal controls, which must be reflected in the policies and procedures of the institution. The compliance function also then reviews the policies and procedures to ensure that all new controls developed and implemented are embedded in the relevant policies and procedures. 

When management plans to define internal controls in policies and procedures, it must consider the interrelationship of the departmental process flows and associated risks. In other words, internal controls should not be developed in isolation. 

To develop a robust internal control system, for the business and operations of the organization, the board of directors and senior management define the business objectives and identify risks arising out of defined business objectives and targets. This is an integrated approach, where business objectives and strategies are linked with existing and emerging risks, to design and develop the controls to mitigate the identified business risks.

In an integrated approach to risk identification and control development, all the departments and functions collaborate to bring transparency in identifying risk issues and internal control needs. Such an integrated approach ensures defining risk ownerships and accountabilities related to risk owners.

Compliance also checks that the updated policies and procedures are reviewed by departmental heads, and approved for dissemination to the employees down the line for compliance purposes. 

Balancing Risk And Opportunity

Final Thoughts

Both small and large cryptocurrency institutions grapple with unique challenges and risks, yet these very challenges also present opportunities for growth and advancement. Smaller institutions, despite their simplistic structure and limited resources, have the capacity to increase their market share and minimize operational costs through effective management and strategic planning. Meanwhile, larger institutions, with their broad customer base and complex operations, can harness the power of technology, skilled manpower, and extensive infrastructure to maintain competitiveness.

The cornerstone for success in both cases lies in developing robust internal controls, ensuring regulatory compliance, and fostering a strong culture of risk management. An integrated approach to risk identification, coupled with an effective internal control system and vigilant compliance function, can help these institutions navigate the dynamic landscape of the cryptocurrency industry, turning potential vulnerabilities into strengths.