Cryptocurrency Risk Scoring: An In-Depth Guide to Internal and External Risk Evaluation

Posted in Crypto Asset Compliance on January 9, 2024
Cryptocurrency Risk Scoring

Cryptocurrency risk scoring serves as a vital tool in today’s digital economy, aiding in the identification, evaluation, and mitigation of internal and external risks associated with the use of cryptocurrencies.

The process of calculating a number, or score, to help determine the risk level of cryptocurrency in the presence of risk factors is called “risk scoring”. A risk-based score involves capturing more data and information about a particular cryptocurrency and its associated risks. 

Accurate risk scoring and rating of cryptocurrency risks help in the identification of priority risks, and the development of relevant controls to mitigate such risks.

Cryptocurrency Risk Scoring

Cryptocurrency Risk Scoring

Risk scores and risk ratings can be broadly classified into the following two types:

Internal risk scores and rating: Internal risk scores and risk ratings are based on risks emanating from within the company, such as risks arising from inadvertent human errors that cause data leaks, poorly defined roles and responsibilities that result in no accountability, etc.

External risk scores and ratings: External risk scores and ratings are assigned to cryptocurrency risks based on external factors, which can threaten the continuity of particular cryptocurrency risks, such as market volatility risks, cybercrime risks, digital fraud risks, etc.

The cryptocurrency risk assessment is performed to rate and score the crypto asset. Criminals are trying to exploit crypto technology, hence, the crypto activity’s traceability is a very important control for anti-financial crime purposes. Risk assessment effectively mitigates the risks of financial crimes associated with cryptocurrencies, and it helps to ensure that the systems, controls, and procedures are developed and implemented to mitigate risks.

An organization follows the logical process of performing a risk assessment where inherent and residual risks assessments are performed, to assess the Impact and likelihood of identified risks. To perform the risk assessment, risks are required to be identified for all the processes and activities of a department. 

When identifying risks related to the finance department, all the above-mentioned processes and activities of finance departments must be known to be risk identifiers. Similarly, for all other departments of an organization relevant processes and activities are identified, to identify the risks and perform a risk assessment.

All identified risks are to be documented in the form of risk statements. Such risk statements are written logically and sequentially, in the risk register or risk database. All risk statements are to be linked with a particular activity, process, or department, such as risk related to the preparation of financial statements of a company must be linked with the financial reporting process being performed in the finance department because the finance department is responsible for preparation of organization’s financial statements.

Cryptocurrency Risk Scoring

Impact and Likelihood Assessment:

After the identification of processes, activities, and documentation of identified risks, an inherent risk assessment is performed. During the performance of the inherent risk assessment, the “impact and likelihood” assessment is performed for each risk.

Impact assessment requires assessing the magnitude of loss which a particular risk may raise for the department or organization.

Likelihood assessment involves assessing the probability of occurrence of each identified risk.  

Impact and likelihood assessment require assigning risk scores or levels for each risk to arrive at an overall inherent risk score.

Based on the inherent risk assessment performed for each risk, the risk evaluation is performed, which means identifying those risks which are found critical or non-critical. Usually, the following levels are considered for the evaluation of risks:

  • High or Critical Level Risks
  • Medium or Non-Critical Level Risks
  • Low or Negligible Level Risks 

Risks ownerships are defined and incorporated into the risk database. Risk owners may be the departments or individuals working in those departments. Assigning risk ownership helps in coordination with relevant departments and personnel for risk and control feedback.

Risk owners are required to update their respective risk database or risk inventory, remain aware of their respective new and emerging risks, and be responsible for the application of internal controls to mitigate their risks.

Final Thoughts

As we delve deeper into the digital age, accurately assessing and mitigating cryptocurrency risk becomes an essential component of sustainable financial management. Understanding both internal and external risk scoring methods provides the foundation for comprehensive risk evaluation, allowing organizations to identify priority threats and develop targeted controls. From identifying relevant processes and activities across different departments, to meticulously documenting risks and evaluating their impact and likelihood, the process of risk scoring is inherently complex.

Yet, its vital role in mitigating potential financial crimes and market volatility associated with cryptocurrencies cannot be overstated. At the end of the day, embracing a comprehensive risk scoring strategy is not just a best practice—it’s a strategic necessity in the evolving landscape of cryptocurrency.