Cryptocurrency specific risks are an integral part of the digital asset landscape, highlighting the need for investors to exercise caution and implement strategic risk mitigation practices. There are various risks associated with cryptocurrencies, such as market volatility, regulatory risks, operational risks, and financial crime risks.
There are various jurisdictions where the regulations around cryptocurrency dealing and investments are relaxed, which make the overall cryptocurrency system riskier. Further, in jurisdictions where the laws and regulations are implemented, there are challenges for the companies to develop a robust compliance program, to counter financial crimes, and ensure regulatory compliance.
Cryptocurrency Specific Risks
Cryptocurrencies are subject to market volatility because the price movement is not much predictable, and normally depends on geo-political factors. Volatility refers to the degree of fluctuation or the variation in the value or price of a crypto asset or cryptocurrencies, over a certain period. Volatility is a measure of how much a crypto asset’s price tends to fluctuate or move up or down in a given period.
High volatility refers to the rapid movements of the price of cryptocurrencies, which may be up or down, leading to benefits or losses to investors or traders. Cryptocurrencies are more volatile because these are a new class of assets to trade.
Financial crime risks are high because criminals find it easier to invest or trade on cryptocurrencies using different cryptocurrency exchanges. Most exchanges have relaxed due diligence and know your customer requirements, which makes criminals easier to enter the financial system and use illegal funds for financial crimes, such as money laundering, terrorist financing, and fraud.
Some cryptocurrencies like Bitcoin became easier to trace, major darknet platforms were taken down by law enforcement, and internal financial crime investigation units have upgraded their technological financial crime prevention solutions. However, the amount that is connected to illicit activity still accounts for more than is good. Further, dark markets attempted to take Silk Road’s place after it was taken down. AlphaBay launched in 2014 and was shut down by law enforcement.
Other crypto financial crimes such as Ransomware attacks were also the most famous ones in 2017. When cases of Bitcoin and crypto assets being used in crime first started appearing a few years ago, there was generally a perception that you had a perfect mechanism for online criminality. The pseudo-anonymous nature of the transactions was the perfect thing that criminals could dream of. However, there was a catch in all of this. What made Bitcoin less ideal for crime than is sometimes acknowledged is the fact that crypto-asset transactions are recorded on the blockchain.
Public ledgers provide a complete and total history of transactions. As a result of those blockchains being open, visible, and constantly being updated with new information, it became possible to more effectively analyse the history of transactions, follow the flow of funds, and begin to unmask those behind certain payments.
One thing that should be mentioned here already is, that if criminals use a cryptocurrency like Bitcoin, it has become a lot easier to trace back the funds than it has been in the past. Nowadays, there are many tools out there that help internal financial crime investigation units to follow the money, and especially law enforcement with the possibility that they can, with a reasonable amount of effort, trace back the funds.
There are various operational risks associated with cryptocurrencies, such as companies finding it difficult to develop the relevant policies, procedures, and systems to control overall operations. Dark web markets are still quite accessible, and they do rely heavily on Bitcoin and other cryptocurrencies to facilitate the dealings. The technology is also emerging on the side of criminals and financial crime and compliance professionals should be aware of mixers and tumblers in particular.
These are services that are offered by third parties that obfuscate a cryptocurrency transaction. They are normally provided by like-minded criminals who charge a certain fee. In essence, mixers and tumblers mix different cryptocurrencies. In addition, there are wallets out there that are extremely private. This protocol is very hard to track, unlike Bitcoin, which means that criminals are more likely to take advantage of its features.
In addition, scams and Ponzi schemes make up an additional third of illicit activity in Bitcoin, and credit card schemes make up just under 10% of the overall illicit activity. Illicit activity around credit cards usually relies on websites on the dark web or sometimes on the open web where criminals that have stolen credit card details can sell those credit card details. Thefts and hacks of exchanges also contribute to this picture. And then, there is the portion that is comprised of miscellaneous activity like money laundering in general, terrorist financing, and sanctions evasion.
Understanding the various risks associated with cryptocurrencies, from market volatility and regulatory hurdles to operational challenges and financial crime threats, becomes crucial. While the somewhat unregulated nature of this sector and its pronounced price fluctuations can lead to significant investment risks, the potentially relaxed diligence measures present a breeding ground for financial crimes, making robust compliance programs essential for businesses operating in this space.
Furthermore, the role of technological advancements is a double-edged sword, aiding both in crime prevention and illicit activities. Thus, as we continue to harness the potential of cryptocurrencies, it’s equally critical that we evolve our risk management strategies, regulatory frameworks, and crime detection tools to create a safer, more transparent digital economy.