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AML/CFT BSA Rules and Regulation Financial Crime Fraud Prevention

Cryptocurrency risks, rewards and red flags for financial institutions

Kate Randazzo
July 22, 2022
Read Time: 0 min

Cryptocurrency regulation is on the horizon

The ups and downs of the cryptocurrency scene have illuminated a need for guidance for traditional financial institutions.

You might also like this whitepaper, "Understanding cryptocurrency."

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Takeaway 1

Cryptocurrency has been able to offer good interest rates on high-yield savings accounts and secured loans with no credit check. 

Takeaway 2

While these financial products are appealing, the lack of stability and consumer protections surrounding them are a concern for the FDIC.   

Takeaway 3

Financial institutions should notify the FDIC of crypto-related activity and be familiar with the risks of the cryptocurrency world. 

Crypto turbulence

A new and unpredictable market

Despite recent turbulence, cryptocurrency has enjoyed a significant rise in consumer interest in the past few years. According to a poll by NBC, one in five Americans today has invested in, traded, or used cryptocurrency.   

Part of the currency’s initial popularity was due to cryptocurrency exchanges offering financial products that competed with—and for a while, outperformed—traditional banking products. As recently as last fall, consumers could stash certain digital assets in a savings account and earn upwards of 10% interest, or even use cryptocurrency to secure a loan without a credit check. But lawmakers and regulators are concerned about the lack of stability and consumer protections that the traditional financial services industry provides.  

 The growth prompted President Biden to sign an executive order directing relevant government agencies to study its risks and benefits. The order seems well-timed given the recent crash of some platforms which helped trigger a flight from the cryptocurrency market, driving its value from $2.9 trillion last fall to less than $900 billion today. 

Historical benefits of cryptocurrency

Cryptocurrency's appeal to consumers

Cryptocurrency was first introduced in 2009 and is lauded for providing a level of privacy and security that traditional banking cannot guarantee. Digital assets’ popularity has skyrocketed, and other platforms have begun offering new financial products and services that exclusively use cryptocurrency. Many companies now offer a chance to earn interest on digital assets, like a high-yield savings account. But instead of providing a fraction of a percent in interest, cryptocurrency platforms often offered interest amounts closer to 10% on certain digital assets.   

Today’s cryptocurrency platforms also offer crypto-backed loans, allowing users to leverage their portfolios as loan collateral in a system similar to securities-based lending. Interest rates are relatively low—often in the single digits—and there's generally no credit check required. 

Cryptocurrency platforms create opportunities for those with less-than-ideal credit or who harbor distrust for traditional banking. People with low credit scores often struggle to find an institution that will offer an affordable personal loan, and most banks and credit unions don’t provide the same high returns on deposit accounts that cryptocurrency can. And the 7.1 million households in the U.S. that were unbanked as of 2019 may not be interested in jumping through the hoops required to open a traditional bank account. Cryptocurrency’s open doors to a savings account may seem more appealing.  

Volatility concerns

Risks for cryptocurrency users

Cryptocurrency platforms may provide some obvious benefits compared with their traditional counterparts, but consumers take on significant risks with cryptocurrencies that they may not be aware of. The recent crash of popular cryptocurrencies Bitcoin, Celsius, and Terraform Labs, increased public concern that digital currency markets—used primarily as an investment vehicle as it is not widely accepted as payment for goods and services—lack rules and accountability.  

While the FDIC supports safe and sound innovations that comply with laws and regulations and are fair to consumers, the FDIC is concerned that cryptocurrency assets and crypto-related activities are rapidly evolving and that risks in this area are not well understood. 

Cryptocurrencies are more mainstream than ever, but they are still a new and highly volatile investment. Even “stablecoins” like Tether, a cryptocurrency that ties its value to the U.S. dollar, can be risky because they do not have sufficient reserves of fiat currency to be backed 100%.  

Consumers must keep in mind that if the platform providing their account fails, their assets are not insured as they would be at a traditional bank. And while their privacy and security are excellent, cryptocurrency networks do not yet have regulations in place in case of hacks or fraud, so consumers who fall victim to financial crime have no recourse to recover. 

The FDIC names an additional concern in a recent letter: consumer confusion regarding cryptocurrency offered by, through, or in connection with insured depository institutions. Consumers will need to thoroughly understand the speculative nature of certain cryptocurrency products compared to traditional banking products, such as deposit accounts. And insured depository institutions face risks in effectively managing the application of consumer protection requirements, including laws related to unfair or deceptive acts or practices, to new and changing cryptocurrency practices.  

What's next

The future of traditional bank involvement and regulations

The risks of cryptocurrency may seem intimidating, but many traditional institutions understand that there is merit and huge potential for profit in the digital asset space, especially as more businesses and payment companies get on board. Visa, for example, is launching a cryptocurrency advisory program to help customers and partners make the most of the digital asset space. Visa has also proposed a theoretical system connecting different blockchain networks to allow central banks, businesses, and consumers to transfer digital currencies. 

As large banks invest in blockchain companies and some lenders begin offering cryptocurrency rewards credit cards, more traditional institutions will join in integrating blockchain technology into their offerings, and more regulations will be clarified to protect them. 

During a recent speech, Federal Reserve Vice Chair Lael Brainard said that financial resilience will be improved if cryptocurrency regulations reflect the same principles as traditional banking regarding risk and disclosure. 

 “Strong guardrails for safety and soundness, market integrity, and investor and consumer protection will help ensure that new digital finance products, platforms, and activities are based on genuine economic value and not on regulatory evasion,” she said. 

Cryptocurrency users should be prepared for government regulations that will provide more stability and protection to digital platforms’ products and services. And financial institutions should make themselves familiar with cryptocurrency, its risks, and the red flags they will need to watch for when regulations begin to appear.  

Red flags

Characteristics of crypto fraud and money-laundering

It is estimated that $2.8 billion was laundered through cryptocurrency in 2019. A prime example of cryptocurrency facilitating illegal activity and money laundering is the darknet market AlphaBay, where more than 40,000 vendors used the marketplace to reach over 200,000 buyers, conducting $1 billion in transactions until international authorities shut it down.  

Cryptocurrency can be mainly exchanged anonymously, thanks to blockchain technology. But the identity-obscuring features of cryptocurrency platforms create a great environment for criminals to launder money without being tied to their actions. While it is not illegal to exchange funds anonymously, it can hinder authorities when investigating suspicious activity with virtual funds.  

Stay up to date with best practices for the digital asset space.

The potential for cryptocurrency to be tied to illicit activities means companies and financial institutions dealing in cryptocurrency should be on the safe side. 

Complying with anti-money laundering regulations is understandably tricky for institutions in the cryptocurrency space, as expectations have not yet been clarified, and more consumers are getting involved in the digital currency exchange. Consider developing a hardware or paper wallet system that backs up identification and protects assets from criminals. Criminals may benefit from the lack of regulation in the industry, but there are still ways to watch out for illegal activity.  

Your organization might take note of: 

  • Users with accounts under multiple names, perhaps to avoid any trade or withdrawal limitations placed by the cryptocurrency platform 
  • Users with many accounts under a single IP address 
  • Accounts or transactions that begin from suspicious IP addresses 
  • Users with a domain registered in a country with little or no regulation, or registered in a jurisdiction other than their country of residence 

Other characteristics that could indicate potential money laundering related to cryptocurrency transactions include: 

  • Transactions using more than one cryptocurrency type, especially highly anonymous currencies. 
  • A substantial volume of peer-to-peer transaction activity indicating that the user is charging high fees to handle others’ wallets. 
  • Funds from a suspicious source deposited to a cryptocurrency wallet, such as gambling sites. 
  • Funds transferred across international borders using decentralized hardware. 

Set the stage

Preventative measures for your organization

Should your financial institution begin working with cryptocurrency-related clients, it is important to be up front with your regulators about any involvement in the digital asset space. 

The recent FDIC letter requests that financial institutions notify an appropriate FDIC regional director of their intent before engaging in crypto-related activity, or, if already doing so, that they promptly send notice of their activity. As stated in the letter, “the FDIC will request that the institution provide information necessary to allow the agency to assess the safety and soundness, consumer protection, and financial stability implications of such activities.” 

The information requested by the FDIC will vary on a case-by-case basis depending on the type of activity. Be sure that your initial notification to the regional director describes in detail your institution’s proposed timeline for engaging in crypto-related activity. This way, any relevant supervisory feedback will be given in a timely manner.  

Given the unknowns and risks surrounding cryptocurrency, BSA/AML programs embarking into the digital asset world should do their best to regularly follow a risk assessment model that reflects their needs. For starters, have CDD processes to identify higher-risk customers for enhanced due diligence, monitor transactions for suspicious activity, and report suspicions to authorities straightaway.  While states like New York and Wyoming have taken the lead, cryptocurrency laws and regulations are taking hold across the U.S. — momentum that may lead to a national framework in the future.  

Financial institutions may note that while traditional fiat currency and cryptocurrency differ significantly, many of the red flags listed above are similar. Knowing your customer and conducting proper due diligence can help reduce the risk of fraud and taking those principles into your institution’s cryptocurrency approach will set your program up for success.  

Learn more about cryptocurrency and the digital asset space.

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About the Author

Kate Randazzo

Content Marketing Manager
Kate Randazzo is a Content Marketing Manager at Abrigo, where she works with industry thought leaders to create digital content that helps financial institutions better serve their customers. Before joining Abrigo, Kate managed social media and produced articles for Campbell University’s quarterly magazine and other university content initiatives. She earned

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