Cryptocurrencies have taken off over the past decade reaching a total market value of $2.2 trillion. However, if they are to go mainstream before they get replaced by Central Bank Digital Currencies (CBDC), cryptocurrencies must join the global non-cash payments ecosystem as actual means of exchange, not just assets. Standing in their way are barriers to the unencumbered trading of fiat for crypto, including money laundering concerns, deflecting fraud attacks and mitigating chargebacks. Only once these obstacles are addressed will cryptocurrencies be able to normalize their connections to global credit networks and will fiat-to-crypto transaction fees and times decline.
By accepting crypto exchanges as merchants of record, acquirers would in fact be underwriting their risk and the cardholders’ issuers would be lending credit to grease the wheels of crypto commerce. This would create a banking ecosystem not too different from the ones controlled by the central banks, just with decentralized currency. Such a development would be necessary to the extent that cryptocurrencies could compete with CBDC, whose liabilities will be backed by the government and whose distribution will be the major privately owned banks.
Soothing regulatory concerns
Precisely because of the appeal of decentralized, pseudonymous cryptocurrencies to criminal elements, governments in major developed economies have been strict in applying anti-money laundering regulations to them. In the U.S. this has taken the shape of know your customer (KYC) regulations from the Bank Secrecy Act. In particular, the Financial Crimes Enforcement Network (FinCEN) made clear in 2019 that cryptocurrency exchanges must comply with the Funds Travel Rule. The rule requires money services businesses, including crypto exchanges, to share the names, addresses and account numbers of both the originators and beneficiaries tied to payments of $3,000 or more with the next financial institution or money services businesses in line to handle the funds.
Moreover, if regulators are to be believed, lax exchanges wherever they are located will be subject to the laws of their customers’ countries as well as their own – leaving open the door for enforcement actions.
“We will hold accountable foreign-located money transmitters, including virtual currency exchangers, that do business in the United States when they willfully violate U.S. AML laws,” said Jamal El-Hindi, acting director of FinCEN. He made this statement after the first FinCEN supervisory enforcement action taken against a foreign located exchanger of virtual currency doing business in the U.S. occurred in 2017.
The big FATF elephant in the room
What happens in the U.S. doesn’t just stay there. When the U.S. held the presidency of the Financial Action Task Force (FATF) in 2018-2019, it introduced the Travel Rule to the organization. The FATF is made up of 39 countries, including the world’s largest economies, to fight money laundering. Officially adopted by the FATF on June 21, 2019, the FATF Travel Rule (Recommendation 16) obligates member countries’ virtual asset service providers (VASPs) and financial institutions, to share beneficiary and originator information with counterparties during transmittals above $1,000.
Under the FATF Travel Rule, originators of virtual asset transfers must submit the following information to beneficiaries: originator name, account number, physical address, national identity number, customer identification number or other unique identity number, date of birth and place of birth. On the other side, beneficiaries must submit to originators the beneficiary’s name and their account number or virtual wallet number.
The new information collection rules will mean that financial authorities are better able to detect and prevent money laundering activities involving cryptocurrency and will also help deter criminals by reducing the number of VASPs through which they can move funds.
Despite these regulations, crypto intelligence firm CipherTrace released a study last October that found that half the world’s cryptocurrency exchanges lacked sufficient customer identification processes to combat money laundering. Also according to CipherTrace, a third of cross-border Bitcoin volume is sent to exchanges with demonstrably weak KYC.
Clearly, AML regulation is moving ahead of the crypto industry and if crypto exchanges are to avoid a regulatory clampdown they must adopt stronger KYC practices. Without these practices, the exchanges will be exposed to competition from major financial institutions with the eventual adoption of central bank digital currencies. Both the design of CBDC and financial institutions experience with regulatory compliance would give this new system a leg up in competing against the current, legally exposed system.
De-risking crypto exchange
While money laundering is a major concern of governments, the percentage of cryptocurrency used for such purposes is small, less than one percent of total volume as of 2020. The bigger concern commercially is that cryptocurrency exchange services are at high risk for fraud.
Blockchain based transfers are irreversible, meaning fraudsters only need to temporarily fool other crypto holders or gain access to their stash to make permanent gains. The decentralized nature of most cryptocurrencies also means that nobody controls them. Consequently, there is no address for redress in court or elsewhere. Customers who keep cryptocurrency in their exchange accounts are at the mercy of the exchanges to protect them from account takeovers by hackers and other types of fraudulent behavior.
On the payments side, consumers rely on the provider of their method of purchase to protect them from cases of stolen identity. However, the largest source of non-cash payments, credit and debit card networks, are extremely wary of working with exchanges. The number of acquirers that accept exchanges is small and they charge high rates to compensate for the increased risk. As an alternative, exchanges are stuck accepting bank wire transfers from customers – a process that can take days. This is much too long a settlement time in the fast moving online economy!
Discussions are underway about how to design central bank digital currencies with greater anti-fraud features. According to Deloitte, commercial banks and fintech will handle the issues of KYC and anti-fraud protection for new CBDC. To compete with central bank digital currencies, the cryptocurrency exchanges will have to use advanced API-based anti-fraud solutions on the market to protect their clients.
Make buying crypto easy
Some 75 percent of non-cash payments by number in the U.S. in 2018 were by credit or debit card, according to the triennial payments study by the Federal Reserve. When interacting online, people prefer to move their fiat money around using their card details. However, many of the largest crypto exchanges have problems accepting credit cards because issuers block payment or acquirers refuse to underwrite merchant risk.
Even when they do accept credit cards, as high-risk merchants, exchanges usually have to charge high rates to cover acquirer fees. Debit cards are more widely accepted, but exchanges charge high rates to accept them as well, often 3-4 percent. The problem is the high risk of chargebacks either due to fraud or to customers unhappy with the post-purchase price movement in their crypto holdings. The only way crypto exchanges can change this high-risk categorization over time is to prevent fraud and fight illegitimate chargebacks. They can easily do the latter by connecting via application programming interface (API) to a chargeback mitigation like AcroCharge.
When customers see that their chargeback claims are not automatically accepted, they will stop repetitively filing for chargebacks. Exchanges that put in the effort to mitigate chargebacks will also improve their reputations as upstanding merchants with acquirers and issuers besides returning money to their bottom line.
With the reduced risk profile and established reputations, exchanges will begin to be able to negotiate better rates with acquirers that can then be passed on to the consumer. This will improve the ease of using crypto exchanges, expanding the volume of trading.
Fight chargebacks now
However, this process of mitigating chargebacks to alter customers and acquirers’ impressions of how exchanges operate must begin soon. There are already 19 countries with CBDC pilot projects running. If the exchanges wait too long, they could find themselves hemmed in by central bank digital currencies that work smoothly within the global banking system.
At AcroCharge we have years of experience fighting chargebacks for cryptocurrency companies. Our tailored made solution uses superior technology and human know-how to achieve the highest success rates in the industry. To find out more about what we can do for you, email us at email@example.com.