Financial service companies may have to dedicate extra time and resources to dealing with crypto clients, something they may not want to do in the face of risks they have difficulty assessing.

  • Because of the negative perception of crypto in general, startups in the industry can have difficulty acquiring the basic necessities for conducting business.
  • Best practices in ALM and KYC need to involve constant monitoring of user transactions.

It’s no secret that crypto still has a bad rap. About eight years ago, Silk Road set the stage for what would become the industry’s most infamous tagline: “only criminals use crypto.”

Even though it’s been verified that illicit activity only accounts for a fraction of a percent of all crypto transactions, the damage has been done. Cryptocurrency’s reputation remains tainted to this day.

This has had aftereffects not just for the average, everyday crypto advocate, but for blockchain and crypto startups around the world.

For more on the subject, we spoke with members of the team at Merkle Science, a next-generation blockchain analytics company. They help organizations in the traditional financial sector, in crypto, and in government to transact safely in cryptocurrency.

Here’s some of their input on how and why crypto startups sometimes struggle to get the financial access they need.

Difficulty acquiring the right services

Because of this negative perception, startups in the crypto industry can have difficulty acquiring the basic necessities for conducting business. Many individuals and organizations whose business is to provide insurance, access to bank accounts, and accounting services have a strong hesitancy to serve crypto startups, according to Mriganka Pattnaik, Co-founder and CEO at Merkle Science. 

“Traditional financial services have a couple of concerns,” Pattnaik said. “First, whenever there’s any type of regulatory uncertainty, traditional financial companies are really cautious, because many of them are beholden to multiple regulators, and they want to make sure that they are absolutely clear on what the rules are so that they can comply with all of them.”

Pattnaik went on to describe how the most common AML and KYC practices in both traditional finance and crypto, which perform the service just one time, may not always suffice. Customers can change their behaviors over time, so best practices need to involve constant monitoring of user transactions.

For this reason, Merkle Science’s automated solution for detecting anomalies in customer behavior has what he calls a “behavioral rule engine.” This allows companies to monitor transactions through a series of questions and rules that companies can put in place to monitor customer activity. These rules can be customized, based on guidance from FinCEN or other global regulators. The rules, or activity markers, will look for the types of activity that might be associated with illicit conduct.

Merkle Science analyzes a series of factors to assign risk scores to crypto currency businesses. Merkle Science’s platform allows users to deploy this automated tool to assess the risks in dealing with their potential business partners

The bottom line is that financial service companies may have to dedicate extra time and resources to dealing with crypto clients, something they may not want to do in the face of risks they have difficulty assessing, according to Pattnaik.

Seemingly “unquantifiable” risk

Another factor that can deter traditional financial services brokers from working with crypto startups is understanding how to assess the businesses’ riskiness. For those who aren’t familiar with the blockchain industry, the breakneck speed at which the industry evolves makes risk assessment very daunting and perhaps even feel impossible.

Traditional finance actors — whether it’s banks, accountants, or insurers — have little experience distinguishing between good and bad actors within the industry or how to differentiate between different types of blockchain businesses. Regardless of whether it’s a crypto exchange or a custodian or highly-regulated stablecoin, blockchain businesses are seen as “highly risky” when in reality they carry varying levels of risk.

In response to the question of how those in the financial services industry might break down the anatomy of crypto risk, Pattnaik said, “we can start by focusing on whether or not a business is in compliance or is in the process of becoming compliant. Jurisdictions around the world are forming digital asset regulations and setting up licensing regimes. Businesses that are going through — or have gone through — the stringent application process of a regulator such as the Monetary Authority of Singapore should absolutely be viewed as less risky compared to one that has not.”

On-chain data is another key factor in crypto business risk assessment — such as whether the business’ crypto wallets are associated to previous illicit activity. And if so, are these risks direct or indirect? How closely is the business linked to the illicit activity?

Off-chain factors — such as previous law enforcement actions, security protocols, or introduction of new technologies — all contribute to a company’s riskiness. While some of aspects of risk assessment may be new, it is not impossible for traditional financial services companies to dissect and evaluate. 

Perception vs. reality

Pattnaik also noted that many within traditional finance adhere to the belief that cryptocurrency is used for criminal activity or, more recently, believed to be used for sanctions evasions. But anyone investigating financial crimes would likely prefer that the suspects had used cryptocurrency.

“Unlike the US dollar, cryptocurrency is traceable, and so if crimes are committed with cryptocurrency, law enforcement has tools to be able to figure out where the cryptocurrency is, where it’s moved, what wallets it’s touched,” said Pattnaik adding that as a result, crimes can be investigated more easily. As for sanctions evasions, “tools such as mixers and tumblers or privacy coins just do not have sufficient liquidity for individuals to move hundreds of millions of dollars in untraceable ways.”

Today, cash is still the preferred monetary medium for smart criminals, according to Pattnaik. Despite this, the regulatory uncertainties and extra monitoring for compliance create too great a barrier for some service providers to consider working with crypto clients.

Perhaps one day, when more providers adopt solutions like those offered by Merkle Science, crypto startups will have easier access to the tools they need.


This content is sponsored by Merkle Science.

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