On April 28, 2022, the New York State Department of Financial Services (DFS) issued steering on using blockchain analytics for digital foreign money companies licensed below 23 NYCRR half 200 (also called a BitLicense) or chartered as restricted objective belief corporations below the New York Banking Law (collectively, NY Virtual Currency Entities). The DFS steering indicators growing regulatory expectations that establishments engaged in digital foreign money actions will benefit from the distinctive alternatives that blockchain analytics supply to assist compliance features, akin to buyer due diligence, transaction monitoring and sanctions screening.
In the steering, DFS identified that, whereas digital currencies current new compliance challenges (for instance, by enabling peer-to-peer pseudonymous transfers with out regulated intermediaries), in addition they current new prospects for management measures, akin to provenance tracing (monitoring of coin transactions), as a result of blockchain know-how usually permits a historic view of digital foreign money transmission between pockets addresses. In this manner, DFS defined, digital currencies can supply larger visibility into transaction lineage than is usually doable with conventional funds transfers.
DFS “emphasize[d] the importance of blockchain analytics” in compliance with anti-money laundering (AML) necessities below 23 NYCRR §200.15, and throughout a variety of Bank Secrecy Act/AML and sanctions-related compliance controls. It mentioned three areas intimately:
- Augmenting Know-Your-Customer-Related Controls. DFS reiterated that, as a part of their know-your-customer tasks, NY Virtual Currency Entities should get hold of and keep info relating to clients and potential clients and perceive and successfully tackle the dangers that they current. DFS cited as notably helpful blockchain analytics merchandise that permit entities to acquire figuring out info that ties on to pseudonymous on-chain knowledge, notably together with “off-chain” and customer-provided info. These merchandise can usually establish pockets addresses related to establishments, in addition to identified high-risk pockets addresses, akin to darkish net marketplaces, DFS famous. They might not be capable of establish underlying homeowners, nonetheless, together with final helpful homeowners, and should have restricted attribution functionality. DFS famous that NY Virtual Currency Entities will need to have insurance policies, processes and procedures to evaluate counterparty publicity in digital foreign money funds transfers.
- Conducting Transaction Monitoring of On-Chain Activity. DFS additionally emphasised that NY Virtual Currency Entities ought to have insurance policies, processes and procedures for tracing transaction exercise for every kind of digital foreign money that they assist, together with inbound and outbound exercise on the blockchain. DFS famous that it can be crucial for NY Virtual Currency Entities to doc “appropriately tailored transaction monitoring coverage against applicable typologies and red flags, identify deviations from a customer’s expected activity, and address other risk considerations as applicable.” Relevant typologies embrace assessing whether or not a digital foreign money has substantial publicity to a high-risk or sanctioned jurisdiction, is processed by a “mixer” or “tumbler,” is shipped to or from darkish net marketplaces, is related to scams or ransomware, or is related to different illicit exercise related to the NY Virtual Currency Entity’s enterprise mannequin.
The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) has equally cautioned that digital currencies might create illicit finance vulnerabilities as a result of world nature, distributed construction, restricted transparency and velocity of probably the most extensively used digital foreign money methods. FinCEN has highlighted darkish net marketplaces, peer-to-peer exchanges, foreign-located cash providers companies and convertible digital foreign money kiosks as elevating specific dangers.
- Conducting Sanctions Screening of On-Chain Activity. DFS additionally emphasised the significance of risk-based insurance policies, processes and procedures to establish transaction exercise involving digital foreign money addresses or different figuring out info related to individuals topic to sanctions, together with individuals on the List of Specially Designated Nationals and Blocked Persons or situated in sanctioned jurisdictions. This is according to the place taken by the Department of the Treasury’s Office of Foreign Assets Control, which has defined that every one corporations within the digital foreign money business, (together with know-how corporations, exchangers, directors, miners and pockets suppliers, in addition to extra conventional monetary establishments which will have publicity to digital currencies or their service suppliers) are inspired to develop, implement and routinely replace, a tailor-made, risk-based sanctions compliance program. Those ought to usually embrace sanctions lists, geographic screening and different acceptable measures primarily based on the corporate’s distinctive threat profile.
In addressing these areas, DFS defined that NY Virtual Currency Entities can use third-party service suppliers or internally developed blockchain analytics merchandise for added management measures, individually or together. However, to the extent management features are outsourced, DFS emphasised that they will need to have clearly documented insurance policies, processes and procedures relating to how the blockchain analytics exercise integrates into the entity’s general management framework, according to its threat profile.
Broadly, DFS emphasised that an NY Virtual Currency Entity’s threat mitigation technique should take account its enterprise profile to evaluate threat throughout digital foreign money sorts and take steps to handle the particular traits of any related digital currencies. While acceptable management measures might fluctuate between NY Virtual Currency Entities, relying on their threat profiles, in all instances documentation should describe case administration and escalation processes and should clearly delineate roles and tasks throughout the enterprise and the compliance operate.
Significance of the Guidance
The DFS steering highlights the significance of blockchain analytics in compliance applications by companies working within the digital foreign money area. Although it’s focused at New York-regulated entities, it could sign a broader shift in regulatory expectations past the state, the place digital foreign money companies are anticipated to make use of blockchain analytics to assist their compliance features, and it could function a helpful information for the business extra usually.
The steering is a constructive growth in that it indicators that regulators might have moved past debating the authorized permissibility of digital belongings actions and are actually extra keenly targeted on the supervision of those actions to make sure they’re performed in a secure and sound method.
Associate Joe Sandman assisted within the preparation of this alert.