In mid-March, Bitcoin investors sweated out a week of the most volatile trading the cryptocurrency had seen in a year, with prices climbing to an all-time high of $73,794 on March 14, 2024, dropping as low as $64,550 over the weekend, and finally settling at $68,193 (briefly) early on March 18. Mid-March’s price swings of between 3% and 7% may have had investors on the edge of their seats, but Bitcoin’s surging performance is not a complete surprise to the crypto world; it has been a wild few months for the industry, with recent price increases that have “pushed total assets under management to a record high of $94.4 billion,” according to March reporting from The Daily Hodl.
So why the Bitcoin-fueled crypto surge? In part because the US Securities and Exchange Commission (SEC) approved listing and trading 11 spot bitcoin exchange-traded product (ETP) shares in early January 2024, marking a “watershed” moment for the crypto industry by lowering the barrier to entry for institutional and retail investors, according to several media outlets. Additionally, the SEC’s recognition and approval of the first US-listed exchange-traded funds (ETFs) has given Bitcoin and other cryptocurrencies greater legitimacy in the eyes of both investors and financial institutions. This regulatory milestone set fire to crypto markets, attracting substantial new investments, and while, “these developments will give much-needed clarity, reassurance and confidence for institutional and retail investors in crypto as a legitimate and trustworthy instrument,” Sasha Skoryk, head of banking at Clear Junction, told The Banker; no doubt the influx of new investments also poses significant risk to financial institutions facing waves of new regulations.
Analysts at Bernstein predict Bitcoin will continue to surge this year, leading the way for “unprecedented” crypto demand from institutional clients. Further suggesting Bitcoin will “Skyrocket” to $3 trillion next year, followed by Ethereum at $1.8 trillion.
Overall, the crypto market could grow to a $7.5 trillion valuation by the end of 2025.
For its part, the SEC is not telling investors to run out and pull their “traditional” investments in favor of crypto; far from it. “Though we’re merit neutral… bitcoin is primarily a speculative, volatile asset that’s also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing,” said SEC Chair Gary Gensler in the January 10, 2024, announcement. CEO of Integrity Risk International, Jim McWeeney commented, “This is the challenge with crypto investments. While the upside has great potential, there are inherent risks to both investors and exchanges so the need for due diligence has never been stronger. Whether you are seeking the sort of stellar returns that crypto investing potentially offers, or whether you are seeking to increase your market share of that investor pool you must know who you are doing business with.”
Impact on Financial Institutions
Even though the SEC has eliminated significant hurdles for investors interested in Bitcoin, the same can’t be said for financial institutions, which are still struggling with cryptocurrency’s inherently secretive nature. The risks mentioned by Gensler in his announcement (money laundering, sanction evasion, terrorist financing, and cyberattacks) are only a few of the fears faced by financial institutions and regulators.
“If widely adopted, the products could pose risks to other parts of the financial system during times of market stress by exacerbating bitcoin price volatility or creating dislocations between the price of the ETF and bitcoin.”
SEC Commissioner Caroline Crenshaw expressed her concern in a dissenting statement, noting “the ETPs that will be enabled by [the January] order are inextricably tied to the spot bitcoin (BTC) markets. Fraud and manipulation that impacts the price of spot bitcoin surely impacts the price of the spot bitcoin held in the ETPs. So, our investor protection inquiry necessarily begins with the spot bitcoin markets. Are those markets safe? Substantial evidence indicates that the answer is no.”
In mid-March U.S. Senators Jack Reed and Laphonza Butler wrote a letter Gensler urging the SEC to take steps to protect investors, saying, “While the bitcoin market has displayed serious weaknesses, it is nonetheless far more established and scrutinized than the market for any other cryptocurrency … However vulnerable Bitcoin may be to fraud and manipulation, markets for other cryptocurrencies are far more exposed to misconduct.” They further noted a FINRA survey disclosed that 70% of brokers’ communications with retail investors violated fair disclosure rules.
According to Bitcoin.com, the duo asked the SEC to “carefully scrutinize brokers’ and advisors’ communications regarding bitcoin ETPs,” “examine brokers and advisors that recommend cryptocurrency ETPs,” and “ensure that bitcoin ETPs do not use inappropriate and confusing naming conversions.”
As Bitcoin leads the way for other forms of cryptocurrency to gain in popularity, there is little doubt that confusion among financial institutions and investors will grow; how can financial institutions ensure they are abiding by regulations when those regulations are spotty and inconsistent at best? Especially since we know that alternative assets such as cryptocurrencies can serve as a gateway for individuals, companies, and even entire countries to engage in illegal activities that will not only generate funds but allow them to avoid sanctions. Linda Huang, EVP and global head of research operations at Integrity Risk International commented: “You should be able to demonstrate a robust compliance program to manage these risks. It’s not enough to rely on routine KYC on-boarding checks, you must be able to demonstrate that you’ve thought about where your risks lie and that your program acknowledges that different levels of checks will be driven by the client profile – the size of their investment, where their residence or domicile is, and the extent to which they are able to clearly articulate their source of wealth. Trust but verify is key here.”
Sanctions Evasion
On March 25, 2024, U.S. Treasury’s OFAC levied additional sanctions on more than a dozen fintech firms and individuals for enabling sanctions evasion, mostly in Russia. US lawmakers believe the heavily sanctioned country has been using cryptocurrency to circumvent sanctions placed on its banks and oligarchs, among others, following the 2022 invasion of Ukraine.
“Russia is increasingly turning to alternative payment mechanisms to circumvent U.S. sanctions and continue to fund its war against Ukraine,” said Under Secretary of the Treasury for Terrorism and Financial Intelligence Brian E. Nelson in a press release “As the Kremlin seeks to leverage entities in the financial technology space, Treasury will continue to expose and disrupt the companies that seek to help sanctioned Russian financial institutions reconnect to the global financial system.”
OFAC’s latest round of sanctions targeted 13 firms and two individuals who have helped build or operate blockchain-based services or who have facilitated virtual currency payments in the Russian financial sector “enabling potential sanctions evasion,” according to the Treasury.
“Many of the individuals and entities designated today facilitated transactions or offered other services that helped OFAC-designated entities evade sanctions. These designations build upon OFAC’s February 23, 2024, action to target companies servicing Russia’s core financial infrastructure and curtail Russia’s use of the international financial system to further its war against Ukraine.”
The Importance of Unmasking Crypto Criminals
This latest round of sanctions demonstrates the United States continued focus on disrupting illegal activities in the fintech space; whether through new regulations within the country or sanctions placed on bad actors abroad, businesses operating in the fintech space can be assured their activities are under close scrutiny. For those who haven’t done their due diligence, the repercussions of (even unknowingly) doing business with crypto criminals can be disastrous, just ask this list of newly sanctioned entities.
Integrity Risk International is uniquely positioned to help financial institutions mitigate their compliance risks. Our global presence, with key offices in all the world’s major financial centers, gives us unparalleled reach to support our clients wherever they may be located, or wherever their due diligence requirements may originate. Contact us today to find out how we can assist with crypto compliance, due diligence, or investigation needs.