Written by: Digital Securities Exchange Limited (DSX): a cryptocurrency exchange, operating since 2014 in the United Kingdom. Born out of London, DSX has harnessed the essence of crypto and combined it with the professionalism of the financial world. DSX offers exchange and trading platforms with multiple crypto and fiat pairs, as well as an API, which enables quick and easy deployment of a crypto payment solution.
What Actually Is the 5th Aml Directive? How Have Cryptocurrencies Been Treated so Far?
We’re at an inflexion point. Cryptoassets have existed for a little over a decade, but relevant legislation is still in its early days and lacks consistency. For instance, cryptocurrencies have not been regulated by UK law until very recently. Nonetheless, cryptocurrencies have finally come into view by British regulators.
In 2018 the UK authorities formed the joint Cryptoassets Taskforce, uniting HM Treasury, the Financial Conduct Authority (FCA) and the Bank of England. The result of their work was a report dedicated to the UK’s approach to cryptocurrency and distributed ledger technologies in financial services.
The Taskforce used the term “cryptoassets” and concluded that they should be divided into three types: exchange tokens (which are referred to Bitcoin, Litecoin and equivalents), security tokens (which referred to a “specified investment“) and utility tokens (which can be redeemed for access to a specific product or service).
The Taskforce experts also concluded that cryptoassets inevitably pose risks to the financial field due to their accessibility online, global reach and pseudo-anonymous nature. Although, the risks associated with cryptoassets were assessed to be relatively low for both money laundering and terrorist financing, their role in this field was expected to grow as cryptoassets become more accessible.
Therefore, the UK authorities are understandably willing to control the use of cryptoassets when criminal activities are involved. With the 5th Anti Money Laundering Directive coming into force in country members of the European Union, we can see the crypto sphere has passed a crucial milestone from a regulation perspective.
The 5AMLD was proposed by the European Commission in 2018 following the Panama Papers revelations and several terrorist attacks that took place in Nice and Brussels. These cases revealed gaps in the European AML/CTF regulation strategy, and so the new directive made important changes and adds to the previous 4AMLD, touching a larger scope of areas including: virtual currencies.
This term, mentioned in the 5AMLD, introduces a definition of virtual currencies as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically”.
When Does the 5 AML Directive Come into Force and How Does It Work in the UK?
The EU’s 5th Money Laundering Directive aims to combat money laundering and terrorism financing, and was issued in 2018. Following this, member states had to bring the directive into national legislation by 10 January 2020.
Each member state chooses its own authority that is responsible for the local supervision on its territory - for example, BaFin (Federal Financial Supervisory Authority) in Germany or AMF (Financial Markets Regulator) in France.
In the UK, it’s the FCA (Financial Conduct Agency) which is responsible for the supervision of the process. So, starting from 10 January 2020 the Directive came into force and all UK cryptoasset businesses engaged in activities within the scope of the 5AMLD will need to be registered with FCA.
On top of this, no one can start a new cryptoasset business without being registered with the FCA.
5AMLD included in its scope providers engaged in exchange services between virtual currencies and fiat currencies, as well as custodian wallet providers.
The UK authorities broadened the list, and AML requirements here also concern every company that undertakes one of the following activities: cryptoasset exchange provider (both crypto-to-crypto and fiat-to-crypto), cryptoasset ATMs, custodian wallet providers, peer to peer providers (a business who provide an online marketplace for crypto-to-crypto and fiat-to-crypto exchanges), ICOs and publication of open-source software e.g. Non-Custodian Wallet providers (the latest one is still under consideration).
What Does This All Mean for Crypto Exchanges?
It’s the first time crypto exchanges have been included in the scope of the AMLD. Platforms holding customers’ private keys, including cryptocurrency exchanges, are considered “obliged entities”, and are now subject to the same measures other financial institutions have been faced so far.
The requirements of the FCA under the Anti-Money Laundering regulation include risk-based policies development, Know Your Customer (KYC) procedures implementation, as well as monitoring and reporting suspicious activities.
In a nutshell, this means that 5AMLD prohibits anonymous transactions on cryptocurrency exchanges, as far as anonymity allows potential misuse for criminal purposes. This means that national authorities will be able to obtain information which enables them to associate virtual currency addresses to their owners.
So what are the main concepts on which the work of crypto exchanges should be built according to AML requirements?
- A risk-based approach - each company must elaborate on a set of measures that allow them to define the potential level of risk of potential financial crime activity impacting business. This means that control measures for each customer should be proportionate to the level of risk they have. This approach pays special attention to third-party states which may have a lack of effective anti-laundering policies, so money coming to the EU needs to undergo these intensive checks.
- Know Your Customer (KYC) procedures must become an integral part of the exchange’s activity. Each exchange must verify the identity of the customer, building a clear understanding who its customer is (both individuals and entities). For individuals, the data required for identification and verification. As for companies, 5AMLD implies an increase in the level of transparency around beneficial ownership information.
It also obliges exchanges to run checks on Politically Exposed Persons (PEPs) according to the list every member state should create. The common risks associated with PEPs are linked to the possible abusing their position for personal gain, and a person is considered to be at high risk for a minimum of 12 months after leaving the position.
Besides that, exchanges should ensure that they do not work with individuals and entities from the Sanctions lists. It’s prohibited to conduct transactions or maintain accounts with or for sanctioned targets, as well as providing financial services to parties resident in, or with exposure to, restricted countries.
- Suspicious Transaction reporting (SAR) implies that if any suspicious activity potentially linked to money laundering or terrorist financing is noticed, employees of the exchange must report it to the responsible authorities.
While many already conduct the activities mentioned before, the 5AMLD makes these requirements mandatory, so no company can ignore them anymore.
What Does It Mean for Customers?
We all know that cryptocurrencies are intended to give people more privacy and anonymity than they have with traditional financial institutions. Moreover, it’s claimed that their peer-to-peer nature is able to remove intermediaries between users.
In fact, 5AMLD stresses that although AML requirements are going to be implemented, the issue of cryptocurrencies’ anonymity will not be entirely addressed, as far as users still can make transactions without providers mentioned in the document.
In any case, full anonymity is no longer possible, as KYC procedures are now mandatory for all companies engaged in the cryptocurrency activity. So, any and every user should be ready to go through the verification process to conduct any financial transactions at a crypto exchange.
With 5AMLD coming into force, customers may perceive AML requirements as burdensome and have some doubts on these procedures. But they should consider its benefits before they pass judgement.
Why KYC/AML are so important for customers? The inclusion of crypto companies in the AML regulated sphere gives users confidence in the providers of crypto financial operations.
Due to regular security checks, cryptocurrency companies will not be able to claim that the disappeared funds become the result of unexplained security breaches. The number of cybersecurity fraud challenges is growing, so it’s incredibly important to be sure that your cryptocurrency service provider knows its customers and monitors money transfers.
At DSX, we started to fulfil similar requirements long before the 5AMLD came to life, having been registered as an agent of ePayments Systems Limited with the FCA. We have huge experience in this sphere and have been constantly working on making this process as smooth as possible. At the moment, we are launching a partnership with the company Veriff, which will let us significantly reduce time spent on verification.
What Does It Mean for the Market? What’s Next?
As far as member states implement the requirements of 5AMLD from 10 January 2020, we can see that we’re at the threshold of wholesale global changes.
This process demonstrates that the European Union admits that cryptocurrencies exist and that they have a chance to become a fully legitimate and integral part of the financial system.
5AMLD introduces this unique regulatory framework, which is an important step to defining cryptocurrency regulation in the European Union. The legal definition of virtual currencies and other provisions of the directive, pave the way for further actions in regulating this field.
These regulatory efforts are a game-changer for the cryptocurrency industry, and therefore we can expect some serious market changes in 2020. After all, not every company will succeed to fulfill all the AML requirements.
Besides that, these regulatory processes are very important for the mass-adoption of cryptocurrency. They make it easier to classify innovations, and can help us all to better understand the crypto-environment and associated risk factors.
So, financial institutions and other market participants may be able to successfully join this new field and can start to promote it. The regulation of the cryptocurrency space will lead to its growth, the promotion of use cases and injection of further funding into research and development.
5AMLD indicates that the European Union admits that cryptocurrencies are here for a long time and that they are going to be treated the same as other types of finance. All these regulatory processes are able to grant the necessary trust to digital assets around the financial world - and help everyone involved to truly begin the journey into the future of finance.