Off-chain, onboard
Crypto wealth is ready to flow into traditional private banking and asset management. Onboarding it is possible with the right approach.
Over the past decade, crypto has generated a vast amount of personal wealth. Forbes estimated in early 2022 that there were 19 known crypto and blockchain billionaires, with a combined net worth of over approximately USD 135 billion. Even following the recent crypto crash, their net worth was estimated to remain above USD 16 billion.
This is to say nothing of the many other quiet multi-millionaires created by the crypto economy. Its inherently privatised and anonymised nature means that numbers are hard to come by, but the breadth of success across crypto is illustrative: early adopters have watched their holdings of popular cryptocurrencies, like Bitcoin, soar in value; personal traders have leveraged markets for significant gains; and digital artists have sold NFT artworks for tens of millions of dollars’ worth of crypto-currencies. Blockchain analytics firm bitinfocharts estimates that there were over 50,000 Bitcoin wallets alone with a value of over USD 1 million. Potentially pointing to future trends of increased overlap between digital and traditional wealth, a 2022 wealth survey by consulting firm Capgemini further showed that 71% of high-net-worth individuals (HNWIs) surveyed have invested in digital assets, a disproportionately high concentration of whom are under 40 years old.
In recent years, some of this crypto wealth has started to flow back into real-world bank accounts and investments. Hedging against crypto’s inherent volatility is one reason. Another is that crypto founders and top management are starting to see rewards from successful projects, on which they want to (at least partially) cash in. Latterly, the collapses in 2022 of blockchain Terra and its native tokens, hedge fund Three Arrows Capital and crypto-exchange FTX – as well as a string of successful hacks – has triggered capital outflows, massive uncertainty and contagion across the crypto economy. While the fallout from FTX will take time to emerge, one immediate casualty is trust across the ecosystem: JPMorgan analysts predict major crypto holders will deleverage their crypto holdings until the impact becomes clear.
There is clear opportunity for private banks and asset managers to work more closely with crypto-HNWIs as they move their digital wealth into real-world currency and investments. While it may seem that laws and regulations make crypto wealth too challenging to onboard from a compliance and financial crime perspective, it is not as impossible as one may assume.
Uncharted Waters
Crypto is generally perceived to pose a high risk of financial crime, and authorities in the world’s major financial hubs are closely scrutinising the sector. This is still a relatively new area to many, but regulators have made concerted efforts to understand its workings. Waves of laws and regulations coming out of Washington DC, London, Brussels, Singapore and elsewhere are currently targeting crypto-finance firms (also known as virtual asset services providers, or VASPs). Take for example the EU’s recent expansion of its existing AML/CTF legislation to mandate that VASPs must hold and exchange information about the originators and beneficiaries of virtual-asset transfers.
Although the current focus is on the activities of VASPs, rather than traditional banks and asset managers taking crypto wealth, the direction of travel is clear. Expect crypto wealth to become a more defined risk within traditional financial crime legislation. This is evident in US Senator Elizabeth Warren’s recently proposed Digital Asset Anti-Money Laundering Act, which stipulates greater KYC and AML/CTF requirements for VASPs. Senator Warren has said the law’s intention is to bring the digital assets ecosystem into greater compliance with existing AML/CTF frameworks.
An equally important takeaway from the scrutiny – and the increasing pace – by regulators is that they are not prohibiting crypto-finance activities. They recognise that crypto is not going away. Existing financial-crime laws, regulations and guidance from bodies like the Financial Action Task Force across the world stipulate that enhanced due diligence (EDD) should be undertaken around high-risk sources of funds. Recognising that crypto is one such source would be in keeping with regulatory best practice – particularly as crypto-source-of-wealth laws and regulations start to evolve.
Crypto EDD
Conducting robust, proportionate and effective source of wealth-focused EDD around crypto funds is possible with the right partner.
External experts can conduct crypto-specific investigative research. As with any EDD investigation, this can be graduated and risk-rated based on the prospect in question. Crypto-due diligence experts can deploy traditional source-of-wealth investigative work with innovative blockchain analysis, which can track transactions associated with the prospect’s crypto wallets and assets based on public data. This can identify if and to what extent the prospect has interacted with other high-risk funds or wallets – those known or thought to belong to sanctioned parties, for example, or “dark markets” selling illicit wares – and track their flows of funds.
Marrying crypto and traditional diligence together gives holistic insight into how a prospect’s wealth has been built, and the crypto and real-world risks that might be associated with them. It also layers specialist expertise over blockchain data, giving vital real-world context and analysis to crypto-specific data. This is pertinent when considering some of the complex and unique financial-crime typologies emerging in crypto – we are able to place them within the framework of traditional regulatory requirements and EDD approaches, per a best-practice regulatory approach.
As crypto wealth crosses into traditional finance, especially from a new generation of investors, the opportunity to onboard this wealth is clear. Applying enhanced measures today can help unlock this opportunity, and demonstrate to regulators now and in the future that you took all best endeavours in compliance at the time.