Is cryptocurrency fixing financial systems or fueling financial crimes?

In today’s climate of fast-paced technological innovation, any expert in computer science and cryptography can create a ‘cryptocurrency’. Cryptocurrencies (or ‘crypto’) are digital currencies that do not require central intermediaries (e.g., commercial banks or central banks) for settlement. A key element of trading in crypto is the public blockchain, which is a distributed ledger technology that records transactions made with cryptocurrencies in a secure and verifiable way.

Cryptocurrencies are growing fast. Currently, there are around 20,000 cryptocurrencies worldwide if we consider both active cryptocurrencies and those which have been discontinued, meaning they are no longer active for trading. The current market capitalisation (which is the market value of the total traded cryptocurrencies) is nearly $3.5 trillion. Notably, the top 10 cryptocurrencies alone constitute around 80% of total market capitalisation. The projected number of traders in crypto is expected to reach 107.30 million by 2025.

The growing appeal of cryptocurrency leads to an important question: What’s behind crypto’s rise? Before answering this question, it is essential to recognise that cryptocurrencies are currently transforming the world of financial technology by establishing their own rules and frameworks, distinct from those of traditional banking systems.

What makes cryptocurrencies attractive?

While cryptocurrencies can be highly volatile, they are nonetheless appealing to investors who are willing to take the risk of speculative investment. Since Donald Trump’s victory in the 2024 US presidential election, the price of Bitcoin (the first decentralised cryptocurrency) experienced a significant jump to a record high of over $100,000, with its value forecasted to reach $261,000 by the end of 2025. Many traders have recently shifted from the traditional banking system towards cryptocurrency platforms not only for their high returns, but also (and perhaps more significantly) because of the user-friendly interface of those platforms and the transparency in transactions granted by the blockchain system. Moreover, compared to traditional banking, cryptocurrency transactions have much less ambiguity and no hidden fees, particularly in cross-border transactions.

The drawbacks of cryptocurrencies

While crypto continues to attract a growing number of investors, its increased use also opens the door for financial crimes, including scams, fraud, and money laundering. One common method criminals use to launder money in cryptocurrency transactions is through a tumbler, which is a tool that mixes illegal and criminal transactions with legal ones so that it became difficult for law enforcement agencies to track and trace the source of the illegal funds.

Crypto represents a perfect tool for committing cross-border money laundering with just a click. This is made possible by the several features of crypto, including the unrestricted accessibility of the system, a high degree of anonymity, low transaction fees, and minimal regulatory oversight. The widely reported collapse of FTX (a cryptocurrency exchange and hedge fund) in 2022 and the famous 2019 money laundering case of the Bitfinex crypto exchange are only two examples of the long list of crimes committed within the cryptocurrency financial system, enabled by inadequate regulatory oversight.

How is the regulatory landscape responding?

Today, the fast pace of technological advancement in the world of crypto has far outstripped the slow movement of regulatory authorities to respond and adjust their oversight of the system. Regulatory ambiguity in the world of cryptocurrency has made it difficult to seize assets, verify ownership, present legal evidence in court, and foster cooperation in cross-border investigations. In response, countries have taken differing regulatory approaches when adapting to these challenges. Some countries, like China, have decided to reduce risks by restricting the use of cryptocurrencies, while others permit the use of cryptocurrencies conditional on licensing and registration for the trading platforms.

International organisations are also taking steps to address gaps in regulatory oversight of crypto markets. The Markets in Crypto-Assets (MiCA) Regulation, adopted by the European Union in 2023, represents a balanced approach to fostering innovation while mitigating risks associated with the crypto market. On the other hand, to combat crypto-related money laundering crimes, the Financial Action Task Force (FATF) – an intergovernmental organization established in 1989 by the G7 to combat money laundering –  has issued the Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (VASPs). This Guidance aims to help ensure that the virtual asset sector is effectively regulated and monitored and to prevent the misuse of cryptocurrencies for illicit activities. One of the main points tackled in this Guidance is Recommendation 16, or ‘The Travel Rule’, which focuses on the importance of submitting information about both the originator and the beneficiary of each transaction involving cryptocurrencies. This rule helps to enhance transparency and traceability, allowing authorities to combat money laundering and terrorist financing more effectively.

The future of cryptocurrency regulation

While many countries and organisations have already laid the groundwork for crypto-related regulations and legislation, others remain hesitant to do so, creating uncertainty and confusion. This uncertain regulatory environment creates opportunities for criminals to exploit loopholes, making it harder for authorities to track and combat illicit activities.

In crafting regulatory frameworks for cryptocurrencies, policymakers should consider three key takeaways.

First, it is important to strengthen cross-border cooperation by establishing international frameworks and partnerships to address transnational money laundering and prevent the exploitation of jurisdictional gaps. Enhanced cooperation is vital for timely enforcement of sanctions and shared regulatory efforts.

Secondly, there is a need to enhance regulatory oversight through public-private partnerships (PPPs), as effective regulation requires collaboration between the public and private sectors. Strong PPPs can support the development of innovative monitoring solutions, fostering a secure and compliant crypto ecosystem.

Thirdly, in light of the accelerating adoption of cryptocurrencies, it is essential to promote clear regulatory frameworks that balance between innovation and consumer protection by providing transparent rules, preventing fraud and illicit activities, while fostering trust.

By focusing on these three pillars, policymakers can build a resilient and trustworthy digital financial ecosystem, collectively paving the way for a safer and more secure future for the world of cryptocurrencies.

Tags: Financial, Finance, cryptocurrency, Financial Markets