Understanding the BIS Plan for Crypto Compliance

In a recent bulletin, the BIS proposed an innovative approach to AML compliance for crypto assets. This involves assigning a compliance score to each crypto holding before it is exchanged for fiat currency. The score is based on the probability that a specific cryptoasset is linked to illicit activity. This system aims to prevent the inflow of illicit funds and promote a “duty of care” among crypto market participants.

The BIS highlighted that current AML methods, which rely heavily on trusted intermediaries, have shown limited effectiveness in the crypto environment. However, it noted the potential of public blockchain transaction histories as valuable tools for compliance monitoring.

Stablecoins: The Preferred Asset for Illicit Crypto Flows

The BIS has identified stablecoins as the preferred asset among criminals using crypto, surpassing Bitcoin (BTC) since 2022. Reports from crypto forensics firms like Chainalysis and TRM Labs indicate that by 2024, stablecoins accounted for approximately 63% of all illicit transactions. To combat this, the BIS suggests using AML compliance scores that reference Bitcoin unspent transaction outputs (UTXOs) or wallets for stablecoins, establishing risk thresholds to manage off-ramp requests.

How the BIS Plan Affects Crypto Off-Ramps

The BIS proposal places a responsibility on crypto off-ramps to adhere to this compliance system. Entities involved in crypto exchanges would be incentivized to avoid accepting or disbursing tainted coins, as non-compliance could result in fines or other penalties. The plan also introduces potential compliance requirements for individual holders. Although some users may acquire tainted assets unknowingly, widespread and affordable compliance services could diminish such defenses.

Potential Market Implications of the BIS Plan

The BIS predicts that tainted stablecoins could trade at a discount under this compliance system. Risk scores may follow tokens throughout the blockchain, embedding themselves into the UTXO or wallet. This could impose a duty of care on users, influencing behavior in decentralized transactions.

By implementing these measures, the BIS aims to strengthen the integrity of the crypto market, ensuring that only compliant and clean assets circulate within the financial system.

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The BIS report, published on April 15, indicates that the magnitude of the crypto market should raise concerns about its stability, beyond its potential impact on traditional finance (TradFi) and the real economy. The report emphasizes the role of stablecoins as a medium for transferring value within the crypto market and advocates for targeted regulations pertaining to stability and reserve asset requirements. Such regulations would ensure stablecoins can be redeemed for US dollars during periods of market stress.

The BIS report was released in the wake of the US House Financial Services Committee’s approval of the Stablecoin Transparency and Accountability for a Better Ledger Economy (STABLE) Act on April 2 with a 32–17 vote. The STABLE Act seeks to establish a comprehensive regulatory framework for dollar-denominated payment stablecoins, emphasizing transparency and consumer protection.

In addition to the STABLE Act, the Guiding and Establishing National Innovation for US Stablecoins (GENIUS) Act was approved by the Senate Banking Committee by an 18–6 vote on March 13. The GENIUS Act intends to establish guidelines for collateralization and enforce full compliance with Anti-Money Laundering laws for stablecoin issuers.

The BIS report also expresses concern that the crypto market could widen the wealth gap by allowing larger investors to exploit the emotions of less experienced retail participants, as seen in the 2022 FTX collapse. It noted that larger Bitcoin holders, known as “whales”, were selling while smaller retail investors, referred to as “krill”, were buying as prices fell.

The report concludes by stating that while DeFi and TradFi share similar economic fundamentals, DeFi’s unique characteristics, such as smart contracts and composability, present new challenges that require proactive regulatory interventions to ensure financial stability and encourage innovation.

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In an announcement from October 2020, the Bank of Japan outlined its approach to preparations for the issuance of CBDC. It explained the steps as a way to making the payment system more efficient and responsive to change.

Several other banks around the world are at different stages in their CBDC rollout process. In particular, a survey conducted at the end of 2019 by the Bank for International Settlements (BIS) found that 80% of participating central banks (66 surveyed) had CBDC in the works.

For instance, in South Korea, Shinhan Bank completed a pilot of the digital won, in preparation for the CBDC rollout by the central bank. Moreover, the central bank of Jamaica is planning to pilot the CBDC in December 2021 before the launch in 2022. In addition, the digital yuan is scheduled to launch before the Winter Olympic Games in 2022.

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