Reading the Red Flags

Sep 29, 2020 - 4 min read

by Lars Hodel, Head Legal & Compliance at Bitcoin Suisse

Earlier this week, the Financial Action Task Force (FATF) published a report which highlights the most important red flag indicators connected to virtual assets. Interestingly, these red flag indicators are not a result of a theoretical analysis but based on more than 100 case studies collected by members of the FATF Global Network. In this commentary, we compare the findings of this publication to the real-life experience of the Bitcoin Suisse Legal & Compliance department.

General comments

The FATF states that its report was created to assist several players in the field of virtual assets, specifically: financial institutions, designated non-financial businesses and professions, Virtual Asset Service Providers (VASPs), Financial Intelligence Units, and law enforcement authorities.

Based on the broad intended target audience, it can be assumed that the red flag indicators mentioned will serve as a reference and benchmark for setting up risk based frameworks within financial institutions, and at the same time lay out a blueprint for how these frameworks will be evaluated and audited by regulators and auditors.
So even if the FATF states that these red flag indicators are always to be considered in context, it can be assumed that their implementation will be considered mandatory, and deviations need to be objectively justified and documented. Luckily, the Swiss Anti-Money Laundering (AML) Framework provides robust and clear guidance regarding the handling of higher risk clients and transactions.

Indicators specific to virtual assets?

The FATF report states that the red flag indicators are specific to the nature of virtual assets and their associated financial activities, and are by no means exhaustive.

However, upon closer examination, most of the red flags feel strangely familiar to the traditional risk indicators applied at financial intermediaries regardless of the assets involved. Size and frequency of transactions, changing between assets, quick deposits and withdrawals to name a few, are also commonly considered to be risk indicators in the traditional financial industry. Also red flag indicators linked to the source of funds or source of wealth are not a virtual asset specialty.

Red flag indicators related to anonymity

The red flag indicators related to anonymity seem to be the ones which are most specific to virtual assets as they target inherent characteristics and vulnerabilities associated with the underlying technology of virtual assets. The indicators listed under this section can usually be dealt with by implementing special tools which allow financial institutions to categorize, label, and score addresses or transactions they interact with according to a risk-based approach.

And let us not forget: as the blockchain is transparent and immutable, clients are not able to omit or hide transactions they once performed. This requires however, as the report states, combination with other characteristics of the client to compare and verify the documented behavior with the transactional reality on the blockchain.

How Bitcoin Suisse is dealing with the red flag indicators

Bitcoin Suisse is a pioneer in the crypto industry and was the first ever AML regulated crypto provider in Switzerland. The policies and procedures implemented by our Legal & Compliance department today enable Bitcoin Suisse to detect these red flag indicators since the Swiss AML framework is designed in a technology neutral way and its principles are applied to virtual assets as well.

In achieving this, multiple components need to play together:

Traditional AML experience and know-how: As most of the red flag indicators need to be seen in the context of other information, traditional AML know-how is crucial to obtain proper client documentation and perform the necessary due diligence.

Specific crypto know-how regarding technology and products: While traditional know-how provides the basics, special cases arise from dealing with virtual assets. This requires the Bitcoin Suisse Legal & Compliance department to understand the underlying technology, protocols, products, and new development to correctly assess the risks associated with transactions and clients.

Supporting tools: Specific tools for blockchain analytics and crypto transaction monitoring allow us to define rulesets which are specifically tailored to the needs and risk appetite of our company.

Interactions with supervisory bodies and authorities: As the FATF also states in the report, a two-way dialogue between public and private sectors enhances the quality and understanding of the red flag indicators. Bitcoin Suisse has the privilege of such dialogue and can benefit from direct interaction with supervisory bodies and other authorities something which is possible in Switzerland.

Organization which is ahead of the curve: Our Legal & Compliance department can benefit from the various experts at Bitcoin Suisse which always keep their pulse on the latest developments. This know-how within the company can then be leveraged in the relevant areas.

On the whole, the latest guidance from the FATF fits well in the context of its overall work with regards to virtual assets. At Bitcoin Suisse, we welcome the latest information from the FATF, knowing that it is very much in line with the approach which we have taken as a company.

Bitcoin Suisse