Who is the Wolfsberg Group?
The Wolfsberg Group (the Group) is an alliance of 13 global banks formed in 2000 to develop anti-money laundering and counter-terrorist financing guidelines. Its members collaborate on creating industry standards and best practices for Financial Institutions (FIs) to prevent financial crimes. The Group also works with international regulators to promote global compliance. The Group has recently come out with a paper spelling out FAQs on Digital Assets (the Paper).
Digital Assets: A New Era of Finance
Digital assets have emerged as a transformative force in the financial landscape. These cryptographically secured digital representations of value or rights can be traded, exchanged and used for various purposes, including payments and investments.
Digital assets are cryptographically secured representations of value or rights, often relying on distributed ledger technology or cryptography. These assets can be transferred, traded or exchanged and may be used for payment or investment purposes. Examples of digital assets include virtual assets, virtual currencies, non-fungible tokens (NFTs) of value, payment tokens and digital securities. Virtual assets and virtual currencies are subcategories of digital assets, with virtual currencies also referred to as cryptocurrencies or convertible virtual currencies. In the Singapore context, these are defined as “Digital Payment Tokens”.
The scope of digital assets in the Paper includes virtual assets such as stablecoins and certain NFTs of value, central bank digital currencies (CBDCs) and digital securities, among others. However, the scope excludes electronic money forms like prepaid cards and other tokenised instruments, unless they fall into the categories mentioned above. CBDCs are considered digital assets, regardless of their issuance by central banks or whether they use Distributed Ledger Technology (DLT), because they present growing risks related to money laundering and terrorist financing (ML/TF).
According to the Paper, NFTs which retain value over time due to collectability or tradability, are considered digital assets as well. However, NFTs that do not hold value, such as those used solely for event access or limited virtual goods, are excluded. The Group sees NFTs of value as a potential risk for ML/TF, similar to other digital assets and FIs should thoroughly assess these assets before accepting them/funds derived from their sale. Furthermore, stored-value fungible digital assets, which are not DLT-based or issued by central banks, are also classified as digital assets.
In summary, digital assets encompass a broad range of digital representations, from virtual currencies to NFTs of value, all with potential financial risks, particularly related to ML/TF.
Architecture of Digital Assets
Digital assets are typically built on DLT, with Layer 1 (L1) protocols forming the base network where native tokens are created. These tokens can be used for value storage, transactions and incentivising network security. Layer 2 (L2) protocols, such as rollups and bridges, enhance scalability by processing transactions independently from the L1 network, improving speed and throughput without compromising security. Tokenisation refers to creating digital representations of assets on a blockchain, which can include both physical and digital assets. L2 protocols can sometimes present distinct challenges for applying ML/TF transaction monitoring controls due to the additional degree of separation from the L1 blockchain.
Smart contracts, which are automated protocols that execute transactions without third-party involvement, play a significant role in facilitating these digital asset transactions. These technologies contribute to the ongoing evolution and complexity of the digital asset landscape. Having said that, digital assets and their underlying technologies, coupled with the anonymity offered by some platforms, creates opportunities for ML/TF activities.
Digital Assets as a Product or Service
There are a broad range of products, services and delivery channels involving digital assets, as well as the roles of custodians, i.e. entities that safeguard digital assets or private keys on behalf of customers, and the potential risks associated with peer-to-peer transactions.
Some Types of Digital Assets
A) Stablecoins
A stablecoin is a digital asset designed to maintain a stable value, usually pegged to fiat currency or a basket of assets. It can be used for payments or as a store of value.
There are other stablecoin types, which may be backed by commodities or digital assets and sometimes use algorithms to stabilise their value1.
The Group highlights that fiat-backed stablecoins generally present lower ML/TF risks, while “other stablecoins” may have higher risks due to inconsistent regulations and reserve requirements.
B) Anonymity-Enhanced Cryptocurrency
An Anonymity-Enhanced Cryptocurrency (AEC) or privacy coin, ensures that transactions are untraceable and cannot be linked on the blockchain, protecting users’ anonymity. This lack of transparency increases risks related to ML/TF. Some AECs are built with privacy features, while others gain privacy through added protocols.
AECs use techniques like zero-knowledge technology, stealth addresses, ring signatures and mixers to maintain privacy.
A privacy enhancer is a protocol or software that improves user anonymity and financial privacy. It can be implemented as native tokens, hard forks, soft forks or extension blocks. These enhancers also apply to NFTs adding to ML/TF risks.
A mixer conceals transaction origins by pooling and redistributing digital assets across multiple wallets or chains. While similar to AECs in privacy concerns, mixers are separate services used as a means to potentially obscure source of crypto-funds.
Both AECs and mixers pose significant ML/TF risks due to their ability to facilitate anonymous transactions and hinder regulatory scrutiny.
C) Security Tokens
A native security token is issued and custodied on a distributed ledger and meets the legal definition of security or financial instrument under local securities law.
Industry Stakeholders
As per the Paper, the role of digital asset industry participants is essential for appropriate ML/TF risk management. The Group proposes 2 main categories of digital asset participants:
- Digital Asset Service Providers (DASPs): Entities that facilitate the exchange, transfer, or custody of digital assets, including platforms for exchanging between fiat and digital currencies, custodians and brokers. DASPs are divided into centralised (CeFi) and decentralised (DeFi) categories based on governance. CeFi is managed by a central entity, while DeFi operates through smart contracts and algorithms without central control.
- Digital Asset Supply Chain Operators (DASCOs): These include entities involved in the creation and development of digital asset services, such as miners, non-custodial wallet providers and developers of protocols for DASPs. DASCOs typically present lower ML/TF risks than DASPs due to their limited scope of activities.
Nonetheless, both DASPs and DASCOs can be exploited for ML/TF purposes. For instance, DASPs can be used to launder illicit proceeds through the exchange of cryptocurrencies, while DASCOs can develop tools and infrastructure that facilitate anonymous transactions.
Investors in DASPs and DASCOs play a significant role in how governance tokens in decentralised systems may equate to ownership stakes, influencing their operations and protocols. It emphasises the need for FIs to recognise when a customer relationship is established with DASPs and DASCOs, particularly when providing services like liquidity or correspondent banking.
A FI’s customer relationship is established with DASPs and DASCOs when access to fiat products, fiat liquidity or traditional financial services are provided.
Conclusion
Generally, conventional assets pose a lower ML/TF risk compared to digital assets. However, aligning definitions and understanding these classifications are essential for effective risk management as the digital asset landscape evolves. Implementing robust controls and maintaining compliance with global standards based on the size and complexity of your business is imperative. While the potential for ML/TF risks associated with digital assets is a concern, the benefits they offer in terms of financial inclusion, efficiency and innovation make it increasingly difficult to ignore their integration into the modern financial system.
What does this mean for you?
Adherence to evolving regulatory standards is essential for preserving your business’ compliance and reputational integrity.
Our experienced Singapore team at Curia Regis can help with your queries relating to Digital Assets. We offer complete support in compliance, specifically tailored to your business model and complexity. We’ll help you understand and fulfil your obligations to MAS, and in accordance to the greater global standards as these become more comprehensive.
Want to learn more? Contact us at [email protected] or follow our LinkedIn page at https://uk.linkedin.com/company/curiaregis for the latest regulatory updates.
- The collapse of the Luna token was caused by its link to Terra, an algorithmically-driven stablecoin. ↩︎
