virtual currencies presentation at acc's 5th annual financial crimes conference in abu dhabi,...
DESCRIPTION
This pioneering seminar attempted to elucidate the rise, purpose, operational intricacies, societal benefits and multiple risks of Bitcoin and the emerging breed of alternative digital currencies. For the first time in history, Bitcoin allows individual consumers to make payments and move funds securely, completely outside of the traditional financial system. In recent months, there has been a lot of hype about the risk of virtual currencies, but not much explanation about how they work and what the real risks and also societal benefits are. In this session, regulators, executives and risk managers had the opportunity to learn how Bitcoin and other digital currencies work, what the true risks are and what can be done to both manage the risks and exploit the opportunities.TRANSCRIPT
Virtual Currencies, Cyber-Payments and
Regulatory Compliance
ACC 5th Annual International ConferenceAbu Dhabi, November 26 , 2013
by Juan Llanos, CAMS
Adult population with NO USE OF formal or semiformal FINANCIAL SERVICES
© 2013 JuanLlanos
2/3 of adults (17 million) | 25% of GNP | 40,000 agents
© 2013 JuanLlanos
M-PESA Swahili for mobile money
© 2013 JuanLlanos
Agenda1. Bitcoin & Math-Based Currencies
What Bitcoin is and why it’s revolutionary
2. Risk Identification & Mitigation
a) Inventory of challenges
b) Mitigating AML risk
c) Customer identification and authentication (de-anonymization)
3. SA Detection via Monitoring and Analysis
Leveraging the blockchain
4. Unsolicited (contrarian) advice
© 2013 JuanLlanos
Agenda1. Bitcoin & Math-Based Currencies
What Bitcoin is and why it’s revolutionary
2. Risk Identification & Mitigation
a) Inventory of challenges
b) Mitigating AML risk
c) Customer identification and authentication (de-anonymization)
3. SA Detection via Monitoring and Analysis
Leveraging the blockchain
4. Unsolicited (contrarian) advice
© 2013 JuanLlanos
Think of Bitcoin as a numbered Swiss bank account living on your smartphone.
[…] retail and online purchases can be made with virtually no transaction fees. It's the ultimate bank debit card, except there's no card –or bank for that matter.
Robert Berry
© 2013 JuanLlanos
Intro Video 2
What is ?
Intro Video 1
© 2013 JuanLlanos
D I G I TA L PAY M E N T S N E T W O R KD I G I TA L M O N E Y
P R O T O C O L
© 2013 JuanLlanos
INSTANTANEOUSSECURE
LOW COSTGLOBAL TRANSFER OF VALUE
D I G I TA L PAY M E N T S N E T W O R K
© 2013 JuanLlanos
D I G I TA L M O N E Y
TRANSACTIONS IN “BITCOINS”DOLLAR VALUE OPEN MARKET
COUNTERFEIT-PROOF “ONLINE CASH”TOTAL CAPPED INFLATION-PROOF
© 2013 JuanLlanos
“bitcoins”
© 2013 JuanLlanos
SCARCE Central Banks can’t inflate themDURABLE they don’t degradePORTABLE can be carried and transmitted electronically or as numbers in your headDIVISIBLE into trillionthsVERIFIABLE through everyone’s block chainEASY TO STORE paper or electronicFUNGIBLE each bitcoin is equalDIFFICULT TO COUNTERFEIT cryptographically impossible
Naval Ravikant
P R O T O C O L
APPLICATIONS BEYOND PAYMENTS SECURE CONTRACTS, ESCROW, TAMPER-PROOF VOTING, NOTARY SERVICES, ETC.
P L AT F O R M F O R I N N O V AT I O N
© 2013 JuanLlanos
© 2013 JuanLlanos
• Contracts can be entered into, verified, and enforced completely electronically, using any third-party that you care to trust, or by the code itself. For free, within minutes, without possibility of forgery or revocation.
• Any competent programmer has an API to cash, payments, escrow, wills, notaries, lotteries, dividends, micropayments, subscriptions, crowdfunding, and more.
• While the traditional banks and credit card companies lock down access to their payments infrastructure to a handful of trusted parties, Bitcoin is open to all.
P L AT F O R M F O R I N N O V AT I O N
Naval Ravikant
ECO-SYSTEM
© 2013 JuanLlanos
K e v i n R o s e
P a u l G r a h a m W i n k l e v o s s T w i n s
A l G o r e N a s s i m N . Ta l e b
A s h t o n K u t c h e r
CENTRALIZED DISTRIBUTED
D I S T R I B U T E D | D E C E N T R A L I Z E D
© 2013 JuanLlanos
PEER
PEERPEER
PEER PEER
PEER
PEER
PEER
PEER
PEER
PEERPEER
PEERPEER
PEER
PEER
PEER
PEER
PEER
PEER
PEER
PEER
PEER
PEER
PEER PEER
PEER
PEER
PEER
PEER
PEER
PEER
PEERNO central authority or fi nancial insti tuti on in control
M AT H - E N F O R C E D T R U S T
PEER PEERPEER
PEER
© 2013 JuanLlanos
Payment + identi ty
© 2013 JuanLlanos
PAY M E N T & I D E N T I T Y S E PA R AT E D
CONSUMER PRIVACY PROTECTEDMERCHANTNO CHARGEBACKS / FRAUD
Payment only
© 2013 JuanLlanos
T R A N S PA R E N C Y
Every transacti on that has ever occurred in the history of the bitcoin economy is publicly viewable in the BLOCK CHAIN.
Privacy without anonymity pseudonymity
© 2013 JuanLlanos
Agenda1. Bitcoin & Math-Based Currencies
What Bitcoin is and why it’s revolutionary
2. Risk Identification & Mitigation
a) Inventory of challenges
b) Mitigating AML risk
c) Customer identification and authentication (de-anonymization)
3. SA Detection via Monitoring and Analysis
Leveraging the blockchain
4. Unsolicited (contrarian) advice
© 2013 JuanLlanos
“ V i r t u a l c u r r e n c i e s p r o m i s e t o b e n e fi t c o m m e r c e o n
m a n y l e v e l s , f r o m s e r v i n g t h e u n b a n ke d t o n e w fi n a n c i a l p r o d u c t s . I
c h a l l e n g e o u r i n n o v a t o r s : d e v i s e c r e a ti v e s o l u ti o n s t o
p r e v e n t v i r t u a l c u r r e n c y a b u s e .”
F i n C E N D i r e c t o r J e n n i f e r S h a s k y C a l v e r y
© 2013 JuanLlanos
R E G U L AT I O NT R A N S PA R E N C Y/ P R I VA C Y
S P E C U L AT I O NS E C U R I T Y
D I S R U P T I O N O F S TAT U S Q U O
CHALLENGES
© 2013 JuanLlanos
Before March 18, 2013
© 2013 JuanLlanos
The Criminal Precedent that Could Curb Bitcoin ’s Enthusiasm
E-Gold
© 2013 JuanLlanos
• ISSUER OF DIGITAL CURRENCY• a medium of exchange offered over the Internet• Global acceptance without the need for conversion between national
currencies
• USED FOR ONLINE COMMERCE AND FOR FUNDS TRANSFERS BETWEEN INDIVIDUALS
• FOUR PRIMARY STEPS1. Opening a digital currency account2. Converting national currency into “e-gold” to fund the account3. Using “e-gold” to buy a good or service or transfer funds to another person4. Exchanging “e-gold” back into national currency
• PARTIES NEEDED:• Digital currency exchanges• Merchants or individuals that accepted “e-gold”
• ABILITY TO OPERATE ACCOUNTS ANONYMOUSLY• Highly-favored method of payment by operators of “get-rich-quick” scams
• ALL TRANSFERS OF “E-GOLD” WERE IRREVOCABLE AND IRREVERSIBLE
© 2013 JuanLlanos
E-Gold2008-07 Guilty Plea
• Conspiracy To Launder Monetary Instruments (federal)• Conspiracy To Commit The Offense Against The United States (federal)• Operating Of Unlicensed Money Transmitting Business (federal)• Transmitting Money Without A License (District of Columbia)
“ T h e r o o t c a u s e s o f E - G o l d ’s fa i l u r e w e r e d e s i g n fl a w s i n t h e a c c o u n t c r e a ti o n a n d p r o v i s i o n i n g l o g i c t h a t
l e d t o t h e u n fo r t u n a t e c o n s e q u e n c e o f v u l n e ra b i l i t y t o c r i m i n a l a b u s e .
“ We a c k n o w l e d g e t h a t E- G o l d i s i n d e e d a fi n a n c i a l i n s ti t u ti o n o r a g e n c y a s d e fi n e d i n U S l a w a n d s h o u l d
b e r e g u l a t e d a s a fi n a n c i a l i n s ti t u ti o n .”Douglas Jackson, E-Gold Founder
March 18, 2013
© 2013 JuanLlanos
FinCEN Guidance FIN-2013-G001
© 2013 JuanLlanos
FinCEN Guidance FIN-2013-G001• “Interpretive Guidance” not new rule-making • Centralized vs. Decentralized virtual currencies• Virtual Currency Actors:
• USER a person that obtains virtual currency to purchase goods or services.
• EXCHANGER a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.
• ADMINISTRATOR a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.
FinCEN Guidance FIN-2013-G001
© 2013 JuanLlanos
• “An administrator or exchanger that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations […]”
• “Under FinCEN’s regulations, sending “value that substitutes for currency” to another person or to another location constitutes money transmission, unless a limitation to or exemption from the definition applies. This circumstance constitutes transmission to another location, namely from the user’s account at one location (e.g., a user’s real currency account at a bank) to the user’s convertible virtual currency account with the administrator.”
• “To the extent that the convertible virtual currency is generally understood as a substitute for real currencies, transmitting the convertible virtual currency at the direction and for the benefit of the user constitutes money transmission on the part of the exchanger.”
• “[…] a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.”
© 2013 JuanLlanos
FinCEN Guidance FIN-2013-G001• Currency definitions:
• REAL CURRENCY the coin and paper money of the United States or of any other country that [i] is designated as legal tender and that [ii] circulates and [iii] is customarily used and accepted as a medium of exchange in the country of issuance.
• VIRTUAL CURRENCY medium of exchange that operates like currency in some environments, but does not have all the attributes of real currency; no legal tender status in any jurisdiction.
• CONVERTIBLE VIRTUAL CURRENCY either has an equivalent value in real currency, or acts as a substitute for real currency.
© 2013 JuanLlanos
FinCEN Guidance FIN-2013-G001• PROBLEM #1 ALL USERS? How does the law apply if one
obtains bitcoins not to purchase goods or services? Reasons:1. speculation that the price of bitcoins will go up 2. simply because one trusts a virtual currency’s stability more than that of a
particular “real currency” (think of Argentina or Zimbabwe), or 3. because one wants to make a remittance to a family member overseas.
• PROBLEM #2 MINERS?• If mine and buy goods users• If mine and sell bitcoins money transmitters. Why?
• Not transmitting bitcoins from one party to another (only 2 parties to the transaction)
• No consumer to protect and no potential for money laundering
• PROBLEM #3 NEW LAW IN THE GUIDANCE?• Definitions of “virtual currency” and “convertible virtual currency” only in
this guidance.
After March 18, 2013
© 2013 JuanLlanos
The End of Bitcoin as We Know It
© 2013 JuanLlanos
Liberty Reserve• alternative digital payment network• “Closed look” centralized virtual currency (LR
dollars)• shut down and its management indicted and
arrested in May 2013.• “the largest money laundering case in U.S.
history”• a convenient tool for foreign currency brokers,
as it allowed them to bypass local legislation and avoid exchange rate fluctuations
• “a shadowy netherworld of cyber-finance”• its realm of anonymity made it a popular hub
for fraudsters, hackers and traffickers
© 2013 JuanLlanos
Liberty Reserve Indictment[x] ANONYMITY product has to dissuade the bad element, never attract it.
• “deliberately attracting, and maintaining a customer base of criminals by making financial activity on LR anonymous and untraceable.”
• “designed so that criminals could effect financial transactions under multiple layers of anonymity and thereby avoid apprehension by law enforcement.”
[y] COMPLIANCE product and operations cannot be in violation of any applicable laws and regulations (the “form” or “paper” side of compliance).
• “was not registered as a money transmitting business with FinCEN”• “operated an unlicensed money transmitting business.”
[z] SUBSTANCE what is written in their policy must actually be implemented. Businesses must be run with integrity, responsibility and control.
• “intentionally creating, structuring, and operating LR as a criminal business venture, one designed to help criminals conduct illegal transactions and launder the proceeds of their crimes.”
• “lying to anti-money laundering authorities in Costa Rica, pretending to shut down LR after learning the company was being investigated by US law enforcement (only to continue operating the business through a set of shell companies)”
• “created a system to feign compliance with anti-money laundering procedures, […] including a ‘fake’ portal that was manipulated to hide data that LR did not want regulators to see.”
Money transmittersand their agents are perceived as
HIGH RISK of• ABUSE TO CONSUMER• MONEY LAUNDERING• TERRORIST FINANCING
Money transmission = highly regulated industry
© 2013 JuanLlanos
Money Transmitter Regulation (US)
© 2013 JuanLlanos
Focus AML/BSA + State Compliance
Main Risk Areas Main Statutes and RegsAnti-Money Laundering BSA, USA PATRIOT Act, Money
Laundering Acts
Anti-Terrorism Financing (CFT) USA PATRIOT Act, OFACPrivacy and Information
SecurityGramm-Leach-Bliley
Safety and soundness State (via licensing)Consumer protection State (via licensing) + Dodd-Frank /
Regulation E (CFPB)
Operational Customer (Sender & Recipient)
Foreign Counterparty
Agent (B&M, online)
MT Risks
Money Transmitter Risk Fronts
© 2013 JuanLlanos
© 2013 JuanLlanos
RISKS MITIGATORS Complicity with agent or foreign
counterparty
Complicity with recipient (or sender)
‘Drip-irrigation’ transfer of illicit funds (O2M recipients, M2O recipient, M2M recipients)
Intra-company structuring
Inter-company structuring (‘smurfing’)
Terrorist financing
Customer acceptance, monitoring and termination protocols
Transaction & behavior monitoring
Lower identity verification thresholds at origin and destination
For cards, maximum loadable amounts, expiration date, and limited number of recipients.
Redundant identity verification procedures at destination
POS training
OFAC screening
Eventually, intercompany transaction monitoring by highly-professional and secure clearing house. This is the only possible antidote against ‘smurfing’.
Customer Risks and Mitigators
© 2013 JuanLlanos
* AML Program Elements (Section 352 of the USA PATRIOT Act)
1. A designated compliance officer + professional team 2. Written policies and procedures + operational controls:
• Licensing, renewal and reporting procedures (S)• Registration, record-keeping and report-filing procedures (F)• KY (Know Your…) Subprograms: Acceptance, monitoring, correction and
termination• KY…Customer• KY…Agent• KY…Foreign Counterparty• KY…Employee• KY…Vendor
• Monitoring, analysis and investigating procedures• OFAC compliance program• Response to official information requests• Privacy and information security protection protocols
3. An on-going training program • Risk & Compliance Committee
4. An independent compliance auditing function
Corporate Safeguards*
© 2013 JuanLlanos
Key Elements of a BSA/AML Program• State Compliance: Licensing, renewal and reporting
procedures // Consumer protection disclosures, etc.• Federal Compliance: Registration, record-keeping and report-
filing procedures (F)• KY (Know Your…) Subprograms: Acceptance, monitoring,
correction and termination (Life-Cycle Management)• KY…Customer• KY…Agent• KY…Foreign Correspondent or Counterparty• KY…Employee• KY…Vendor
• SA Detection: Monitoring, analysis and investigating procedures
• Information Sharing: Response to information requests• OFAC Compliance Program• Privacy and information security protection protocols (GLBA)
© 2013 JuanLlanos
Product Safeguards• Anonymous identification• No value limits• Anonymous funding• No transaction records• Wide geographical use• No usage limits
Cash features
Anything we do to
counter these
will mitigate the
risk of our
product!
© 2013 JuanLlanos
Customer Identification
© 2013 JuanLlanos
Non-Face to Face Card not present standards
NON-DOCUMENTARY Independently verifying the customer’s identity through the comparison of information provided by the customer with information obtained from a consumer reporting agency, public database, or other source• contacting a customer• checking references or obtaining a financial statement
DOCUMENTARY Review an unexpired government-issued form of identification from most customers. • evidence of a customer’s nationality or residence • photograph or similar safeguard• form a reasonable belief that of the true identity of the customer. • E.g.: driver’s license (U.S.) or passport.
Authentication StrengthMultifactor authentication:
• Something the user knows (e.g., password, PIN)• Something the user has (e.g., ATM card, smart card)• Something the user is (e.g., biometric feature)
Authentication methods:• Shared secrets• Tokens (smart card, one-time password generating
device)• Biometrics (fingerprint, face, voice, keystroke
recognition) • Out-of-band authentication• Internet protocol address (IPA) location and geo-location• Mutual identification
Source: FFIEC
© 2013 JuanLlanos
Agenda1. Bitcoin & Math-Based Currencies
What Bitcoin is and why it’s revolutionary
2. Risk Identification & Mitigation
a) Inventory of challenges
b) Mitigating AML risk
c) Customer identification and authentication (de-anonymization)
3. SA Detection via Monitoring and Analysis
Leveraging the blockchain
4. Unsolicited (contrarian) advice
© 2013 JuanLlanos
“What customers do speaks so loudly that
I cannot hear what they’re saying.”
(Paraphrasing Ralph Waldo Emerson)
Customer identification vs. customer knowledge
B E H AV I O R A L A N A LY T I C S © 2013 JuanLlanos
© 2013 Juan Llanos
Machine Learning (AI) MethodsSUPERVISED LEARNING: relies on two labeled classes (good vs. bad)
Goal Detect known suspicious patterns1. Training set:
a. Select dataset with clean and dirty cases.b. Classification algorithm to discriminate between the two
classes (finds the rules or conditions)c. Probabilities of class 1 and class 2 assignment
2. Run discrimination method on all future purchases.
UNSUPERVISED LEARNING: no class labelsGoal Detect anomalies
3. Takes recent purchase history and summarize in descriptive statistics.
4. Measure whether selected variables exceed a certain threshold. (deviations from the norm)
5. Sounds alarm and records a high score.© 2013 JuanLlanos
• Structuring (Many-to-one)• High amounts • High frequency• Use of multiple locations • Use of multiple identities• Use of untrusted device• Values just below threshold• Immediate withdrawals
Known Suspicious Behaviors
© 2013 JuanLlanos
Sample Entity Pair Concentration
Analysis
© 2013 JuanLlanos
Sample Geographical Concentration (“heat”) Map
© 2013 JuanLlanos
• The entire history of Bitcoin transactions is publicly available.
• “Using an appropriate network representation, it is possible to associate many public-keys with each other, and with external identifying information.”
• “Large centralized services such as the exchanges and wallet services are capable of identifying and tracking considerable portions of user activity.”
An Analysis of Anonymity in the Bitcoin System - Bitcoin is Not Anonymous
by Fergal Reid and Martin Harrigan (2011)
Link: http://anonymity-in-bitcoin.blogspot.com/2011/07/bitcoin-is-not-anonymous.html
© 2013 JuanLlanos
• The victim woke up on the morning of 13/06/2011 to find a large portion of his Bitcoins sent to1KPTdMb6p7H3YCwsyFqrEmKGmsHqe1Q3jg.
• The alleged theft occurred on 13/06/2011 at 16:52:23 UTC shortly after somebody broke into the victim's Slush pool account and changed the payout address to 15iUDqk6nLmav3B1xUHPQivDpfMruVsu9f.
• The Bitcoins rightfully belong to1J18yk7D353z3gRVcdbS7PV5Q8h5w6oWWG.© 2013 JuanLlanos
© 2013 JuanLlanos
Bitcoin
Anonymous
Untraceable
“Invisible to law enforcement and the taxman”
© 2013 JuanLlanos
Myths
© 2013 JuanLlanos
Resources• Bitcoin Educational Resources:
http://www.forbes.com/sites/jonmatonis/2013/05/13/6-new-bitcoin-educational-resources/
• Bitcoin Education Project (Udemy): https://www.udemy.com/bitcoin-or-how-i-learned-to-stop-worrying-and-love-crypto/
• Bitcoin Primer for Policymakers: http://mercatus.org/sites/default/files/Brito_BitcoinPrimer_embargoed.pdf
• Bitcoin Wiki: https://en.bitcoin.it/wiki/Main_Page
• Cato Unbound-The Private Digital Economy: http://www.cato-unbound.org/issues/july-2013/private-digital-economy
• CoinDesk: http://www.coindesk.com/
• Contrarian Compliance: http://contrariancompliance.com/
• Let’s Talk Bitcoin: http://letstalkbitcoin.com/
• Khan Academy Bitcoin Series: https://www.khanacademy.org/economics-finance-domain/core-finance/money-and-banking/bitcoin/v/bitcoin-what-is-it
• We Use Coins: https://www.weusecoins.com/en/
Agenda1. Bitcoin & Math-Based Currencies
What Bitcoin is and why it’s revolutionary
2. Risk Identification & Mitigation
a) Inventory of challenges
b) Mitigating AML risk
c) Customer identification and authentication (de-anonymization)
3. SA Detection via Monitoring and Analysis
Leveraging the blockchain
4. Unsolicited (contrarian) advice
© 2013 JuanLlanos
• Prevention trumps damage control• Risk MGT Both reducing downside and
increasing upside• Simplicity and common sense• Train for behavior change, not theoretical
knowledge• Form-substance continuum substance• Letter-spirit continuum focus on spirit
(underlying purpose and values) facilitates• Operational synergies (leveraging tech)• Compliance without compromising performance• Flexibility and sustainability
© 2013 JuanLlanos
What i f…?
© 2013 JuanLlanos
Adult population with NO USE OF formal or semiformal FINANCIAL SERVICES
© 2013 JuanLlanos
BRAZILCUBA
CYPRUSVENEZUELAZIMBABWE
Etc., Etc…© 2013 JuanLlanos
© 2013 JuanLlanos
Underground Economy
© 2013 JuanLlanos
“If you haven't heard of BITCOIN, drop what you're
doing and go research it, for it is THE MOST
IMPORTANT PROJECT ON THE PLANET.”
Erik Voorhees
© 2013 Juan Llanos
Juan LlanosEVP & Compliance OfficerUnidos Financial Services, Inc.275 Seventh Ave. - 20th FloorNew York, NY 10001Direct: (646) 485-2264Mobile: (646) 201-6217Email: [email protected]
LinkedIn: www.linkedin.com/in/juanllanosTwitter: @JuanLlanosBlog: contrariancompliance.com
Thank you!