Enhancing Virtual Asset Licensing and Supervision with Blockchain Intelligence

Virtual assets and their service providers (VASPs) have been under international anti-money laundering (AML) rules for nearly five years. Those tasked with licensing and supervising VASPs continue to seek out the best ways to manage both the risks and opportunities they present.

In this paper we highlight how regulators and supervisors can best leverage blockchain intelligence tools for maximum effectiveness at each stage of their mandate.

What is Blockchain Intelligence and how are regulators using it?

Blockchain intelligence combines raw blockchain transaction data with off-chain threat intelligence to identify links between on-chain entities and indicators of and illicit activity. Armed with these insights, regulators gain a more comprehensive view of a VASP’s risk exposure and are able to make data-driven decisions on whether to grant an authorization or license, to ask for more information during supervision or open an investigation into a potential problem.  

How Blockchain Intelligence Can Support Licensing 

Effective gatekeeping at the authorization or licensing stage requires a holistic view of an entity in order for regulators to corroborate its claims. Blockchain intelligence tools are designed to validate whether activity reported by an entity in its application matches its true on-chain transactions. Some providers, including TRM, go a step further and can be a valuable source of off-chain data too.

TRM’s block explorer tool, for example, surfaces off-chain and on-chain information to provide regulators with data to answer questions critical for licensing, which could include:

• Where is an entity based and who is it serving
• Who is in control of the entity 
• What service is being provided, and 
• How much business is the entity doing

Here we detail how blockchain intelligence tools can provide useful data points in the following areas:

‍Where 

In the borderless world of virtual assets, it can be difficult to determine where an entity is based and which jurisdictions it serves. Blockchain intelligence tools can help by leveraging proprietary methodologies to geolocate different services. At TRM, our methodology for attributing location is based on FATF guidance and relies on data points such as registration lists, location of senior leaders and location of headquarters. Our VASP location data is reassessed on a regular basis. 

It’s also useful to understand where a VASP has other licenses and which fiat currencies it supports, which can provide additional data points on a VASP’s geographic footprint. For example a VASP that submits a license application exclusively in the UK but is found to support the Polish Zloty is likely to be servicing the Polish market, leading the regulator to question why a Polish registration was not listed on the application.

Who

Off-chain sources are typically used to establish the identities of a VASP’s leadership team, including any politically exposed persons (PEPs) or sanctioned individuals. This is important because most jurisdictions will have a fitness and probity threshold for the senior leaders of a VASP. TRM also integrates adverse media checks to further gauge the potential reputational risk of the entity and its principals.

‍What... and how much?

Monitoring which assets are supported by a VASP allows regulators to corroborate a license or authorization application. Blockchain intelligence tools will do this by making off-chain and on-chain assessments of the assets moving between wallets associated with the entity - which is especially important following the development of international standards and other regional regulatory requirements on asset liability.

Regulators frequently ask the following questions of VASPs under their jurisdiction:

• Does the on-chain volume correlate with the numbers in the license application? 
• Do peaks and troughs in volume correlate to known market events? 
• Is the level of risk proportionate to the overall volume?
• If risky activity is occurring, is the entity taking the correct steps to report it and amend controls?

TRM provides consolidated insights into an entity’s volume of transactions, their dollar value, counterparties and any illicit risk exposure. This information is updated in real time as transactions are recorded on blockchain ledgers.

Understanding counterparty exposure is not only important for identifying an entity's exposure to illicit activity, but it may be important in identifying large counterparties which could in fact be nested exchanges, also known as parasite exchanges. Parasite exchanges rely on the architecture of a larger exchange to provide digital assets trading services to users, usually without the knowledge or consent of the host exchange. Such exchanges are as much as 100 times more exposed to illicit funds, according to TRM research. With most parasite exchanges based in Russia and Iran, they are also frequently linked to sanctioned entities.

How Blockchain Intelligence Can Support Ongoing Supervision

Blockchain intelligence has several applications for ongoing supervision, the next stage in the supervisory lifecycle. 

First is the ability to track changes in an entity’s transaction volumes in real time. Regulators can use blockchain intelligence to help determine whether the entity's volumes are consistent with its submitted business plan and its anti-financial crime controls commensurate with the proportion of high-risk transactions it handles. 

Where a regulated entity has heightened risk exposure, the regulator may want to engage with the entity to ensure it is submitting appropriate suspicious activity reports. At that point, those implementing risk-based supervision may decide to dedicate more resources to overseeing that entity.

Ongoing geographic awareness is key. Licensed entities are typically required to seek approval or inform their regulator of new market entries. Regulators will need to ensure that the entities are fulfilling these obligations in a timely and complete manner, so having access to updated entity information via blockchain intelligence tools will be crucial. 

Monitoring the countries an entity serves also matters for sanctions compliance. Blockchain intelligence tools can provide a list of entities they believe are operating within a given jurisdiction based on proprietary research. For example, if an entity adds Ruble support to their asset coverage, it may be transacting with Russian entities - an illegal act under several sanctions regimes.

On an ongoing basis, regulators will also need to keep a close eye on unlicensed entities operating from their jurisdiction. To ensure the integrity of their jurisdiction’s virtual asset sector, such entities must be identified before they potentially harm consumers or the market. Blockchain intelligence tools can identify entities operating in a jurisdiction without an appropriate license.

How Blockchain Intelligence Can Support Enforcement 

Regulators can use blockchain intelligence tools to investigate suspected malfeasance and compile a carefully considered case against an entity. Take the example of an unlicensed business. Once it has been identified by the regulator as operating in their jurisdiction, understanding the entity’s activity, transaction volumes and illicit exposure can help with prioritization of the case. Having its significant persons listed within an entity's profile can help contact to be established. The regulator can then present the case against the entity.

Conclusion 

Blockchain intelligence is an essential tool for gauging an entity or jurisdiction’s exposure to illicit finance risks. It also helps regulators conduct granular, data driven supervisions of individual actors as well as the wider sector. Armed with these insights, supervisors and regulators can work towards achieving a demonstrable level of anti-financial crime effectiveness.

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Want to dig even deeper into how to leverage blockchain intelligence in ongoing supervision? Check out our guide, "Elevating Ongoing AML Supervision."