Crypto Fraud vs Banks

By: Scott Purcell
Published On: March 27th, 2020

As everyone in crypto knows, it’s really hard to open a bank account. We’ve seen firms like Coinbase hopscotch around the banking industry, opening accounts at Silicon Valley Bank, Barclays and other places only to have the banks compliance departments decide to abruptly close them down.

Why? Two reasons:

  • crypto fraud

  • anti-money laundering (AML) issues

For this blog I’m going to focus on the topic of fraud.

There are now three financial institutions that dominate fiat (money) on-and-offramps for businesses in the blockchain space – Prime Trust, Signature Bank and Silvergate Bank. The large exchanges and OTC desks tend to have accounts and money at all three as a precaution for business continuity.

And the thing is, the fraud problem is pretty easy to fix. (more on that in a minute)

Problem Overview:

We are seeing a continuous, accelerating trend of end customers (meaning the customers of our customers) who send funds, buy Bitcoin (or whatever coin), immediately have the exchange or OTC desk deliver it out to their personal wallet, and then claim the funds were fraudulently sent to the bank in the first place.

  1. In some cases it’s legitimate – hackers have obtained someone’s bank log-on credentials or credit card data and wired, ACH’d or charged credit/debit cards from other peoples accounts.

  2. In other cases, it’s the user who is directly perpetuating the fraud (meaning they are sending their own money from their accounts, but then after they get delivery of the Bitcoin they are calling their bank and claiming fraud even though it really was them…but since Bitcoin is untraceable, there’s no way for their bank to know that).

The result? Losses for the exchanges, for the OTC desks and for the banks.

HOWEVER, more than that, for financial institutions like Prime Trust, Signature and Silvergate, the losses are just part of the risk; we are all subject to oversight and examinations by our respective banking commissioners, we are subject to the rules of the Federal Reserve, of the National Automated Clearinghouse (NACHA), of VISA and Mastercard, and of SWIFT...any of whom could shut us down for too many chargebacks or complaints (especially fraud complaints) and thus literally kill our entire businesses. These are very real, very terrifying risks with the potential for horrific downside outcomes.

Thus even if a bank is willing to stomach the risk of some losses due to fraud chargebacks, it is the very rare banker who’s up for accepting the regulatory, the AML, and the funds-processing-infrastructure risks associated with crypto. Hence only a very few banks in this industry. The biz dev teams at Silicon Valley, Barclays, US Bank and other places may have happily onboarded firms, only to later have their compliance and risk departments slap them down hard. Too much risk, too little upside.

Solution:

Obviously stringent KYC on new accounts is critical. And pretty much all of the big crypto exchanges and desks now have solid programs globally, and some financial institutions such as Prime Trust even offer to do this as compliance-as-a-service. Fine, that’s part of the solution. But the full solution…and I’m about to get heretical for crypto purists…is this:

Stop delivering crypto directly to customers. Require that it remain in custody for the full risk period (or even longer) of the funds-processing mechanisms used to onramp the fiat. Period.

Operational Practice:

For Prime Trust this is easy, since as a trust company we can custody both fiat (money) and crypto. But banks can’t manage this, hence their aversion to retail segregated accounts where the fraud problems can really hurt them. Regardless, we all have exchange and OTC customers who hold their customers crypto directly, so we have to trust them to do the right thing (and usually they have seven-or-eight-figure deposits with us so we know at least our financial losses are covered, even if not our regulatory or funds processing relationship risks).

So to help your financial institution partner manage our very real business risks we need the industry to STOP DELIVERING CRYPTO DIRECTLY TO CUSTOMERS until the funds processing risk periods are closed (a couple of days for wires, 10 days for checks, 60 days for ACH, and 180 days for credit & debit cards).

Trading? Sure, let them buy Bitcoin and happily trade away on your exchange or desk, buying/selling whatever the heck they want in their accounts with you. But don’t permit them to withdraw anything.

Thus in the event of a chargeback your financial risk is market price and not an entire loss. And when fraudsters see they can’t just send funds, buy Bitcoin, withdraw Bitcoin, and then claim fraud on the funds then I believe that this problem will subside. And your financial institutions regulatory and funds-processing risks will subside. Everyone wins.

Cheers,

Scott


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