How Anonymous Is the Purchase of Crypto? Regulations, Practice, Risks

What are the regulations and the practice of crypto anonymity

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, you should conduct your own research when making a decision.

In a worldwide environment where privacy is constantly under threat, purchase of cryptocurrencies is not an exception. In the early stage of this market, as the number of users and exchanges was not significant, the formalities around the identification of the users were not widespread. However, over the course of the years, the situation changed.

Criticisms on the anonymity of many Bitcoin users and the perceived risk that cryptocurrencies were used as a way of money laundering or for other illicit activities, increased the attention of international regulators.

Is crypto anonymous?

During the latest AMA (Ask me anything) meeting, when Bill Gates was asked for his general thoughts on cryptocurrencies, he responded:

“The main feature of cryptocurrencies is their anonymity. I don't think this is a good thing. The [government’s] ability to find money laundering and tax evasion and terrorist funding is a good thing.”

On the other side, Edward Snowden talking about Zcash (cryptocurrency aimed at using cryptography to provide enhanced privacy for its users), defined it as “the most interesting Bitcoin alternative,” adding:

”Bitcoin is great, but if it's not private, it's not safe.”

The proliferation of cryptocurrencies and their constant increase in negotiation volumes has increased the attention of different national and international authorities. As of 31 December 2015, the daily volume of cryptocurrencies trading was $46 mln, whereas during the same day of 2017 this arrived at $12,136 mln (hence representing a 26,283 percent increase)

Image source: Coinmarketcap

Regulations – Government initiatives

United States

In the US exchange platforms have to comply with the Anti-money Laundering (ALA) and Know your customer (KYC) regulations. The ALA/KYC regulations are intended to strengthen the measures to prevent, detect, and prosecute money laundering and the financing of terrorism and require the subjected entities, to establish written customer identification programs, with the aim of:

• obtaining customer identifying information from each customer prior to account opening
• verifying the identity of each customer, within a reasonable time before or after account opening
• making and maintaining a record of information obtained during identity
• verification
• determining within a reasonable time after account opening or earlier whether a customer appears on any list of known or suspected terrorist organizations designated by US Treasury

European Union

In the EU exchange platforms have to comply with the international standards issued by the Financial Action Task Force (FATF), then complemented by national rules. The FATF framework prohibits the subjected entities, from keeping anonymous accounts or accounts in fictitious names. These institutions should be required to undertake customer due diligence measures when:

• establishing business relations
• carrying out occasional transactions above the applicable designated threshold (USD/EUR 15,000)
• there is a suspicion of money laundering or terrorist financing
• the financial institution has doubts about the veracity or adequacy of previously obtained customer identification data

Asia

As many Asian countries are part of the FATF, the established framework also applies to them. South Korea, representing one of the world's biggest Bitcoin exchanges where cryptocurrencies have gained popularity among national investors along the course of the years, has recently banned anonymous trading of cryptocurrencies and requires the subjected entities to verify their customers properly.

A government official of Japan said on March 13, the country will urge its G20 counterparts at the March meeting to beef up efforts to prevent cryptocurrencies from being used for money laundering. The meeting then set a firm deadline to July for providing recommendations on how to regulate cryptocurrencies globally.

Implementation of the regulations

The implementation of these regulations have also been encouraged by the International Monetary Fund, whose head Christine Lagarde recognizes the potential of the Blockchain technology and praises the work of FATF as “useful guidance to countries on how to deal with cryptocurrencies and other electronic assets.”

Today, exchange platforms all around the world have to put in place procedures in order to be compliant with ALA/KYC regulations, hence requiring new clients to go through an identity verification process.

Coinbase, a digital currency wallet and platform where merchants and consumers can transact with new digital currencies like Bitcoin, Ethereum, and Litecoin, requires new clients to go through an identity verification process.

In some instances, different stages of verifications are required, based on the services used by the clients. Kraken a San Francisco-based company, founded in 2011, requires different stages of verifications, that change based on the services used by the clients. The steps go from Tier 0, where the client can look around but can't deposit, withdraw or make any trades, and where only the email address is required, to Tier 4 where the clients are required to upload a valid Government ID, a recent proof of residence, a signed application form and KYC documents.

Trading anonymously still possible

Despite the efforts of regulators anonymous trading is still possible, mainly through:

1) peer to peer trading platforms that allow users to trade Bitcoins for traditional currencies through person-to-person trades.

For example, Localbitcoins is a platform where users post advertisements where they state exchange rate and payment methods for buying or selling Bitcoins. An interested buyer replies to these advertisements and agrees to meet the person to buy Bitcoins with cash, or trade directly with online banking.

2) decentralized exchanges built into Bitcoin wallets that help to arrange local trades between buyers and sellers. For example, Mycelium Local Trader help arrange the trade between buyers and sellers, manage the transaction, and calculate reputation ratings based on the trades.

These platforms don’t require ID verification or any personal information besides an email address to sign up.

In addition to online platforms, Bitcoin ATMs allow a person to exchange Bitcoins and cash. Some Bitcoin ATMs offer bi-directional functionality enabling both the purchase of Bitcoin as well as the redemption of Bitcoin for cash. Another functionality is the possibility to send cash-to-cash payments to other people resident in different countries by using two Bitcoin ATMs. The diffusion of these machines is today very capillary as they can be found in more than 65 countries, in the main important cities.

Risks and correlation between ease of purchase and anonymity

Anonymous trading comes at risks. The first one could be related to the use of cash for settling the transactions through peer-to-peer platforms. The direct exchange of cash between unknown buyers and sellers poses security risks, which the feedback system of the users only partially mitigated.

The second risk is related to scams. The absence of a central entity that functions as a market settler, may not guarantee the two parties that the transactions will be successfully finalized. LocalBitcoins has a forum dedicated to this issue where suspected users are constantly signaled to the community.

The third risk could be connected the tightening of the regulatory framework around the cryptocurrencies. On Feb. 23, the Financial Action Task Force announced that it “will step up its efforts in the understanding of the misuse and risk of virtual currencies.” After that, on March 7, the SEC required that platforms trading digital assets to register with the agency.

Decentralized regulation

As the trading of cryptocurrencies is still at an initial stage, the rules around identifications of the users are not uniforms and some countries are stricter than others. The US and the EU are front-lining the regulatory environment, requiring the exchange platforms to be compliant with the AML/KYC regulations.  

Peer-to-peer transactions and the use of ATM services still allow, with some risks, interested users to transact without disclosing their personal information.

International prosecutors are also catching up the cryptocurrency environment. As Ryan Schoen, senior financial services policy analyst at Washington Analysis said:

"I think the next step here will likely be subpoenas to exchanges if they haven't already started."

As a result, in the short term, it could be expected that national and international authorities would strengthen further the regulatory framework around exchange platforms and cryptocurrencies trading.