Crypto Compliance: An Emerging Investment Opportunity


Written by Finalis

Last edited on Sep 11, 2023

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Cryptocurrency regulation is coming as massive growth in the crypto space continues to unfold at a startlingly rapid rate. In 4Q21, the crypto industry breached a global market cap of $3T. Governments have been paying very close attention, preparing to better regulate what has traditionally been something of a “wild west” of an industry.  The impetus for this is the ease of using cryptocurrencies for nefarious ends such as fraud, theft, and money laundering. An estimated $7.7B was lost in 2021 to crypto scams, a huge 81% jump from 2020.

All of this should be exciting for investors. Why? Here’s leading crypto journalist Hannah Miller, from her “Crypto Predictions for 2022” at The Information:

“Crypto compliance startups will gain favor. There’s no doubt that regulators will increase their scrutiny of crypto, and will likely home in on DeFi and decentralized autonomous organizations (DAOs) as well. All of this regulatory attention would be a boon for compliance startups that make it easy for crypto companies to meet the anti-money laundering and know-your-customer requirements common among traditional financial institutions.”

Miller is spot-on. There is now serious potential for businesses offering cryptocurrency regulation and compliance solutions to thrive. This is a new, emerging space – what can we say about it at present? Where should investors be looking? 

The Complicated Nature of Cryptocurrency Regulation

Among the appealing traits of cryptocurrencies are their decentralization and self-regulation. The absence of control and decision-making from a centralized figure means participants are no longer required to place enormous levels of trust in one another. This impedes the  ability of that centralized figure to exercise control or authority. In a decentralized environment, participants enjoy greater and fairer services.

Crypto is here to stay. According to a Mastercard survey, 93% of financial institutions predict that their clients will use cryptocurrencies for both transactions and investments. The same study reported that 40% of consumers based in the Americas, Africa and the Middle East are planning to use digital currencies to make purchases in 2022.

However, the decentralized and self-regulated nature of cryptos, plus its general emphasis on user anonymity, frustrate various regulatory requirements, including Know-Your-Customer (KYC), Customer Identification Procedures (CIP), and Prevention of Money Laundering (PLA) among others.

According to the US Treasury Department, cryptocurrency is already  a “significant detection problem” as it broadly facilitates illegal activities, such as tax evasion. The 2022 Crypto Crime Report from leading crypto firm Chainalysis states that “cryptocurrency-based crime hit a new all-time high in 2021, with illicit addresses receiving $14B over the course of the year, up from $7.8B in 2020.”

In response, the Biden administration made several proposals recently to crack down on cryptocurrency markets and transactions. The cryptocurrency regulation initiative will push for wide regulatory coverage to include “cryptocurrencies and crypto asset exchange accounts and payment service accounts that accept cryptocurrencies.”

European financial institutions are also keen to get the ball rolling with cryptocurrency regulations. The European Union (EU) has already brought forward regulatory proposals for Markets in Crypto-Assets (MiCA). In July 2021, the European Central Bank activated a Digital Euro Project. Both activities indicate that these institutions recognize the potential impact of cryptos in the European market.

In short: regulation is coming. Both individuals and businesses looking to use, trade, and hold cryptocurrencies will need to meet compliance standards if they want to stay on the right side of the law.

The Advent of Crypto Compliance

As an asset class, cryptocurrencies are still in their infancy and almost by default are riddled with crypto compliance issues.

Existing cryptocurrency regulation and rules will likely evolve multiple times before standards are firmly established. “Much like the development of early internet protocols, the vast potential for cryptocurrency applications makes it challenging to automatically apply existing legal frameworks and definitions,” says Alpen Sheth of Mercy Corps Ventures.

To regulate cryptos and ensure compliance from crypto firms, various technologies will be involved. These technologies include blockchain, threat intelligence, advanced analytics, and powerful data visualisations, among others.

As the frameworks emerge, the space for business opportunities will become clearer. 2022 is expected to be a pivotal year for cryptocurrency regulation. The Federal Reserve, Federal Deposit Insurance Corporation (or FDIC), and Office of the Comptroller of the Currency (OCC) recently announced a combined initiative to further clarify the rules and regulations regarding cryptos and the role of banks in crypto trading, investment, and management.

All of this creates a demand for crypto compliance service providers – providers capable of leveraging technologies to help crypto firms adhere to current rules, regulations, and laws regarding cryptocurrency. These solutions will help crypto firms oversee crypto compliance issues, and detect fraud and financial crime.

Recent Crypto Compliance Deals

The crypto compliance market is still nascent. But the following recent activities indicate massive investment potential in the crypto compliance space.

Chainalysis, a blockchain analysis company that offers crypto compliance services, raised $100M in 1Q21. Paradigm led the Series C funding, along with Addition, Ribbit, and TIME Ventures.

In November 2021, Solidus Labs, a New York-based cryptocurrency surveillance and risk-monitoring software developer, raked in a total of $35M of funding from various fintech and crypto firms. The investors included Liberty City Ventures, Exor Seeds and the crypto trading firm GSR.

End-to-end crypto compliance solutions provider Notabene secured $10.2M via Series A funding. F-Prime Capital and Jump Capital both led the round last November 2021.

Hummingbird RegTech received $30M Series B funding back in December 2021. The round was led by Battery Ventures with Flourish, Homebrew, FinVC, and William Hockey participating.

Blockchain intelligence company TRM Labs recently scored $60M in a Series B funding round last December 2021. Finance giants like Visa, Amex Ventures, Citi Ventures, PayPal Ventures, and Block (formerly Square) participated in the round.

These deals are a clear signal: crypto compliance is a dedicated, emerging, and valuable space. Crypto will rise in popularity, right at the moment that legal requirements become clearer and more enforceable. This creates a huge opportunity.

A Vibrant Future

2021 was a breakthrough year for cryptocurrency. However, for those inside the industry, regulation and its associated compliance requirements are a key area of concern. 

“Regulation is probably one of the biggest overhangs in the crypto industry globally,” says Jeffrey Wang, head of the Americas at Amber Group, a Canada-based crypto finance firm. “We would very much welcome clear regulation.”

Market experts are certain of the positive impact crypto compliance solutions providers will have on the industry. The projected effects include the prevention of market manipulation, standardization of select cryptocurrencies, and a deeper understanding of the risks associated with crypto technology.

Experts do not doubt that once the crypto space is made safer for investors and less appealing to cybercriminals, the entire industry will expand exponentially. Once regulations are in place, the expanded expertise between regulatory bodies and financial institutions, enhanced clarity on the sources of crypto funding, and diminished complexity of cryptocurrency and related technologies will empower more players, particularly financial institutions, to get more involved. Crypto compliance firms will be at the forefront of this endeavor. 

Smart money should look to catch this “Mavericks”-class wave.

Sources: EY, TechCrunch, The Information, Bloomberg, World Economic Forum, Finextra

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