Public service runs in my family. My antecedents served in the military from the American Revolution up until the Cold War. I followed my father, a United States Secret Service agent, into law enforcement.
So it might seem surprising that a few months ago I gave up leadership of transnational criminal investigations at the Department of Homeland Security to join a private sector organization. Or it would if you weren’t aware that the same organization provides tools that help combat crypto criminality, not just in the United States but all over the world.
My decision comes as jurisdictions from the United States to Australia work toward tighter crypto regulation. This is a watershed moment for the blockchain industry, and despite concerns in some quarters that greater oversight will suffocate innovation, it is one that I believe will revitalize growth—but in a healthier, safer form.
Crypto came onto my radar early. In 2012, I was appointed to run the global Homeland Security Investigations financial crimes portfolio, with operational responsibility for probes in the United States and in more than 60 offices in over 40 countries. I was also involved in policy and represented HSI at multi-jurisdiction forums.
From this vantage point, I had a clear view of how much the decade since has altered the relationship between criminals and virtual currencies.
In early 2013, I went with a group of other experts on financial crime subject matter to brief congressional staffers on international narcotics trafficking. During the briefing, we were asked whether we saw the cartels using cryptocurrency to launder criminal proceeds. One of our members immediately answered, “No. Not a threat.”
Back then, investigators believed cartel financiers would not exploit virtual currency because of its complexity and volatility. Fast-forward to today, where they are regularly using cryptocurrency systems to move their ill-gotten gains.
We are in a technological arms race between criminals and investigators. When my father used to investigate financial crimes, he mostly dealt with straightforward counterfeiting and check fraud. Now, technology is evolving so fast that new avenues for malfeasance—money laundering, terrorist financing, ransomware and other scams—are opening every day.
Scams cost. U.S. consumers reported losing more than $1 billion to crypto con artists from January 2021 to March 2022, according to the Federal Trade Commission.
My 13-plus years overseeing federal investigators and analysts trying to keep abreast of new forms of criminality have shown me that as criminals become more and more technologically sophisticated, law enforcement must adopt advanced tools to keep up.
That’s why I decided to join Merkle Science: to help give investigators, regulators and executives the technology they need to fight financial crime.
Merkle Science uses predictive analytics, machine learning and behavioral modeling to proactively surface risks. It also helps Web3 businesses comply with shifting rules, which is vital when jurisdictions around the world are working toward regulating the virtual asset space.
One Goal, Multiple Approaches
The European Union is leading the pack on clarity and speed. In mid-April, the European Parliament passed Markets in Crypto Assets (MiCA), a mammoth piece of legislation that encompasses everything from consumer protections to safeguards against fraud, money laundering and terrorist financing.
MiCA will introduce a single regulatory framework for digital assets across the EU, replacing a hodgepodge of rules in different member states. The aim is to bring clarity and oversight to the digital asset space by regulating the issuance and trading of tokens in a standardized manner.
The U.K. is taking a more pragmatic and phased approach, one that allows for greater innovation and flexibility in the sector. In contrast to the EU’s sweeping legislation, the U.K. plans to focus attention on risks associated with security tokens and certain types of stablecoins. The U.K. is still in the process of consulting the public and the industry on its regulatory framework, but the Financial Conduct Authority and other bodies have sketched out broad outlines.
Hong Kong has also been good at keeping a dialogue going, while the United Arab Emirates has been clear about which bodies will regulate the industry and how.
In the United States, where financial regulation is handled by a patchwork of state and federal regulators, we have seen an enforcement-first approach that has left the industry clamoring for clarity on everything from whether crypto is deemed a commodity or security to specific direction on how to be compliant.
There have been laudable efforts by state regulators such as New York’s Department of Financial Services (NYDFS) to set clear and rigorous standards that address capitalization, cybersecurity protection and anti-money laundering protocols. But many crypto companies are still clamoring for specifics on how they will be policed.
The centralized exchange Coinbase has taken the Securities and Exchange Commission (SEC) to court, demanding explicit guidance. Coinbase has reason to want a window on the rules: In January, it was forced to pay $50 million to the NYDFS for insufficient customer background checks and to commit to investing another $50 million in compliance.
This month, the SEC turned on Coinbase and the world’s largest digital assets exchange, Binance, and sued them for alleged securities law violations, among other accusations. This is the regulator’s most aggressive enforcement action to date, and both companies have vowed to fight back in the courts.
But while the outcry is loudest among bigger players, it is the smaller ones whose survival is most at risk if the low-clarity, high-enforcement climate persists, since they often lack the wherewithal to hire experienced compliance staff or to shoulder the cost of financial penalties.
New Rules, New Realities
Clarity will come and with it a whole new reality for the global crypto sector.
While some countries may take a tougher approach than others, blockchain companies in highly regulated areas are unlikely to escape by moving offshore. A company that wants to retain a U.S. customer base, for instance, will have to adhere to U.S. regulations wherever it is located.
To remain compliant, companies will need to do a full risk assessment and then stay on top of changes. With tools that are customizable to fit each company’s operating jurisdictions, blockchain analytics providers such as Merkle Science can help identify compliance risks early and identify illicit activity before it takes hold.
But while compliance will cost, it also has the potential to substantially benefit the industry. Indeed, I believe the perception that blockchain was an unregulated Wild West has been a major barrier to crypto growth.
Robust regulations will change all that. Institutional investment will surge because banks and big brands will be more comfortable expanding into a properly regulated space, and their participation will spur mainstream Web3 adoption. Ordinary consumers, meanwhile, are certain to be more willing to dip a toe into crypto if they feel protected.
Indeed, compliant financial systems are safer for everyone, blockchain companies included. By using a risk-based approach, predictive analysis and machine-learning tools to identify and halt criminality, crypto projects can help stem the flow of illicit proceeds and defend the financial system—and therefore themselves—from exploitation.
A compliance-first approach is the key to a healthy and thriving blockchain industry and to getting the best of increasingly sophisticated bad actors who don’t have anyone’s best interests at heart, except their own.
Stephenie Lord Eisert is the senior director of law enforcement and regulatory relationships at Merkle Science, a predictive Web3 risk and intelligence platform.
