The decentralised nature of the cryptocurrency market has different interpretations for different actors.
For consumers, it means freedom from third parties like the Central Bank of Nigeria (CBN) and banks, faster transactions, and more convenience. For regulators like the CBN, it means unchartered territory, opacity, and “thin-air” transactions.
But for cryptocurrency exchanges it is a challenge to stay ahead of the game, to ensure criminals who may also have open access to the blockchain don’t take advantage of unsuspecting users and their platforms are constantly secure.
Cryptocurrency related-crimes reached a peak in 2019 according to a report from Chainalysis. But the market has seen a significant drop in 2020 because operators started to tighten up controls that made it unattractive for many criminals to venture into space during the period.
Interestingly, the Nigerian crypto market is considered one of the safest despite being one of the largest trading countries in the world.
Experts alluded to varying degrees of factors as being responsible. First, many cryptocurrency exchanges in Nigeria follow a risk-based approach to customer acquisition in line with international best practices and based on the Financial Action Task Force (FATF) Recommendations and Guidance for Virtual Assets.
This is the first step to becoming a user of exchange and if done wrong could lead to not only an unsatisfied customer but also an unsafe exchange. Some criminals mask as new users to gain entry.
Hence, exchanges carry out specified levels of due diligence for new customers. These may include customers providing Bank Verification Number (BVN) or National Identification Number (NIN) which are verified and compared with data as well as email and phone number confirmations.
Some exchanges also use third-party verification tools to verify government-issued identity documents such as international passports, driver’s licence, voters card, and National ID. These documents can also be compared against the BVN or NIN and a self-portrait photo.
In some cases, exchanges have to carry screening against persons that are politically exposed. There is also comprehensive and ongoing customer risk profiling with higher-risk customers being subject to enhanced due diligence which includes confirmation of source of funds.
A source in one of the exchanges also said that some exchanges rely on Chainalysis, a blockchain monitoring technology services provider, to identify the direct and indirect origin of transactions for all identified addresses and monitor in real-time the exposure of all Nigerian customers on the blockchain. The company is trusted by organisations such as the United Nations Officer on Drugs and Crime (UNODC), Europol, and Barclays Bank, to provide similar services.
Risk identification and management
Exchanges also conduct periodic anti-money laundering (AML) and counter-terrorist financing (CTF) assessments to facilitate the management of risk and this goes into a risk register as is best practice. It is used to identify potential risks in a project or an organisation, sometimes to fulfil regulatory compliance but mostly to stay on top of potential issues that can derail intended outcomes.
The risk register is regularly assessed to help ensure that policies remain up-to-date (meet regulatory requirements) and that procedures are operated as prescribed including regular reviews of information technology (IT) security measures and risk management procedures to ensure efficacy and compliance. These are monitored on an on-going basis and are frequently reviewed and audited (including external audits).
The controls are applied in a tiered system. Exchanges such as Quidax, Binance, Buycoins, Chiji14exchange, Luno, and Naijacrypto run this tiered system that is similar to the guidelines from the CBN to banking and non-banking financial institutions which ensures transactions limits based on the level of KYC (Know-Your-Customer).
Customer conduct or behaviour controls
Exchanges are obliged to report on and remove customers that are strongly suspected or confirmed to have engaged in fraudulent activity. They do this by using state-of-the-art fraud detection capabilities that take into consideration aspects such as account and device behaviour, deposit, and transfer velocity, and sending or receiving exposure.
Also, Luno and Quidax proactively prevent transactions from being processed to cryptocurrency wallet addresses identified by Chainalysis as being associated with illicit activity.
The exchanges and fintech are also planning a local Blacklist of fraudsters as a collaborative effort.
An exchange like Luno prohibits third-party deposits and international deposits on accounts. The exchange requires debit and credit card transactions to follow 3D secure authentication.
3D Secure requires customers to complete an additional verification step with the card issuer when paying. Typically, customers are directed to an authentication page on their page’s website, and they enter a password associated with the card or a code sent to their phone.
Investigation and reporting
Under Nigeria’s AML and CFT regulatory framework, some exchanges go as far as registering as reporting entities and comply with the obligations. Exchanges also work closely with law enforcement, financial and regulatory bodies globally to investigate and prosecute criminal conduct in the industry.
It might be early days but the cryptocurrency market is far from the rowdiness that regulators assume is second nature to it. As Yemi Osinbajo, Vice President of Nigeria, noted on Friday, the regulation of cryptocurrency transactions puts the country in a better position to reap the benefits of the innovations in the market, and businesses in the market may have laid a foundation that could be built upon should the CBN decide it is ready to walk the regulatory rope.