Introduction:

The recent regulatory shift marked by the SEC’s repeal of Staff Accounting Bulletin (SAB) 121 presents a significant opportunity for financial institutions (FIs) to more confidently expand their services into the realm of cryptocurrency custody. This development allows financial institutions to expand their traditional scope and offer cryptocurrency products. The repeal of SAB 121 allows these entities to take custody of digital assets on behalf of their clients, unlocking new avenues for growth and innovation and expanding the cryptocurrency footprint into traditional finance. However, this expansion into the digital asset space necessitates a comprehensive understanding of the associated risks, particularly concerning the use of cryptocurrency illicit activities. While cryptocurrency has developed into the mainstream and the vast majority of uses are legitimate, cryptocurrency is still a vehicle for money laundering, terrorist financing, fraud and sanctions evasion The scale of these risks is significant, as evidenced by estimations of substantial cryptocurrency transactions linked to illicit purposes. To effectively mitigate these risks and ensure compliance, FIs must adopt robust risk management strategies that incorporate data beyond the blockchain itself.

The Inherent Limitations of On-Chain Analysis:

Blockchain technology, while providing a transparent record of transactions, alone offers limited visibility into the real-world identities and activities of participants. Relying solely on on-chain data can obscure the true nature of transactions and fail to identify connections to illicit activities such as money laundering, terrorist financing, and sanctions evasion. Transactional patterns alone are insufficient to understand the broader context of cryptocurrency usage. This limitation underscores the necessity of supplementing on-chain analysis with a more comprehensive approach. Expanding this visibility is the focus of FraudOptics. FraudOptics utilizes off-chain data to provide greater clarity and insight to on chain transactions, the participants, the beneficial owners and the crypto wallets that are utilized.

The Importance of Off-Chain Data for Effective Risk Mitigation:

To gain a holistic understanding of cryptocurrency risk, FIs must leverage off-chain data. FraudOptics is focused on precisely this conundrum. FraudOptics gathers information from

a wide range of sources, including web3 social platforms, data leaks, code repositories, sanctions lists, and the deep/dark web. By aggregating and analyzing this diverse data, institutions can establish a more complete picture of the entities and activities associated with cryptocurrency transactions.

Off-chain data provides crucial context, revealing connections and affiliations that are not visible on the blockchain. This information can help identify high-risk individuals and entities, detect potential vulnerabilities, and ensure compliance with regulatory requirements. For example, information gleaned from social media can expose associations with sanctioned individuals or groups, while data leaks can reveal compromised credentials and potential security risks. The ability to analyze code repositories can reveal malicious code that could be used for fraudulent activities.

Key Considerations for Cryptocurrency Custody in a Post-SAB 121 Environment:

The repeal of SAB 121 has created a new landscape for cryptocurrency custody, demanding a proactive approach to risk management. FIs should prioritize the following considerations:

• – Enhanced Due Diligence: Implement comprehensive due diligence processes that incorporate both on-chain and off-chain data to assess the risk profiles of clients and counterparties.
  
  
• – Continuous Monitoring: Establish robust monitoring systems that continuously track cryptocurrency transactions and associated off-chain data to detect suspicious activities and emerging risks.
  
  
• – Regulatory Compliance: Ensure compliance with all applicable regulations, including AML, KYC, and sanctions requirements, by leveraging data-driven risk assessment tools.
  
  
• – Custody Security: Implement robust security measures to protect custodied cryptocurrency assets, including multi-signature wallets, cold storage, and regular security audits.
  
  
• – Data Integration: Develop the capability to integrate on-chain and off-chain data from diverse sources to create a unified risk assessment framework.
  
  

Building a Robust Risk Management Framework:

The successful adoption of cryptocurrency custody requires a robust risk management framework that prioritizes data-driven decision-making. FIs should invest in tools and technologies that enable them to effectively collect, analyze, and interpret both on-chain

and off-chain data. This includes leveraging AI and machine learning techniques to identify patterns and anomalies that may indicate illicit activity.

Furthermore, institutions should foster a culture of collaboration and information sharing, both internally and with external partners, to enhance their ability to detect and prevent cryptocurrency-related risks.

Conclusion:

The repeal of SAB 121 presents a significant opportunity for FIs to expand their services into the growing cryptocurrency market. However, this expansion must be accompanied by a comprehensive understanding of the associated risks and a commitment to robust risk management practices. By prioritizing the integration of off-chain data into their risk assessment frameworks, institutions can effectively mitigate the risks associated with cryptocurrency custody and ensure the safe and responsible adoption of digital assets.

FraudOptics Summary

FraudOptics was founded by former FBI/DOJ leaders and expert developers to combat illicit cryptocurrency activities. Our government-grade commercial risk intelligence solution uniquely integrates on-chain and off-chain data to untangle complex connections across blockchain wallets, businesses, and individuals. Using AI-driven analysis and labeling, we have curated a database of 141M+ labeled wallets, 301M+ off-chain tags, and 16M+ on-chain labels. Continuously updated through automation, our datasets provide current and dynamic insights. FraudOptics empowers compliance departments, financial institutions, corporations, exchanges, and government agencies to efficiently detect wallets linked to illicit activities like terrorism financing, fraud, money laundering, ransomware, and sanctions evasion. Our solution enables proactive risk mitigation and regulatory compliance, ensuring stakeholders access the most comprehensive and actionable intelligence available in the cryptocurrency ecosystem.

For additional information contact: Ren McEachern | ren@fraudoptics.com

Disclaimer

Cryptocurrency remains a volatile ecosystem. Customers, purchasers, and participants should fully understand the risks before engaging in the use, investment, purchase or transmission of cryptocurrency.