Coinbase, the world’s most centralised decentralised crypto exchange/wallet broker/dealer, revealed in April that it had partnered with Paysafe and Visa to bring customers a crypto-funded card in the UK.
This was big news in the world of crypto.
Many outfits have in the past tried to launch cryptocards before but failed (often due to the unofficial and roundabout way they’ve gone about issuance or for compliance reasons).
But the concept of a cryptocurrency-funded Visa card has come to tantalise crypto fans. Ever since it became obvious bitcoin, or its copycats, would not establish themselves as money, crypto fans have longed for a workaround that might help them spend their cryptocurrency as easily as cash.
Since crypto’s volatility, illiquidity, and ties to the dark economy have discouraged the legitimate global merchant network from ever accepting it on a mass scale, the only way to achieve that has been to abandon defiant attitudes about cryptocurrency’s role in subverting state regulation.
As the adage goes, if you can’t beat them, join them. And in this case joining them has meant acknowledging Visa isn’t a nemesis, but rather a network that needs to be courted as a prospective partner (on its terms).
In the case of Coinbase, meanwhile, this has seen the broker/dealer throw in the towel on any notion that it is offering a parallel system to customers that is distinct to the core fiat network or in any way less stringently supervised or in any way more decentralised.
On that basis, Visa’s decision to support a Coinbase-issued card is more a reflection of the cryptocurrency broker/dealer having been absorbed into the core regulated banking-system than it is an endorsement of actual cryptocurrency. It’s a win for big banking. Not for crypto.
Nonetheless the question remains: is Visa right to assume Coinbase is as compliant as (or arguably more compliant than) any fiat money transmission equivalent, especially with respect to anti-money laundering and know-your-customer rules?
Or does the partnership expose the core regulated financial system to a whole new plethora of risks originating from the crypto sector?
To understand what’s at stake, it’s important to go through the mechanics of how these crypto-card relationships work.
Visa, the gateway into the core financial system
Visa, ultimately, are a network provider. From a regulatory standpoint, they are charged with doing due diligence on immediate partners — namely, credit card issuers such as Paysafe. It is these issuers who are then charged with doing due diligence on their immediate partners (the likes of Coinbase).
Nonetheless, in a case like crypto, it’s clear additional risks are afoot. From that perspective Visa has a duty to do enhanced due diligence on the partners of its partners, especially if it is aware its immediate partners are servicing crypto entities.
This would have been the case with Coinbase. Indeed, the fact Visa lent its name to the associated press release concretely implies the credit card network will have evaluated the associated cryptocurrency and been satisfied by Coinbase’s compliance practices.
Visa’s other regulatory standpoint will also be that, in the worst-case scenario, the company itself is not interfacing with cryptocurrency directly. Issuers take on the responsibility of converting crypto into fiat before processing the transaction with Visa.
In that sense, a crypto card works similarly to any standard Visa credit or debit card when used outside of its core currency jurisdiction. The merchant receives the currency of the realm as demanded, while the user is provided with a conversion rate by the issuer. That conversion rate can either be locked in on the spot, with the user bearing the cost of immediate conversion, or it can be deferred until the processor lays off the risk. The benefit of the latter is that the spread might be tighter but the downside is that the user bears the risk of the FX moving against them between the time of sale and the time of actual conversion.
Either way, it is the issuing bank’s responsibility to convert the currencies accordingly, and they themselves bear risk if too many customers opt to lock in to prices offered at the point of sale. As far as Visa is concerned there is no FX exposure.
But that’s also why it’s a poor risk mitigation by Visa.
It’s just not the case that money laundering facilitation is prevented by currency exchange. If it was, money laundering would be as simple as exchanging the proceeds of crime into another currency. And it’s not.
No doubt, in the enhanced due diligence conducted by Visa, Coinbase’s commitment to regulatory compliance, KYC, and its active banning of accounts suspected of non-compliant activity will have helped to reassure the payments network that any accompanying money laundering risks are well contained.
Indeed, an argument often made by cryptocurrency supporters is that it is easier to monitor suspicious activity in the sector because of the transparency of the blockchain. Cooperation with outfits like Chainalysis and Elliptic, which work to identify illicit activity by analysing cryptocurrency blockchains, is perceived to offer enhanced KYC and AML techniques.
And yet, none of this changes the fact that point-to-point identifiers are not applicable in the sector. Scour and monitor the blockchain as much as you want, but at best the information derived is retroactive rather than proactive. This means it fails to combat cryptocurrency’s greatest money laundering challenge: the unstoppable push-payment nature of illicit transactions from anonymous/pseudonymous sources.
Exchanges/wallets like Coinbase, which operate as intermediary custodians (processing transactions on behalf of customers out of blockchain addresses they control), can only mitigate these risks so far.
Even if they stand between a customer and an incoming payment — and thus have the capacity to block a suspicious transfer or prevent customers from accessing their funds — they cannot screen transactions emerging from newly created wallets that have no blockchain history without simultaneously stifling legitimate business at excessive levels and turning themselves into extremely closed systems.
There is no way chain analysis can mitigate these risks either. It’s impossible to differentiate between a new wallet address receiving payments for illicit goods from an otherwise “clean” purchaser (especially since so many drug users fund their habits through legitimate business or salaries in the real economy) and a new wallet address receiving an honest payment. Money launderers and dark economy operators understand this. This is why they, and their specially devised transaction mixers, exploit new wallet addresses all the time, especially since they are so easy to generate automatically.
The only way to deal with this risk is to block all incoming transactions from new addresses (especially those issued by non-regulated parties) or limit them only to regulated crypto exchanges by introducing the practice of point-to-point identifiers (as used in the banking sector). Anything else allows for anonymous funding to enter the system. And it’s the anonymity of the funding source that matters, not necessarily the identity of the account holder, who might always turn out to be a mule.
There’s a reason why FX is expensive
But filtering transactions in this way gates international cryptocurrency exchange in exactly the same way conventional foreign exchange is already gated. In FX, these gates appear precisely because institutions know they cannot trust transactions emanating from light-touch jurisdictions to the same degree as those that emanate from more compliant systems.
Managing the additional due diligence and risk associated with dealing with multiple jurisdictions is how costs and frictions are introduced into FX.
If cryptocurrency is to suffer the same costs and frictions for the same reasons, the point of using cryptocurrencies at all (aside for speculation) reduces markedly. The sector no longer offers any differentiation from the core banking system (other than additional complexity and cost).
Which is why it’s hard to believe any cryptocurrency business model can stay viable and operate on a level-playing field with the mainstream regulated market when it comes to KYC and AML.
Which leads to the final point about why the proliferation of crypto-funded Visa-style cards could be a game changer for would-be money launderers.
As it stands, the cryptocurrency world remains bifurcated between regulated and the unregulated players, namely those who can cash out into fiat currency legitimately, and those who can’t.
The latter defend their lack of compliance on the grounds the rules only apply to “fiat”, while they operate without ever touching the fiat system.
But try as they might to dissuade their market from continuing to want to use fiat, they can’t — fiat embodies too many desirable properties, among them stability. This is why stable coins — issued by opaque entities with limited financial track records — have become so popular. They provide the crypto market the fiat stability it craves without ever having to touch fiat.
And so it is that the worst of the worst occurs in the parallel world of stable-coin funded crypto, where doppelganger dollars trade as if they were the real thing with little to no regulatory oversight.
But eventually even that world needs to connect back to the core fiat system. And it does. Albeit for now in a very complex, expensive and high-risk way.
First, via the way stable coins are funded and collateralised*. (This includes by way of physical cash deposits, which by being transformed into stable coins and can be made internationally portable and thus more useful).
Second, via the way crypto and stable coins are cashed out. (This includes by money laundering mules who operate on behalf of those frozen out of the core banking system — until they themselves are flagged or suspended from the crypto zones permitted to deal with fiat. Until they are they can extract physical cash and transfer it to beneficiaries for spending.)
But now, thanks to the crypto card, the ability of mules to transfer funds to their beneficiaries will be simplified even further. Rather than having to deal with cash, all they need do is handover their cards and pin numbers to their overseers. That doing so breaks the terms and conditions of the cards is irrelevant. Nobody in this corrupted practice cares.
The irony is, pin numbers and contactless cards have greatly eased the ability of mules to share their cards with those they are working for. And that is why crypto cards pose such a risk.