Abu Dhabi - 5th Annual Financial Crimes Conference

Virtual Currencies,
Cyber-Payments and
Regulatory Compliance
by Juan Llanos, CAMS
ACC 5th Annual International Conference
Abu Dhabi, November 26 , 2013

Adult population with NO USE OF formal or semiformal FINANCIAL SERVICES

© 2013 JuanLlanos

2/3 of adults (17 million) | 25% of GNP | 40,000 agents
© 2013 JuanLlanos

M-PESA  Swahili for mobile money

© 2013 JuanLlanos

Agenda
1. Bitcoin & Math-Based Currencies
What Bitcoin is and why it’s revolutionary
2. Risk Identification & Mitigation
a) Inventory of challenges
b) Mitigating AML risk
c) Customer identification and authentication (deanonymization)
3. SA Detection via Monitoring and Analysis

Leveraging the blockchain
4. Unsolicited (contrarian) advice
© 2013 JuanLlanos

Think of Bitcoin as a numbered Swiss
bank account living on your
smartphone. *…+ retail and online
purchases can be made with virtually no
transaction fees. It's the ultimate bank
debit card, except there's no card –or
bank for that matter.
Robert Berry
© 2013 JuanLlanos

What is
?
Intro Video 1
Intro Video 2
© 2013 JuanLlanos

D I G I TA L PAY M E N T S N E T W O R K
D I G I TA L M O N E Y
PROTOCOL
© 2013 JuanLlanos

D I G I TA L PAY M E N T S N E T W O R K

INSTANTANEOUS
SECURE
LOW COST
GLOBAL TRANSFER OF VALUE

D I G I TA L M O N E Y

TRANSACTIONS IN “BITCOINS”
DOLLAR VALUE  OPEN MARKET
COUNTERFEIT-PROOF “ONLINE CASH”
TOTAL CAPPED INFLATION-PROOF
© 2013 JuanLlanos

“bitcoins”
SCARCE  Central Banks can’t inflate them
DURABLE  they don’t degrade
PORTABLE  can be carried and transmitted
electronically or as numbers in your head
DIVISIBLE  into trillionths
VERIFIABLE  through everyone’s block chain
EASY TO STORE  paper or electronic
FUNGIBLE  each bitcoin is equal
DIFFICULT TO COUNTERFEIT  cryptographically
impossible
Naval Ravikant
© 2013 JuanLlanos

PROTOCOL

APPLICATIONS BEYOND PAYMENTS 
SECURE CONTRACTS, ESCROW, TAMPER PROOF VOTING, NOTARY SERVICES, ETC.
P L AT F O R M F O R I N N O V AT I O N
© 2013 JuanLlanos

P L AT F O R M F O R I N N O V AT I O N
• Contracts can be entered into, verified, and enforced
completely electronically, using any third-party that
you care to trust, or by the code itself. For free, within
minutes, without possibility of forgery or revocation.
• Any competent programmer has an API to cash,
payments, escrow, wills, notaries, lotteries, dividends,
micropayments, subscriptions, crowdfunding, and
more.
• While the traditional banks and credit card companies
lock down access to their payments infrastructure to a
handful of trusted parties, Bitcoin is open to all.
Naval Ravikant

© 2013 JuanLlanos

ECO - SYST E M

© 2013 JuanLlanos

Ashton Kutcher

Kevin Rose

Paul Graham

Al Gore

W i n k l e v o s s Tw i n s

N a s s i m N . Ta l e b

DISTRIBUTED|DECENTRALIZED
CENTRALIZED

DISTRIBUTED

© 2013 JuanLlanos

PEER

PEER

PEER
PEER

PEER

PEER
PEER
PEER

PEER

PEER

PEER

PEER

PEER

PEER

PEER

NO central authority or
PEER
financial institution in control
PEER
PEER

PEER

PEER

PEER

PEER

PEER

PEER
M ATPEER- E N F O R C E D T R PEERS T
H
U
PEER

PEER

PEER

PEER

PEER

PEER

PEER
PEER

PEER

PEER

PEER

© 2013 JuanLlanos

Payment
+ identity

© 2013 JuanLlanos

PAY M E N T & I D E N T I T Y
S E PA R AT E D
CONSUMER PRIVACY PROTECTED
MERCHANTNO CHARGEBACKS / FRAUD
Payment only

© 2013 JuanLlanos

T R A N S PA R E N C Y
Every transaction that has ever
occurred in the history of the bitcoin
economy is publicly viewable in the
BLOCK CHAIN.
Privacy without anonymity 
pseudonymity

© 2013 JuanLlanos

“ Virtual currencies promise
to benefit commerce on
many levels, from serving
the unbanked to new
financial products. I
challenge our innovators:
devise creative solutions to
prevent virtual currency
a b u s e .”
FinCEN Director Jennifer Shasky Calvery
© 2013 JuanLlanos

C H A L L E N G ES
R E G U L AT I O N
T R A N S PA R E N C Y/ P R I VA C Y
S P E C U L AT I O N
SECURITY
D I S R U P T I O N O F S TAT U S Q U O

© 2013 JuanLlanos

Before March 18, 2013

The Criminal Precedent that Could
Curb Bitcoin’s Enthusiasm

© 2013 JuanLlanos

• ISSUER OF DIGITAL CURRENCY

E-Gold

• a medium of exchange offered over the Internet
• Global acceptance without the need for conversion between national
currencies

• USED FOR ONLINE COMMERCE AND FOR FUNDS TRANSFERS BETWEEN
INDIVIDUALS
• FOUR PRIMARY STEPS
1.
2.
3.
4.

Opening a digital currency account
Converting national currency into “e-gold” to fund the account
Using “e-gold” to buy a good or service or transfer funds to another person
Exchanging “e-gold” back into national currency

• PARTIES NEEDED:
• Digital currency exchanges
• Merchants or individuals that accepted “e-gold”

• ABILITY TO OPERATE ACCOUNTS ANONYMOUSLY
• Highly-favored method of payment by operators of “get-rich-quick” scams

• ALL TRANSFERS OF “E-GOLD” WERE IRREVOCABLE AND IRREVERSIBLE
© 2013 JuanLlanos

E-Gold
2008-07 Guilty Plea
•
•
•
•

Conspiracy To Launder Monetary Instruments (federal)
Conspiracy To Commit The Offense Against The United States (federal)
Operating Of Unlicensed Money Transmitting Business (federal)
Transmitting Money Without A License (District of Columbia)

“ T h e r o o t c a u s e s o f E - G o l d ’s f a i l u r e w e r e d e s i g n
flaws in the account creation and provisioning logic
that led to the unfortunate consequence of
vulnerability to criminal abuse .

“ We a c k n o w l e d g e t h a t E - G o l d i s i n d e e d a f i n a n c i a l
institution or agency as defined in US law and should
b e r e g u l a t e d a s a f i n a n c i a l i n s t i t u t i o n .”
Douglas Jackson, E-Gold Founder

© 2013 JuanLlanos

March 18, 2013
FinCEN Guidance FIN-2013-G001

© 2013 JuanLlanos

• “Interpretive Guidance”  not new rule-making
• Centralized vs. Decentralized virtual currencies
• Virtual Currency Actors:
• USER  a person that obtains virtual currency to
purchase goods or services.

• EXCHANGER  a person engaged as a business in the
exchange of virtual currency for real currency, funds, or
other virtual currency.

• ADMINISTRATOR  a person engaged as a business in
issuing (putting into circulation) a virtual currency, and
who has the authority to redeem (to withdraw from
circulation) such virtual currency.
© 2013 JuanLlanos

• “An administrator or exchanger that (1) accepts and transmits a
convertible virtual currency or (2) buys or sells convertible virtual currency for
any reason is a money transmitter under FinCEN’s regulations *…+”
• “Under FinCEN’s regulations, sending “value that substitutes for currency” to
another person or to another location constitutes money transmission,
unless a limitation to or exemption from the definition applies. This
circumstance constitutes transmission to another location, namely from the
user’s account at one location (e.g., a user’s real currency account at a bank) to
the user’s convertible virtual currency account with the administrator.”
• “To the extent that the convertible virtual currency is generally understood as a
substitute for real currencies, transmitting the convertible virtual
currency at the direction and for the benefit of the user constitutes money
transmission on the part of the exchanger.”
• “*…+ a person that creates units of convertible virtual currency and sells those
units to another person for real currency or its equivalent is engaged in
transmission to another location and is a money transmitter. In addition, a
person is an exchanger and a money transmitter if the person accepts
such de-centralized convertible virtual currency from one person and transmits it
to another person as part of the acceptance and transfer of currency, funds, or
other value that substitutes for currency.”
© 2013 JuanLlanos

• Currency definitions:
• REAL CURRENCY  the coin and paper money of the
United States or of any other country that [i] is
designated as legal tender and that [ii] circulates and
[iii] is customarily used and accepted as a medium of
exchange in the country of issuance.

• VIRTUAL CURRENCY  medium of exchange that
operates like currency in some environments, but does
not have all the attributes of real currency; no legal
tender status in any jurisdiction.

• CONVERTIBLE VIRTUAL CURRENCY  either has an
equivalent value in real currency, or acts as a substitute
for real currency.
© 2013 JuanLlanos

• PROBLEM #1  ALL USERS? How does the law apply if one
obtains bitcoins not to purchase goods or services? Reasons:
1. speculation that the price of bitcoins will go up
2. simply because one trusts a virtual currency’s stability more than that of a
particular “real currency” (think of Argentina or Zimbabwe), or
3. because one wants to make a remittance to a family member overseas.

• PROBLEM #2  MINERS?
• If mine and buy goods  users
• If mine and sell bitcoins  money transmitters. Why?
• Not transmitting bitcoins from one party to another (only 2 parties to
the transaction)
• No consumer to protect and no potential for money laundering

• PROBLEM #3  NEW LAW IN THE GUIDANCE?
• Definitions of “virtual currency” and “convertible virtual currency”  only in
this guidance.

© 2013 JuanLlanos

After March 18, 2013

The End of Bitcoin as We Know It

© 2013 JuanLlanos

Liberty Reserve
• alternative digital payment network
• “Closed look”  centralized virtual currency (LR
dollars)
• shut down and its management indicted and
arrested in May 2013.
• “the largest money laundering case in U.S.
history”
• a convenient tool for foreign currency brokers,
as it allowed them to bypass local legislation
and avoid exchange rate fluctuations
• “a shadowy netherworld of cyber-finance”
• its realm of anonymity made it a popular hub
for fraudsters, hackers and traffickers
© 2013 JuanLlanos

Liberty Reserve Indictment
[x] ANONYMITY  product has to dissuade the bad element, never attract it.
• “deliberately attracting, and maintaining a customer base of criminals by
making financial activity on LR anonymous and untraceable.”
• “designed so that criminals could effect financial transactions under multiple
layers of anonymity and thereby avoid apprehension by law enforcement.”

[y] COMPLIANCE  product and operations cannot be in violation of any
applicable laws and regulations (the “form” or “paper” side of compliance).
• “was not registered as a money transmitting business with FinCEN”
• “operated an unlicensed money transmitting business.”

[z] SUBSTANCE  what is written in their policy must actually be implemented.
Businesses must be run with integrity, responsibility and control.
• “intentionally creating, structuring, and operating LR as a criminal business
venture, one designed to help criminals conduct illegal transactions and launder
the proceeds of their crimes.”
• “lying to anti-money laundering authorities in Costa Rica, pretending to shut
down LR after learning the company was being investigated by US law
enforcement (only to continue operating the business through a set of shell
companies)”
• “created a system to feign compliance with anti-money laundering procedures,
*…+ including a ‘fake’ portal that was manipulated to hide data that LR did not
want regulators to see.”
© 2013 JuanLlanos

Money transmitters
and their agents are perceived as

HIGH RISK

of

• ABUSE TO CONSUMER
• MONEY LAUNDERING
• TERRORIST FINANCING
Money transmission = highly regulated industry
© 2013 JuanLlanos

Money Transmitter Regulation (US)
Main Risk Areas Main Statutes and Regs
Anti-Money Laundering
Anti-Terrorism Financing (CFT)
Privacy and Information
Security
Safety and soundness
Consumer protection

BSA, USA PATRIOT Act, Money
Laundering Acts
USA PATRIOT Act, OFAC
Gramm-Leach-Bliley
State (via licensing)
State (via licensing) + Dodd-Frank /
Regulation E (CFPB)

Focus  AML/BSA + State Compliance
© 2013 JuanLlanos

Money Transmitter Risk Fronts
Operational

Customer
(Sender & Recipient)

MT Risks
Foreign
Counterparty

Agent
(B&M, online)
© 2013 JuanLlanos

Customer Risks and Mitigators
RISKS

MITIGATORS

Complicity with agent or foreign
counterparty

Customer acceptance, monitoring and
termination protocols

Complicity with recipient (or sender)

Transaction & behavior monitoring

‘Drip-irrigation’ transfer of illicit funds
(O2M recipients, M2O recipient, M2M
recipients)

Lower identity verification thresholds
at origin and destination

Intra-company structuring

Inter-company structuring (‘smurfing’)
Terrorist financing

For cards, maximum loadable amounts,
expiration date, and limited number of
recipients.
Redundant identity verification
procedures at destination
POS training
OFAC screening

Eventually, intercompany transaction
monitoring by highly-professional and
secure clearing house. This is the only
possible antidote against ‘smurfing’.
© 2013 JuanLlanos

Corporate Safeguards*
1. A designated compliance officer + professional team
2. Written policies and procedures + operational controls:
•
•
•

Licensing, renewal and reporting procedures (S)
Registration, record-keeping and report-filing procedures (F)
KY (Know Your…) Subprograms: Acceptance, monitoring, correction and
termination
•
•
•
•
•

•
•
•
•

KY…Customer
KY…Agent
KY…Foreign Counterparty
KY…Employee
KY…Vendor

Monitoring, analysis and investigating procedures
OFAC compliance program
Response to official information requests
Privacy and information security protection protocols

3. An on-going training program
•

Risk & Compliance Committee

4. An independent compliance auditing function
* AML Program Elements (Section 352 of the USA PATRIOT Act)
© 2013 JuanLlanos

Key Elements of a BSA/AML Program
• State Compliance: Licensing, renewal and reporting
procedures // Consumer protection disclosures, etc.
• Federal Compliance: Registration, record-keeping and
report-filing procedures (F)
• KY (Know Your…) Subprograms: Acceptance, monitoring,
correction and termination (Life-Cycle Management)
•
•
•
•
•

KY…Customer
KY…Agent
KY…Foreign Correspondent or Counterparty
KY…Employee
KY…Vendor

• SA Detection: Monitoring, analysis and investigating
procedures
• Information Sharing: Response to information requests
• OFAC Compliance Program
• Privacy and information security protection protocols (GLBA)
© 2013 JuanLlanos

Product Safeguards
•
•
•
•
•
•

Anonymous identification
No value limits
Anonymous funding
No transaction records
Wide geographical use
No usage limits
Cash features

Anything we do to
counter these
will mitigate the
risk of our
product!

© 2013 JuanLlanos

Customer Identification
Non-Face to Face  Card not present standards
DOCUMENTARY  Review an unexpired government-issued form
of identification from most customers.
•
•
•
•

evidence of a customer’s nationality or residence
photograph or similar safeguard
form a reasonable belief that of the true identity of the customer.
E.g.: driver’s license (U.S.) or passport.

NON-DOCUMENTARY  Independently verifying the customer’s
identity through the comparison of information provided by the
customer with information obtained from a consumer reporting
agency, public database, or other source
• contacting a customer
• checking references or obtaining a financial statement

© 2013 JuanLlanos

Authentication Strength
Multifactor authentication:
•
•
•

Something the user knows (e.g., password, PIN)
Something the user has (e.g., ATM card, smart card)
Something the user is (e.g., biometric feature)

Authentication methods:
•
•
•

•
•
•

Shared secrets
Tokens (smart card, one-time password generating
device)
Biometrics (fingerprint, face, voice, keystroke
recognition)
Out-of-band authentication
Internet protocol address (IPA) location and geo-location
Mutual identification
Source: FFIEC
© 2013 JuanLlanos

“What customers do
speaks so loudly that
I cannot hear what
they’re saying.”
(Paraphrasing Ralph Waldo Emerson)

Customer identification vs. customer knowledge

B E H AV I O R A L A N A LY T I C S
© 2013 JuanLlanos

Machine Learning (AI) Methods
SUPERVISED LEARNING: relies on two labeled classes (good vs. bad)
Goal  Detect known suspicious patterns
1. Training set:
a. Select dataset with clean and dirty cases.
b. Classification algorithm to discriminate between the two
classes (finds the rules or conditions)
c. Probabilities of class 1 and class 2 assignment
2. Run discrimination method on all future purchases.
UNSUPERVISED LEARNING: no class labels
Goal  Detect anomalies
1. Takes recent purchase history and summarize in descriptive
statistics.
2. Measure whether selected variables exceed a certain threshold.
(deviations from the norm)
3. Sounds alarm and records a high score.
© 2013 Juan Llanos
© 2013 JuanLlanos

Known Suspicious Behaviors
•
•
•
•
•
•
•
•

Structuring (Many-to-one)
High amounts
High frequency
Use of multiple locations
Use of multiple identities
Use of untrusted device
Values just below threshold
Immediate withdrawals
© 2013 JuanLlanos

An Analysis of Anonymity in the Bitcoin System - Bitcoin is Not
Anonymous
by Fergal Reid and Martin Harrigan (2011)
Link: http://anonymity-in-bitcoin.blogspot.com/2011/07/bitcoin-is-not-anonymous.html

• The entire history of Bitcoin transactions is
publicly available.
• “Using an appropriate network representation,
it is possible to associate many public-keys
with each other, and with external identifying
information.”
• “Large centralized services such as the
exchanges and wallet services are capable of
identifying and tracking considerable portions
of user activity.”
© 2013 JuanLlanos

• The victim woke up on the morning of 13/06/2011 to find a large portion of
his Bitcoins sent to1KPTdMb6p7H3YCwsyFqrEmKGmsHqe1Q3jg.
• The alleged theft occurred on 13/06/2011 at 16:52:23 UTC shortly after
somebody broke into the victim's Slush pool account and changed the payout
address to 15iUDqk6nLmav3B1xUHPQivDpfMruVsu9f.
• The Bitcoins rightfully belong to1J18yk7D353z3gRVcdbS7PV5Q8h5w6oWWG.
© 2013 JuanLlanos

Resources

• Bitcoin Educational Resources:

http://www.forbes.com/sites/jonmatonis/2013/05/13/6-new-bitcoin-educationalresources/

• Bitcoin Education Project (Udemy): https://www.udemy.com/bitcoin-or-how-ilearned-to-stop-worrying-and-love-crypto/

• Bitcoin Primer for Policymakers:
http://mercatus.org/sites/default/files/Brito_BitcoinPrimer_embargoed.pdf

• Bitcoin Wiki: https://en.bitcoin.it/wiki/Main_Page
• Cato Unbound-The Private Digital Economy: http://www.catounbound.org/issues/july-2013/private-digital-economy

•
•
•
•

CoinDesk: http://www.coindesk.com/
Contrarian Compliance: http://contrariancompliance.com/
Let’s Talk Bitcoin: http://letstalkbitcoin.com/
Khan Academy Bitcoin Series: https://www.khanacademy.org/economics-financedomain/core-finance/money-and-banking/bitcoin/v/bitcoin-what-is-it

• We Use Coins: https://www.weusecoins.com/en/

© 2013 JuanLlanos

• Prevention trumps damage control
• Risk MGT  Both reducing downside and
increasing upside
• Simplicity and common sense
• Train for behavior change, not theoretical
knowledge
• Form-substance continuum  substance
• Letter-spirit continuum  focus on spirit
(underlying purpose and values) facilitates
• Operational synergies (leveraging tech)
• Compliance without compromising performance
• Flexibility and sustainability
© 2013 JuanLlanos

“If you haven't heard of
BITCOIN, drop what you're
doing and go research it,
for it is THE MOST
IMPORTANT PROJECT ON
THE PLANET.”
Erik Voorhees

Thank you!
Juan Llanos

EVP & Compliance Officer
Unidos Financial Services, Inc.
275 Seventh Ave. - 20th Floor
New York, NY 10001
Direct: (646) 485-2264
Mobile: (646) 201-6217
Email: jllanos@unidosfinancial.com
LinkedIn: www.linkedin.com/in/juanllanos
Twitter: @JuanLlanos
Blog: contrariancompliance.com
© 2013 Juan Llanos

Abu Dhabi - 5th Annual Financial Crimes Conference

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