Cryptocurrencies: how can digital authentication and KYC prevent digital fraud?

Cryptocurrencies: how can digital authentication and KYC prevent digital fraud?
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November 27, 2022

 Author: Jaime Ramirez, Founder and Ceo Preventor

The time has come to remove the dark areas that are taking away the transparency of these cryptocurrency operations and finally take decisive action against digital frauds.

Cryptocurrency fraud is skyrocketing and in this context the adoption of digital authentication systems represents a determining factor for the success or failure for many platforms that urgently need to know in depth the clients that perform operations in their network, while at the same time fighting against money laundering and strengthening their policies to comply with strict international regulations. 

Although cryptocurrencies represent a financial revolution by decentralizing finance and offering access to more people, this market is highly exposed to crimes such as fraud, so digital authentication and clear Know Your Customer policies among the different actors working in this business is key to be able to mitigate the risk associated with these operations.

Digital fraud is a critical aspect in the cryptocurrency business, as it directly impacts companies and undermines trust in this market. Those who are victims of these attacks suffer immediate losses as a result of identity theft and other associated crimes. The scale of the problem is enormous, since by the middle of this year hackers had managed to steal the equivalent of some US$2 billion in cryptocurrencies, much more than what they had achieved in the same period last year (US$1.2 billion).

In order to achieve this, they activate their malicious strategies by stealing the identity of the users of these platforms or exploiting the vulnerabilities of the tool, many of which are based on fragile onboarding processes and poor KYC practices.

Precisely, regulatory gaps are among the main challenges for the global expansion of the cryptocurrency business, which has given rise to powerful criminal organizations taking advantage of these loopholes to carry out million-dollar digital fraud operations around the world outside of the authorities' scrutiny. But how to solve it?

Trust underpins the security

In view of these threats, there seems to be a growing consensus on the need to generate greater global control over this market to fight organized crime and at the same time mitigate risk, in the midst of the so-called cryptowinter that hit investors this year with the collapse in May of the Terra platform and its associated Luna token, and now with the declaration of bankruptcy of the FTX exchange, founded by the millionaire Sam Bankman-Fried.

In this challenging context, the European Union has already taken firm steps to regulate the global cryptocurrency market through the Markets in Crypto Assets Act (MiCA), which shines a light on transactions that were conducted anonymously by forcing platforms that provide digital wallet or exchange services to apply KYC policies.

These measures could be decisive in combating the scourges of digital fraud and money laundering through cryptocurrencies, a crime that last year allowed criminals to launder US$8.6 billion or 30% more than in 2020, according to figures from Chainalysis. And as criminal activity does not stop, the crypto world's platforms cannot sit idly by and must act now.

In Latin America, for example, the United Nations Office on Drugs and Crime warned about how Mexican cartels are carrying out operations in bitcoin in order to support their criminal activity of selling drugs and laundering about US425 billion a year in that country, helped by this and other modalities.

The authentication must be the cornerstone

Faced with the global rise of digital fraud, platforms are challenged to make investments and change their strategy to protect their users from increasingly sophisticated attacks that target in particular decentralized finance protocols (DeFi), which are often vulnerable to these crimes as they are open source.

To mitigate these risks, companies must go a step further by integrating monitoring systems that allow them to fully track transactions, which could reveal anomalous behavior within the platforms that have to manage large volumes of transactions on a daily basis.

From Preventor's point of view, multi-factor authentication should be a priority for these platforms in order to guarantee reliability in crypto investments and consolidate their expansion in a more secure environment, in which in-depth knowledge of the client must be at the heart of the strategy. But in order to start generating these changes, it is necessary to identify where the main gaps in these platforms are.

Cryptocurrencies are supported under the blockchain infrastructure, which allows all transactions to be recorded in a kind of open book and have full end-to-end traceability. This allows users to have certainty that the transaction will not be intercepted or hacked, a model similar to the international SWIFT used by banks.

Although blockchain is secure and offers this shielding, the risks are beginning to materialize in the digital platforms that serve as a bridge for such transactions, mostly operated by fintechs and other financial entities. And the fact is that, when using such services, users must create an account, register and delegate their security to the device in order to open the mobile application by means of two-factor authentication (2FA).

The greatest risk for users is generated when accessing these applications, since by delegating security to the phone, what is shielded is access to these mobile devices, but not monetary transactions, leaving people exposed.

Preventor comes in to solve these gaps from digital onboarding and KYC practices, integrating biometric authentication with voice recognition and face detection, technologies that are currently also supported by artificial intelligence and automation to track different types of fraud (Liveness detection) through algorithms.

These tools come in to replace solutions such as two-phase authentication or other mechanisms such as Google Authenticator, which, although widely used today, are highly vulnerable and are the source of most digital fraud.

This is not the time to give in

The dynamics of digital fraud are forcing platforms to rethink what they are doing, changing their security strategies to avoid user leakage in the midst of the crypto-winter that has already hit the reputation of this market hard.  

Specifically in emerging markets, the United Nations Conference on Trade and Development issued a recent warning about tax evasion associated with cryptocurrency transactions through what it described as illicit financial flows, making the simile with tax havens.

"In this way, cryptocurrencies can also curb the effectiveness of capital controls, a key instrument for developing countries to preserve their policy space and macroeconomic stability," it warned in a report on the issue.

With the eyes of regulators on them in these difficult times for cryptocurrencies, these platforms must not give advantages and therefore it is important that they adapt to this new reality that puts pressure on them to be more rigorous in the way they incorporate clients, manage their transactions, monitor this activity and avoid the risk of fraud.

Failure at this point could be fatal for the survival of these platforms and above all for trust in the crypto world, which is called to rely on the technology that has given rise to it to offer a safe environment for all, in which KYC policies are at the core of their business and in which security is a fundamental pillar to shield themselves from the illicit activities that are doing so much damage to this ecology and to the environment.

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