On September 17, the New York State Department of Financial Services (NYDFS) issued a notice to all New York banking organizations[1] engaging or considering engaging in cryptocurrency activities, advising such organizations to follow April 2022 guidance on utilizing blockchain analytics as a compliance tool and risk identifier and mitigant.
When issued in April 2022, this guidance applied only to licensed virtual currency business entities or entities chartered as limited purpose trust companies under the New York Banking Law. Now, noting expanded interest by New York-chartered entities in virtual currency-related activities, the NYDFS indicates that it expects such banking organizations to apply the earlier guidance and consider utilizing blockchain analytics tools to help prevent against illegal activities, including money laundering, terrorist financing and sanctions evasion.
Prior guidance
The April 2022 guidance emphasized to all virtual currency business entities the importance of blockchain analytics to Bank Secrecy Act and anti-money laundering (BSA/AML) requirements and Office of Foreign Assets Control-related compliance controls, including “those relating to customer due diligence, transaction monitoring, and sanctions screening.”
Noting that virtual currency transactions raise different compliance challenges than traditional fiat currency activities due to different funds flows and sources, NYDFS reminded virtual currency business entities that their compliance programs must effectively address these challenges to be compliant with New York banking laws and BSA/AML requirements. The guidance suggested that entities apply blockchain analytics to address various requirements, including:
- Know your customer-related controls
- Transaction monitoring of on-chain activity
- Sanctions screening of on-chain activity
After this April 2022 guidance, the NYDFS subsequently issued additional guidance announcing its expectation that all New York banking organizations seek prior approval before engaging in new or significantly different virtual currency-related activity.
Current guidance
Now, NYDFS reminds all banking organizations, as well as all branches and agencies of foreign banking organizations licensed by NYDFS, that are engaged in, or considering engaging in, virtual currency-related transactions to reference the prior guidance and “consider” using blockchain analytics tools “tailored to [each entity’s] business model, risk appetite, and operations.” NYDFS suggests employing blockchain analytics to, among other things:
- Screen wallets of customers who have disclosed crypto-related transactions to assess risk exposure.
- Verify the source of incoming funds originating from virtual asset service providers.
- Monitor the crypto ecosystem “holistically” to assess customer exposure to, for example, money laundering and sanctions violations.
- Identify and assess the risk of third parties with whom a customer has engaged.
- Evaluate expected versus actual activity of customers engaging in virtual currency activity.
- Utilize intelligence gained from holistic monitoring to further develop the entity’s risk assessments and risk appetite.
- Assess the risks associated with a virtual currency product or service to be offered.
The guidance reiterates that entities should use blockchain analytics continuously to reassess how new business models, customer types and market entrants may impact compliance and increase risk.
What’s next?
With virtual currency activities currently facing much less skeptical reactions from federal regulators, the NYDFS guidance aims to set clear expectations at the state level for banks and other financial institution types as engagement in crypto-related activities expands. While the guidance does not place formal requirements on entities, it sheds light on the regulator’s compliance expectations. We expect other states may follow in New York’s footsteps to ensure that state-regulated entities manage risks and remain in compliance with state and federal laws regulating virtual currency-related activities.
[1] “Banking organization” means “all banks, trust companies, private bankers, savings banks, safe deposit companies, savings and loan associations, credit unions and investment companies.” New York Banking Law § 2.11.