NYDFS Superintendent Issues Guidance on Use of Blockchain Analytics in Virtual Currency Compliance
Commentary by Jason Schwartz
New York State Department of Financial Services ("NYDFS") Superintendent Adrienne A. Harris issued guidance on the importance of blockchain analytics for purposes of compliance with the Bank Secrecy Act and with OFAC-issued sanctions. In a letter to New York State-regulated limited purpose trust companies that are involved in the transfer of virtual currencies, Ms. Harris urged regulated institutions to ensure the following:
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Know Your Customer-related Controls. NYDFS recommended the use of products that allow users to retrieve identifying information such as "wallet addresses on a specific exchange for custodial transactions."
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Transaction Monitoring of On-Chain Activity. NYDFS stated that it is important for firms to be able to trace transaction activity "for each type of virtual currency the entity supports and the flow of funds through the blockchain for any inbound or outgoing activity."
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Sanctions Screening of On-Chain Activity. NYDFS emphasized the importance of identifying information that is associated with "sanctioned individuals and entities listed on [OFAC's] SDN List or located in sanctioned jurisdictions[.]"
Commentary
Superintendent Harris is absolutely right to recognize the importance of chain analysis to the future regulation of crypto transactions. That said, decentralized finance is just that: decentralized. The liquidity for smart contract token swaps and yield-generating protocols comes from a swarm of anonymous depositors located all over the globe. If U.S. regulators prohibit U.S. intermediaries from interacting with a smart contract because its back-end liquidity cannot be adequately traced, U.S. customers will withdraw their crypto into self-custody so that they can interact with the smart contract directly. Regulators should avoid policies that encourage flight from regulated entities.