[Bitcoin Now] "Stablecoins Abused for Money Laundering... 'Scoring System' and International Cooperation Needed"

Stablecoins Overtake Bitcoin as Criminals' Preferred Asset
BIS Report Proposes AML Compliance Scoring to Block Illicit Funds
International Cooperation Urged as Crypto-Fiat Integration Accelerates

Stablecoins have surpassed Bitcoin as the most commonly used vehicle for criminal funds. As the integration between virtual assets (cryptocurrencies) and traditional financial systems accelerates, urgent regulation is needed. In this context, a new study has attracted attention by suggesting that scoring virtual assets could help block the conversion of criminal funds into cash.

Shin Hyun Song, Head of Research at the Bank for International Settlements (BIS), and others recently published a report titled "An AML Compliance Approach for Cryptocurrencies." The report states, "By creating an 'AML compliance score' based on the likelihood that a cryptocurrency unit or balance is linked to illegal activity, and referencing this score at the point of contact with the banking system-specifically, when converting to cash-it is possible to block the inflow of proceeds from illegal activities."

According to the report, as the interconnectedness between virtual assets and traditional financial systems grows, so does the risk of their misuse in criminal activities. The most widely used virtual asset is the stablecoin. Since 2022, stablecoins have overtaken Bitcoin as the preferred asset among criminals, and last year, approximately 63% of the total $51.3 billion in illegal virtual asset transactions involved stablecoins. The report also notes that if indirect uses, such as drug trafficking, are included, the proportion could be even higher.

However, the report points out that there are limitations to applying current AML regulations to virtual assets in the same way as traditional assets. Shin explained, "Customer identification (KYC) can be performed at points of contact with the traditional financial system, such as virtual asset exchanges, when funds flow in or out. However, once assets move to personal wallets on the blockchain, traditional forms of intervention become difficult." He added, "There have been cases where stablecoin issuers have frozen balances in major financial crime cases at the request of authorities, but it is unrealistic to apply this approach to billions of routine transactions."

AML Compliance Score Using Transaction History and Token Origin.

As a solution, the report proposes introducing an 'AML compliance scoring system.' This system would assign a score from 0 to 100 based on how closely a particular virtual asset has been linked to illegal activities in the past. When converting virtual assets to fiat currency (off-ramping), assets with scores below a certain threshold would be denied conversion.

The UTXO (Unspent Transaction Output) of Bitcoin or the wallets of stablecoins allow for the verification of all transaction histories and the wallets they have passed through on the blockchain. The report states that by leveraging this information, it is possible to assess how closely a particular unit of virtual asset is associated with illegal activities.

Through this method, funds originating from a 'whitelist'-considered relatively clean-would receive higher scores, while tainted funds known to be on a 'blacklist' would receive lower scores. Each country's financial authorities could set their own score thresholds according to their regulatory environment, and decide whether to allow or deny conversion based on these standards. The determination of what constitutes a crime could also vary from country to country.

The report notes that if virtual asset exchanges, stablecoin issuers, and banks are required to apply safeguards based on a minimum AML compliance score when converting virtual assets to cash-and are subject to penalties such as fines for non-compliance-they would be incentivized to avoid accepting or distributing tainted coins. Given the transparency of blockchain transactions, the report suggests that third-party service providers could emerge, similar to credit rating agencies, to assess the degree of contamination in stablecoins.

Considering the cross-border nature of virtual assets, international cooperation is essential. Shin stated, "International cooperation can significantly improve regulatory outcomes," and added, "International rules can allow for broader collaboration as regulation develops."

Meanwhile, this approach could result in the value of virtual assets being differentiated based on their origin. Stablecoins that have passed through wallets with suspicious histories could trade at a higher discount compared to 'clean' coins. This contradicts the principle of 'fungibility,' which holds that all forms of money (cash, digital currency, etc.) should always maintain the same value ratio. However, the report points out that this serves as an example of the economic theory that the value of goods can vary depending on time, place, and circumstance.