Why is it crucial to have Anti-Money Laundering procedures in place for ERC20 tokens?

As the new dominant value transfer layer, Ethereum network is becoming more and more popular, so are the ERC20 tokens, especially stablecoins.

Recently, Tether alone is the most traded coin in the crypto world. 

With the wide use of ERC20 tokens and the development of global AML/CTF regulations that put Ethereum transactions under the scope, monitoring ERC20 tokens is becoming a necessity for different kinds of crypto-related businesses.

In June 2020, FATF last plenary session has pointed out the fact that ERC20 and especially stablecoins are falling under the scope of AML monitoring. And this is challenging. 

This article focuses firstly on this category of asset, and then gives some insights on the importance of monitoring the transactions from the AML/CTF perspectives, and explains at the end how to achieve it.

What are ERC20 tokens?

ERC20 is a technical standard used for smart contracts on the Ethereum Blockchain for implementing tokens.1 “ERC” means Ethereum Request for Comment, “20” is the number that was assigned to this request. 

It defines a common list of rules that Ethereum tokens have to implement, including how the tokens are transferred between addresses, how data within each token is accessed.

Like other cryptocurrencies, ERC20 tokens can hold value and can be sent/received by using ethereum addresses and transactions, using gas to cover transaction fees.

Why are ERC20 tokens created and become popular? 

ERC20 tokens have extensive adaptation capabilities. Tokens allow the creation of Dapps (Decentralized Applications) and smart contracts. Developers can code logic into the blockchain, for example, if certain conditions are met, a process will be carried out automatically. In this case, a token is used not only as a way of exchanging value but also as a medium to execute a smart contract. For example, people can use BNB (Binance Coin), an ERC20 token, to pay for services (exchange, listing etc.) on the Binance platform.

Lastly, ERC20 tokens become popular also because of crowdfunding companies with their initial coin offerings (ICOs) projects, which make the best of their ease of deployment and their potential for collaboration with other ethereum token standards. That’s why Ethereum has become the most popular platform for ICO’s in 2017.2

Nowadays, ERC-20 tokens are one of the most widely used tokens. According to Etherscan, 275,038 kinds of ERC-20 are available on the Ethereum network as of July 2020. (https://etherscan.io/tokens)

Stablecoins: on-trend ERC20 tokens 

Stablecoins are a new type of crypto asset, whose value is pegged to a certain fiat (US dollar for instance), other cryptocurrencies, commodities (precious metals), or a combination of the three. 

Many of them are on the Ethereum blockchain as ERC20 tokens, among which the most famous include tether (USDT), trueUSD (TUSD), gemini dollar (GUSD), and USD coin by Circle and Coinbase (USDC) etc. Demand for stablecoins has been growing since these years. 

Take Tether(USDT) as an example: this February, the 24-hour trading volume of the Tether broke records with almost 10 billion higher than Bitcoin, triple of Ethereum’s volume, and became the most traded cryptocurrency. We published an article back then to analyze this phenomenon. Review the article  here:  https://blog.scorechain.com/how-to-implement-aml-risk-assessment-on-the-most-widely-traded-stablecoin-tether/

Generally speaking, the sharp growth of stablecoins could be explained mainly by their relatively stable conversion rate compared to the inherent volatility of cryptocurrency prices, which makes them more practical to buying goods/services; secondly, the progress of the decentralized finance/DeFi ecosystem plays an important role in this trend as well; at last, the COVID-19 crisis drives worldwide businesses to seek a low-cost solution for value transfers.

Importance of monitoring ERC20 tokens for AML/CTF purposes

As ERC20 tokens and stablecoins grow in popularity, the need to mitigate risk for investors and companies becomes more prominent. 

From the perspective of virtual asset service providers, it is even more important, especially because more and more jurisdictions put this asset under the scope of AML/CTF regulations, such as the European Union, the United States, Singapore, Australia, Japan, South-Korea, etc.

In its latest 12-month report of the revised FATF Standards on virtual assets and VASPs, FATF pointed out, particularly that the area of stablecoins must be closely monitored because of residual risks and a range of practical challenges for jurisdictions that stablecoins raise. Review the summary of the report here: https://blog.scorechain.com/summary-of-the-12-month-review-of-the-revised-fatf-standards-on-virtual-assets-and-vasps

How to assess the ML/TF risks regarding ERC20 tokens?

To fulfil the regulatory requirements, 

– Companies should keep records of ERC20 transactions

– Companies need to implement a risk-based approach

– Transaction screening and monitoring are requested

– Suspicious transactions and accounts should be reported to the authority and the watchlist should be regularly updated. 

Failure to do so will result in the shutting down of the business.

With a comprehensive and transparent risk assessment methodology, Scorechain has accumulated rich experience in helping crypto-related businesses to implement a risk-based approach to fulfil requirements since 2015. 

Scorechain Ethereum Analytics Platform can identify the origin and destination of ETH, ERC20 and stablecoins traded on the Ethereum network. Now the solution covers more than 250 000+ ERC20 and stablecoins.

For each ERC20 token and stablecoin, Scorechain Ethereum Analytics provides:

  • Unique risk scoring for addresses and transactions;
  • Risk indicators to help users redflag suspicious activities at the level of entities/ transaction behaviours and jurisdictions with more than 350 risk scenarios;
  • Real-time alerts system to achieve ongoing monitoring;
  • Comprehensive reports to help users fulfil the reporting requirements; especially, the risk indicators are integrated into the KYT report;
  • Last but not least, customisable scoring system allowing users to implement their own internal control policies.

Need help to implement ERC20 monitoring?

Leave us a message on contact@scorechain.com

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References:

  1. New Frontiers In Entrepreneurial Finance Research, edited by Anita Quas, Yan Alperovych, Cristiano Bellavitis, Ine Paeleman, Dzidziso Samuel Kamuriwo, World Scientific Publishing Co (October 7, 2019)
  2. https://cointelegraph.com/explained/erc-20-tokens-explained