AML and Cryptocurrencies in Israel
Decentralized finance and banking services for cryptocurrencies is a fast-growing industry enabled by blockchain technology. In recent years cryptocurrencies have emerged as a prominent feature in the global financial system with both the number of different currencies and the overall value in circulation growing exponentially.  Cryptocurrencies have become a significant source of personal wealth, but also serve as a means of payment in retail, international commerce, gaming and other sectors.  Opportunities presented by crypto currencies are great, but so are the risks of compliance with a global anti-money laundering/counter-terrorism financing (“AML/CFT”) regime that need to be managed carefully.

In Israel, digital currencies and virtual assets are still considered very risky activities.  Cryptocurrencies are widely viewed by regulators as speculative assets with no intrinsic value, rather than a currency or a payment system.  Financial regulators are rightfully concerned about money laundering and terrorist financing exposure and thus designate cryptocurrencies as high-risk activities and subject the players in the field to enhanced means of monitoring and control.  

For some time, Israeli Tax Authority has been paying increased attention to the digital currency market and inspecting this sector for tax collection, including requests to digital wallet holders to report assets and income and inquiries to cryptocurrency exchanges to obtain information on assets and activities of Israeli nationals. [1] The issue, however, was not resolved on a practical level, where the banks would not be accepting funds originating from cryptocurrency sales, so taxes could not really be paid from cryptocurrency holdings.  This is bound to change with the implementation of the new regulation.

As of November2021, Prohibition on Money Laundering Order, also applies to the activity of financial-asset service providers, such as cryptocurrency exchanges, and is aimed at completing the process of granting licenses to such entities by the Capital Markets Authority.  The order imposes the following main obligations on financial service providers in virtual currencies: identifying and recognizing a customer, monitoring and reporting to the Anti-Money Laundering Authority about cross-platform activity and application of the “Travel Rule” (i.e., mandating virtual asset service providers to obtain, hold and exchange information about the originators and beneficiaries of virtual asset transfers).

This is a welcome development, which is in line with international standards and should serve as an additional tool to reducing risks.  The Financial Action Task Force, an inter-governmental body that sets international standards to prevent money laundering, developed a set of standards to be applied to virtual asset service providers (“VASPs”) in order to enable a global AML/CFT regime for virtual assets.  VASPs are critical, as they enable exchange or withdrawal of virtual assets for fiat currency and thus serve as an interface with the traditional financial system.  A lot will depend on the willingness and risk appetite of banks to accept and transact in cryptocurrencies.  

The Banking Supervision Department in Israel is advocating for a cautious approach, suggesting that banks should not be obligated to deal with virtual assets or provide services related to them. Instead, the expectation is that a bank may choose to provide such services, in which case they should act with informed risk management, including monitoring activity at a level sufficient to ensure that it cannot be used for money laundering or terrorism financing.  Some of the banks in Israel have started formulating their policies for receiving the money if the cryptocurrency transaction took place with a licensed VASP meeting all the requirements of the Prohibition on Money Laundering Order. It is likely that the banks will heavily rely on certifications by accountants, lawyers, or other qualified cryptocurrency experts, who would, after conducting the necessary due diligence process, assure that the cryptocurrency transactions were compliant with all the requirements of the Prohibition on Money Laundering Order.  While the solution offered is a good start to address the issue, it may prove too cumbersome to deal with a ubiquitous phenomenon of cryptocurrency use.  We anticipate that procedures and capabilities will continue developing and this process will gain traction quickly, fueled by the demand in the marketplace.

Increased ability of regulators to identify the shortcomings of cryptocurrencies and enhanced capabilities of banks and other financial service providers to tackle cryptocurrency money laundering risks will enable greater acceptance of crypto currencies and virtual assets in traditional financial system and greater economy.  

In the United States, for example, the issue of reporting to the Internal Revenue Service(the “IRS”) has been addressed in the Infrastructure Investment Jobs Act(the “Infrastructure Act”), signed into law earlier this month.  The Infrastructure Act requires exchanges to report certain information to IRS, such as: proceeds from taxable sales and exchanges of digital assets, transfers of digital assets to other exchanges (or to wallet addresses that are not attributed to other exchanges) and receipts of more that USD 10,000 in digital assets. These reporting requirements will come into effect in 2023, thus giving the exchanges some time to develop technological solutions.

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