Beware the risks of virtual currencies posing modern slavery

29 December 2017, Bachir El Nakib

Virtual currencies are becoming a more mainstream investment, but investors and their wealth advisers must be aware of the risks. In the winter of 1928, Joe Kennedy made a quip that became famous around the world: “You know it's time to sell when shoeshine boys give you stock tips.”

This idiom articulates the risks that arise when a financial instrument becomes accessible to a mainstream audience who lack the sophistication to understand how to invest in it.

Whereas the shoeshine boy was providing an affluent and sophisticated investor with an equity tip, in today’s world, virtual currencies are following a similar path.

Not merely another vehicle for mainstream investors and speculators, virtual currencies have established themselves as a de facto asset class, one increasingly becoming part of a diversified wealth portfolio.


The rise of Bitcoin, the virtual currency

In the past two years, virtual currencies have become a phenomenon that has reached a mainstream audience. They have become so ubiquitous that terms such as “bitcoin” and “ether” have been accepted into the popular vernacular of ordinary people across the world.


Does the rise of virtual currency schemes pose a significant fraud risk to users, to the global financial system because of financial stability risk, or to businesses and law enforcement because of tax crimes, as well as AML/CTF and sanctions risks? A number of policy-making institutions, including the European Central Bank, US Treasury, and the Financial Action Task Force, have raised these questions for debate.


The European Central Bank has defined virtual currency as “a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community”. Virtual currency schemes are distinguished by their lack of legal monetary status: they are not legal tender in any jurisdiction. They are not subject to the gamut of domestic and international regulations that apply to real world currencies.


There are a variety of types of virtual currency schemes. In theory there is little governmental interest in “closed virtual currency schemes” where virtual goods and services are traded only in the virtual environment, so that there is no link to the real economy”. Examples of such closed schemes are the World of Warcraft® (WoW) Gold which is purchased by players to use only within this online game. Because WOW Gold cannot be exchanged for real value, it is unlikely to pose any serious regulatory, operational or tax compliance risks. But as there is a risk that a black market could develop outside the virtual currency scheme, regulators should monitor even closed schemes, particularly as they grow in popularity. WOW had nearly 10 million users at the end of December 2012.

Businesses and products based on virtual currencies such as bitcoin could link financial services to modern slavery and child exploitation. 

Law enforcement agencies and human rights organisations say the anonymity provided by digital payment systems and virtual currencies make them attractive to criminals including people traffickers and child pornographers. 

"The demands of customer-focused AML risk are fundamental to a bank. If it has dealt with AML risk it should have dealt with most customer-facing modern slavery risk. Virtual currencies, however, pose additional AML risks. Banks can only deal with cryptocurrencies if they can address the heightened risk," said Robin Brooks, a partner at Norton Rose Fulbright. 

Before jumping on the virtual currency and digital payments bandwagon, financial services providers must assess modern slavery and child exploitation risks. They must adhere to the provisions set out in the UK's Modern Slavery Act 2015. 

"Given the financial crisis and the collapse of trust in banks in particular, and then following scandals like Libor, banks should be mindful of the need to have robust procedures in place [to address slavery in their business and supply chains]," said Marilyn Croser, director at Corporate Responsibility (CORE), a coalition of civil society groups that campaigned for the Modern Slavery Act (MSA).

Section 54 of the MSA, "Transparency in Supply Chains" (TISC), requires every organisation carrying on a business in the UK with a total annual turnover of £36 million or more to produce a slavery and human trafficking statement for each financial year.

"There is a responsibility on banks to do due diligence on all their lending. That's massive because the scale of the problem is [so] huge that banks must be linked to that at present. It's in the construction industry, the garment industry. You name it, it's there. The responsibility is on banks to do their due diligence and not finance these activities," Croser said. 

In April 2015 Thomson Reuters Regulatory Intelligence published an article, "How the Modern Slavery Act has an impact on regulated financial services firms", outlining a range of considerations for firms. 

"Is there something so risky about bitcoin that no reputable bank should deal in it? I'm sceptical about that. It's difficult to make an ethical judgment about dealing in bitcoin," said Brooks, one of the co-authors of that 2015 article. 

Digital economy taskforce findings

In 2014, the International Centre for Missing and Exploited Children and Thomson Reuters convened the Digital Economy Taskforce which brought together legal, human rights and law enforcement officials to study the how the digitisation of financial services opens up avenues for those seeking to engage in illicit activities — particularly child pornography and exploitation as well as human sexual trafficking. 

The taskforce's findings were presented in "The Digital Economy: Potential, Perils and Promises". It found:


  • "Children exploited in this manner are often located in impoverished communities outside of the United States, and forced into online pornography by criminal syndicates, locally powerful neighbourhood residents, or even their own parents. ... It could be argued that in time, emerging digital payment systems, with their potential for anonymity, could become an attractive payment option in these situations, further complicating efforts to investigate and apprehend those responsible for exploiting young victims." 
  • "Regulatory agencies face a difficult task in adapting to the rise of the digital economy (including the growth of non-fiat currencies and the associated infrastructures designed to facilitate anonymous or pseudonymous storage and movement of money), and its relation to multiple forms of unlawful behaviour, including commercial child sexual exploitation." 
  • "In its April 24, 2012 Intelligence Assessment focusing on bitcoin, the FBI [Federal Bureau of Investigation] reported: 'Bitcoin … provides a venue for individuals to generate, transfer, launder and steal illicit funds with some anonymity. Bitcoin offers many of the same challenges associated with other virtual currencies, such as WebMoney, and adds unique complexities for investigators because of its decentralised nature.'"


  • "The FBI report added: 'Since Bitcoin does not have a centralised authority, law enforcement faces difficulties detecting suspicious activity, identifying users, and obtaining transaction records — problems that might attract malicious actors to bitcoin. Bitcoin might also logically attract money launderers and other criminals who avoid traditional financial systems by using the internet to conduct global money transfers.'"

Modern slavery reporting generally poor 

All the big financial institutions operating in the UK have modern slavery statements and are supposed to be reporting annually on their efforts to comply with the s 54 (TISC) of the MSA. 

CORE published a report analysing the s 54 MSA reporting of 50 businesses (excluding financial services) and found it to be poor.

"We've looked at companies associated with high-risk activities or are sourcing high-risk commodities or raw materials. We found that reporting on risk was quite poor. In some cases companies didn't address a particular risk at all which would indicate they're probably not doing anything to guard against it," Croser said.

Croser said financial services firms had modern slavery risks in their operations and in their own business. Two common risk areas are the use agency workers for cleaning and catering services. But bitcoin and virtual currency services are an emerging risk to be addressed in MSA statements and audits.

"There can be the risks associated with their customers. I've seen reporting about bitcoin being used for illegal activity because it's decentralised and anonymous. It's attractive to those people. From a banking perspective some of the risks around that would be covered by AML measures. [Banks] may not be coming at it from the perspective of addressing modern slavery but from a perspective of addressing corruption," Croser said.


  Rachel Wolcott is risk management and financial regulation correspondent for Thomson Reuters Regulatory Intelligence