BIS Floats AML Scores for Non-Custodial Crypto Wallets

The Bank for International Settlements (BIS) published a bulletin on Aug. 13 suggesting that anti-money laundering (AML) checks could be extended to non-custodial crypto wallets using their past transaction history, a concept that blockchain analysts warn could represent a “significant shift in how blockchain networks operate.”

The report, titled “An approach to anti-money laundering compliance for cryptoassets,” claims that current standards “have limited effectiveness with decentralised record-keeping in permissionless public blockchains.”

According to the BIS, the full transaction history available on public ledgers could potentially be used to determine whether tokens are “tainted” and block or penalize their conversion into fiat currency at off-ramps.

The central banks’ coordination body wrote that “users could reasonably be expected to exercise a duty of care in transacting with crypto tokens by checking beforehand if a crypto coin is known to be compromised,” adding that failure to comply could result in fines.

“While some users may reasonably claim to have received a tainted token in good faith if information on illicit use is scarce, such an argument would be less persuasive if there were widespread and affordable compliance service providers,” BIS explained.

Risk of Fragmentation

The bulletin even acknowledged that such a system could fragment stablecoins, noting that those linked to illicit flows “could trade at a higher discount relative to others with no such history.”

The proposal includes mechanisms ranging from “allow lists” of wallets that have passed KYC checks to “deny lists” flagging addresses tied to criminal activity. The BIS claims the scoring could be embedded into wallets or tokens themselves. Hence, the system could even be extended to users who transact solely through non-custodial wallets.

Ari Redbord, global head of policy and government affairs at blockchain forensics firm TRM Labs, said in commentary to The Defiant that while blockchain analytics can already identify exposure to illicit wallets, the key is “ensuring that any such score does not become a black box.”

He argued for what TRM calls “glassbox attribution,” where compliance teams can see the wallet connections behind any score and make their own judgments.

Redbord added that embedding compliance ratings into tokens or requiring KYC for non-custodial wallets “could represent a significant shift in how blockchain networks operate” and may create “tiered assets, where the same token is treated differently based on its transaction history.”

He added that privacy would be at risk right away, and that bad actors would likely switch to mixers or unregulated platforms.

“A scoring system might be one tool in the toolbox, but it is not a complete solution on its own. Regulators, standard-setters, and policymakers face a challenge in the age of DeFi — how to ensure lawful users can transact in a safe and private manner on public blockchains while keeping out bad actors who seek to exploit transformative technology,” Redbord said.

The BIS noted the challenges but said its plan could help close gaps in the global financial system. With stablecoins now accounting for 63% of illicit crypto transactions in 2024, according to Chainalysis and TRM Labs data cited in the report, BIS said embedding provenance into regulation “emerges as a promising avenue to close regulatory gaps.”