In the early days of cryptocurrency, security measures were starkly binary: if an address appeared on a blacklist, organizations simply avoided doing business with it.
Criminals, however, quickly found ways to bypass these blacklists. For example, they could create new addresses unlinked to any previously blacklisted ones.
To address this, crypto risk scores were developed, enabling businesses to assess wallets and transactions with greater nuance. This article explores what crypto risk scores are, how they can be tailored to specific needs, and what organizations should prioritize when selecting a tool to determine these scores.
Most people are familiar with credit scores, which range from 350 to 850. Similarly, crypto risk scores span a spectrum, though they are typically expressed in qualitative terms: low, medium, and high risk.
While businesses can customize each level to meet their specific risk tolerance—which may differ across markets—these categories generally align as follows:
High Risk
High-risk wallets should be avoided by exchanges. They may have direct exposure to wallets sanctioned by entities like the Office of Foreign Assets Control (OFAC) or other regulatory bodies maintaining blacklists. Alternatively, they may be linked to high-risk jurisdictions with inadequate Anti-Money Laundering (AML), Know Your Customer (KYC), or Combating the Financing of Terrorism (CFT) regulations, such as North Korea, Russia, or Iran.
Certain behaviors may also justify a wallet being deemed high risk. For instance, while coin mixers have legitimate applications for privacy, frequent use may signal potential criminal activity. Other red flags include involvement in money laundering techniques like layering, chain hopping, peel chains, or unusual behaviors, such as withdrawing most funds within minutes of receipt.
Medium Risk
Medium-risk accounts often fall into gray areas that would be most impacted by a blacklist-only approach. Without crypto risk scores, organizations might either reject legitimate customers (false positives) or inadvertently accept bad actors (false negatives). Risk scores enable exchanges to take intermediate actions, such as requesting additional documentation or conducting further screening for medium-risk wallets.
A wallet flagged as medium risk may, for example, have indirect exposure (more than two hops away) to sanctioned entities or be linked to jurisdictions under regulatory scrutiny, such as Barbados or Kenya. Behavioral indicators might include interactions with unregulated exchanges or moderate use of privacy tools.
Low Risk
Contrary to the perception of crypto as a "Wild West," the majority of transactions are low risk. These wallets likely belong to legitimate users, showing no direct or indirect ties to sanctioned entities, high-risk jurisdictions, or illicit businesses. Behavioral patterns, such as consistent trading activity, further support their legitimacy.
Businesses should enable low-risk wallets to operate freely but subject them to continuous monitoring. Crypto risk scores are dynamic; a wallet’s status can shift to medium or high risk if it gains exposure to suspicious activity or entities.
By categorizing wallets, exchanges can block high-risk accounts, require additional screening for medium-risk ones, and allow low-risk accounts to transact—ultimately aiding in the prevention of crypto-related crimes.
Crypto risk scores should be tailored to align with a business’s specific needs. Key factors to consider include:
Careful customization of risk categories is as critical as selecting the right compliance tool to ensure robust risk management.
When selecting a compliance tool for crypto risk scoring, businesses should prioritize the following features:
Crypto risk scores are indispensable for effective blockchain analytics and financial crime prevention.
By leveraging these scores, businesses can adopt a nuanced approach to risk management. Configuring scores to account for jurisdictional differences, cryptocurrency-specific risks, and evolving transaction behaviors empowers organizations to mitigate risks effectively.
Ultimately, success lies in implementing a robust risk-scoring program. Such a program enables businesses to block criminals, scrutinize suspicious wallets, and facilitate legitimate transactions. To achieve this, organizations must invest in a compliance tool that combines power with flexibility, like Merkle Science’s Compass. Get in touch for a demo today.
