A publicity stunt and a shameful act or a long overdue investigation? Last week, Bulgarian state authorities and foreign investigators began a large-scale investigation into alleged illegal activities, conducted by the Bulgarian-founded international crypto platform Nexo. The Bulgarian Prosecution raised a number of charges, including money laundering, organized criminal group, tax crimes, providing banking services without the necessary license, computer fraud, and violations of the international sanctions against Russia.
The local media outlet Capital reports that as of now, the Prosecution has raised official charges for alleged participation in an organized criminal group against four key individuals associated with Nexo – Antoni Trenchev (co-founder), Kosta Kantchev (co-founder), Trayan Nikolov (CPO), and Kalin Metodiev (CFA). It has become clear that the police raided Nexo’s offices without an immediate search warrant, and now the crypto-lending bank plans to sue the Bulgarian state.
Even though Nexo never ceased operations, data trackers show that hundreds of thousands of dollars worth of cryptocurrencies are leaving the platform in large transactions.
Many questions are left unanswered, but one thing is sure – the investigation has brought a great sense of polarization and instability in the crypto community and has created an unstable environment for doing crypto business in Bulgaria. The dispute around Nexo in Bulgarian public life has not been so much about the facts as it was used to fuel politically motivated attacks between national political parties. This has further sparked an atmosphere of uncertainty in the crypto space.
The Recursive spoke to a number of people operating in the field about the short and long-term effects on the local crypto community, and the pressing need for more stability and regulations in the crypto market. Some of them asked to remain anonymous given the sensitivity of the topic.
“The Prosecution needs to be more specific in the accusations it makes and refers to the exact procedures and processes that Nexo breaches. This turmoil raises lots of questions for the people in the industry. By and large, the crypto community asks for clear regulations. We operate in a field where it is still not specified what is legal and what is not. Every process should be clearly explained so that we are aware of how to oblige. The paradox right now is that we need to have a compliance officer, but we don’t know exactly what to comply with. Most of the rules under which crypto companies operate are based on previous experience instead of official regulations,” one Bulgarian crypto founder comments for The Recursive.
Beyond Nexo: will more regulations bring stability?
“The recent events with FTX and Nexo show that there is a need for more transparency and coherence in the provision of such services as well as public token offerings. These are the blank spaces that the MiCA (Markets in Crypto-Assets) regulation which would take effect next year, is looking to address,” blockchain and law expert comments.
In June 2022, the new MiCA regulation was agreed upon between the European Commission, the European Parliament, and the Council of the European Union. It is possibly the first comprehensive cryptocurrency regulation of any jurisdiction in the world that is tailored specifically to crypto assets.
The EU agreement encompasses the Transfer of Funds Regulation (TFR) which sets EU-wide rules for the so-called “Travel Rule”. In essence, it establishes a monetary threshold above which cryptocurrency transactions are subject to the rule. The other part of the regulation establishes a licensing regime for all cryptocurrency businesses in the EU. The exact details are still in the making, but the rules are expected to take effect by the end of 2023.
“MiCA aims to tackle anti-money laundering, but this is not its sole purpose. The main goal of the regulation is to introduce fair and equitable treatment standards and establish license requirements for every activity related to cryptocurrencies – from consulting and issuing, to management, and for exchange,” crypto experts clarify.
Knowns, unknowns, and questions left unanswered
According to the Prosecution, the alleged crimes have taken place in Bulgaria, the UK, Switzerland, and the Cayman Islands. Nexo’s platform is officially not available for the use of Bulgarian citizens.
“Nexo does not offer its services in the Republic of Bulgaria, precisely because of the possibility of being bombarded with such absurdity, given Bulgaria has a track record for corrupt authorities,” Nexo commented in a response to the police raids.
Additionally, prosecutors stated that the investigation was launched months ago after suspicious transactions were made on the platform. It is said that the reported transactions were meant to allow Russian citizens to circumvent Western sanctions imposed against the Russian Federation. Officials stated last week that they had evidence that at least one person using the platform had been declared a financier of terrorism. Some claims even suggest that the investigation has identified 100 transfers to the militant group Hamas which is on the list of foreign terrorist organizations of the US State Department.
The reality is that Nexo accepts deposits in Russian rubles. This means that it allows Russian citizens to take a loan in their local currency and receive the funds almost instantly by local bank transfer. Who are global crypto platforms obliged to report to if they detect that one of their clients is involved in illegal activity?
“First, it is unrealistic to think that large crypto companies, such as Nexo, are able to follow through every transaction that happens on their platform. And legally, they are not obliged to inform anyone if they do come across such suspicious activity. Every verification, compliance, and AML mechanism that they do is based on three processes – KYC (know your customer), KYT (know your transaction), and Source of Funds. In order to pass the KYC process clients are obliged to provide an ID document, alongside a real-time photo. Third-party services such as Sumsub then verifies the history of users, and detects whether a user has had a previous dubious activity. The KYT process, which could also be conducted by a third-party service such as Chainalysis assesses whether the transaction is legal and not linked to financial crimes. Then, if users want to make larger incoming transfers, they need to send an additional document known as a Source of Funds in order to prove the source of the assets they are putting into the platform,” Martin Kuvandzhiev, crypto expert and CEO of the startup development studio GoStartups, shares with The Recursive.
In the case of Nexo, the platform is using the third-party services of Chainalysis, Onfido which provides document and facial checks for the platform, and Travel Rule Universal Solution Technology (“TRUST”) which allows financial institutions to share certain basic information about customers when sending funds to another financial institution.
Another local blockchain specialist explains that crypto platforms are obliged to collect data on each transaction and provide it to the police when asked about it. “For instance, if the police are suspicious that any of the clients of Nexo is a terrorist, they can ask the company to provide all the data associated with the account, together with the history of the transactions. One of the crypto founders that we work with gets asked to go to the police station once every two months to testify and provide the identification of their clients,” our source adds.
Coming back on the topic of regulations, KYC, KYT, and Source of Funds are verification mechanisms that crypto platforms are obliged to use under the regulations of some jurisdictions but not everywhere. The legal obligations of crypto businesses depend on existing national AML laws.
Another part of the accusations made last Thursday is connected to the fact that Nexo operates through “post boxes” – numerous registered commercial companies that have been set up to cover financial, legal, and tax fraud. On a couple of occasions, media outlets reported that this type of structure functions as a crypto pyramid. Local crypto experts weighed in to explain how are crypto platforms typically structured, what is the purpose behind that, and what role regulations have to play in the way founders choose to structure their entities.
“The business logic behind setting entities abroad is to allow the crypto platforms to take advantage of the existence of crypto regulations in different jurisdictions. Founders can choose the jurisdiction with the regulations which best fit their needs and objectives. For example, if a crypto founder wants to work with Asian clients, they can set up an entity in Singapore and onboard their Asian clients from that entity. Whereas, if they want to work with European clients, they would set up an office in Estonia or Lithuania. Most often, founders gather their initial capital investment in the Bulgarian entity and set up various entities which earn revenue and are able to store it before transferring it back to the main entity,” Martin Kuvandzhiev explains.
The raid of the Prosecution created a lot of turmoil, which exacerbates the need for more consistent regulations and transparency in the crypto space. One can argue that such public actions are counterproductive for the industry, while others may think that it could serve as a cautionary tale and introduce urgency in the implementation and transposition of crypto regulations. Nexo’s case poses questions about the future growth of the local crypto industry.
Crypto founders are asking for more precise explanations of the accusations against Nexo, so that they know how to avoid a similar scenario. How to structure a crypto company in such a way that it can grow fast, without ending up being investigated for a crime?
The Recursive is continuing to follow the story closely.