- The Financial Action Task Force (FATF) has called for the need for the implementation of the Travel Rule for crypto assets.
- The Travel Rule requires virtual asset service providers (VASPs) to exchange originator and beneficiary identifying information with counterparties during transmittals above $1,000.
- The compliance with the Travel Rule can help prevent money laundering, stop payments to sanctioned individuals, and block terrorist financing activities. However, as of March 2022, only 11 jurisdictions have started their enforcement, supervisory, and preventative measures for the Travel Rule.
- The challenges for the crypto industry include identifying counterparty VASPs and performing due diligence, P2P transfers of private wallets, specific wording issues, and language differences, and how to deal with VASPs in unregulated countries
- It’s explained how the Travel Rule applies to stablecoins, NFTs, and DeFi.
The ever-changing regulatory framework for crypto assets can be confusing for both novices and crypto professionals alike. In 2022 alone, there were many important regulatory acts, such as the MiCA regulation from the European Parliament and the Comprehensive Framework for Responsible Development of Digital Assets in the United States, both of which continue to expand the legal framework for cryptocurrencies. But according to the latest report from the Financial Action Task Force (FATF), the targeted update on the implementation of FATF Standards on virtual assets (VAs) and virtual asset service providers (VASPs) released in June 2022 continues to raise the so-called “sunrise problem.”
This refers to the issue of various jurisdictions needing different timelines to develop and roll out their virtual asset regulatory frameworks. The FATF report states that the vast majority of jurisdictions have not yet fully implemented FATF’s R.15/IN.15 requirements (which set the global anti-money laundering/counter-terrorist financing Standards for VAs and VASPs). Over the last year, jurisdictions have made only limited progress in introducing FATF’s Travel Rule (which is a key FATF requirement calling for the private sector to comply with sanctions rules and to detect suspicious transactions). As of March 2022, while 29 out of 98 responding jurisdictions reported having passed Travel Rule legislation, only 11 jurisdictions have started their enforcement, supervisory, and preventative measures.
It is quite clear that without the introduction of basic rules in all jurisdictions, further implementation of the rules for crypto assets will not be possible to the full extent, and here the question arises: What is so important about the Travel Rule for crypto assets, and why should all regulation start here? Let’s find out below.
What is the Travel Rule for crypto assets?
In 2019, the FATF, a global organization enabling cohesive anti-money laundering (AML) and counter-terrorist financing (CTF), recommended a coordinated approach to combat money laundering and terrorist financing. Formally known as FATF Recommendation #16, it states that the “Travel Rule,” requires member countries’ VASPs, financial institutions, and obligated entities to exchange originator and beneficiary identifying information with counterparties during transmittals above $1,000.
Member countries can choose to interpret this guidance and implement versions that best suit their local crypto industries. For example, in South Korea’s interpretation of the Travel Rule, VASPs had until March 24, 2022, to put in place measures that will be applied to all transactions equivalent to or greater than KRW 1 million (around $830).
What kind of information should be exchanged according to the FATF recommendations?
According to the FATF Interpretive Note to Recommendation 16, originator and beneficiary information should include the following:
- Name and account number of the originator
- Originator’s (physical) address, or national identity number, or customer identification number, or date and place of birth
- Name and account number of the beneficiary
- Cross-border transfers below the USD/EUR 1,000 threshold should also include the names and account numbers of the originator and beneficiary. However, this information does not need to be verified for accuracy unless there is a suspicion of money laundering or terrorist financing.
Why is the Travel Rule for crypto assets so important?
Compliance with the Travel Rule for crypto assets provides participating states with the ability to:
- Stop payments to sanctioned individuals, entities, and countries
- Block terrorist financing activities
- Enable law enforcement to subpoena transaction details
- Support reporting of suspicious activities
- Prevent money laundering of crypto assets
FATF is actively engaging with the virtual asset service provider sector to forge partnerships between governments and the sector, and to better understand the challenges and risks involved. This includes holding annual fintech and regtech forums. Through its Contact Group, the FATF continues to clarify its requirements for the industry, monitor developments, and understand how the industry is coping with various challenges.
In addition to the sunrise problem, the main challenges for the crypto industry currently include:
- Identifying counterparty VASPs and performing due diligence
- Lack of a global list of VASPs to mitigate risk
- P2P transfers of private wallets
- Specific wording issues and language differences such as spelling
- How to deal with VASPs in unregulated countries
- Batch post facto submission
What does the Travel Rule say about Stablecoins, NFTs, and DeFi?
As clarified in FATF’s Updated Guidance (October 2021), NFTs that are unique, and used in practice as collectibles rather than as payment or investment instruments, are not considered to be VAs for the purpose of the FATF Standards. Nevertheless, jurisdictions should apply the FATF Standards on VAs to NFTs in cases where they perform the same function as VAs (that is, they are used for payment or investment purposes). Given the rapid development of NFT markets and their functions/forms, FATF will continue to monitor this issue and discuss any new implementation issues and individual countries’ approaches.
The revised FATF Standards clearly apply to so-called stablecoins. Under these standards, a stablecoin will either be considered a virtual asset or a traditional financial asset, depending on its exact nature. A range of the entities involved in any stablecoin arrangement will have AML/CTF obligations under the revised FATF Standards.
According to FATF’s 2021 Updated Guidance, the FATF Standards do not apply to software. However, the FATF Standards can apply to persons who maintain control or sufficient influence over a DeFi arrangement or protocol providing VASP services. Open-source data and engagement with industry suggest that, even where projects publicly brand themselves as “DeFi,” often there continue to be persons and centralized aspects that may be subject to AML/CTF obligations. Key challenges for jurisdictions therefore are in identifying which DeFi entities should be regulated, and how to consistently enforce the FATF’s Travel Rule and other FATF regulations for such entities, particularly when they move to non-compliant jurisdictions.
Thus, thanks to the FATF recommendations, we are seeing a gradual regulation of the cryptosphere starting with the most basic rules. But it is worth noting that its regulating activities do not correspond to the pace of the industry’s development or the pace of implementation of existing norms by both private and public sectors. This opens up additional opportunities for bad actors to create new schemes for money laundering and terrorist financing. That is why the FATF describes the current situation as “urgent” and calls for increased efforts to implement and enforce the Travel Rule. Even larger regulatory changes are expected in the short to medium term as jurisdictions around the world adapt to this new reality.