The discussion surrounding the adoption of the Financial Action Task Force’s (FATF) Travel Rule in the cryptocurrency sector has brought forth several crucial issues. Officially known as FATF Recommendation 16, the Travel Rule is designed to implement new measures to combat money laundering and terrorism financing by mandating virtual asset service providers (VASPs) to share specific details for cryptocurrency transfers above a certain threshold.
The Travel Rule pertains to the exchange of information between the sender and receiver for any funds transfers conducted on behalf of a sender with the intention of making funds available to a recipient. The required information must be transmitted promptly and securely.
Let’s pause and examine how this would operate in the blockchain’s ‘pseudonymous’ setting:
In contrast to traditional banking systems, blockchain technology offers unmatched transparency with publicly accessible transaction ledgers. The application of the Travel Rule expands this transparency by unveiling the identities of individuals behind wallet addresses and their transaction history.
This necessitates a cautious approach from the administrators of the Travel Rule protocol, compliance providers, and VASPs in managing and sharing customer data. While advantageous in some aspects, this level of transparency presents significant privacy risks absent in traditional finance (TradFi). Observers can easily track all transactions between wallet addresses, as well as the assets being sent and received.
Another challenge is the “sunrise issue,” where inconsistent regulatory requirements across different jurisdictions create obstacles for global compliance. For example, a VASP operating in one country might need to adhere to different rules compared to another, resulting in complexities and inefficiencies in cross-border transactions.
Diverse approaches to VASPs’ due diligence also pose significant challenges. While some protocols are permissionless, requiring no due diligence from participants, others enforce strict checks. The variation across jurisdictions leads to ambiguity for VASPs’ compliance efforts and, from a technical standpoint, operational overhead for compliance teams as they strive to adhere to multiple standards for handling cross-jurisdiction transactions. This leaves VASPs with no choice but to take a risk-based approach per transaction, which can result in operational inefficiency and gaps.
Moreover, the multitude of national regulations on the required data fields to be exchanged and the interpretation of shared customer data introduces another layer of complexity. This can lead to misunderstandings and compliance errors.
The industry has developed the InterVASP Messaging Standard 101 as a universal standard to address standardization and formatting for the communication of required sender and recipient information between VASPs, which has recently been updated. However, it does not resolve the fact that different national regulations may request different sets of data to be exchanged.
Unsurprisingly, the introduction of the Travel Rule has sparked numerous important questions from the blockchain and cryptocurrency industry. I had the opportunity to converse with several executives from within the industry, and here is what they have to say about this pressing issue:
Delphine Forma, Solidus Labs, Policy Lead for Europe and UK, Crypto Compliance and Legal TG Group Founder
Delphine Forma highlighted the importance of user experience, which is crucial for the widespread adoption of cryptocurrencies. She pointed out that the proof-of-ownership process can be cumbersome, involving methods like the “Satoshi test” or live video verification, which can deter users. Technologies like AOPP could potentially address this issue but need broader adoption.
Interoperability is another significant challenge. Current solutions in the market lack interoperability, meaning manual processes may be necessary if counterparties do not utilize the same solution. This is impractical and poses data protection risks and scalability issues.
The complexity of counterparty due diligence is another issue Delphine emphasized. With VASPs potentially maintaining thousands of relationships, the need for extensive due diligence is burdensome and costly.
Furthermore, the inconsistency in guidelines across jurisdictions, or the “sunrise issue,” adds to the complexity. Different thresholds, approaches to unhosted wallets, third-party transfers, and data sets exchanged further complicate compliance. Delphine highlighted the lack of clear and practical guidelines on handling funds received without the required information or when to terminate a relationship due to missing data. The selection of Travel Rule providers is also crucial, as factors like interoperability, pricing, data storage, and ease of implementation vary widely.
Delphine concluded by questioning the overall efficiency of the Travel Rule, noting that while VASPs must adhere to KYC and AML regulations, the ease of creating new addresses and moving funds quickly can undermine these efforts. She summarized that applying traditional financial rules to crypto without adaptation could stifle innovation and fail to leverage blockchain’s unique capabilities.
Ivar Zukovskis, BitPay Director of Compliance
While Ivar Zukovskis supports regulating the crypto space to facilitate the widespread adoption of cryptocurrencies, he also acknowledges the contentious nature of the Travel Rule. Despite BitPay’s robust compliance framework, including licenses in the United States and VASP registrations in the Netherlands and Italy, Zukovskis highlights the ongoing challenges of the Travel Rule even five years after its introduction.
While the crypto industry has adapted to other AML obligations, such as AMLD5 in the European Union, the Travel Rule remains problematic. Key issues include the lack of global consistency, with different countries imposing varying requirements, complicating cross-border compliance. Zukovskis underscored the difficulty of ensuring comprehensive wallet attribution, which is crucial for identifying the parties involved in transactions but is currently underdeveloped.
The implementation of the Travel Rule imposes additional operational burdens on companies by requiring investments in compliance tools, according to Zukovskis. This could place smaller companies under significant financial strain, as compliance costs continue to rise in the crypto space. This could potentially impact market competition fairness, as larger firms can more readily adapt to rising costs.
The inconsistency in shared customer data formats exacerbates compliance challenges. Differing interpretations and formats can lead to errors and inefficiencies, making it imperative for the industry to move towards standardized data-sharing practices. Zukovskis emphasized the importance of selecting the right Travel Rule provider, considering factors like interoperability, data privacy, and ease of implementation to ensure seamless compliance.
In his view, the Travel Rule, while well-intentioned, has yet to fully demonstrate its effectiveness. Tracing illicit transactions back to their source remains challenging, and the rule’s application to the rapidly evolving crypto space requires constant adaptation to avoid stifling innovation.
Tommaso Astazi, Blockchain for Europe Head of Regulatory Affairs
Tommaso Astazi noted that while the Markets in Crypto-Assets (MiCA) Regulation is widely recognized, the recent AML package, including the review of the 2015 Transfers of Funds Regulation (TFR), is equally significant. This is because the review of TFR would serve as the EU’s implementation of the Travel Rule for the crypto industry.
Astazi emphasized that the TFR mandates crypto asset service providers (CASPs) to ensure that each crypto-asset transfer includes relevant information on the sender and recipient. This rule applies to transactions involving CASPs but not to peer-to-peer (P2P) transactions between self-custodial wallets.
He added that while the European Parliament initially pushed for additional verification requirements, the industry succeeded in preventing impractical measures that would have been impossible for providers of self-hosted wallet software to comply with.
Educating policymakers on blockchain is also a crucial step, he emphasized. The industry has effectively influenced legislative discussions through workshops and direct engagement, ensuring that regulations remain in line with FATF recommendations without stifling innovation. This proactive approach has led to a regulatory environment that strikes a balance between compliance and the need for technological advancement.
Astazi stressed the vital role of ongoing dialogue between the crypto industry and policymakers. By fostering understanding and collaboration, the industry can help shape regulations that support innovation while ensuring robust compliance measures are in place.
Maintaining an Open Dialogue
The implementation of the FATF Travel Rule in the crypto sector sheds light on several significant challenges. From the transparency risks inherent in blockchain technology to the inconsistent regulatory environment across jurisdictions, these issues demand careful consideration and adaptation.
Leaders like Delphine Forma, Ivar Zukovskis, and Tommaso Astazi offer valuable insights into the complexities and potential solutions. Their perspectives underscore the necessity of standardized practices, effective due diligence, and continuous engagement with policymakers to successfully navigate these challenges. Ultimately, striking a balance between robust regulation and fostering innovation will be crucial for the sustainable growth of the crypto industry.
Ilya Brovin joined Sumsub in 2021 and was appointed as Chief Growth Officer in 2023. With over 20 years of experience in finance and private equity, Ilya has worked at prominent firms such as Hellman & Friedman, Eton Park, and Morgan Stanley. He brings extensive experience working with tech and financial services companies as an investor and board member/observer.
At Sumsub, Ilya is responsible for growth and strategy, overseeing key sales, strategic partnerships, fundraising, investor relations, and M&A activities. He holds a degree in Economics & Finance and an MBA from Harvard Business School. Currently residing in London, UK, one of Sumsub’s international offices, Ilya has been featured on NBC Chicago TV Channel, BBC Sounds, PayPod podcast, and quoted and interviewed by industry-leading media outlets such as CoinDesk, FinTech Magazine, and FinanceFeeds.
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