Article

What Do the Latest FATF Guidelines Mean For The Crypto Industry?

by the Crystal marketing team

December 14, 2021

The topic of crypto regulation has always been a hot-button issue among industry leaders, investors, and even regulators. Oftentimes, the challenge has been finding the right balance between protecting investors and enabling innovation without hurting stakeholders in the crypto market. 

The Financial Action Task Force (FATF), for instance, has been at the forefront of trying to find this balance and has issued several draft papers and documents over the years that aimed at offering standard guidelines for crypto regulation.

Recently, the global anti-money laundering agency further clarified its regulatory guidance for the crypto industry offering game-changing definitions and guidelines that are set to not only impact the crypto industry but other involved entities in the world of finance.

History of FATF’s Guidelines

From as early as June 2019, the Financial Action Task Force had officially begun its work of providing regulatory guidance to companies and parties in the digital asset space.

From the onset, the first set of guidelines recommended the implementation of a global “Travel Rule” designed to corral much of the emerging crypto industry into a compliant sector molded after the traditional world of finance. The “Travel Rule” which is also known as the crypto Travel Rule as it mimics the Travel Rule of the Banking Privacy Act in the US, is FATF’s blanket strategy at replacing complex AML/KYC and KYT regulations.

The Travel Rule first came to fruition in 2019 with a recommendation for all digital fund transfers, creators, and beneficiaries to exchange various types of transactional data to help establish an anti-money laundering and anti-terrorism financing policy. The information to be shared between these institutions in the crypto space include customer ID numbers, date of transaction, and the location of the digital asset creator and beneficiaries among other types of metadata. As expected, these new recommendations brought about a bag of mixed reactions as many continued to wonder how these regulatory guidelines would affect the industry as a whole.

In continuing with its work of developing new global anti-money laundering standards for cryptocurrencies, the FATF released a report in the summer of 2020 highlighting the progress made. The report also highlighted the need for better clarification of what FATF calls Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs).

Eventually, Sandra Garcia (co-chair of FATF’s Virtual Asset Contact Group) announced plans by the FATF to widen the scope of its definition of VAs and VASPS to include peer-to-peer exchanges in 2021. This announcement was made at the V20 Virtual Asset Service Providers Summit in November 2020, thus giving ground to the new guidelines that were released in March 2021. After a month from the release of the guidelines, FATF once again announced its intentions to widen the scope of its definitions, especially to mitigate risks caused by P2P transactions on unhosted (self custody) wallets. The newly updated guidelines finally arrive by October 2021 and give more official clarity to the existing document signaling incoming crypto regulations that are set to have a marketwide effect.

Regulation is Imminent

Regulation in the crypto world is inevitable. However, regulators need to adopt a flexible approach during initial rollout periods to make sure they appreciate real-world use cases of cryptocurrencies and their underlying technology just as much as they implement KYC and AML policies.

 In an industry that is constantly in a state of flux, so-called virtual asset service providers (VASPs) face several challenges especially when it comes to regulatory compliance. Not only do VASPs need to comply with data protection laws, but they are also required to implement technologies and procedures that give regulators access to data for KYC and AML purposes.

Yet, in the past decade, the crypto industry has been less focused on regulatory compliance and more on technological innovation, leaving a wide gap for compliance solutions. The rapid growth of the industry makes it seemingly impossible even for regulators to keep up as seen with the massive growing decentralized finance (DeFi) arena where decentralized and autonomous peer-to-peer platforms rule the landscape. NFTs have also emerged as a leading force, with sales expected to go past $17 billion by the end of 2021.

For this reason, the new FATF guidelines are an attempt at formulating flexible and up-to-date regulatory guidelines in line with the fast-changing crypto space. Simply put, the industry has grown too big to ignore hence FATF’s need to formulate a clear framework for regulators and stakeholders as mainstream adoption increases.

DeFi and NFT Clarity

According to the revised crypto regulator guidance by the FATF, actors in a DeFi arrangement who “maintain control or sufficient influence” over the virtual assets in that DeFi ecosystem will have the responsibilities of a VASP. This updated definition suggests that if the developers of a DeFi platform can restrict the listing of coins or halt transactions in a significant way, they could be required to comply with FATF’s VASP requirements.

FATF’s new VASP definition is set to cover “any natural or legal person” who is a business acting on behalf of another legal or natural person. While this requirement is clear cut for centralized entities in the DeFi landscape that facilitate the transfer, exchange, or custody of digital assets, it can leave room for misinterpretation, especially for decentralized applications (dApps).

Fortunately, FATF’s guidelines clarify the fact that dApps are not VASPs; however, those developers who create, maintain, own, and operate such dApps are likely to be categorized as VASPS even though parts of the dApp are decentralized or autonomous.

FATF’s updated guidelines further clarify the meaning of “sufficient influence” in the DeFi space and point out that individuals who hold the governance token of a dApp or DeFi protocol will not be regarded as VASPS if they don’t have sufficient influence over the platform or network. While most of the DeFi P2P transaction guidelines from FATF’s previous document remained unchanged, the FATF removed a clause that suggested “denying of licensing to VASPs if they allow transactions to or from non-obliged entities.”

Non-fungible tokens, on the other hand, are not virtual assets, except when they are used as forms of payment. For the first time, FATF’s guidelines introduced NFTs defining them as digital assets with a unique and rare quality that is interchangeable. According to FATF’s guidelines, NFTs should be categorized in consideration of their nature and function. When used as a form of payment, the FATF’s guidelines mention that those NFTs can fall under the VA definition.

Overall, given the changing nature of DeFi, FATF’s guidelines leave a lot of room for jurisdictions around the world to decide for themselves on how to deal with DeFi platforms and NFTs on a case-by-case basis.

Other Updates to the Regulatory Guidelines

In addition to clarifying definitions on DeFi dApps and NFTs, the revised FATF guidelines also introduce new guidance around the Travel Rule. These include an update that says VASPs don’t need to identify parties that receive the transaction fees produced by the transfer of a virtual asset. 

This is because those who receive transaction fees in a DeFi setting are usually miners and liquidity miners who are not originators or recipients of the VA itself. Also, the Travel Rule on UTXO-based digital assets was lifted. UTXO based digital assets are digital currencies that are left unspent in a wallet after making a VA transfer from one wallet to the other. 

These are unspent cryptocurrency outputs whose main purpose is to confirm the results of a transaction and balance the ledger. VASPS will not be required to give regulators this data. An additional Travel Rule guideline addition is set to be a costly compliance measure for VASPs as they are required to submit the required Travel Rule information simultaneously or concurrently with the transfer of assets.

As well, given the growing risk that FATF anticipates with crypto transfers shifting towards peer-to-peer platforms and self-custody wallets to escape regulation, FATF has updated its guidelines to require VASPs to perform ongoing -risk-based supervision on all unhosted wallet transactions. With the new guidelines, VASPs will be required to only facilitate the transfer of digital assets to and from sources deemed acceptable and compliant.

Another sector under the watch of the FATF is stablecoins. Given the potential for the mainstream adoption of stablecoins, the FATF has offered an update on its definition of stablecoins. The agency is not the only regulatory body that has had its eye on stablecoins, this digital asset class has been a point of concern for regulators across the globe. Although the agency does not endorse them, it recognizes them as virtual assets even though CBDCs (central bank digital currencies) are not considered virtual assets. Also, the FATF’s guidelines consider the central entity backing a stablecoin to be a VASP.

FATF are listening to the crypto industry

As it seems, FATF has tried to take on industry advice regarding certain updates to its guidelines.

While many of these changes may be subject to interpretation, and implementation by the respective regulatory bodies and jurisdictions may take a while, it is clear that regulation of the crypto industry will pick up speed.

Companies in the industry need to seek blockchain analysis solutions that will help them stay on track with increasing compliance requirements set to hit the industry. Crystal Blockchain is one of the leading solutions providers giving companies in the crypto space a competitive advantage with access to blockchain analysis tools that enable comprehensive monitoring and investigation of digital assets.

Furthermore, it is important to note that there exist several other governing bodies such as SFC (the Securities and Futures Commission of Hong Kong) or the SEC (Securities and Exchange Commission) that will continue to look at the emerging crypto world and issue further compliance requirements. 

For this reason, stakeholders in this emerging industry should employ companies that help them manage their compliance costs in an increasingly decentralized digital world. 

Book a demo to learn more about our AML compliance tools and our Travel Rule solution (in collaboration with Notabene) at contact@crystalblockchain.com 

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