Financial Action Task Force moves to regulate crypto exchanges

The Financial Action Task Force issued new guidelines on Friday, including a requirement that virtual asset service providers (VASPs), such as crypto exchanges, will have to pass on customer information when transferring funds between firms.

To send money, they should obtain and hold information on the sender and the recipient and submit the information to the beneficiary institution.

Most crypto exchanges, which are used to buy and convert virtual assets and trade them, already require personal identification, like a passport, before they provide their services.

The new measure attempts to replicate the so-called travel rule for banks, that transfer this type of information, for example. in a wire transfer. As such, it goes beyond basic know-your-customer due diligence employed by regulated exchanges.

Under the new FATF guidance, which is part of an Interpretive Note to FATF Recommendation 15 on New Technologies, each transfer should include the originator’s name, virtual asset wallet if it is used to process the transaction, the physical address, national identity number, customer ID, and place of birth, as well as the beneficiary’s name and wallet.

The FATF is giving countries 12 months to implement the guidelines into their laws and regulations and has set a review for June 2020.

At a FATF plenary session held on 21 June in Orlando, Florida, US Treasury Secretary Steven Mnuchin, said, “We will not allow cryptocurrency to become the equivalent of secret numbered accounts.” Proper use would be allowed but the continued use for illicit activities would not be tolerated.

“By adopting the standards and guidelines agreed to this week, the FATF will make sure that virtual asset service providers do not operate in the dark shadows,” Mnuchin added.

The blockchain industry has criticised the new rules during a public consultation period following the publication of draft guidelines in February as overly onerous and difficult to implement in the crypto space.

The new guideline effectively tries to treat exchanges like banks and other payment providers who process payments between their customers’ accounts. It somewhat ignores that users of virtual assets do not need a payment processor to transfer value to another party. This is handled by a decentralised blockchain that records transactions between virtual asset wallets, which are not accounts but rather a software or device that stores the public and private cryptographic keys needed to track ownership of or transfer cryptocurrencies.

This makes a value transfer between two wallets more like a cash transaction, except that each transaction is added to the publicly visible blockchain ledger.

To tackle this problem, the FATF rules force even individuals, who act as businesses and transfer funds using their crypto wallets, to be licensed as virtual asset service providers.

“In cases where the VASP is a natural person, it should be required to be licensed or registered in the jurisdiction where its place of business is located – the determination of which may include several factors for consideration by countries,” the guideline states.

However, if individuals use virtual assets, like bitcoin, to buy goods or services or for a one-off exchange or transfer, they would not be treated as VASPs.

Given that virtual assets are designed to move value without having to identify the parties of the transaction, the new measure could force many crypto transactions into an unregulated space.

In practice, many transactions are already not conducted between virtual asset service providers but between VASPs and wallets or between individual wallets.

Another issue is that there is no existing mechanism for exchanges to transfer customer information. They will have to make significant investments to create such a communication network, as it would be difficult to change the way existing blockchains operate to include this type of data.

The new FATF rules demand that countries properly regulate VASPs and prevent criminals from controlling these types of services, for example by pre-approving changes in shareholders, business operations and structures.

The guidelines put the onus on VASPs to mitigate the risk of mixer and tumbler services that mask the origin of virtual assets, stating they should not be licensed to operate if they are unable to do so.

VASPs are also required to freeze or prohibit transactions with sanctioned individuals, the FATF said.

At the end of 2018, about 32 million wallets existed for bitcoin, the most popular cryptocurrency. The number of actual bitcoin users is likely to be lower, as many users have multiple wallet addresses to enhance their financial privacy. Blockchain analysis company, Chainalysis, estimates 34% are active users.

Earlier this month, Cayman legislators amended the Proceeds of Crime Law to include a definition of virtual assets for anti-money laundering purposes. The law now defines virtual assets as a “digital representation of value that can be digitally traded or transferred, and can be used for payment or investment purposes”.

Financial services related to the sale, transfer or administration of virtual assets are classed as relevant financial businesses that are subject to anti-money laundering laws and regulations. These anti-money laundering rules also apply to token sales and initial coin offerings.

The price of bitcoin has been buoyed by Facebook’s announcement of Libra, its own cryptocurrency project, last week. Since then, bitcoin has breached the $11,200-mark, an increase of 16% in one week. Since December 2018, the value of bitcoin increased by 250%.

Investors appear to expect Libra to benefit bitcoin by bringing cryptocurrencies mainstream attention. The latest regulatory hurdles for virtual asset service providers have also not dampened bitcoin trading, indicating that investors believe more regulation will be better for mainstream adoption.