New FATF Requirements & What They Mean for Cryptocurrency Exchanges

FATF Requirements

New guidelines released last month from the international Financial Action Task Force (FATF) have caused quite a stir in the crypto community. Some have called it the “end of anonymity” for digital tokens, while others have lauded the new rules as important steps toward legitimizing cryptocurrency. To be sure, the controversial FATF requirements will have a big impact on cryptocurrency, specifically cryptocurrency exchanges and other service providers.

In this article we’ll examine exactly what the new FATF guidelines are, their motivations, and the potential impacts they’ll have on the industry. In the end, we’ll see the pros and cons of the new requirements and what crypto exchanges can do about them.

1. What Are the New FATF Requirements?

The Financial Action Task Force is an intergovernmental body composed of leaders of national treasuries and federal banks from 39 countries around the world, including the European Commission, United States, and China. The FATF began in the 1980s as a way for governments to cooperate on Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) activities and policies.

The new FATF Recommendation 15 lays out detailed requirements for member countries on the regulation of Virtual Asset Service Providers (VASPs). Indeed, virtual assets explicitly include cryptocurrencies, and the requirements on service providers apply to crypto exchanges and other crypto-handling entities that provide client services.

Crypto experts are concerned about Recommendation 15 specifically in regards to paragraph 7(b):

“Countries should ensure that originating VASPs obtain and hold required and accurate originator information and required beneficiary information on virtual asset transfers, submit the above information to beneficiary VASPs and counterparts (if any), and make it available on request to appropriate authorities.”

In addition, beneficiary accounts should collect and store the same information.

In summary, paragraph 7(b) requires cryptocurrency exchanges to collect and share account holder information whenever a transaction occurs between exchanges or other VASPs.

Known as the “travel rule” in traditional banking, sharing account holder information when a transfer occurs is a common AML practice for fiat currencies. The challenge, of course, is so many cryptocurrencies rely heavily on anonymity. The burden of compliance could become quite high.

2. Is This a Law?

To be clear, FATF recommendations are not law. With these new guidelines, cryptocurrency exchanges are not yet compelled to comply.

However, the FATF holds tremendous influence over its member states. Each country in the FATF is expected to issue its own matching legislation or regulations in order to comply with the FATF recommendations. If they do not, they risk being added to the FATF graylist or blacklist, which could severely limit their access to markets and credit.

The recommendation gives member countries 12 months to enact legislation or regulations meeting the guidelines.

3. Why Were They Enacted?

Within the financial industry, there’s growing concern over the use of cryptocurrencies for criminal means. Additionally, criminal groups have used cryptocurrencies to launder proceeds from illicit activities. As recently as June 2019, Spanish authorities arrested 35 conspirators in a money laundering scheme involving a Bitcoin ATM.

U.S. Secretary of the Treasury, Steve Mnuchin, argued that stricter guidelines could curtail this type of activity:

“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.”

“Nevertheless, it’s unclear the full extent to which criminals are successfully using cryptocurrency for money laundering. Most exchanges require identity information when you want to make a crypto to fiat transaction. Other AML regulations already apply to most exchanges in major countries.

4. What Are the Potential Benefits?

Benefits and Drawbacks

The main potential benefit of the new requirements is a reduction in the use of cryptocurrency for illegal activities. If the new regulations can stop criminals from laundering their proceeds, it could go a long way toward slowing the growth of criminal organizations.

In addition, compliance with these recommendations would bring crypto further into the realm of regulated, established financial institutions. Adding the “travel rule” to crypto transactions means the crypto market may be able to integrate more readily with traditional markets. There’s potential that increased regulation could eventually make it possible to cash out crypto to fiat within the traditional banking system. Increased mainstream adoption of cryptocurrency could bring a host of benefits and efficiencies to society as a whole.

5. What Are the Potential Drawbacks?

The primary concern for many cryptocurrency users is privacy. If personally identifying information is shared every time you commit a transaction between crypto service providers, then anonymity is essentially gone from the system. This divide between anonymity and VASPs could mean that the cryptocurrency ecosystem as a whole splits into two factions: white wallets and black wallets.

The white wallets are legitimate, open, and have identifying information. They’re regulated and participating in the crypto economy. The black wallets are anonymous and off the books. They conduct person to person transactions that don’t require identifying information.

Ellen Lake at the law firm Clifford Chance puts it this way:

“The Travel Rule makes sense in a context where all financial transactions are sent through intermediaries, virtual asset transactions can occur not just through crypto exchanges or other businesses, but also from person to person, person to machine, machine to machine, via smart contracts and through multiple other combinations and potential endpoints.”

There’s also a case to be made that the new requirements might backfire on the FATF. Instead of making the crypto market more transparent, it could drive more people to conduct transactions off the grid.

Jeff Horowitz, chief compliance officer at Coinbase said:

“I get why the FATF wants to do this. But applying bank regulations to this industry could drive more people to conduct person-to-person transactions, which would result in less transparency for law enforcement.”

Former FATF President Roger Wilkins also supports the view:

“What we are hearing from industry is that the new rules may have the opposite effect to which they were intended, effectively forcing crypto transactions off the controlled platforms, which are currently one of the best avenues we have in gaining visibility over financial crime.”

Finally, it’s worth considering the cost of compliance. Adding new regulations could become onerous on cryptocurrency exchanges. If compliance is too expensive, crypto exchanges could shut down, leading to a consolidation in the industry.

7. How Can Cryptocurrency Exchanges Comply?

In many cases, exchanges don’t really know much about the beneficiary wallet addresses. When currency leaves an account, the exchange doesn’t verify the identity of the recipient. But that might have to change under the new rules.

Indeed, the FATF recommendations indicate exchanges will need to collect the following information:

  1. originator’s name (i.e. the sending customer)
  2. originator’s account number (e.g. wallet public_key)
  3. originator’s physical (geographical) address, or national identity number, or customer identification number (i.e., not a transaction number) that uniquely identifies the originator to the ordering institution, or date and place of birth
  4. beneficiary’s name
  5. beneficiary account number (e.g. wallet)

Storing this information securely and consistently will be a major challenge for exchanges. As countries begin to pass regulations and legislation to meet Recommendation 15, it will be interesting to see how crypto service providers respond to the changes.

6. skalex Advantage

For exchanges on the skalex platform, we’re developing a FATF Recommendation 15 compliance system to meet all the requirements. While national regulations will vary, our know your customer (KYC) features are extensible to handle the new compliance challenges coming for crypto exchanges worldwide.Currently, our software is capable of obtaining and holding beneficiary information for incoming transactions and originator information for outgoing transactions.

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