The discussion surrounding the implementation of the Financial Action Task Force’s (FATF) Travel Rule in the crypto industry has brought to light various crucial issues. Officially known as FATF Recommendation 16, the Travel Rule is designed to introduce new measures aimed at preventing money laundering and terrorism financing by requiring virtual asset service providers (VASP) to share specific details for cryptocurrency transfers above a certain threshold.
The Travel Rule pertains to the exchange of information between an originator and a beneficiary for any funds transfers made on behalf of an originator with the goal of making funds available to a beneficiary. The required information must be transmitted promptly and securely.
Let’s take a moment to consider how this would operate in the blockchain’s ‘pseudonymous’ environment:
Unlike traditional banking systems, blockchain technology offers unmatched transparency with publicly accessible transaction ledgers. The implementation of the Travel Rule expands on this transparency by revealing 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 handling and sharing customer data. While advantageous in some aspects, this level of transparency poses significant privacy risks not present in traditional finance (TradFi). Observers can easily view 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 complexities for global compliance. For example, a VASP operating in one country may have to adhere to different rules compared to another, leading to challenges and inefficiencies in cross-border transactions.
Diverse approaches to VASPs’ due diligence also present significant challenges. While some protocols are permissionless, requiring no due diligence from participants, others enforce stringent checks. The variation across jurisdictions causes uncertainty for VASPs’ compliance efforts and, from a technical perspective, operational overhead for compliance teams as they strive to keep up with multiple standards for handling cross-jurisdiction transactions. This leaves VASPs with no choice but to adopt a risk-based approach per transaction, which can result in operational inefficiencies and gaps.
Moreover, the array of national regulations on the required data fields to be exchanged and the interpretation of shared customer data adds another layer of complexity. This can lead to misunderstandings and compliance errors.
The InterVASP Messaging Standard 101 has been developed by the industry as a universal standard to address standardization and formatting for the communication of required originator and beneficiary information between VASPs and has recently been updated. However, it does not resolve the fact that different national regulations may require different data sets to be exchanged.
Not surprisingly, the introduction of the Travel Rule has raised many important questions from the blockchain and crypto industry. I had the opportunity to speak with several executives from within the industry, and here is what they had to say about this pressing issue:
Delphine Forma, Solidus Labs, Policy Lead for Europe and UK, Crypto Compliance and Legal TG Group Founder, emphasized the importance of user experience, crucial for the widespread adoption of crypto. She pointed out that the proof-of-ownership process can be cumbersome, involving methods like the “Satoshi test” or live video verification, which may deter users. Technologies like AOPP could potentially address this issue but need broader adoption.
Interoperability is another major challenge. Current solutions in the market lack interoperability, meaning manual processes may be necessary if counterparties do not use the same solution. This is impractical and poses data protection risks and scalability challenges.
Delphine reminded of the complexity of counterparty due diligence. With VASPs possibly 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 choice 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 comply with KYC and AML regulations, the ease of creating new addresses and moving funds quickly can undermine these efforts. She summarized that applying TradFi rules to crypto without adaptation could stifle innovation and fail to leverage blockchain’s unique capabilities.
Ivar Zukovskis, BitPay Director of Compliance, holds a supportive stance towards regulating the crypto space — as long as it paves the way for the widespread adoption of cryptocurrencies — but also acknowledges the controversial 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 highlighted the persistent 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, which complicates cross-border compliance. Zukovskis emphasized the difficulty of ensuring comprehensive wallet attribution, crucial for identifying the parties involved in transactions but 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 put smaller companies under significant financial strain, as compliance costs continue to rise in the crypto space. This could potentially affect market competitiveness fairness, as larger firms can more easily 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 essential for the industry to move towards standardized data-sharing practices. Zukovskis stressed 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, while well-intentioned, the Travel Rule 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, pointed out that while the Markets in Crypto-Assets (MiCA) Regulation is well-known, 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 highlighted that the TFR requires crypto asset service providers (CASPs) to ensure that each crypto-asset transfer includes relevant information on the originator and beneficiary. 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 aligned with FATF recommendations without stifling innovation. This proactive approach has resulted in a regulatory environment that balances compliance with the need for technological advancement.
Astazi stressed the essential 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 conversation
The implementation of the FATF Travel Rule in the crypto sector underscores several significant challenges. From the transparency risks specific to blockchain technology to the inconsistent regulatory landscape across jurisdictions, these issues require thoughtful 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 need for 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 to the sustainable growth of the crypto industry.
Ilya Brovin joined Sumsub in 2021 and was appointed as Chief Growth Officer in 2023. Ilya has over 20 years of experience in finance and private equity, having previously worked at such firms as Hellman & Friedman, Eton Park, and Morgan Stanley. He has vast experience working with tech and financial services companies as an investor and board member/observer.
At Sumsub, Ilya is responsible for growth and strategy, including key sales, strategic partnerships, fundraising, investor relations, and M&A.
Ilya holds a degree in Economics & Finance and an MBA from Harvard Business School. He currently resides in London, UK, where one of Sumsub’s international offices is located.
Ilya has been featured on NBC Chicago TV Channel, in BBC Sounds and PayPod podcast, as well as quoted and interviewed by industry-leading media outlets such as CoinDesk, FinTech Magazine, FinanceFeeds, among others.
Disclaimer: Cointelegraph does not endorse any content or product on this page. While we aim to provide you with all important information that we could gather in this sponsored article, readers should conduct their research before making any decisions related to the company and assume full responsibility for their choices, nor can this article be considered as investment advice.
Strategies for the crypto industry to adhere to the Travel Rule