29 January 2020

 How Compliance Will Shape The Cryptocurrency Space

Graham Tonkin

Many within the cryptofinance industry have been patiently waiting for regulatory oversight to deliver the clarity required for institutional adoption. Recent updates by the Financial Action Task Force (FATF), which issues guidelines for 200 countries and territories, attempts to apply the same rules and regulations required of traditional finance to the world of virtual currencies.

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Many within the cryptofinance industry have been patiently, yet nervously, waiting for regulatory progress to increase legitimacy in the space and deliver the clarity required for institutional support. Recent updates by the Financial Action Task Force (FATF), which issues guidelines for 200 countries and territories, demonstrates a lack of industry participation or technological understanding of blockchain technology, attempting to apply the same rules and regulations of traditional finance.

While anti-terrorism is undoubtedly a cause we can all support, the recent rules set forth may not hinder cryptocurrency adoption, or it’s illicit use. Instead, they are most likely to add cost and complexity to the service providers building the ecosystem. The updates generally apply the same regulations (notably the Travel Rule) required of traditional financial service providers, to Virtual Asset Service Providers (VASP). VASPs include a wide swath of industry actors, including exchanges, custodial wallets, or entities that hold or control private on behalf of an individual or entity. 

The “travel rule” requires money transmitters to include personal information on all parties in fund transfers between institutions. VASPs will be required to share personal data with each other as transactions are made, just as traditional service providers to do today in finance. While traditional service providers must carry out the due diligence on transfers that exceed $15,000, VASPs will be required to complete due-diligence for transfers in excess of $1,000. 

While VASPs hire teams of compliance experts to build infrastructure to ensure compliance with new regulations, criminals will mitigate the major costs and complexities with a click of the mouse. Regulating the centralized institutions in the ecosystem will likely have unintended consequences, such as criminals simply not interacting with services where they must trust a third party. Why keep funds in a custodial wallet or access a centralized exchange when self-custody wallets and DEXs offer permissionless access? 

Criminals in the past have done two things to avoid such regulations: hold and transport their own cash, or access institutions who are willing to break the law. Standard Chartered and other banks have used “wire-stripping” to launder hundreds of billions of dollars for Iran, while J.P Morgan, Bank of America, Deutsche Bank, and CitiGroup helped Danske Bank Estonia launder $234 billion for Russian and Eastern European customers.  While the regulation may have the right intentions, criminals will likely continue to sidestep regulatory roadblocks, while more personal data of innocent participants is collected and put at risk. 

All of this antiquated regulation might actually be a blessing in disguise for the industry. While the regulation of centralized service providers may slow the adoption by the mainstream, it may, in fact, create greater resilience as services outside of the scope of regulation attract greater use and adoption. Decentralized exchanges, self-custody wallets, and other permissionless DeFi applications will likely continue to grow as centralized VASPs invest more resources in compliance. While on-ramps and off-ramps will face heavy regulation, I’m hopeful that services will develop to keep us within the ecosystem and in control of our own money. 

An updated review of FATFs updated guidelines will take place in June or 2020, and I’m excited to see what comes of it. I fear that the review will simply bring on worse regulation as lawmakers gain a greater understanding of permissionless, peer to peer transactions. While I don’t believe governments are likely to make possession of a seed phrase illegal, let’s not forget the 44 years in America’s history where the federal government made it illegal to possess gold coins and bars under the “Trading with eh Enemy Act of 1917”.

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