The world of cryptocurrencies is constantly changing, as governments, markets, and communities continue adapting to the new phenomenon. These transformations were particularly evident in 2020 and the first months of 2021 with the introduction of new regulatory measures. Such changes were expected in the context of the soaring bitcoin prices that breached its historical maximum of $40,000 per BTC in January 2021.
The U.S. Financial Crimes Enforcement Network (FinCEN) became actively involved in the regulatory environment of cryptocurrencies with the introduction of the new proposed rule, highly debated in the crypto community. Since the implications of this new rule could have far-reaching consequences, it is important to dissect its origins, specifics, and potential future implications, especially in terms of the U.S. Financial Action Task Force (FATF) recommendations.
The rule imposed by the FATF
The U.S. FATF has the Recommendation 16, known as “the travel rule”, to prevent and fight terrorist financing and money laundering. It focuses on wire transfers and requires banks to report any suspicious activity. An amendment made to Recommendation 16 in June 2019 included Virtual Asset Service Providers (VASPs) as well. A similar amendment to Recommendation 10 was requiring VASPs to conduct due diligence upon necessity.
VASPs are businesses that provide exchange services between cryptocurrencies and fiat currencies, between various cryptocurrencies while also conducting cryptocurrency transfers on behalf of their clients. The updates to Recommendation 10 and Recommendation 16 required VASPs to:
- Conduct customer due diligence for occasional transactions above 1,000 USD or EUR (Recommendation 10).
- Obtain, store, and provide the required beneficiary and originator information in a timely and secure manner in relation to the transfers of virtual assets (Recommendation 16).
The updates prompted discussion in the crypto community in terms of their effects and implementation feasibility, especially since they were affecting only VASPs and transfers between them.
The rule proposed by the FinCEN
The FinCEN operates as a bureau of the U.S. Department of Treasury in defining rules for preventing and fighting terrorism financing and money laundering. The bureau was actively focusing on regulating cryptocurrency markets and transactions in recent years. Specifically, it is possible to mention its most recent proposal published in December 2020. The proposal received a large number of comments with the majority opposing the offered regulatory changes.
The new rule would require exchanges or VASPs to collect personal information, specifically names and home addresses of the owners of private crypto wallets also referred to as “unhosted wallets” or “self-hosted wallets”, that were receiving an equivalent of $3,000 or more per day. Furthermore, VASPs would have to file a Currency Transaction Report (CTR) to FinCEN in case the transaction to a single wallet would exceed an equivalent of $10,000.
FinCEN used the term “convertible virtual currency” (CVC) for all cryptocurrencies that were subject to exchange for fiat currencies. The main difference of the rule proposed by the FinCEN from the updates to Recommendation 10 and Recommendation 16 was the fact that it was applicable to all wallets, not only VASPs, as well as the higher limits of the daily transactions.
Context, Details, and Examples
The FATF Recommendation 16 utilized the previously existing rules for wire transfers. Despite the inherent difficulties associated with its implementation in cryptocurrency markets, the importance of the rule stems from its ability to ensure compliance. In particular, cryptocurrency markets are compliant with the respective wire transfer regulations.
On the other hand, the new FinCEN rule extends beyond the fundamental regulatory requirements applied to standard cash transactions. The main criticisms of the new rule, amongst numerous others, revolve around the effectiveness of the new rule and data privacy implications. These drawbacks imply add to the negative connotation associated with the new regulatory requirement.
When describing the applications of the FATF rule and the proposed FinCEN rule, it is possible to use two scenarios involving three individuals. In particular:
- Individual 1 would have an account on Exchange 1;
- Individual 2 would have an account on Exchange 2;
- Individual 3 would have a self-hosted Wallet 3.
Individual 1 wants to transfer $4,000 worth of cryptocurrency (CVC) to Individual 2. This transaction implies a transfer of funds from Exchange 1 to Exchange 2:
- The imposed FATF rule: the transaction falls within the scope of the imposed rule because of the amount exceeding $1,000 worth of CVC (updated Recommendation 10 and updated Recommendation 16). Therefore, Exchange 1 would have to share the details of Individual 1 with Exchange 2.
- The proposed FinCEN rule: the transaction does not fall within the scope of the proposed FinCEN rule because the transaction does not involve the self-hosted wallets, despite the actual sum qualifying under the rule.
Individual 1 wants to transfer $4,000 worth of cryptocurrency (CVC) to Individual 3. This transaction implies a transfer of funds from Exchange 1 to Wallet 3 directly:
- The imposed FATF rule: the transaction does not fall within the scope of the imposed rule, because one of the parties involved in the transaction did not have an account with a VASP.
- The proposed FinCEN rule: the transaction falls within the scope of the proposed rule since one of the parties was an owner of a self-hosted wallet and the transaction exceeded the $3,000 equivalent threshold. Thus, Exchange 1 would have to obtain and store the name and home address of Individual 3.
Future Outlook and Implications
With the continued growth of cryptocurrency markets, it is evident that the new regulatory mechanisms will provide guidance to its participants and exchanges. In this regard, it is essential to understand new rules and their implications. Such an understanding will not only ensure compliance with the law but may provide additional context behind the exchange rate movements of the main cryptocurrencies.
The updated Recommendation 10 and Recommendation 16 (Travel Rule) will remain amongst the focal regulatory requirements in the observable future. Currently, the adoption rate of the Travel Rule remains low primarily because of the issues associated with its implementation. Furthermore, the annual FATF review of VASPs conducted in June 2020 concluded that there was a shortage of “sufficient holistic technological solutions” in terms of their establishment and adaptation for a global implementation of Travel Rule. Therefore, it is possible to state that resolving an issue associated with a sufficient technological solution will determine the implementation rate of the Travel Rule.
Similarly, the proposed FinCEN rule poses an even wider range of challenges related to technological capabilities, data and information security, and well as accountability. The good news is that FinCEN acknowledged the potential issues and extended the comment period for the proposed rule by 60 days. The dialogue is essential for the effectiveness of the regulatory initiatives and cryptocurrency markets.
Also the new rules on financial regulation for the EU countries − 6AMLD will take effect this June.
In general, we observe that the regulatory requirements for cryptocurrencies become stricter, and 2021 is no exception. If these measures are introduced in countries where the crypto business has been actively operating for quite some time, other regions may choose the simplest path. Countries like the Russian Federation might ban cryptocurrencies completely following the introduction of laws that prohibit the possession of crypto by civil servants.
Therefore, the question is not “if” but “when” it happens. In this case, will it be possible to comply with such strict rules for the cryptocurrency industry where one needs only the Internet to operate? The future will show.