FATF Virtual Assets Guidance Update: DeFi, Stablecoins, and Self-Custody Wallets

Author: Amy Liu

Image source: Internet

Image source: Internet

The Financial Action Task Force’s (FATF) Virtual Assets Guidance Update lays out a comprehensive set of guidelines to regulate the fast-growing cryptocurrency space. With the release of this update, the next few years are likely to bring more clarity to digital asset firms regarding anti-money laundering and countering the financing of terrorism (AML/CFT) regulations around the world.

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The FATF reminded regulators not to blindly accept crypto industry marketing that calls various platforms “decentralized.” Functionally, these platforms usually have a natural person controlling or influencing their activities. The term "control or influence" is key and provides a framework for analyzing who should be the entity obliged to comply with the AML/CFT regulations. In the view of FATF, almost all DeFi platforms are still virtual asset service providers (VASP). The FATF provides extensive guidance for bringing DeFi platforms under regulation, one of which is that jurisdictions could order the establishment of VASPs as their obligatory entities if the DeFi platform does not have an entity to operate.

The rise of new DeFi platforms may slow down in 2022. There may be contentious legal battles between regulators and blockchain entrepreneurs over who “controls or influences” various DeFi protocols. Many organizers of DeFi platforms will begin to accelerate efforts to achieve true decentralization, such as trying to unravel the on-chain and off-chain ties that may exist between specific individuals and platforms. Like other regulated VASPs, DeFi platforms operating without following AML/CFT requirements will increasingly be viewed by these VASPs as higher risk businesses. DeFi activity won’t disappear, but it may dwindle, as it did during the once-booming initial coin offering (ICO) phase a few years ago.

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According to the FATF, there is one major factor that determines the risk of a stablecoin: the potential for widespread market adoption. The FATF emphasized that jurisdictions must monitor stablecoin projects before they launch and ensure that AML/CFT mitigations are in place during the planning stages of these projects.

Launching a truly "global" global stablecoin may become more difficult in the coming year. Regulators may take greater urgency to oversee stablecoin issuers and establish rules and procedures specific to this class of cryptoassets. While FATF's focus is on AML/AML and sanctions regulation, it seems likely that other types of financial regulators will be more emboldened to exercise authority over stablecoins in their respective regulatory areas (e.g. securities regulation, consumer protection, etc.). The U.S. government certainly agrees with the FATF on stablecoins, and the Biden administration last week called on the U.S. Congress to legislate to strengthen oversight of stablecoin issuers.

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You can't block non-custodial wallets

However, VASPs can limit user interaction with them when appropriate.

The guidance acknowledges that non-custodial wallets lack VASP regulation and therefore have no obligation entity to act as an intermediary poses certain risks. Nonetheless, the FATF explained that regulators need to study the nature and extent of the risks of non-custodial wallets in their jurisdiction and manage those risks accordingly. An appropriate risk-based approach, the guidance suggests, might be for VASPs to restrict or even prohibit their users from using non-custodial wallets for transactions. But again, policy should depend on the risk environment, and VASPs should use technological tools such as blockchain analysis software to address most risks. There is no one-size-fits-all approach to non-custodial wallets.

Non-custodial wallets have long faced scrutiny from VASPs, and the scrutiny is likely to intensify, especially until VASPs institute formal risk-based restrictions, such as transaction or volume limits between users and non-custodial wallets. FATF’s directive to research and understand the risks of non-custodial wallets could be a boon for blockchain analytics firms. It may also encourage blockchain privacy advocates to double down on software anonymization. The regulated crypto space may grow, but the non-custodial ecosystem will remain a niche area with significant development and innovation.

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VASPs need to start complying with the travel rule

In addition, the FATF acknowledged the importance of data handling and privacy, emphasizing that VASPs must conduct due diligence on counterparties before sharing Travel Rule-related data with them.

That should accelerate the industry's experiments in complying with the travel rule. At the very least, some VASPs may not wait for an industry-wide solution and may try to create their own channels and mechanisms to comply, even though this may be an inefficient approach overall. But if there is any doubt in the industry about the need to implement the travel rule, there is little room for discussion.

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unresolved issues

For one, the guidance explicitly has nothing to do with central bank digital currencies (CBDCs). And for good reason. CBDCs are likely to be regulated as legal tender, and their inclusion in the guidance of permissionless virtual assets could complicate matters. Furthermore, only a few CBDCs have actually been launched. For FATF, it is too early to talk about CBDC. However, as CBDC pilots progress, they will deserve more attention from the FATF.

This article is from Bitpush.News, reproduced with authorization.