What FATF Recommendation 16 Means for the Crypto Industry

Implementing strict KYC processes to comply with the ‘travel rule’ may be costly, but it is a necessary sacrifice to build a stronger industry in the long-run, says Michael Ou at CoolBitX.

2020 will be a pivotal year for the cryptocurrency industry, as its steady maturation into a legitimate new asset class for institutional and mainstream investors spurs governments to establish and enforce new rules for regulatory oversight. 

Looming large this year is the implementation of the Financial Task Force’s (FATF) Recommendation 16, colloquially known as the “travel rule”, which is expected to be enforced by mid-2020 across 200 global jurisdictions that follow FATF standards for mitigating money laundering and terrorist financing. 

Following this recommendation, Virtual Asset Service Providers (VASPs) registered or licensed within FATF member countries will be required to exchange and hold personally identifiable information (PII) to each other when transferring crypto assets — a move that some in the industry fear will alienate its more libertarian users. 

Regulatory compliance, however, also comes with long-term legal certainty and rebuild cryptocurrencies’ reputation, opening doors to traditional financial markets that could push crypto further towards mainstream adoption.

Building credibility and securing crypto’s future

Traditional financial institutions and banks remain wary of virtual assets and their providers despite the gradual maturation of the industry from its rocky beginnings. For now, they are put off by the legal uncertainty that still surrounds the industry, and the cost of implementing systems for AML/KYC that are required for them to deal in cryptocurrency. 

This could change as clear regulatory frameworks are put in place to define and categorise the various functions of digital assets. If these efforts at regulation are also coordinated across regions, VASP users will then be able to transact in digital assets with any regulatory-compliant destination without having to undergo lengthy KYC registration and checks each time they open a new account. With the same protections in place as those in traditional finance, mainstream traders and institutional investors may be more open to putting a larger portion of their investment portfolios into digital assets.

As regulation becomes the accepted fate of the cryptocurrency sector, there may be a divide between VASPs that choose to comply, and those who do not. Compliant exchanges will work together with regulators to identify and validate legal transactions on their platforms, while using personally identifiable information to track criminals who may try to use crypto transactions for illicit purposes such as money laundering or terrorist financing. 

On the other hand, some bad actors will also be driven underground, conducting their digital asset transactions in jurisdictions where legal ambiguity remains to avoid the scrutiny of regulatory standards. 

It’s possible that by accepting regulatory oversight, the crypto industry can finally shed the stigma that digital assets are the preferred currency of criminals intent on evading the law, and instead build a new reputation as a viable long-term investment for institutional and mainstream investors.

Achieving long-term stability

At the moment, the majority of investors consider cryptocurrency as a short-term investment at best, as its sporadic price jumps and falls are swayed by unpredictable geopolitical events, financial scams, or market manipulation. Instead of striving for a high cryptocurrency price, what the market needs is stability and a level playing field where real identities can be linked to illicit activities to stop market manipulators in their tracks.

With better regulation in place, digital assets can be judged purely on their merits rather than their price jumps, becoming more attractive as long-term stores of value and improving their liquidity as more money moves into the space.

Overall, the security and safety of buying and owning digital assets will be improved if cryptocurrency custodians and owners are held accountable for their financial transactions. VASPs will have the weight of the law behind them to monitor and reject suspicious requests, stop the progress of irregular transactions, or reverse transmittals that are deemed illegal after the fact.

Improved security measures such as these may make institutional actors more willing to partner with VASPs in future, to the benefit of both. By collaborating with traditional financial institutions and leveraging their superior AML-compliance systems, crypto exchanges will be able to develop more sophisticated means of protecting their legitimate customers and detecting criminal activities, while financial institutions gain a secure new avenue for prospective investment.

Building a stronger industry

When it comes to establishing a clear set of rules for digital assets, Asian regulators are at the forefront, with Japan, Singapore, and South Korea setting out comprehensive regulatory boundaries for crypto industry players. 

Unsurprisingly, twenty of the top 50 crypto exchanges are based in Asia-Pacific, accounting for 40% of global Bitcoin transactions in the first half of 2019, according to data from Chainalysis. China is home to the majority of these exchanges, and while its crackdown on cryptocurrency may seem heavy-handed, the country’s regulators have been consistent in communicating their policies regarding the sector. 

Where the US is struggling with how to best regulate digital assets, regulatory clarity from APAC regulators is a welcome development for an industry in need of stability and security. In 2020, Asia is set to be the epicentre for sweeping change in the industry and may provide a blueprint for the rest of the world to court institutional buy-in.  

Take, for example, Japan. One of the earliest jurisdictions to adopt digital asset regulation, Japan has seen a number of its institutional finance and traditional corporations invest in its biggest crypto exchanges. Still, a new law is expected to take effect in June which will further tighten rules on the industry’s participants.

Regulation is an inevitability of crypto’s march towards mainstream acceptability. For some crypto exchanges, the concern is that implementing costly and strict KYC processes will only drive their customers to other exchanges with laxer rules. However, to build a stronger industry in the long-run takes some sacrifices, and it’s better for VASPs to plan ahead by implementing solutions for compliance with minimal disruption to their businesses. 

Going forward, the industry will have to embrace compliance, and work alongside regulators to shape a future for the crypto sector that is more stable, secure, and fruitful. 

Michael Ou is Founder & CEO of CoolBitX.

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