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The Financial Action Task Force (FATF) has released new guidance on virtual assets and virtual assets service providers (VASPs), superseding those that it previously issued in 2019.
The FATF standards require countries to assess and mitigate the risks associated with virtual asset financial activities and providers.
Jurisdictions that are part of the 39-member standard setter must license or register providers and subject them to supervision or monitoring by financial regulators.
“FATF is laying down the gauntlet to regulators across the world and we will undoubtedly see more crypto businesses incorporated into the regulatory frameworks governing traditional financial services firms in many jurisdictions,” said David Carlisle, director of policy and public affairs at blockchain firm Elliptic.
According to Carlisle, this is a reflection of a world in which virtual assets are increasingly accepted as part of the financial ecosystem today.
“By sweeping virtual assets into the regulatory frameworks designed for mainstream finance, the FATF is acknowledging virtual assets are too big to ignore,” he said, speculating that this will ultimately be a boon for mainstream adoption.
This new guidance is intended to help countries and VASPs understand their anti-money laundering and counter-terrorist financing (AML/CFT) obligations, so that they can effectively implement the FATF’s requirements as they apply to this sector.
New rules
Reflecting a consultation that the Paris-based standards body undertook in spring of this year, the new guidance focuses on six areas:
- To clarify the definitions of virtual assets and VASPs to make clear that these definitions are expansive, meaning there should not be a case where a relevant financial asset is not covered by the standards — either as a virtual asset or another financial instrument.
- To guide how the FATF Standards apply to stablecoins and clarify that a range of entities involved in stablecoin arrangements could qualify as VASPs under the FATF Standards.
- To contribute additional guidance on the risks and the tools available to countries to address the AML/CFT risks for peer-to-peer transactions, which are transactions that do not involve any obliged entities.
- To offer updated guidance on VASPs’ licensing and registration.
- To include Principles of Information-Sharing and Co-operation Amongst VASP Supervisors.
- To provide additional guidance for the public and private sectors on the implementation of the travel rule.
The travel rule, which already applies to traditional fund transfers, courted controversy among the crypto industry, members of which have voiced concerns to competent authorities that the rule could lead to data protection issues if applied to crypto transactions.
The recent FATF guidance is therefore not something unique and game-changing in terms of regulation for virtual assets service providers, said Michal Nowakowski, head of NewTech at Warsaw-based consultancy NGL Advisory, noting crypto-related reforms in jurisdictions such as the EU.
For Nowakowski, the main problem is not the regulation for VASPs but rather the catching of peer-to-peer (P2P) and cryptocurrencies transfers that may not be covered by AML systems. “While FATF has recommended paying particular attention to this area of virtual assets, the lack of more concrete and technical guidance makes it less effective,” he said.
NFTs and DeFi
Other topics that were covered included decentralised finance (DeFi) and non-fungible tokens (NFTs) — which have both been big trends within the crypto industry and further afield.
For example, Visa acquired CryptoPunk, one of the thousands of NFT-based digital avatars, for nearly $150,000 in ethereum over August. Meanwhile, MasterCard launched a competition in September to win an NFT in partnership with the Portuguese football coach, José Mourinho.
In particular, the new guidelines classified DeFi applications (as in, the software platform used) as not a VASP under the FATF’s guidance. This is because they do not apply to the underlying software.
However, individual governance token holders are not considered VASPs if they do not carry “control or sufficient influence” over the DeFi arrangement.
“The FATF has made clear that DeFi shouldn’t operate in a parallel sphere, completely outside of regulation. But the devil is in the details,” said Carlisle.
Trying to impose long-standing regulatory frameworks on DeFi will be fraught with challenges, and regulators remain reluctant to abandon their established approaches in favour of new paradigms, he noted.
So far, regulators have attempted to swerve the matter. For example, the European Commission’s Digital Finance Package puzzled some in the financial services sector as it failed to mention the matter at the time it was proposed in 2020.
Meanwhile, NFTs that are used as collectibles, instead of a payment or investment instrument, should not be considered as virtual assets, the FATF has said.
As with DeFi, however, this definition is not rigid, and the standard-setter has said that certain NFTs, depending on the nature, characteristics and functions, may be considered to be virtual assets under the FATF definition.
"The guidance clarifies that in most cases NFTs are not virtual assets because their primary purpose is not value transfer,” said Carlisle, noting that it also states that in most cases, NFTs will be captured as part of other regulated activity — such as securities requirements, or art dealership — that require AML measures.
Ultimately, most businesses allowing users to buy and sell NFTs should be applying AML measures, he said. “We can expect that on the back of the FATF's guidance AML regulators to start scrutinising the NFT space much more closely."
Ari Redbord, head of legal and government affairs at TRM Labs, pondered whether FATF’s guidance here made sense. “The use-case for NFTs at the moment seems to be for those very things, selling, trading, investing, generally transferring value which FATF defines as a virtual asset,” he said.
The benefit of regulation
These new guidelines will inevitably filter through to national and supranational authorities now, but the question is whether crypto firms will welcome these new requirements or be concerned about what it will inevitably mean in terms of costs and compliance challenges.
Firms should not be too pessimistic about potential new indirect costs, said Edo Bakker, Madrid-based founder of Agile Control Solutions, a business management consultancy. “It is beneficial for the virtual assets space as it will increase the adoption of this type of products and services and it will weed out the bad players,” he predicted, noting that these types of companies can refuse to invest in compliance and even promote fraudulent activities.
“It will create a level playing field and create several big players, partly through consolidation of the sector, and smaller players which are very innovative and provide specific value to the ecosystem,” he predicted.
The crypto industry’s eye has been focused on innovation for a decade, but it is more important than ever to be responsive to regulatory changes, noted Carlisle, cautioning that regulatory compliance can pose a genuine operational threat to businesses that are not prepared for it.
It is reasonable to expect that compliance expertise in this industry will be in extremely high demand in the years to come, he predicted. “Businesses that embrace regulatory compliance as a growth enabler will have a major head start on those that try to avoid compliance,” he warned.
As for the greatest winners from this, they could end up being the traditional players, Carlisle pointed out.
“Perhaps counterintuitively, the greatest opportunity could be for the banks and larger financial institutions entering the space,” he suggested.
Complying with financial regulation takes time and money, and businesses that have historically invested in compliance resources will have a significant head start, Carlisle pointed out. “Banks looking to enter the virtual asset space have been eager for greater regulatory clarity, and the FATF is giving them a huge boost in that regard.”
In addition, Redbord pointed out that FATF has spent time working with the industry since the new guidelines were opened for consultation in March.
“That said, it is attempting to regulate emerging technology in real-time which can be challenging and why FATF encourages a broad interpretation of the standards,” he commented.
