Making sense of FATF’s latest 12-month crypto review

The Financial Action Task Force released the second 12-month review of its controversial cryptocurrency guidance on Monday. 

In the review, the global anti-money-laundering watchdog expressed considerable concern over what it sees as a slow global rate of implementation for its crypto guidance. Fewer than half of the jurisdictions that report to FATF have acted in response to the 2019 document. 

Then again, it also said that the guidance — which is still in draft form — won’t be finalized until November 2021.

Many crypto advocates breathed a sigh of relief when FATF's president, Dr. Marcus Pleyer of Germany, said during a press conference on June 25 the body would delay finalizing its controversial crypto guidance in order to digest a wealth of industry comments.  

At the time, Jerry Brito, director of crypto policy think tank Coin Center, called this a "win" for the crypto space. Jake Chervinsky, DeFi chair of lobbying group the Blockchain Association, said the increased lead time to finalizing was a "good start" to addressing concerns in the current draft.

A 'self-reinforcing conundrum'

The main concerns relate to the so-called travel rule, which calls for “virtual asset service providers” or VASPs to transmit originator and beneficiary information between one another when a transaction is valued at more than $3,000.

The industry is still sorting through potential technical approaches in search of one that won’t wall off the fast-emerging decentralized finance space. Sharing personal information with a smart contract — as opposed to a person or centralized group — poses technical challenges. 

Those technical challenges will have to be met in order to clear FATF’s standards, but the body expressed worry in its yearly review that crypto firms may be less incentivized towards progress at present than they were a year ago.

Currently, 52 of the 128 reporting jurisdictions have created rules for VASPS based on the FATF guidance. Six jurisdictions have banned VASPs altogether. Given that only a minority of jurisdictions have taken tangible steps towards implementation, FATF is concerned about the big picture. 

Progress has slowed since the last 12-month review, it said. Indeed, only 17 jurisdictions agreed that there are sufficient technical solutions to encourage “efficient and effective implementation of the travel rule," according to the FATF questionnaire. 

“These two problems — the lack of implementation and the lack of globally available, comprehensive travel rule solutions — appear to have created a self-reinforcing conundrum,” said the review. “The lack of national implementation reduces the incentive for technical progress, and the lack of technical progress is used to justify lack of national implementation.”

This creates a bigger problem, according to the watchdog. Because crypto is global by nature, the failure to implement worldwide compliance means bad actors will be able to take advantage of jurisdictions that fail to comply.

For now, that means the slow rate of compliance allows “jurisdictional arbitrage” and raises money laundering risks. But FATF also worries that the slow progress will end up discouraging VASPs from coming up with the systems and infrastructure necessary to make the whole arrangement work as intended.

The guidance also poses even bigger questions for DeFi. To begin with, it’s unclear if protocol developers or self-hosted wallets — and perhaps even other kinds of DeFi participants —  will fall under FATF’s definition of VASP.

The Global DeFi Coalition, which represents more than 350 firms globally, sent a missive this week to FATF, calling on the group to avoid “stifling innovation and preventing new ideas from emerging” with its forthcoming DeFi standards. 

Clarification, not revision

FATF has committed to answering many of the nuanced questions industry members have been asking in the finalized guidance.

Specifically, it has identified five areas to clarify in that forthcoming November revision: the definition of "VASP," licensing and registration of VASPs, peer-to-peer transactions, stablecoins and the implementation of the travel rule.

For its part, FATF already contracted seven firms including Chainalysis, CipherTrace and Elliptic to examine how the peer-to-peer world of crypto compares to its more centralized counterparts and its role in illicit finance.

“The share of illicit transactions also appears higher for P2P compared with transactions with VASPs, at least in terms of direct transactions,” said the FATF on its findings. “However, the substantial amount of variation in the data means that there is no consensus on the size of the P2P sector and its associated (money laundering and terrorism financing) risk.”

Overall, the data from the analytics firms didn’t show any sign of a meaningful shift from centralized transacting to P2P transacting. 

The FATF implied in the 12-month review that the information it is gathering won’t lead to a revision of the standards articulated in 2019, but rather a clarification.

“While there are many areas where both jurisdictions and the private sector seek further clarity, these are questions regarding the application of the Standards rather than the Standards themselves,” it said.

Still, the watchdog said it isn’t opposed to making changes in the future. For now, FATF says it hasn’t found evidence that its standards are stifling the industry — but if that changes, it will adjust:

“Depending on how the virtual asset market develops, the FATF may need to further revisit the definition of VASP ... or the broader Standards in the future.”