According to Merkle Science’s own data, between 2016 and 2019, transaction volumes between illicit actors and UK-headquartered VASPs increased by 9.5 fold. In addition, out of the 23 virtual asset exchanges headquartered in the UK, 14 of them (60%) have strict compliance already in place and do not allow customers to transact on their platform without proper KYC.
With increasingly great attention placed on DeFi and institutional finance moving into the space, our panelists Matthew Homer (Exec. In Residence, Nyca Partners & Former Executive Deputy Superintendent, Research & Innovation, New York State Department of Financial Services ), Jacob Yunger (Director Financial Innovation, FINRA), Philip W. Raimondi (Sr. Assistant General Counsel, CFTC), and our very own Mary Beth Buchanan (EVP Americas & Global Chief Legal Officer, Merkle Science) discussed the risks and regulatory challenges surrounding DeFi with Ian Taylor ( Executive Director, CryptoUK).
Merkle Science believes in smart regulation around DeFi. Merkle Science recently published “Diving into DeFi: Fundamentals from the Financial Frontier” — a comprehensive primer of the current DeFi landscape especially well-suited for those who have started navigating DeFi, that gives an overview of the types of DeFi platforms, emerging trends, regulatory concerns, as well as risks individuals should be aware of when engaging with the ecosystem.
Decentralized Finance (DeFi) is pegged to be the next frontier of fintech innovation. Though the future of DeFi looks promising, it faces some significant regulatory hurdles. Merkle Science recently published “Diving into DeFi: Fundamentals from the Financial Frontier” — a comprehensive primer of the current DeFi landscape that includes a look into the Financial Action Task Force’s (FATF) potential approach toward the space based on its latest draft updated guidance for virtual assets (VAs) and virtual asset service providers (VASPs).
Last week, the U.S. regulatory front attempted to address a long-standing desire from the industry for regulatory clarity. During a speech on 3 August 2021, at the Aspen Security Forum, the Securities Exchange Commission (SEC Chairman Gary Gensler outlined the approach that SEC may adopt to regulate the crypto industry. Keeping investor and consumer protection as his focal point, Gensler highlighted some of the concerns SEC had about DeFi platforms, stablecoins, exchange-traded funds (ETFS), crypto exchanges, and lending — and asked for resources from Congress to prevent transactions, products, and platforms from falling through regulatory cracks. This statement comes shortly after the introduction of the “Digital Asset Market Structure and Investor Protection Act” bill by Rep. Don Beyer (D-VA) on 28 July 2021. The bill, which is pegged to be the most comprehensive one to date lays down provisions that (a) regulate the categorization of digital assets, (b) desecuritization of tokens, and (c) allow the Department of Treasury to veto the creation of stablecoins amongst other measures. Further, on 1 August 2021, the senate proposed provisions on taxing digital assets in order to fund the Infrastructure Bill. The broadly worded definition of ‘broker’ in the bill has been a source of significant controversy, as the industry leaders believe it stifles innovation and investment in the crypto space.
Decentralized finance (DeFi) is the confluence of blockchain technology and financial applications. It enables the execution of financial transactions through decentralized applications (dApps) that are essentially, services built upon public blockchains. Through smart contracts, DeFi looks to increase efficiency and accuracy by replacing intermediaries with products such as Automated Market Makers (AMMs).
Last week, the European Commission and the United Kingdom's HM Treasury separately introduced proposals to further strengthen crypto anti-money laundering frameworks — highlighting the continent’s desire to bring crypto assets and services into the financial ecosystem’s fold.
Merkle Science’s RegWatch provides expert commentary on the impact of recent regulatory developments from our partners. This article has been contributed by Aaron...
DLT Act entering fully into force on 1 August 2021, our panelists Bruno Kellenberger (CEO at KYC Spider AG), Ekaterina Anthony (Board Director at Crypto Valley Association and Compliance Expert at GWP geissbühler weber & partner), Lars Hodel (Head of Legal & Compliance at Bitcoin Suisse AG) spoke with Merkle Science’s Director of Communications, Gaby Hui, about the implications of these regulatory changes on crypto businesses looking to domicile in the Swiss crypto haven. Further, following the most recent Financial Action Task Force Meeting (FATF) plenary meeting, our panelists also discussed some of the key concerns raised by the FATF in its official release highlighting the outcome of the plenary session.
The United States Financial Crime Enforcement Network (FinCEN) issued its first government-wide list of priorities for Anti Money Laundering and Countering the Financing of Terrorism National Priorities (Priority List) on 30 June 2021. The Priority List coupled with the Department of the Treasury’s Illicit Finance Strategy 2020 and National Risk Assessment Priority List 2018, aims to help the covered institutions assess their risks, tailor their AML program and prioritize their resources in line with the key AML/CFT threats identified by the FinCEN. As per FinCEN, covered institutions are those financial institutions that are required by the Bank Secrecy Act (BSA) to maintain an AML Program. Covered Institutions include both banking institutions and non-financial banking institutions such as mutual funds, banks without a Federal functional regulator, money service businesses (MSBs) amongst others.
Following the fourth Financial Action Task Force (FATF) Plenary Meeting in June 2021, panelists Siân Jones (Senior Partner, Xreg Consulting), Pelle Brændgaard (CEO, Notabene) and Mriganka Pattnaik (CEO, Merkle Science) spoke with Ian Taylor (Chair, CryptoUK) about some of the key concerns raised by the FATF in its official release highlighting the outcome of the plenary session.
For those who missed the live discussion or would like to listen again, the full webinar can be found here. Below are key takeaways that the Virtual Asset Service Providers (VASPs) should take note of:
Challenges Deterring Jurisdictions from Ensuring Strict and Timely Compliance with The Travel Rule
During the Plenary Meeting, the FATF drew attention to gaps in the implementation of Recommendation 16 also known as the Travel Rule. The global financial watchdog, the FATF, noted that a majority of jurisdictions still have not yet implemented the Travel Rule. According to the FATF, this implementational gap can enable continued misuse of virtual assets through jurisdictional arbitrage. Therefore, the FATF made it clear that timely compliance with the Travel Rule by the jurisdictions is not an option, but a requirement.
However, even though the meaning of the Travel Rule is clear, its execution poses certain challenges. As per the Travel Rule, the originators and beneficiaries of all digital fund transfers must exchange identifying information. Our panelists highlighted some of the main challenges in its implementation.
VASPs continue to encounter the “sunrise” problem, whereby the lack of regulatory cross-border clarity, a uniform timeline for implementation of compliance standards and widely differing regulatory expectations affect the VASPs’ global transactions.
The interoperability of different Travel Rule solutions is vital to ensure comprehensive coverage when facilitating transactions with the VASPs across the crypto community. While competing Travel Rule solutions have emerged in the last few years, these solutions continue to be plagued by interoperability issues owing to the differences in their fundamental features such as governance systems, data ownership, etc. Therefore, in line with the statement made by the FATF, when it comes to interoperability it is essential to set common global technical standards for the implementation of Travel Rule solutions.
What the Industry Can Do to Overcome the Challenges in Travel Rule Implementation
The VASPs that are looking to overcome the ‘sunrise problem’ should not only monitor the regulatory requirements of their own jurisdictions but also those of their counterparties — those from whom VASPs are sending and receiving funds. Further, even if the regulators in the VASPs’ jurisdictions are not obligating compliance with the Travel Rule, then the VASPs should proactively implement the Travel Rule on their own.
The crypto industry has also taken some steps towards overcoming the interoperability problem. In May 2020, the InterVASP Messaging Standard or IVMS101 was launched, this standard was developed to create a universal language for communication of required originator and beneficiary information between the VASPs. Despite the non mandatory nature of these standards, a large number of Travel Rule solutions such as CoolBitX’s Sygna Bridge have committed to adopting IVMS101 but still have a long way to go in overcoming interoperability issues.
FATF Extends the Publication of Revised Guidance on Virtual Assets and VASPs
The FATF extended the deadline for the finalization of the FATF’s revised draft updated guidance on Virtual Assets and VASPs. This delay may be due to the outpouring concerns received by the FATF from the crypto industry, specifically around expanding the definition of VASPs to regulate DeFi and unhosted wallets.
Siân Jones noted that the draft updated guidance reflects the FATF’s belief that no technology should be completely decentralized. As per the guidance, decentralized applications also have “central parties” that are involved in creating, launching, setting parameters, holding an administrative key and all such entities will now fall under the definition of VASPs.
This expansive definition may create problems both for the regulators and developers alike. On the one hand, due to the decentralized nature of the project, the regulators may find it difficult to identify specific entities within the definition of VASPs responsible for implementing AM/LCFT guidelines. On the other hand, VASPs may have to dedicate vast resources to ensure AML/CFT compliance — ultimately detracting from their businesses’ core competencies. While discussing the implications of regulating DeFi under the draft updated guidance, Mriganka Pattnaik, observed that, given the complexities of DeFi, the DeFi platforms may bear higher compliance costs in comparison to the centralized VASPs.
