This legislation was initially designed by federal regulators in the U.S. to aid both domestic and international law enforcement agencies in the global fight against money laundering. Because the Travel Rule requires maintaining an information trail of all transaction origins and beneficiaries, illicit activities are much easier to detect and their perpetrators brought to justice.
The Travel Rule is nothing new to the world of traditional finance. In fact, it was first issued in 1995 by the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) under the Bank Secrecy Act (BSA). It was later amended in 2013 to include new guidance for its application to the exchange of virtual currencies. This included two new stipulations to consider entities that administer or exchange virtual currency as "money transmitters" and be subject to the BSA.
Six years later, FinCEN amended its guidance on the Travel Rule again and, along with global partners, extended its reach to cover cryptocurrency transactions as well.
The Financial Action Task Force (FATF) is the global money laundering and terrorist financing watchdog. It is an inter-governmental body that sets international standards aiming to prevent these illegal activities and is made up of 39 members including the US, EU, UK, Japan, Hong Kong, and China.
In order to address challenges associated with the increasing use of cryptocurrencies globally, the FATF updated its guidelines in June 2019. In what became known as the 'FATF Travel Rule,' it aims to prevent illicit transactions from taking place with cryptocurrency, thereby allowing law enforcement agencies to better track any criminals using cryptocurrency to launder money or finance terrorism.
Because of its rapid growth and relative anonymity (in cryptocurrency transactions, while the originator of the funds must provide verified information, the beneficiary can remain anonymous), the Travel Rule aims to enhance AML/CFT efforts by making the audit trail visible when virtual assets are transferred between entities, including exchanges and wallets. This should also help deter criminals from using cryptocurrency illicitly by reducing the number of VASPs available to move funds through.
Like the FinCEN Travel Rule, according to the FATF Travel Rule, all transactions between originators and beneficiaries must be accompanied with customer data including originator name, account number, physical address, national identity number, customer identification number or other unique identity number, date of birth, and place of birth.
The threshold amount varies by jurisdiction. In the US, for example, the rule applies to any transaction equal to or above $3,000. In Singapore, when the transaction exceeds SGD 1,500, the emissary is required to send the full set of customer data mentioned above. So, what are the implications of the Travel Rule on VASPs and how can they achieve compliance?
As you can see, information sharing between institutions is at the core of the Travel Rule. However, this isn't so simple when it comes to the cryptocurrency industry, which has its roots in anonymity and peer-to-peer transactions. Because there is a lack of common standards that allow VASPs to share sufficient data, they must develop their own KYC/AML solutions that allow them to comply with existing privacy laws, such as the EU’s General Data Protection Regulation and California’s Consumer Privacy Act.
Data security is another major challenge for VASPs that need to comply with this rule. Since VASPs are required to submit the information immediately and securely, they are at a continuous high risk of malicious attacks. This means that VASPs must dedicate substantial resources to thwarting cyber attacks as they must vouch for the integrity of the data as well as to protect it from unauthorized access.
The cost of compliance can be hard to bear for many smaller digital asset exchanges and wallets. They may simply be unable to find a balance between meeting regulatory requirements and providing efficient, cost-effective cryptocurrency transactions for their customers. To avoid this significant cost increase, VASPs should consider integrating with solutions such as the OpenVASP protocol that makes it easier to implement the FATF Travel Rule requirements.
As institutional interest in cryptocurrencies grows, greater regulation is both necessary and welcome in the industry to ensure the safety of customers' accounts and prevent illicit behavior. With legislation such as the Travel Rule in place, standards are transparent and will allow for greater collaboration between VASPs and the wider financial sector.
This type of regulation also provides the legitimacy the cryptocurrency sector needs to increase its potential for mass adoption, which could eventually increase the usage of cryptocurrencies as a medium of exchange.
However, with a lack of uniformity across jurisdictions and no standard protocol adopted for VASPs to interchange customer data securely, implementation of the Travel Rule remains a challenge. It once again highlights the necessity for the industry to maintain an open dialogue with regulators in order to grow and flourish–while being held to the same high standards as traditional finance.
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