The Financial Action Task Force (FATF) issued new compliance guidelines for cryptocurrencies. Critics argue stricter regulatory requirements will increase compliance costs and push crypto users off the radar. But more regulations will also lead to the legitimization of cryptocurrencies in the long-term and speed up adoption.

Blockchain businesses like to complain about regulations. For some, decentralization is a way to escape from legal restraints and oversight and some might find the idea of a techno-anarchic society more appealing than the current centralized financial system.

Across most of the developed world, regulators have not yet put up significant regulatory hurdles. Especially compared to the traditional financial industry, crypto businesses have so far not faced much regulatory hassle. That, however, could change soon.

On June 21st, the Financial Action Task Force (FATF) has released guidelines on how participating nations should govern digital assets. These rules will apply to businesses working with tokens and digital currencies, including exchanges, custodians, and crypto hedge funds – the FATF uses the term “Virtual Assets Service Providers” (VASP).

FATF rules are not legally binding, but countries face risks by not following suit

The Financial Action Task Force is a multinational organization that includes 200 member countries. Its goal is to combat money laundering and terrorism financing. Members include most of the world’s developed nations, including the US.

Whenever the FATF issues rules, it’s up to the national regulators to interpret these rules and integrate them into their frameworks. While in theory, FATF rules are not legally binding for the member states, in practice, countries that don’t comply with FATF rules risk being blacklisted. As a result, a country could lose access to the global financial system.

New rules require the identification of sender and receiver

Eric Turner, Director of Research at Crypto Researcher Messari Inc., says the new rules are “one of the biggest threats to crypto today.” He adds, “Their recommendation could have a much larger impact than the SEC, or any other regulator has had to date.”

The new guidelines will force companies to collect information about customers undertaking transactions of more than $1,000, including the recipients of the funds.

The required information for each transfer includes:

  1. originator’s name;
  2. originator’s account number where such an account is used to process the transaction
  3. originator’s physical address, or national identity number, or customer identification number that uniquely identifies the originator to the ordering institution, or date and place of birth;
  4. beneficiary’s name; and
  5.  beneficiary account number where such an account is used to process the transaction

FATF said it would give countries 12 months to adopt the guidelines, with a review set for June 2020.

Increasing compliance costs will cut returns for exchanges and trading entities

Collecting sender and receiver data will increase the compliance costs of crypto service providers, at least in the short term. Currently, wallet addresses are mostly anonymous, so an exchange does not know who the recipient is. To comply with the new requirements, service providers need to change their processes fundamentally.

John Roth, Chief Compliance and Ethics Officer at Seattle-based exchange Bittrex, says, “It’s either going to require a complete and fundamental restructuring of blockchain technology, or it’s going to require a global parallel system to be constructed among the 200 or so exchanges in the world. You can imagine difficulties in trying to build something like that.”

Mary Beth Buchanan from Kraken says, “Without enhanced technology systems, this is a case of trying to apply 20th-century rules to 21st-century technology. There’s not a technological solution that would allow us to comply fully. We are working with international exchanges to try to come up with a solution.”

Increased compliance costs will not only be an issue for exchanges but also for trading entities such as crypto hedge funds. Documentation requirements could result in trading delays and transactional costs, which will cut returns.

FATF recommends collaboration with law enforcement to identify rule-breakers

The guideline aims at regulating all Virtual Assets Service Providers. A VASP could also be a natural person; not if they just use cryptocurrencies to buy goods and services, but if they use it in a business context or for commercial purposes.

The document reads, “In cases where the VASP is a natural person, it should be required to be licensed or registered in the jurisdiction where its place of business is located—the determination of which may include several factors for consideration by countries.”

The FATF recommends national regulators to work with law enforcement agencies to use open-source information and web-scraping tools to identify unlicensed operators. However, the primary responsibility to comply with the rules remains with the VASP.  “If the VASP cannot manage and mitigate the risks posed by engaging in such activities, then the VASP should not be permitted to engage in such activities,” says the FATF document.

The fears of crypto businesses are exaggerated – long-term benefits of regulations outweigh short-term costs

Some argue that the new rules will result in the exact opposite of what FATF is trying to achieve. Instead of enabling greater transparency, services will shut down and drop off the radar. Users will migrate to decentralized exchanges to avoid governmental oversight.

But how likely is this scenario? It might happen on a small scale, but most users won’t care much. The primary reason why people use crypto is not to escape governmental oversight but to transfer money faster and at a lower cost.

Phil Liu, chief legal officer at Los Angeles-based hedge fund Arca, agrees, “People in crypto like to make a big deal about giving personally identifiable information to the government, but I don’t see a whole lot of disruption for legitimate players if the proposal is enacted.”

Likewise, the FATF doesn’t view the guidelines as an attempt to put up barriers for crypto trading. “By adopting the standards and guidelines agreed to this week, the FATF will make sure that virtual asset service providers do not operate in the dark shadows,” said U.S. Treasury Secretary Steven Mnuchin. This will enable the fintech sector to “stay one step ahead of rogue regimes and sympathizers of illicit causes.”

This narrative is not wrong. Increased regulations will improve trust and might help to fix the image of the crypto industry.

Jesse Spiro, head of policy at Chainalysis, says “Will it be a potential hardship? Certainly, at least initially. While it may be a hardship, it seems to be something that’s necessary. The road map at the end of the day after this is less arduous for this industry.”

The FATF guidelines come one week before the start of the G20 summit in Japan. Cryptos will be on the agenda there, too.

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