What You Need to Know About FATF’s Forthcoming Regulatory Guidance

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Over the past couple of months, the Chainalysis policy team has spoken to customers, partners, and regulators all over the world to better understand what to expect when the Financial Action Task Force (FATF) publishes updated standards for virtual asset service providers (VASPs), including cryptocurrency exchanges, later this year. What we found is somewhat remarkable: FATF’s guidance, as it is currently drafted, would have profound implications for the cryptocurrency industry. But it seems like no one is talking about it.

If you are unfamiliar with FATF, or don’t have their regulatory guidance on your radar, you are not alone. Below, we discuss what FATF is, why it matters, how we’re responding, and what you can do to get involved.

Background

FATF is an inter-governmental body that sets global standards relating to anti-money laundering and combating the financing of terrorism (AML/CFT). Last year, it announced that member states, which include over 180 countries, would have to start regulating their virtual asset markets and signaled that more precise guidance would come in June 2019.

This is a big deal. FATF’s size and scope is massive, and if a country is deemed deficient regarding AML/CFT, FATF will add the country to its list of non-cooperative countries, which would have a substantial effect on potential financial borrowing from institutions like the IMF and World Bank, lead to a downgrade in country ratings by the likes of Moody's, S&P and Fitch, affect its bond market, and potentially lead to a loss of access to the Euro and/or USD.

In February, FATF published a draft of their proposed guidance, 15-7(b), with a request for private sector feedback. It states:

Countries should ensure that originating VASPs obtain and hold required and accurate originator information and required beneficiary information on virtual asset transfers, submit the above information to beneficiary VASPs and counterparts (if any), and make it available on request to appropriate authorities.

In other words, this would require VASPs not only to verify their customers’ identities, but also to identify the recipients of their customers’ transfers, and transfer that information. This would be applicable to all transactions above a 1,000 USD/EUR threshold.

You might be thinking, “that makes sense for traditional wire transfers, but that’s not how blockchains work.” Again, you are not alone.

Our take

We provided written feedback to FATF earlier this week. Our argument boils down to three main themes:

Technical challenges 

There are clear technical obstacles that prevent cryptocurrency businesses from being able to comply with these standards. Cryptocurrencies were originally designed as a peer-to-peer financial system that has no central authority and no intermediaries. In most circumstances, cryptocurrency exchanges are unable to tell if a beneficiary is using another exchange or a personal wallet. Therefore, requiring a transmission of information identifying the parties is not technically feasible.

Technical opportunities 

There are, however, technical characteristics of blockchains that can be harnessed to achieve FATF’s AML/CFT goals. Cryptocurrency exchanges can use the transparency of the shared ledger to form an effective risk-based approach. Exchanges should collect and store Know Your Customer (KYC) information on the identity of the originator. While the transactions themselves are public, exchanges should also link their customers with their specific transactions as this information is not available on the public ledger. Independent observers, including regulators, law enforcement, and banks, can then leverage blockchain analytics tools like Chainalysis to identify suspicious activity and work with exchanges performing this analysis to mitigate laundering, terrorism financing, and other illicit activity. This process works; Chainalysis has helped track billions of dollars of stolen funds and illicit activity.

Unintended Consequences 

There is no infrastructure to transmit information between cryptocurrency businesses today, and no one has the ability to change how cryptocurrency blockchains work. Forcing onerous investment and friction onto regulated businesses, who are critical allies to law enforcement, could reduce their prevalence, drive activity to decentralized and peer-to-peer exchanges, and lead to de-risking by financial institutions. Such measures would decrease the transparency that is currently available to law enforcement.

We also requested clarification from FATF on questions we heard from our customers and other stakeholders. Specifically: What is the definition of a VASP and should all VASPs be regulated in the same way, considering their various business models? How will this work with current and future privacy laws, and would a closed network with standards like SWIFT be required to transmit information?

Finally, we put forth several recommendations to FATF. Most notably, we suggested that FATF consider including the virtual asset industry in existing public/private working groups. The industry wants to be able to legally share information faster than current processes under the Mutual Legal Assistance Treaty (MLAT) and Egmont Group allow in order to weed out illicit activity and hacks in the space.  

What you can do

Although we already submitted our written feedback to FATF, we are attending FATF’s private sector consultation session in Vienna on May 6-7, which will provide another critical venue for us to share questions and comments from our stakeholders.

If you have any questions or feedback you’d like us to share with FATF, please fill out this form.

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Learn more about KYT for Stablecoins & Token Issuers

Monitor transactions across the token’s full lifecycle, from issuance to redemption—and any transaction in between.

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How Transaction Monitoring Works at Chainalysis

One of the reasons Chainalysis KYT is so popular is that it uses global anti-money laundering (AML) standards common across regulatory bodies. We apply these standards when each transaction is screened.

Cryptocurrency businesses also need to understand the aggregate risk profile of each of their users. That’s why Chainalysis KYT provides a view of risk profiles at the user level, which reflects all of a user’s screened transactions. For example, if an organization has a user who receives funds from a darknet market, our software automatically flags that transaction as high risk. If the user sends funds to a regulated exchange, our software marks that transaction as low risk. And so on. Every screened transaction feeds into a user’s risk profile. Chainalysis KYT displays all user profiles, sortable by high, medium or low risk (using traffic light colors) for easy scanning.

We apply our risk methodology in real time to all users within an organization’s user base. This saves compliance teams from laborious, manual screening work. They can instead focus on developing comprehensive compliance programs. Organizations that work with us tell us this has enabled them to meet regulatory expectations and launch or grow their businesses.

Customizable risk level

We’re now giving our customers the ability to adjust the risk level of a category or a service. For example, not all jurisdictions around the world treat gambling the same way. In some countries, gambling is not considered a legitimate business activity and thus online gambling sites would be treated as high risk. In other countries, gambling is not considered illicit, which means properly licensed online gambling sites would be treated as low risk.

The ability to customize the risk level of categories and specific services means our customers can automate even more of their compliance workflows.

Organization-wide dashboard

One of the most useful facets of Chainalysis KYT is having a view of all users and their risk profiles directly accessible upon first logging in. It provides a visual alert of which users have high risk profiles and therefore require the most immediate attention. In keeping with the spirit of simplified visual cues, we have now launched a dashboard that summarizes key indicators at the total organization level. For example, organizations can now see what percentage of their user base is falling under high, medium or low risk. They will soon be able to see things like total exposure by category, or total transaction volume per day. These and other metrics will provide our customers additional understanding of their organization’s total exposure trends over time.

In-app chat

At Chainalysis, we strive to provide as much support to our customers as we can. To make it easier to interact with us, we added in-app chat to Chainalysis KYT. This allows our customers to send us questions or feedback without having to leave the environment. Our team typically responds within minutes.

Looking ahead

We know software is most valuable when it makes the lives of our customers easier and more productive. This means we’ll continue to add intuitive capabilities to our compliance products while increasing versatility for ongoing transaction monitoring. In the coming months, we will improve how transaction information is displayed. We will also boost our monitoring capabilities for other cryptocurrencies beyond Bitcoin. And we will deepen the integration with Chainalysis Reactor, which is used for enhanced due diligence and investigations.

The momentum around cryptocurrency compliance is only just starting and we look forward to continuing to offer software that builds trust in blockchains.

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