Crypto travel rule 101

Crypto Travel Rule Compliance: Challenges and Opportunities for VASPs

The Travel Rule presents itself as a regulatory burden on crypto companies worldwide. For virtual asset service providers (VASPs), several events will need to coincide:

During its second 12-month review of its revised standards on virtual assets & VASPs, the Financial Action Task Force (FATF) reported that less than half of the surveyed jurisdictions had introduced the necessary legislation to implement their revised standards. 

Conversely, the new FATF global framework is crypto’s most significant opportunity to cross into the mainstream. Since their inception, cryptocurrency and blockchain technology have continually enabled transactions between people and businesses. Still, a lack of regulation and nonexistent links to the traditional finance industry has prevented mainstream adoption. 

This post dives into the challenges and opportunities for VASPs implementing FATF’s Crypto Travel Rule.

Travel Rule Compliance Challenges for the Crypto Industry

There are three common Travel Rule compliance challenges VASPs face when implementing Crytpo Travel Rule compliance:

1. The Sunrise problem/loss of business

According to CoinMarketCap, more than 500 cryptocurrency exchanges worldwide collectively trade trillions of dollars worth of cryptocurrency daily. If an exchange starts requiring Travel Rule data alongside transactions, will they be able to do business with exchanges that don’t currently have compliance solutions in place? This phenomenon causes various stages of implementation. The “sunrise period” occurs when the Crypto Travel Rule fails to be fully in effect across jurisdictions. Learn more about the Sunrise issue in Chapter 3 of Notabene’s State of Crypto Travel Rule Compliance Report.

2. A lack of existing technology or trust frameworks

The crypto industry is young and heterogeneous. Each business is built on varying tech and runs diverse business models, making it challenging to apply the models from the traditional payment associations directly. Long-standing associations such as traditional finance’s SWIFT, VISA, and MasterCard offer a widely-used trust framework for banks to plug and play and immediately comply with the Travel Rule. Meanwhile, the crypto industry lacks similar universal messaging networks. 

3. Unknown compliance costs

In most cases, implementing the Travel Rule requires VASPs to change funding, withdrawal, and transfer functionality fundamental to their business. This will require back-end changes and modifying the UX of customer-facing screens and APIs. Also, because of the new know your customer (KYC) requirements for crypto-to-crypto exchanges, many will have to implement this from scratch, adding friction and cost to their businesses.

Travel Rule Compliance Opportunities for the Crypto Industry

There are five opportunities for VASPs that are Travel Rule compliant.

1. Enhanced Regulatory Clarity

One of the biggest challenges crypto exchanges have faced over the years is the lack of regulatory clarity. This has been particularly problematic for exchanges outside the leading global financial centers, which have had problems directly with regulators and indirectly through the loss of financial partners.

The FATF guidelines for virtual assets force local regulators to take a stance. Regulators are required to either create a roadmap for a regulatory framework for VASPs or, unfortunately, outright ban it. While the second option is troublesome, well-thought-out legal frameworks from the US, Switzerland, South Africa, Singapore, and other countries provide an excellent example to more risk-averse regulators.

2. Access to banking

The inability to prove a good source of client funds has been a cited primary reason that traditional banks would not open bank accounts for crypto businesses. It was simply too risky for them to touch customers touching crypto. The Travel Rule explicitly solves this problem by using the same rules banks have to implement. 

The most successful crypto businesses have invested copious amounts of time convincing their banking connections that they have outstanding quality KYC and anti-money laundering (AML) policies in place.

Solving the Travel Rule for VASPs and performing strong counterparty VASP due diligence will help reduce this risk. This is also an excellent reason to start implementing the Travel Rule before your jurisdiction requires it.

3. Improved fiat on/off ramps globally

Better access to banking brings better access to local payment systems worldwide. This alone could drastically improve the adoption of cryptocurrencies and provide much better access to the innovations in the DeFi space to whole new classes of untapped users around the world.

4. Crypto and DeFi could become the rails for future FinTechs

Most FinTechs today differentiate themselves by improving UX, onboarding, and finding new use-cases for what is, in essence, the same products the traditional financial industry has offered for years. Having Travel Rule support and more blockchain-specific KYC/AML tools will allow them to adopt many new products coming out of the DeFi space–thus finding better ways to differentiate themselves from incumbent financial services.

5. Lower regulatory risk means easier access for institutional investors.

Institutional investors worldwide are actively looking at adding crypto as a new asset class. Lack of regulatory certainty has been one of the most significant issues holding them back from broader investment in the space. Blockchain analytics tools have helped lower crypto AML risk, but unlocking counterparty identification and verification through the Travel Rule will help open the asset class to institutional investors.