Challenges and Progress: The 2023 State of Pre-Transaction Compliance in Crypto Travel Rule

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In June 2023, the Financial Action Task Force (FATF) published a Targeted Update report on the global state of Travel Rule adoption. The report stressed that the Travel Rule must be applied before a crypto transaction occurs. Yet, insights from our study published in April 2023 revealed that nearly 40% of companies reporting compliance are not fulfilling their obligations before the crypto transaction occurs.

In this second installment of a three-part series, we discuss why Travel Rule compliance is a pre-transaction requirement, the current industry compliance gaps. The final article in the series addresses how Notabene's SafeTransact helps VASPs achieve pre-transaction compliance.

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FATF’s Pre-Transaction Compliance Requirement

In its June 2023 Targeted Update report on the worldwide Travel Rule adoption, the FATF emphasized the necessity for Travel Rule compliance before the crypto transaction occurs. In the report titled “Virtual Assets: Targeted Update on Implementation of the FATF Standards,” the FATF revealed vital insights on the global enforcement of the Travel Rule, disclosing minimal progress, with three-quarters of surveyed jurisdictions found to be ‘only partially’ or ‘not compliant’ with its requirements for VAs and VASPs.

The report underscored instances of post-transaction compliance as a form of non-compliance. It stressed the urgency of immediately submitting originator and beneficiary information to the Beneficiary VASP or financial institutions before, simultaneously, or concurrently with the transaction. [1] This order of operations facilitates sanctions screening of the counterparty at or before the time of the transaction. It allows VASPs the chance to stop transfers with sanctioned persons or entities.

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Key Trends from Notabene’s 2023 State of Crypto Travel Rule Compliance Report

Notabene conducts an annual review to comprehensively assess the virtual asset industry's compliance efforts with FATF’s virtual asset Anti-Money Laundering (AML) guidelines. The 2023 State of Crypto Travel Rule Compliance survey ran from December 2022 to January 2023, covering 69 VASPs and financial institutions globally, and yielded the following results:
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‍Increased compliance efforts

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Compared to the 2022 survey, the number of VASPs reporting 'already compliant' doubled, marking a 117% increase (11% in 2023, compared to 23% in 2023).

Limited increase in pre-transaction compliance

Although the number of VASPs reporting 'already compliant' doubled from last year, only 20% of VASPs send Travel Rule information pre-settlement (up by 50% from last year’s 13%).

This data reveals a disparity between assertions and actions, as well as confusion around what‘ fully compliant’ means.

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Post-transaction compliance dominates

The study highlights that 37.5% of firms performing Travel Rule meet the requirements only after completing transactions, which goes against the FATF's instructions.

While showing progress, these findings accentuate the need for local regulators to clarify that the Travel Rule is a pre-transaction obligation, a clarification reinforced by the FATF in its June 2023 update.

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Balancing Speed and Compliance in Cryptocurrency Transactions: The Challenges of Implementing the Travel Rule

The purpose of the Travel Rule is to ensure that appropriate checks and balances are in place before a transaction is initiated. To fulfill the goals of the Travel Rule effectively, the Beneficiary VASP should have sufficient time to scrutinize the transmitted information. Suppose instantaneous settlements take place without giving the VASP adequate time to react. In that case, it might hinder their ability to conduct essential due diligence tasks, such as matching the beneficiary's name and performing sanctions screening before the funds are received.

In some cases, VASPs might not have enough time to release the funds to the end customer, depending on the systems in place.
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Traditional SWIFT payments, characterized by their clearance times that span several days, give banks the luxury of time. They can share data and perform comprehensive checks before the transaction is initiated. This time factor is a significant difference between traditional and crypto transactions. Most cryptocurrency transactions occur instantaneously and are irreversible, leaving little to no room for pre-transaction checks. 

In the context of Travel Rule compliance, this characteristic of crypto transactions poses a unique problem for VASPs. It takes longer for VASPs to develop a compliance strategy that can effectively detect and halt illicit activity without impacting transaction speed or volumes. Therefore, the challenge lies in creating a compliance system that allows for comprehensive pre-transaction checks while still maintaining the speed and efficiency inherent to cryptocurrency transactions.

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Notabene’s SafeTransact: Solving Crypto Pre-Transaction Decision-Making

Notabene welcomes the FATF’s clarification that Originator VASPs must submit originator and beneficiary information before or concurrently with the crypto transaction. We’ve designed SafeTransact: The Crypto Pre-Transaction Decision-Making Platform to enable VASPs to Identify and stop high-risk activity before it occurs.

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Notabene’s SafeTransact offers a secure, holistic view of crypto transactions, enabling customers to automate real-time decision-making, perform counterparty sanctions screening, identify self-hosted wallets, and complete the smooth rollout of global Travel Rule compliance in line with global regulations.

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