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

Lesa Moné
Lesa Moné
July 21, 2023
Lesa, Head of Content at Notabene, combines her deep B2B crypto and SaaS experience to deliver impactful insights for clients, fostering Notabene's reputation as a thought leader in the crypto regulatory tech space.
Table of Contents
Summary
  • FATF’s Targeted Update (June 2023) clarifies that Travel Rule is a pre-transaction obligation.
  • Despite an overall increase in compliance efforts, Notabene's study (April 2023) reveals only 20% of VASPs send Travel Rule information pre-settlement.
  • Crypto transactions pose unique compliance challenges due to their instantaneous and irreversible nature, limiting time for pre-transaction checks compared to traditional SWIFT payments. 
  • Notabene's platform aids VASPs in navigating these complexities, enabling comprehensive pre-transaction checks while maintaining transaction speed and efficiency.

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.

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.

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:

Increased compliance efforts

Figure 1: Key Finding 1 from Notabene’s 2023 State of Crypto Travel Rule Compliance Report, page 26.

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%).

Figure 2: Key Finding 7 from Notabene’s 2023 State of Crypto Travel Rule Compliance Report, page 36.

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

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.

Figure 3: Key Finding 7 from Notabene’s 2023 State of Crypto Travel Rule Compliance Survey, page 35.

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.

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.

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.

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.

SafeTransact's Travel Rule Compliance Dashboard


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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References

[1] FATF (2021). Updated Guidance for a Risk-based Approach to Virtual Assets and Virtual Asset Service Providers, page. 59, paragraphs 184-185

FAQs

What does the FATF's June 2023 Targeted Update report reveal about Travel Rule compliance?

The FATF's June 2023 Targeted Update report emphasized the critical importance of pre-transaction Travel Rule compliance in the cryptocurrency market. It identified that instances of post-transaction compliance don't align with FATF's global crypto regulation and underscored the need to submit originator and beneficiary information before or during the crypto transaction.

How does pre-transaction compliance contribute to effective Travel Rule application?

Pre-transaction compliance in cryptocurrency transactions is crucial in implementing the Travel Rule effectively. It enables VASPs to conduct thorough counterparty sanctions screening before the transaction is initiated. It provides a safety net to stop transactions involving sanctioned persons or entities, thereby bolstering anti-money laundering (AML) measures in the crypto space.

What are the key findings from Notabene's 2023 State of Crypto Travel Rule Compliance Report?

Notabene's 2023 State of Crypto Travel Rule Compliance Report found that pre-transaction Travel Rule compliance is still lacking despite increased global efforts in crypto regulation compliance. It revealed that 37.5% of firms only meet Travel Rule requirements after cryptocurrency transactions are completed, a practice that contradicts FATF's guidelines.

How do traditional SWIFT payments differ from cryptocurrency transactions in terms of compliance checks?

Traditional SWIFT payments afford banks several days to conduct comprehensive compliance checks and share data before initiating a transaction. In contrast, the nature of blockchain technology means cryptocurrency transactions occur almost instantaneously, leaving little time for pre-transaction checks and thus making the compliance landscape more challenging.

What challenges do VASPs face when implementing the Travel Rule in cryptocurrency transactions?

One of the central challenges for VASPs in implementing the Travel Rule in the crypto space lies in balancing cryptocurrency transactions' inherent speed and efficiency with thorough pre-transaction compliance checks. Cryptocurrency transactions' near immediate and irreversible nature poses unique hurdles to achieving pre-transaction compliance.

How does Notabene's SafeTransact platform assist VASPs in achieving pre-transaction compliance?

Notabene's SafeTransact platform is designed to assist VASPs in navigating the complexities of pre-transaction Travel Rule compliance in the fast-paced cryptocurrency market. The platform provides a secure, holistic view of crypto transactions, enabling real-time decision-making automation, effective counterparty sanctions screening, identification of self-hosted wallets, and facilitating the smooth rollout of Travel Rule compliance in line with global crypto regulations.