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Leveraging Travel Rule Compliance as a Pre-Transaction Risk Mitigation Tool

Catarina Veloso
Catarina Veloso
April 10, 2024
Catarina, Regulatory & Compliance Senior Associate at Notabene, specializes in global crypto regulations. With roles including co-chair of the CryptoUK Travel Rule group and part of the EBA Expert Group, she shapes Travel Rule compliance. Holds Masters in Energy Law and BA in Law.

This article explores the intricacies of the crypto Travel Rule, which is not merely an information exchange mechanism but also a powerful tool that companies can use to mitigate pre-transaction risks (including sanctions risks) and unlock new opportunities. We explore the rule’s purpose, objectives, and core components: VASP identification, due diligence, transaction qualification, information collection, and pre-transaction counterparty risk assessment.

The Crypto Travel Rule: A Shield Against Illicit Activities

The Travel Rule presents a robust safeguard against money laundering, fraud, and other illicit activities within the cryptocurrency landscape. Introducing stringent information exchange requirements creates a powerful barrier against criminals seeking to obscure the origin of their funds. However, it is essential to understand that the Travel Rule transcends mere data transmission. When executed effectively, the Travel Rule enables virtual asset service providers (VASPs) to stop potentially illicit transactions before they are created on the blockchain, significantly reducing VASP’s overall risk and exposure to sanctions — a pivotal development for the crypto industry.

Pre-Transaction Travel Rule Implementation: A Defensive Tactic

Crypto transactions are immediate and irrevocable, a sharp contrast to traditional SWIFT payments, where settlements occur at scheduled intervals during the day, allowing beneficiaries time to request fund withholdings in the case of discrepancies, such as a mismatched beneficiary name. In crypto transactions, it’s essential that VASPs exchange information before settling the underlying transaction. Once funds are transferred, remediation becomes operationally burdensome — and in some cases, the risk may already have entered the VASPs’ spheres. 

A pre-transaction implementation of the Travel Rule ensures that VASPs can perform critical risk assessments like beneficiary name matching and sanctions screening before receiving funds and, depending on their systems, before releasing funds to the end customer.

The Travel Rule: Bridging the Gap Between Crypto Transactions and Real-World Entities

In addition to being a powerful counterparty risk mitigation tool, the Travel Rule is an indispensable infrastructure layer for crypto transactions because it establishes a connection between crypto activities and real-life individuals and entities.

Bridging this gap is essential for three reasons:

  • Enhancing sanction controls: Before implementing the Travel Rule, VASPs conducted transactions with minimal information about their counterparties, leaving them vulnerable to potential risks. Now, the Travel Rule is a catalyst for reconstructing trust within the crypto space by enhancing sanction controls and counterparty risk management.

  • Enabling new use cases: The Travel Rule opens the door to novel crypto transaction applications previously hindered by the lack of traceability. Traceability is crucial for several use cases (e.g., for accounting purposes) and paves the way for broader adoption of crypto payments and transactions.

  • Preventing fraud: Fraud is a pervasive issue in crypto, and the Travel Rule addresses this problem by fostering collaboration among VASPs. This collaborative effort allows VASPs to verify the parties involved in a transaction collectively. For instance, if Alice initiates a transaction and informs her VASP that the funds are destined for her friend Bob’s account with another VASP, the beneficiary VASP can raise a red flag if the funds are actually being received by Daniel, a fraudster who has deceived Alice. 
Ultimately, when strategically implemented as a pre-transaction risk mitigation tool, the Travel Rule boosts the security of crypto transactions and opens up new horizons for the industry that could redefine how we interact with digital assets. 

The Travel Rule is a robust safeguard against money laundering, fraud, and other illicit activities within the cryptocurrency landscape. By fostering a culture of proactive compliance and collaborative risk management, VASPs can unlock new dimensions of trust and operational excellence.