One of the more significant controversies that has shaken the cryptocurrency industry in the past 12 months is the proposed crypto wallet rule.
On December 18, 2020, the U.S. Financial Crime Enforcement Network (FinCEN), part of the U.S. Treasury Department, released a Proposed Rule-Making Notice (NPRM) asking banks, crypto exchanges, and other money service providers to Know Your Customer (to collect). KYC) data about individuals transferring cryptocurrency worth USD 3,000 or more to or from a private wallet.
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It caused an immediate outcry for two reasons.
First, the initial consultation for the NPRM only lasted 15 days and was supposed to run over the Christmas and New Years period when most of the world was closed for the holidays. Proponents of the cryptocurrency smelled a rat. Typically, consultations last at least 60 days to allow full representations of industry participants.
Second, the dictation appeared to be designed to be enforced as part of the death throes of the outgoing Trump administration. In a matter of weeks, Treasury Secretary Steven Mnuchin would be deposed by Joe Biden’s future presidency and replaced by former Federal Reserve Chairman Janet Yellen.
Critics were quick to speak out in favor of FinCEN, saying it was technically impossible for most companies involved in crypto services to stick to the decision. Smart contracts contain no name or address information and are just pieces of code that process transaction data.
Within a few days, FinCEN said it had received over 7,500 “robust” comments.
The response from Katie Haun, a former federal prosecutor and partner of the VC giant Andressen Horowitz (a16z), was typical of the immediate feedback from the industry.
Via Twitter, she claimed Mnuchin “tried to force regulatory changes into the end of an administration without trial” and promised that a16z would challenge the “procedurally flawed … vaguely written … overarching” judgment in court if it did ever come close to being imposed.
Peter van Valkenburgh, Research Director at the Coin Center, best summed it up when he described FinCEN’s move as a sneaky “midnight rule”, noting, “The time constraints of the so-called midnight period should never be an acceptable justification for introducing rules its about americans and innovative american companies without adequate opportunity to notice and comment.
“In similar situations, banks have undergone extensive consultation and a gradual (sometimes absurdly slow) rulemaking process. For example, FinCEN has pending due diligence for bank customers since 2014 and has not yet completed it. “
Timeline of a botched rule change
- December 18, 2020: Steven Mnuchin’s FinCEN issues the NPRM wallet rule with an unprecedented 15 day consultation. Instant game.
- January 2, 2021: Original 15-day final consultation planned
- January 14, 2021: Under fire FinCEN announces that it has extended the comment period for crypto wallet rules by 45 days
- January 21, 2021: President Biden will freeze all Treasury Department regulations for 60 days pending review
- March 22, 2021: The end of the FinCEN regulatory freeze is planned
What the industry has learned from the FATF travel rule
In 2018, the “travel rule” of the Financial Action Task Force – later codified as “Recommendation 16” – triggered one of the first major existential crises for the industry. The travel rule would seek to balance cryptocurrency transactions with broader anti-money laundering (AML) and KYC regulation, specifically requiring that personal data “travel” with transactions. Any person who has received more than $ 1,000 worth of cryptocurrency must be identified. The recommendations were finalized in June 2019 and the deadline for compliance was set 12 months later.
As one of the most powerful intergovernmental watchdogs in the world, financial services companies sit up and listen when the FATF speaks.
However, the participants in the crypto industry strongly argued that the travel rule was an abomination to the way the cryptocurrency works. In a response from Global Digital Finance, the problem was clearly articulated.
In a comment on the FATF consultation in April 2019, GDF explained the difference between Bitcoin addresses and IBAN bank codes, both of which are used to send and receive transactions. The letter pointed out that while IBAN numbers contain information about the entity sending or receiving a transaction built right into their code, unlike Bitcoin addresses, which are a randomly generated sequence of letters and numbers (alphanumeric characters).
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This demonstrated the impossibility of the FATF request; Bitcoin addresses are simply not intended to contain identifying information like traditional bank codes. How Financial tycoons Indeed, efforts to collect data could result in “P2P transfers being made through non-custody wallets, which are significantly more difficult for law enforcement to track or control”. This is the law of unintended consequences: the efforts of financial regulators to interfere with this complex system could lead to an entirely undesirable outcome.
In truth, the crypto industry managed to find a way to meet the FATF travel rule without breaking the cryptocurrency altogether.
First came Ciphertrace, which said it had created software that would create a validation certificate to confirm transactions sent between exchanges and wallets. At the time as the company’s marketing director, John Jeffries summed up the situation: “The industry has said that it is virtually impossible to comply with the travel rule. The reality is that it is possible. “
Dutch multinational ING was the first bank to come up with a solution in June 2020 with its ‘FATF-friendly’ remittance tracking protocol. Custodian BitGo later added support for the travel rule via an advanced API that collects the sender and recipient information. And Coinbase – which is about to go public shortly – has, for example, developed a P2P system for exchanging user information in accordance with the provisions of the travel rule.
And the FATF responded positively to benefits in kind in an update dated February 25, 2021 [our emphasis]: “Transition from rule-based supervision to risk-based supervision needs time and can be challenging as that Results of mutual evaluations have shown. “
The FATF correctly recognized that the cryptocurrency industry want Compliance: Regulation creates security, common priorities to prevent money laundering and terrorist financing, and an overall better experience for consumers and investors.
The same collaborative solution development must happen when FinCEN convenes again after President Biden’s rule freeze ends. But it can only work with mutual respect on both sides.
The picture for the crypto industry has changed a lot since 2018. It is no longer largely isolated from the mass of venture capital funds, private equity, banks, and financial services firms that deal with day-to-day transactions in the trillions of dollars. Cryptocurrency is now firmly anchored in the world banking systems – not least in the latest guidelines that US banks can keep crypto and use stable coins for payment processing, or in the fact that the world’s largest custodian BNY Mellon – with an AUM of 41 Trillion US Dollars No Less – Now billions of dollars in crypto assets are being held for wealth managers, pension funds and foundations worldwide.
It’s possible FinCEN didn’t expect the overwhelming backlash they received. It is quite possible that you misjudged the extent to which those affected would object to a short-term regulation of baits and counters.
The FATF has demonstrated that mutually acceptable solutions to combating money laundering and terrorist financing can be found and that deadlines and threats on the cliff are not the way to promote better financial services. For example, the next 12 month review of the FATF is underway and will be released in June 2021. This suggests that the ongoing consultation with the industry will now take the form of an annual rolling review.
The Travel Rule created new, dedicated organizations to help financial services companies comply with Recommendation 16, including the US Travel Rule Working Group, which was formed from 25 leading US virtual asset service providers to serve industry-wide work solution and the Travel Rule Information Sharing Alliance, whose whitepaper proposes an open source P2P mechanism for compliance with the judgment.
That is the scope of the task ahead for the Crypto Wallet Rule. More lobbying needs to be directed towards the administration of Joe Biden, and both political and financial capital needs to be used to move FinCEN towards the “peer review” scheme introduced by the FATF.
If the industry can break away from a controversial relationship with FinCEN and push for closer collaboration, as with the FATF, a solution that both sides are happy with is completely within reach.
Maxim Bederov is an investor and entrepreneur.