At SDF, we often stress the importance of public-private partnerships in developing regulatory policy around emerging technologies. Policymakers who engage with industry experts to understand the complexity of technologies like blockchain tend to be better informed and, in turn, make better policy.
A corollary to that, as we said in our January comment letter on FinCEN’s Self-Hosted Wallet NPRM, is that new technology deserves new approaches to regulation. We warned that foisting antiquated rules onto entirely new paradigms doesn’t work and can lead to unintended consequences — especially when regulators act without a full understanding of those new paradigms. We urged FinCEN to slow down and partner collaboratively with the blockchain community to develop a tailored framework to prevent financial crime without choking off the promise of networks like Stellar to serve financially excluded populations around the world. To realize both outcomes requires regulators to approach new technologies with an open mind — to accept that regulation must evolve over time. Thankfully, it seems FinCEN may now be taking that approach.
But another regulatory body in the AML space, the Financial Action Task Force (FATF), has stepped in to take their place, doubling down on enforcing the “old way” without seeking input from the private sector. On March 19, 2021, FATF released Draft updated Guidance for a risk-based approach to virtual assets and VASPs which represents a sweeping overhaul of global AML recommendations. If adopted, the draft guidance would dramatically expand the universe of businesses that would be defined as a Virtual Asset Service Provider (VASP). The upshot of this designation is to make nearly anyone who touches virtual assets or is involved with virtual asset products or platforms subject to the full panoply of AML regulations:
“The expansiveness of these definitions represents a conscious choice by the FATF. Despite changing terminology and innovative business models developed in this sector, the FATF envisions very few VA arrangements will form and operate without a VASP involved at some stage” (¶ 76).
This raises some important questions: what’s motivating such an expansion of terms and what are the implications?
While the FATF proposal opens with cursory references to financial crime , this broadening of the reach of AML regulations may not be driven by a genuine concern over virtual assets’ use in money laundering. The draft guidance is short on facts and concrete evidence to justify such a massive expansion of regulatory scope. In fact, evidence suggests that virtual assets’ use in illicit finance is just one-third of one percent (0.34%) and falling — a significantly lower incidence of financial crime than occurs with fiat currencies!
Additionally, the proposal is framed through the lens of preserving the status quo. Historically, the global AML regime was premised on regulating centralized intermediaries that engage in the businesses of money transmission. What makes public blockchain networks transformative is that they are decentralized and empower individuals by freeing them from dependence on intermediaries. This seems to be precisely the innovation that concerns FATF:
“Moreover, full maturity of these protocols that enable P2P transactions could foreshadow a future without financial intermediaries, potentially challenging the effectiveness of the FATF Recommendations” (¶ 35).
FATF appears more concerned with regulators protecting their turf, than protecting against financial crime. But regulatory “turf-protection" is not a basis for sound policymaking — a fact FATF itself tacitly acknowledged when it launched a new project to study and mitigate unintended consequences resulting from its own standards. FATF’s review is rightly focused on addressing the de-risking, financial exclusion, and threats to fundamental human rights its standards have imposed, particularly upon the poorest and most in need around the world.
But from our perspective, it is difficult to reconcile these contradictory actions by FATF. On one hand, through its de-risking review, FATF appears to recognize the role its standards have sometimes played in denying individuals access to basic financial services and seeks ways to rectify those past wrongs. On the other hand, through its draft guidance, FATF seems determined to push expansive new rules that would drive a whole new wave of de-risking and curtail the most promising technological solution to the de-risking it has already caused.
It’s our sincere hope that, after hearing from the many stakeholders joining us in voicing their concerns, FATF reexamines its proposal for virtual assets and VASPs through the lens of its de-risking review, embraces a more open-minded approach to decentralized technologies, and proactively partners with blockchain industry experts to enable it to craft more informed policies in the future.
For more detailed analysis of the FATF Draft Guidance, please see the comment letters filed by the Blockchain Association and Chamber of Digital Commerce, which we are proud to support.