New Cryptocurrency Travel Rules Come into Force in the UK: International Comparison and Evaluation of Travel Rules

In recent years, the development and popularization of virtual assets have attracted attention from countries around the world, and have also brought new challenges and risks to financial regulation and anti-money laundering (AML)/counter-terrorist financing (CFT) efforts. In response to this, the Financial Action Task Force (FATF) has extended the traditional financial sector's "travel rules" to the virtual asset sector. When a virtual asset transaction exceeds a certain amount, the identity information of both parties to the transaction must be passed along with the transaction, which is called the "travel rule".

This article aims to explore the travel rules and their application in the cryptocurrency industry, analyze the progress, differences, and difficulties in implementing the travel rules in different regions, evaluate the effectiveness and limitations of the travel rules, and propose corresponding perspectives.

1. Concept and background of travel rules

Overview of Travel Rules: From traditional finance to cryptocurrencies

In a nutshell, the Travel Rule is an international standard against money laundering and terrorist financing. It requires that when a financial transaction exceeds a certain amount, the identity information of both parties must be passed along with the transaction (this is a "travel") so that regulators can track and prevent illegal activities.

The travel rules were first proposed by the Financial Action Task Force (FATF) in 1996 for banks and other financial institutions in the traditional financial sector, and revised in 2001 and 2012. With the rise and development of cryptocurrencies, the FATF recognized the money laundering and terrorist financing risks in the virtual asset space, and in June 2019 extended the travel rules to Virtual Asset Service providers (VASPs), which are entities or individuals that provide services such as cryptocurrency trading, money transfer, custody, etc.

1.2 How does the FATF promote the implementation of virtual asset travel rules

The FATF is an intergovernmental policymaking institution of 39 member states and regions whose objective is to develop and promote global international standards and measures against money laundering, terrorist financing and the financing of weapons of mass destruction proliferation. Established in 1989 and headquartered in Paris, the FATF is currently the most influential and authoritative international anti-money laundering and counter-terrorism financing organization in the world.

The 40 recommendations issued by FATF are internationally recognized standards for anti-money laundering and anti-terrorist financing, including the legal system, preventive measures, international cooperation, regulatory supervision and so on. The "Rules of travel" fall under article 16 of the 40 recommendations.

In June 2014, the FATF published Virtual Currencies: Key Definitions and Potential Money Laundering and Terrorist Financing Risks. This is the first time that the FATF has defined and analyzed virtual currencies, pointed out the risk that virtual currencies may be used for illegal purposes, and recommended that countries take appropriate regulatory measures. This means that the FATF recognizes the impact of the development and popularity of cryptocurrencies on the global financial system and cross-border payments.

In June 2015, the FATF issued Guidance on a Risk-Based Approach to the Regulation of Virtual Currencies. This is the first time that the FATF has proposed an anti-money laundering/counter-terrorism financing regulatory framework for virtual currency activities and service providers, meaning that customer due diligence, record keeping, reporting and supervision requirements that would otherwise apply to traditional financial institutions will also apply to virtual currency activities and service providers. However, the definition of the concept of "virtual currency" in this framework is narrow, and the risk supervision of virtual assets is not well coordinated.

Finally, in June 2019, the FATF issued the Guidance for A Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (hereinafter referred to as the Guidance). The renaming of virtual currencies as virtual assets and the inclusion of virtual assets and VASPs in the regulatory scope means the finalization and maturity of the regulatory scope of FATF virtual assets. The Standard contains guidelines for applying travel rules to the cryptocurrency space. The travel rules require VASPs to collect and transmit the identity information of originators and beneficiaries when processing cryptocurrency transfers of more than $1,000 or the equivalent to prevent money laundering and terrorist financing activities. In 2021, the FATF revised the Standards to better regulate fast-moving virtual assets.

1.3 Overall impact of travel rules on the crypto industry

1.3.1 Reporting obligations of VASP

In its revised Guidance for 2021, the FATF defines a VASP as "a business entity that provides one or more of the following services to or on behalf of others." This includes the exchange or transfer of virtual assets, the custody and/or management of virtual assets or tools related to virtual assets, and participation in and provision of financial services related to the issuer's offering and/or sale of virtual assets.

The Guidance also points out that the VASP does not include entities that only provide technical support or communication services, entities that only provide virtual asset wallet software or hardware, individuals or legal entities that only use virtual assets for themselves.

A VASP that meets the above conditions is obligated by the travel rules to collect and transmit the identity information of the originator and beneficiary when processing virtual asset transactions exceeding $1,000 or equivalent in order to prevent money laundering and terrorist financing activities. Specifically, the VASP should collect information such as the promoter's name, account number and address (or nationality, date of birth, ID number, etc.), beneficiary's name and account number, transaction amount and asset type.

The VASP should send this information along with the transaction to the next participant or provide it to the relevant authorities upon request. The VASP should also retain this information for at least five years and take appropriate action based on risk assessment and regulatory requirements.

1.3.2 Overall impact of VASP reporting obligations

On the one hand, the travel rules are conducive to improving transparency and trust in the crypto industry, preventing virtual assets from being used for criminal activities such as money laundering and terrorist financing, and promoting connectivity between the crypto industry and the traditional financial system.

On the other hand, travel rules remove the anonymity of virtual assets to some extent. Travel rules require VASPs to report trader identification information and retain it for at least five years. Therefore, the crypto industry needs to balance the needs and expectations of users for data security and privacy rights.

2 Application of virtual asset travel rules in various countries

2.1 International regulatory direction of FATF's 40 recommendations

The 40 FATF recommendations are not mandatory provisions with legal effect, but a voluntary policy framework for countries to comply with, requiring countries to formulate and implement corresponding legal and regulatory measures according to their own legal systems and actual conditions. The FATF conducts a comprehensive assessment of the anti-money laundering and anti-terrorist financing systems and measures of member states or regions at regular intervals to check whether they comply with the 40 recommendations of the FATF and other relevant standards, and issues an assessment report.

If a member country does not meet the requirements of the FATF, it may be placed on the list of high-risk or non-cooperative countries or areas. These countries or regions may face sanctions or restrictions from other countries or regions, such as increasing due diligence, reducing financial transactions, freezing assets, etc.

2.2 Countries and regions with virtual asset travel rules

2.2.1 United States

As of October 1, 2019, all VASPs operating in the United States or providing services to U.S. customers, regardless of the type or form of virtual asset services they provide, must fill in the recipient and sender's name, account details, financial institution and other information in the transfer order when processing funds transfers of more than $3,000.

2.2.2 Switzerland

From January 1, 2020, any company engaged in activities such as virtual currency exchange, crypto wallet services, brokerage services, virtual currency transfer services, issuance of virtual currencies, commissioning of third-party trading services, etc., will fall within the scope of VASP and will need to apply for a license from FINMA. All virtual asset transfers must follow travel rules. When transferring virtual assets, the VASP must obtain and notify the name, account number or unique reference number used, address or other identification information (such as date of birth, certificate number, etc.) of the transferring party and the receiving party. In addition, the VASP must also store information such as the date of the transaction, the type and amount of each virtual currency involved in the transaction, each reference number and identifier associated with the transaction (such as the transaction hash, sending and receiving addresses, etc.), the exchange rate used and its source.

2.2.3 Singapore

From January 28, 2020, all institutions offering digital payment token (DPT) services will have to apply for a licence from the Monetary Authority of Singapore (MAS) and comply with anti-money laundering and Counter-Terrorism Financing (AML/CFT) requirements. Crypto transactions of S $1,500 and below are regulated by travel rules in Singapore and require the name and account number of the originator and beneficiary. Transactions over S $1,500 require additional beneficiary information such as address and date.

2.2.4 South Africa

As of October 28, 2020, all VASPs operating in South Africa are required to enforce the travel rules if the following conditions are met: transactions involving two or more CASPs, transactions involving two or more different jurisdictions, transactions involving major virtual assets such as BTC or ETH and transactions exceeding $1,000. The CASP needs to report and save the name, address or customer identification number of the initiator and beneficiary, the address of the virtual asset, the CASP name of the beneficiary, the purpose of the transaction, the amount, the date and time, and so on.

2.2.5 Canada

Effective June 1, 2021, all directed financial entities (FEs), money service businesses (MSBs), foreign MSBs and casinos operating in Canada must report and keep the following information when sending or receiving virtual currency transfers of $1,000 or more equivalent: The name, address and account number or other reference number of the originator of the transfer request (sender), the name, address and account number or other reference number of the recipient, the amount and currency of the transfer, the date of the transfer, the purpose of the transfer, the name of the service provider used by the sender and the recipient. In addition, when an FEs, MSBs or FMSBs receives virtual currency equivalent of $10.000 or more, a large virtual currency transaction report must be filed with FINTRAC.

2.2.6 Germany

From October 1, 2021, all VASPs operating in Germany will have to provide their customers' names and addresses to the crypto service provider on the receiving side of the transaction for any transaction over €1,000, and this information will have to be retained along with the relevant information throughout the payment chain.

2.2.7 Estonia

As of March 15, 2022, all VASPs operating in Estonia that provide services including virtual currency exchange services and wallet services, virtual currency transfer services, and services related to the issuance of virtual currencies, for virtual asset transactions of any amount, must report and save the following: names of clients and beneficiaries; whether customers and beneficiaries have used other VASPs and, in some cases, provided their names and the address of the transferred virtual assets; the types and quantities of virtual assets transferred; purpose and background of the transfer (from 1 October 2022); residential address of the client and beneficiary (from 1 October 2022).

2.2.8 Japan

As of April 1, 2022, the scope of the VASP includes natural or legal persons engaged in one of the businesses of exchanging fiat currency and virtual assets, exchanging different kinds of virtual assets, transferring virtual assets, keeping or managing virtual assets or controlling the tools of virtual assets, participating in or providing the issuance or sale of virtual assets in Japan. For virtual asset transactions, travel rules apply regardless of the amount. However, if the target of the transfer is a country or region that does not have travel rules in place, the notification obligation may be waived. The VASP is required to report and keep the following information: the name, address, date of birth, occupation or main business nature of the sponsor and beneficiary; The account number or unique reference number of the originator and beneficiary; The type, amount and date of the virtual asset transferred; Identifiers such as the hash value, sending and receiving address of the transaction; The exchange rate used and its source.

2.2.9 United Kingdom

From 1 September 2023, it will be used by all VASPs operating in the UK, as well as individuals or entities that have never complied with travel rules to send or receive virtual assets from overseas jurisdictions. Virtual asset service providers in the UK are required to collect, verify and share information on all transfers over €1,000 involving a CASP. If an account payment is received from an individual or entity in an overseas jurisdiction that has not yet implemented the travel rules, the virtual asset service provider must conduct a "risk-based assessment" to decide "whether to provide the crypto asset to the beneficiary," and the rules also apply to Britons who wish to make payments outside the UK.

It is worth noting that the EU's Crypto Asset Market Regulation Act (MiCA) also has corresponding guidance on travel rules. According to the MiCA, the travel rules will be extended to all crypto asset transactions that meet its definition, and the exemption of the minimum threshold for transactions and the minimum transfer value will be removed. MiCA is expected to come into effect in February 2024, when the travel rules of EU member states will be more harmonized and harmonized.

3 Conclusions and prospects

3.1 Validity and limitations of the Travel Rules

Travel rules have a certain effectiveness in the cryptocurrency field, mainly reflected in their promotion of the standardization and specialization of the cryptocurrency industry, improving the compliance awareness and capabilities of VASP. The Travel Rules provide a clear regulatory framework and standards for VASPs, enabling them to conduct self-regulatory management and risk control in accordance with uniform requirements. This will also help to improve the fairness of competition and market order among VASPs and avoid the occurrence of regulatory arbitrage or unfair competition.

However, travel rules also have some limitations in the cryptocurrency space, mainly in the following areas:

First, the travel rules dissolve the anonymity and decentralized features of cryptocurrencies, compromising users' needs and expectations for data security and privacy rights. Travel rules require VASPs to report trader identification information and retain it for at least five years. As a result, cryptocurrency users' personal information may be leaked or misused, leading to a violation of their privacy rights. At the same time, travel rules are also contrary to the decentralized spirit of cryptocurrencies, making cryptocurrency transactions subject to regulation or intervention by centralized institutions, resulting in restrictions on their autonomy and freedom.

Second, the travel rules increase the operating costs and compliance risks of VASPs, which may cause some VASPs to exit the market or move into the underground economy. Travel rules require VASP to establish and maintain a complex information collection, verification, transmission and storage system, which requires a lot of manpower, material and financial input, increasing the operating costs of VASP. At the same time, the travel rules also expose VASPs to higher compliance risks, and failure to implement the travel rules in a timely or accurate manner may result in penalties such as fines or license revocation. This may cause some VASPs to exit the market unable to withstand the pressure brought by the travel rules, or to move into the underground economy, thus affecting the development of the cryptocurrency industry.

Again, travel rules are difficult to adapt to the rapid changes and innovations in the cryptocurrency space, and emerging forms such as DeFi, NFT, and others may not fall within the scope of VASP or apply to travel rules. The cryptocurrency space is an area full of innovation and change, with new technologies, products and services constantly emerging, such as decentralized finance (DeFi), non-homogeneous tokens (NFT), stablecoins, and more. These emerging forms may not fall within the scope of VASP or apply to travel rules because they may not have a centralized service provider or involve traditional identity information. This creates challenges and difficulties in the implementation and monitoring of travel rules.

Finally, it is difficult to achieve uniform implementation and supervision of travel rules on a global scale, and there are differences and difficulties in the implementation of travel rules in different countries or regions. While the FATF provides a common regulatory framework and standards, countries have different schedules, approaches and details for implementing travel rules, depending on their own legal systems and circumstances. This creates complexity and uncertainty for cross-border transactions, as well as obstacles to coordination and communication between regulators.

3.2 Improvement direction of travel rules

First, expand the scope of travel rules to include more types or forms of crypto assets or service providers, such as DeFi, NFT, stablecoins, etc. DeFi, for example, has the advantage that it can provide greater efficiency, transparency and fairness, but its disadvantage is that it is difficult to enforce travel rules because it does not have clear information about the identity of the service provider or the customer. This paper believes that DeFi's own information sharing platform or protocol can be used for on-chain verification, so that DeFi traders can automatically collect, verify, transmit and store identity information, and realize self-execution of travel rules.

Second, lower the threshold for the enforcement of travel rules, remove the exemption of the minimum amount or minimum transfer value of a transaction, and apply travel rules to crypto asset transactions of all amounts. This is in response to the increasing trend of cryptocurrency trading and segmentation, as well as the regulatory difficulties caused by cryptocurrency price volatility. This direction is consistent with the direction indicated by MiCA.

Finally, the establishment of unified technical standards and solutions, such as the use of blockchain, distributed ledger, smart contracts and other technologies to achieve the safe transmission and storage of information. This is to solve the technical obstacles and security risks of information sharing between VASPs, as well as improve the efficiency and convenience of information sharing, which is conducive to the operation and management of VASPs.