The travel rule in a nutshell
Since 1996, the FATF (Financial Action Task Force) has required banks to send information about the originators and beneficiaries of cross-border financial transfers of over 1,000 USD/EUR along with each transaction. Known as the ‘travel rule’, the objective was to promote greater transparency and controls on money laundering or terrorist financing in cross-border transactions.
Luckily for the traditional financial system, they already had protocols like SWIFT in place which made it relatively easy to implement the travel rule. But when the FATF extended the travel rule requirement to all global Virtual Asset Service Providers (VASPs) in June 2019, many feathers were ruffled. Though FATF recommendations are only required to be implemented by member jurisdictions, the change meant that in practical terms digital asset companies – exchanges and custodians – were now in the same position as traditional financial institutions when it comes to FATF obligations. In a bid to secure their own standing with regulators, major exchanges may demand non-custodial wallets to fall in line or be excluded from the ecosystem.
The Technical Standards Committee of the Bitcoin Association is working on creating a travel rule Standardised Format for BSV, and we need your input! Head over to our Travel Rule Specification page and learn how you can participate over here.
How are Bitcoin consumers and intermediaries likely to be impacted? We invited Centbee co-founder and TSC member Angus Brown to address the herd of elephants in the room in this edition of our TTDR (Too Technical, Didn’t Read) blog.
Technical Standards Committee (TSC): For all its history, it has been unclear whether the cryptocurrency industry is obliged to comply with existing regulations. With the June 2019 FATF amendment, Virtual Asset Service Providers (VASPs) are explicitly included in the travel rule recommendation.
Do you consider cryptocurrency’s inclusion in financial regulations a threat?
Angus Brown (AB): Compliance is a good thing for two reasons. Money laundering has a cost to society, and that cost is that crimes are rewarded. By keeping it to the fringes, you are doing right by society.
The other reason why Bitcoin SV is embracing regulation is because it ensures that our business model fits into the global financial system. There are people who believe you can operate completely independently of the global financial system, but it’s not feasible in the short term. Perhaps it could work in a closed community that’s in it for the long run, but most of us live in a world where you have to buy food from a grocery store, and most grocery stores don’t (yet) accept electronic money.
TSC: Will the travel rule have a positive, negative or a neutral impact on the industry in general and Bitcoin SV in particular?
AB: I think it’s going to have a massive impact and that most people have not given much thought to it. In some cases, it will be positive, in some negative, but definitely not neutral. For crypto assets as a whole, the travel rule is likely to have a negative impact. For Bitcoin SV, it’s likely to be positive.
Let me unpack why I think it’s going to be negative for the industry as a whole. For a start, it will be a huge change that will impact both companies and individual users. Crypto services will have to collect and transmit more information – and that comes at a cost and will cause friction. For users, it will become more onerous to use crypto.
Then there’s the matter of coordination. The crypto industry is particularly fragmented along political and philosophical lines resulting in different standards and practices. There are crypto-anarchists who will completely refuse to comply with the travel rule. But there are also large exchanges who are commercially incentivised to secure their businesses. We’re talking about thousands of entities and cryptocurrencies in over 150 countries each operating according to their own system. Implementation of the travel rule requires everyone to come together to introduce an inter-organisational communications system. The road to get there will be disruptive and chaotic.
For Bitcoin SV specifically I see an interesting opportunity. The BSV ecosystem has several unique attributes. Unlike the typical crypto exchange, most Bitcoin SV entities operate with only one cryptocurrency: BSV. This makes implementation much easier. We’re also a fairly small community, which makes it easier to coordinate and organise. Part of the TSC’s motivation for proposing a Travel Rule Standard for Bitcoin SV is that it’s highly implementable.
Then there’s our philosophical and commercial leaning. Bitcoin SV’s vision is to be an enterprise-friendly blockchain, and we therefore have a strong focus on regulatory compliance. We aim to implement the travel rule quickly to give us time to battle test and perfect our solution. This is an opportunity to create stability within the chaos, so that even more entities will be drawn to the Bitcoin SV ecosystem.
TSC: To which crypto service providers will the travel rule apply?
AB: The easiest part about the travel rule is figuring out what to do. The answer is an old one, as the purpose behind the rule is to combat one of the oldest problems in finance: money laundering. In practice, entities classified as VASPs must ensure that beneficiaries and sender information travels along with cross-border financial transfers. That’s why it’s called the travel rule.
The question of whom it applies to is a more difficult one.
According to the old definition of a VASP, private, unhosted wallets are exempt. Person-to-person transactions were considered exempt largely because of the technical difficulty of making an unhosted wallet comply. The FATF’s concept of money laundering is built around the concept of intermediaries who are defined as entities that handle funds on behalf of a customer.
In the scenario of an unhosted wallet and a DeFi (decentralised finance) world, you could argue that the wallet or DeFi platform is not an intermediary. But this poses a huge challenge because someone is required to do the work of implementing money laundering controls. FATF is quite clear that it’s not supposed to be the individual, human customer. The new definition has provided more clarity about whether the unhosted wallet service provider should be considered a VASP. The way I interpret it, in many cases the answer is ‘yes’.
TSC: What about financial transfers occurring between people within the same geographic location, via different financial intermediaries?
AB: The messaging format to pass this information along was originally built in the days of wire transfers between financial intermediaries. Within this context, the rule exempted domestic financial transfers – or funds being sent between entities based in the same country. It was more practical to exempt these. Institutions within a certain locale would be subject to the same money laundering rules anyway, and inclusion of domestic transfers would create an impractical volume of transaction messages.
When it comes to virtual assets, the exemption does not apply, as the FATF effectively considers them all as ‘foreign assets’. In effect, it means that virtual asset services providers have to include the information with financial transfers (above the threshold), even if all parties are based in the same country.
TSC: How will the travel rule impact Bitcoin end-users?
AB: I want the public to be aware of the impact the travel rule will have on how you use your Bitcoin, and what the entities you interact with will need from you. The days of staying completely anonymous are over. Entities that help you to buy, sell or send Bitcoin will require you to provide some sort of identification.
It might be more of a hassle, but it’s not a bad thing. Bitcoin will have to adapt to fit in with global regulations, but it will also normalise it to some extent. In some ways it’s a maturing and coming of age of Bitcoin, and a recognition that Bitcoin is money. If it was just a ‘tech experiment’, regulators wouldn’t have bothered.
TSC: How binding are the FATF recommendations?
AB: FATF is a global money laundering advisory group and not a local legislator. FATF writes recommendations (not laws) which are intended as guidance for legislators around the world. To enforce the recommendations, local regulators like the United States’ Securities and Exchange Commission have to implement a local version of that rule. Once the recommendations are promulgated locally in each jurisdiction, they become legally binding in those locales.
TSC: What happens if a country decides not to implement the recommendations in their domestic laws?
AB: Every five years, the FATF assesses and rates country compliance, and makes recommendations for improvement. If a country is found to have poor money laundering prevention protocols in place, FATF will put them in a ‘high risk’ category and advise other countries to take additional precautions when dealing with entities within that country. Although it doesn’t prevent international trade, it increases the burden of transacting with high-risk countries, encouraging them to improve their financial controls. Once a country has amended their processes, they can apply to FATF to get reassessed.
TSC: How is the TSC progressing in coming up with a solution?
AB: The TSC’s travel rule Standard combines existing mechanisms like BIP 270 and Paymail as a solution.
Paymail is made possible by BIP 270 (an updated version of BIP 70), a protocol for ‘handshaking’ information between two entities. The way it works is that one party (typically a VASP or a merchant) would reach out to another, receive a response, and return it with a set of structured information that allows the parties to discover who they’re talking to, what they want from each other, what they want to pass on to each other, and that it’s accepted.
This is a fairly standard mechanism in any payment transaction, except it’s like a handshake backwards and forwards instead of simply a push transaction. What makes the handshake particularly useful is that it can be used to send the information required by the travel rule, and it also illuminates the identity of the entities that are party to the transaction. When it comes to information sharing, you always have to be wary of bad actors. If you are sharing customer information, you have to ensure you abide by data protection laws like the EU’s GDPR and South Africa’s POPI.
TSC: You’re telling us that Bitcoin SV’s travel rule standard will use existing mechanisms. Would you say it puts the ecosystem at an advantage over chains that have to come up with a messaging protocol from scratch?
AB: I think so. It also speaks to the fact that Bitcoin SV is quite a mature protocol, technically speaking. If you were building a new chain from scratch, you’d have to invent all the solutions and you would make all the mistakes and break it many times. In our case, we have tested standards like BIP 70 to rely on when building new mechanisms like Paymail. The other thing that puts us at an advantage is that many of these mechanisms are already widely implemented in the BSV ecosystem. We’re not basing our solution on some theoretical concepts, but on technology that’s actually in use and that developers are familiar with.
There are lots of organisations and commercial firms trying to solve the travel rule problem for VASPs, including Bitcoin Suisse, CipherTrace and KYC-Chain. Some of the solutions are good – you can tell they’ve given a lot of thought to the problem. Some use crypto to solve the problem, like an Ethereum second layer. But none of those solutions have been battle-tested like BSV’s Paymail.
TSC: How can people participate in the process of creating a travel rule Standard for Bitcoin SV?
AB: There’s a working group that will remain open until the standard is finalised, and we’d be happy for anyone to join. You don’t have to be a Bitcoiner, a techie, or in compliance. The travel rule working group is made-up of a mix of people, with around a half specialising in compliance, and the other half more focused on technical aspects. We’re also working to get the standard to the public review step of the process as fast as we can.
If you’d like to comment during the public stage, make sure you register as a contributor and sign up for the newsletter to receive updates.
You can review our processes and how to get involved before emailing [email protected] for details on how to apply if you’d like to join the working group.
TSC: Which entities and individuals should participate in the TSC’s travel rule standardisation?
AB: Mainly it’s the compliance people who need to take note so they can ensure they don’t fall foul of the travel rule. We’d like them to evaluate our proposed solution from a business and technical point of view and let us know if they spot any issues or gaps.
