New regulations are forcing the blockchain industry to develop a global standard for crypto payments. It may not be ideal, but it will come anyway.

Cryptocurrencies: Proponents call them the future of the monetary system, proponents see them as a tool for money laundering and terrorism financing. But both camps agree at least on one front: blockchain markets need rules.

But what exactly these rules should look like is up for debate. While regulations give digital currencies greater legitimacy and thus contribute to their long-term development, they may also put up roadblocks and hinder – or at least slow down – progress. The challenge is to find a middle way.

Finding this middle way was the goal of the new rules announced by the Financial Action Task Force (FATF) last year. However, according to the blockchain industry, the proposed “Travel Rule” is missing the point. It requires senders and receivers of crypto-transactions to be identified by digital payment service providers and digital exchanges. While the goal of the rule is to cut off money launderers, it also contradicts the basic ideas and objectives of the technology. 

The Travel Rule aims at preventing anonymous transactions  

The FATF, a multinational organisation comprising 200 countries, announced the Travel Rule for crypto in June 2019, giving national governments 12 months to implement the new requirements. Although these rules are not legally binding, those who don’t comply risk being blacklisted, which would have severe consequences for any national economy. 

In the traditional financial system, the Travel Rule is reflected in the SWIFT interbank messaging system. Each bank has a Bank Identifier Code (BIC) that identifies the banks involved in payment transactions. Additionally, the sender and recipient each have an International Bank Account Number (IBAN). Thus, the system assigns each transaction to a specific person and financial institution. 

Crypto transactions, on the other hand, are much harder to track, as wallet addresses are anonymous and many digital exchanges do not even require identification documents when onboarding new users. Since an anonymous system is prone to abuse, the FATF took action.

Old solutions for a new technology 

The FAFT certainly addresses a challenge of the crypto market. However, the Travel Rule as a proposed solution seems to go in the wrong direction, as it does not fit the new technology. 

Cryptocurrencies are superior to Fiat currencies mainly because they allow more efficient, faster and cheaper transactions. An obligation to provide information on crypto to crypto transactions hampers this efficiency. Also, higher compliance costs could lead to central exchanges shutting down which means criminal activity moves to uncontrollable shadow exchanges. 

Overall, the travel rule will do little to improve investor protection or to prevent money laundering. A better way would be to monitor only Fiat gateways, meaning in-and outflows of Fiat money into the crypto market. 

SWIFT for Crypto: a global standard for crypto payments  

Whatever one may think of the Travel Rule, the deadline will run out in June 2020 and the blockchain industry is working on solutions. The InterVASP Group, a consortium of blockchain companies and organisations, is developing a global standard that can be used by payment service providers and digital exchanges to transfer funds. The result will probably resemble a kind of “SWIFT for crypto” system.

The bright side of this development is that such a system will finally dispel the accusation that cryptocurrencies were a tool for money launderers. After all, the vast majority of crypto investors want the same: An asset with an attractive risk-return profile that is uncorrelated to other asset classes and thus fits into their portfolio. Anonymity and FATF regulations are of no interest to most investors.