Crypto Exchanges to Face Their Biggest Regulatory Hurdle Yet

The Financial Action Task Force is about to publish a note to clarify how participating nations should oversee virtual assets, FATF spokeswoman Alexandra Wijmenga-Daniel has said in an email. The new rules will apply to businesses working with tokens and cryptocurrencies, namely exchanges, custodians and crypto hedge funds.

The overseeing body is yet to reveal how long governing traditional bank wire transfers will be interpreted and applied by country-specific regulators.  However, these are currently viewed as “one of the biggest threats to crypto today,” Eric Turner, director of research at crypto researcher Messari Inc., said in an email. “Their recommendation could have a much larger impact than the SEC or any other regulator has had to date.”

According to Bloomberg, the new guidelines will require exchanges like Coinbase Inc. and Kraken as well as asset managers like Fidelity Investments to collect customer information for transactions of over $1,000 or 1,000 euros. These will include details about the recipients of the funds, and the data will then be sent to the recipient’s service provider along with each transaction.

This proposed regulation will have serious implications both for users as well as service providers. Users sending and/or receiving cryptocurrencies in countries that have issued a ban on the digital assets and are using VPNs to access crypto exchanges will no longer be able to circumvent government restrictions. For exchanges and other service providers, compliance with the new guidelines will be costly and difficult to reinforce, particularly for large players like Bittrex, which has about $58 million in daily-trading volume.

It can’t be overlooked that such proposed measures go against the anonymous and borderless nature of the blockchain and cryptocurrencies. Most crypto exchanges use wallet addresses on digital ledgers that are largely anonymous, so an exchange currently has no way of knowing who the recipient of the funds is.

“It’s either going to require a complete and fundamental restructuring of blockchain technology, or it’s going to require a global parallel system to be sort of constructed among the 200 or so exchanges in the world,” Roth said.

There are serious implications in trying to implement a measure like that.

As a result, several US-based exchanges are discussing how to set up such a system, said Mary Beth Buchanan, general counsel at San Francisco-based Kraken, which does about $195 million in daily volume.

“Without enhanced technology systems, this is a case of trying to apply 20th-century rules to 21st-century technology,” Buchanan said. “There’s not a technological solution that would allow us to fully comply. We are working with international exchanges to try to come up with a solution.”

The end result could be increased compliance costs for many cryptocurrency exchanges, Buchanan said. Some non-compliant businesses could shut down, said Phil Liu, chief legal officer at Los Angeles-based hedge fund Arca.

“People in crypto like to make a big deal about giving personally identifiable information to the government, but I don’t see a whole lot of disruption for legitimate players if the proposal is enacted,” Liu said in an email.

U.S. exchanges may also lose customers. Many users, especially those trading from countries where there is a ban on crypto trading, will likely opt for other service providers rather than going through an exchange or another virtual-asset service provider (VASP), to safeguard their privacy.

“I get why the FATF wants to do this,” Jeff Horowitz, chief compliance officer at San Francisco-based Coinbase, the largest U.S. crypto exchange.

Applying bank regulations to this industry can result in more people preferring person-to-person (P2P) transactions, which would result in less transparency for law enforcement. There are many consequences stemming from the FATF’s proposed guidelines that need to be taken into account.

How soon these changes will start affecting the sector will depend on the individual agencies. Groups like the Financial Industry Regulatory Authority (FINRA) are expected to start to vigorously enforce the rules. Financial Crimes Enforcement Network (FinCEN) recently issued interpretive guidance that looks similar to those being considered by FATF. Some state agencies could follow suit, raising the risk that non-compliant businesses will lose money-transmitter licenses.

“Countries that fail to comply with FATF rules will be blacklisted, which will have an impact on their access to the global financial system,” said Jesse Spiro, head of policy at crypto investigative firm Chainalysis Inc.

The proposed regulations could also impact many of the more than 500 crypto funds that have popped up in the past few years, according to Josh Gnaizda, chief executive officer of CryptoFundResearch.

“Trading delays or additional transactional costs as a result of compliance with FATF could significantly chip away at returns.”

The regulator is expected to hold multiple meetings with the crypto industry to discuss the steps necessary in implementing the proposed changes. Some participants point out the benefits of greater oversight that can lead to more institutional acceptance of crypto.

“Will it be a potential hardship? Certainly, at least initially,” Chainalysis’s Spiro said.

Many investors have long argued that greater regulatory control and standardization is what’s necessary in the nascent crypto sector, so it can reach its full potential. Evidently, this will not happen without a certain level of turbulence for this industry and everyone involved.