Updated FATF Guidance on DeFi. The FATF has issued updated guidance on DeFi. However, some aspects of the guidance are still unclear, including whether VASP standards apply to DeFi. In light of this, the FATF has postponed the finalization of the guidance until October. In the interim, however, the FATF clarified the draft guidance, making the requirements clearer and reinforcing its intent to use the terms broadly.
NFTs do not constitute VAs
According to FATF guidance on DeFi, NFTs are not VAs. The definition of VAs is context-based. In other words, NFTs are not a VA if they do not provide payment or investment services. However, issuing a VA could involve providing exchange or transfer services. In such a scenario, a financial institution could be operating under the definition of a VASP.
DeFi operators may be determined by their influence over assets or aspects of the service protocol. In some jurisdictions, the entities involved in “DApps” can be regarded as virtual asset service providers, and they must comply with the same anti-money laundering requirements as those in traditional finance. But the terminology in the FATF guidance isn’t necessarily the same as in traditional finance, and there are several differences.
According to FATF guidance on DeFi, NFTs do not qualify as virtual assets (VAs). However, if a collector is using a NFT for investment or payment, it might be a VA. This is because NFTs are generally tradable, and have a secondary market. Moreover, most NFTs are collectible, and collectors hope they will appreciate in value and eventually be sold.
The definition of a virtual asset is a broad one. However, the FATF definition does not define “investment purposes.” It is likely to include buyers who intend to sell their NFTs to others for profit. However, many buyers buy NFTs because they like the artist or are interested in the potential value appreciation. Although the definition of a virtual asset is vague, the new guidance could still be used as a basis for stricter regulation in countries that are not FATF members.
However, FATF guidance on DeFi also addresses issues regarding the definition of VASPs. Although decentralized applications are not VAs, the entities that use them are still VASPs. In addition, they must conduct or facilitate certain activities in order to be a VASP. The revised guidance also raises the question of which national authority would make this requirement.
As a result, FATF’s guidance emphasizes parts of the crypto industry with the highest regulatory uncertainty, while providing guidance on the definition of virtual assets. Although the new guidance is less aggressive than the U.S. guidance, it still leaves room for member states to regulate these assets for investment purposes.
NFT categorization should be assessed on a case-by-case basis
NFTs are emerging technologies that are based on blockchains and smart contracts. They are not currently covered by existing financial regulatory frameworks and definitions and have generated concerns over their environmental and social impacts. Congress may also consider privacy and content moderation issues when assessing specific NFT applications. However, it is important to note that NFTs are only one piece of the decentralized ecosystem and market puzzle.
Companies operating outside the United States typically have less stringent regulatory requirements and business models. These companies are not required to comply with as stringent regulations as their American counterparts, so they are often unregulated or operate in low-compliance jurisdictions. These companies also may be offering products in highly regulated jurisdictions.
Financial transactions are impacted by a number of legacy constraints, including geographic limitations, multiple administrative layers, and the need to deal with a large number of intermediaries. These legacy constraints add friction and inefficiencies to the value chain, and increase costs for end users.
In addition to financial and legal concerns, third-party providers may be subject to cybersecurity incidents, denial-of-service attacks, and privacy breaches. Moreover, they may be prone to human error, power failure, and natural disasters. These factors can jeopardize a company’s financial and operational results.
Regulation of CBDCs
The regulation of CBDCs is one of the most important aspects of the global payments system. The IMF recently published a report on the issues surrounding cross-border payments. Among the issues that this report addresses are the role of central banks in regulating such systems. While this report does not provide recommendations on how to regulate CBDCs, it does provide some guidelines to be aware of.
One of the main challenges for regulating CBDCs is the complexity of their design. Currently, the regulatory framework makes charging fees difficult. Moreover, charging fees to intermediaries would contradict the central bank’s principle of providing payments as a public good. As a result, central banks would likely rely on seignorage to generate revenues. In the meantime, it appears that the regulation of CBDCs should be flexible.
The central banks of several countries have expressed concern about the legality of CBDCs. Many of them have sought the help of external counsel in developing a legal-regulatory framework. However, it is imperative to consider internal capacity building and needs assessment before bringing in external counsel. Further, it is important to maintain close communication with financial intermediaries.
The Financial Action Task Force is a global organization that sets international standards for money laundering and terrorist financing. The United States co-chairs the working group on virtual assets at FATF. Among other things, it supports countries with the implementation of FATF standards. It also supports the Egmont Group, which brings together countries’ FIUs for the purpose of international AML/CFT efforts.
The FATF considers CBDCs to be virtual representations of fiat currencies and not a form of digital assets. However, FATF Guidance cautions that CBDCs could present different AML/CFT risks than standard fiat currencies. As such, it is necessary for private sector stakeholders and central banks to address these risks before CBDCs are issued.
The Chinese central bank has yet to fully determine its legal authority to issue CBDCs. However, it has successfully piloted digital currency transactions with commercial banks.
Updated FATF Guidance on DeFi
The Updated FATF Guidance on DeFI provides clarity and outlines the requirements of DeFi dApps and NFTs. It also details new requirements for VASPs, as well as information sharing and cooperation between the parties. Specifically, the guidelines address how DeFi dApps may be characterized as virtual assets (VAs), and what they must do to comply with them.
First, a DeFi operator may be considered a VASP if the company has sufficient influence over assets and aspects of the service protocol. The company can prepare for this requirement by implementing a company-wide AML program, including hiring a compliance officer and drafting internal policies. It can also use KYC tools to verify client identity and monitor transactions.
However, the FATF is also aware that a DeFi platform cannot be a VASP, as it is not a custodial platform. Instead, a DeFi platform is a non-custodial service that facilitates transfers of funds between users’ wallets. DeFi protocols accomplish this through underlying smart contracts, which execute transactions between the wallets of users.
The updated FATF guidance is a major step forward for the industry, as it gives regulators a clear framework for regulating crypto assets. The crypto space has grown too big to ignore, and the FATF has been working to create an appropriate framework for all stakeholders. The new guidelines are expected to be finalized by October 2021.
Decentralized autonomous organizations (DAOs) are community-governed organizations with shared governance systems. Members are expected to follow agreed-up rules enforced by smart contracts. However, the decentralized nature of DAOs makes it difficult to identify their owners, putting them at risk for ML/TF transgressions. This puts a great deal of pressure on the FATF, which has made it clear that DeFi-centric sections will be subject to regulatory scrutiny.
The updated FATF Guidance focuses on a comprehensive approach to tackling ML/TF risks. It highlights the importance of understanding and mitigating ML/TF risks associated with P2P transactions. The updated FATF guidance also identifies important factors and measures that countries should take to implement in their jurisdiction.
