What is the Crypto Travel Rule & How Does It Help in Combatting Money Laundering

This article is a knowledge base on how FATF’s Travel Rule for Cryptocurrency can ensure AML compliance and what AML professionals need to know for regulating Virtual Currency worldwide under this regulation.

M Abd'al Bari

Research Associate

Overview

Virtual Currencies like Crypto are now becoming an easy target for money laundering and terrorism financing. Cryptocurrency can easily and swiftly be transferred online. It offers complete anonymity to the crypto asset owners so it is difficult for Anti-Money Laundering professionals and regulators to identify and monitor transactions of cryptocurrency. So, to mitigate the threat, specific regulations for Crypto were introduced. Crypto Travel Rule needs to be ensured for cryptocurrency compliance against Money Laundering.

What is the Travel Rule for Crypto?

Travel Rule is not something new in the financial world. Many countries have implemented it in the traditional finance way before virtual currencies existed. For example, the FinCEN Travel Rule is a renowned compliance rule that was introduced in 1996.

The Travel Rule requires regulated entities to transmit specific information above a certain threshold along with the transaction itself. In this way, the information of the sender & receiver of the payment can be monitored and the risk of Money Laundering is reduced to a minimum.

Similarly, the Crypto Travel Rule introduced by FATF is a recommendation made under the same mechanism to monitor the cryptocurrency for suspicious transactions that can pose Money Laundering and Terrorism funding threats.

Why Cryptocurrency is Vulnerable to Money Laundering?

Cryptocurrency has several loopholes due to which it is misused for illegal transactions. Following are the common risk factors in cryptocurrency due to which money laundering becomes challenging to identify.

Cross-Border Transactions: cryptocurrency being intangible money can easily be used for cross-border transactions. Commonly, crypto transactions are carried out through something other than traditional banks leaving no trace. Therefore, this feature can be exploited and money laundering is carried out discreetly and swiftly where authorities cannot trace the exact source of funds and link it back to the owner of crypto assets.
Initial Coin Offerings (ICOs): whenever a newly issued cryptocurrency is launched, Money Launderers try to raise funds in it through frauds, scams, and other illicit activities. Once, the funds are stolen, they are shown as legitimate investments through ICOs.
Weak KYC/AML procedures: Cryptocurrency exchanges usually ignore KYC (Know Your Customer) and AML (Anti-Money Laundering) measures. That is necessary at every step of the transaction. This can let the Money Launderers use anonymity and exploit their financial system. Money Laundering becomes easy when a cryptocurrency exchange has a weak or no KYC/AML system implemented.
KYC AML Compliance Challenges: Cryptocurrency is a global payment system and is easily accessible anywhere in the world. But with restrictions in many countries, Cryptocurrency is difficult to regulate because different countries have different compliance rules. This complicates the efforts to fight Money Laundering in the Crypto Trading world.
Tracing Crypto Transactions: While cryptocurrency generally offers anonymity, it is difficult for law enforcement & regulatory agencies to identify the true ownership and trace the transaction back to money launderers.
Tumblers and Mixers: The notion of increased and enhanced privacy in cryptocurrency is achieved through mixing multiple transactions in cryptocurrency exchanges. Again, it makes it difficult to identify the sources of funds. Hence, Money Launderers use multiple tricks to penetrate the crypto market and use it to hide illicit money.

Travel Rule in Traditional Financial System (Brief)

‘Travel Rule’ was introduced in the early 90s. Jointly, the Federal Reserve and FinCEN issued a rule in 1995 for banks and other financial institutions to follow a two-point guideline:

Record-Keeping Rule	Travel Rule
Financial Institutions are obligated to collect & retain information on transactions amounting to $ 3000 or more.	Financial Institutions need to transmit information alongside the transaction information to other financial institutions involved in that transaction.

The Objective Behind the ‘Travel Rule’

Money Laundering, fraud, and other financial crimes are easier to carry with a poorly monitored transaction. For years banks, financial institutions, and other money service businesses have been used for hiding illegal money. FinCEN implemented the ‘Travel Rule’ with the Bank Secrecy Act to ensure that the true ownership of transactions can be traced with the underlying information that is shared in the financial network.

Financial Institutions were empowered through the ‘Record-Keeping Rule’ and the ‘Travel Rule’ to record and retain certain information about the transactions to help regulators and law enforcement agencies identify and report Money Laundering.

FinCEN Travel Rule and Crypto Travel Rule

There’s nothing new in the implementation of the Travel Rule in Crypto. FinCEN and FATF both issue the Travel Rule for Crypto Assets to ensure that Anti-Money Laundering (AML) and Counter-Terrorism Financing (CTF) efforts are in place.

Crypto Travel Rule Requirements

FATF recommendations pinpoint the exact issue in regulating Cryptocurrencies. It recommended the risk-based approach in crypto assets. According to this requirement, The Virtual Asset Service Provider (VASP) at the sender’s end is obligated to send the personal information that is identifiable (PII) to the VASP present at the receiving end and vice versa.

A document published by FATF mandates virtual currencies and guides the crypto exchanges and other associated members to stay compliant while being in the crypto business.

Challenges in Crypto Travel Rule Implementation

Crypto Travel Rule implementation can be challenging for many exchanges. The fast nature of crypto transactions and their anonymity can become a complexity for VASPS and regulators as well. Here are a few challenges that are faced during the implementation of the Crypto Travel Rule.

Technical Complexity: The VASPs are required to update their systems and infrastructure to ensure secure crypto transactions alongside the information. It involves technicalities like ensuring compatibility between VASPs, Data Privacy, and Security and Maintaining a standardized data transmission.
Data Privacy Concerns: Data Transmission via online mediums between VASPs can be compromised by hackers, scammers, and spammers. A balance is required between sharing the information and maintaining the privacy of VASPs and their financial activity. While doing so, the implementation of Data protection measures can be a challenge too.
Interoperability: Establishing secure connections in different jurisdictions and maintaining streamlined and secure coordination among VASPs online can be challenging while sharing sensitive transactional information online. Crypto Travel Rule makes it even more complex for information sharing to become an obligation.
Compliance Costs: Since introducing a new rule or regulation requires investments, introducing the Crypto Travel Rule also incurs costs. New market entrants in cryptocurrency and VASPs can feel a financial burden while implementing it.
Global Harmony: Harmonising the compliance rules and regulations from different geo-locations can be challenging as well. Especially, when it comes to cryptocurrency’s widespread network and usability, the situation becomes more complex. Many countries do not even recognize crypto assets as legitimate currencies. Therefore, global harmony is one of the major concerns while implementing the Crypto Travel Rule.

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Wrap Up Words

Virtual currency is volatile and uncertain in every sense. It is an intangible currency with the potential to enable Money Launderers to seamlessly hide their money and commit crimes worldwide. FATF and FinCEN like other regulators need to ensure the implementation of regulations like the Crypto Travel Rule to mitigate the threat of online fraud and crypto money laundering. However, they must consider overcoming the challenges faced during the process through a robust KYC and AML system in place.

Crypto Travel Rule is helping in regulating virtual currencies and its scope is increasing with time. With the rapid evolution of cryptocurrency, the Crypto Travel Rule is an important regulation to fight Money Laundering and Enhance the transparency of the crypto world. However, the regulators need to effectively embrace the KYC and AML changes and keep pace to maintain the integrity of virtual currencies globally.