On July 7, the Financial Action Task Force on Anti-Money Laundering (hereinafter referred to as FATF) published on its official website the stable currency report submitted to the finance ministers and central bank managers of G20 member countries. The newly revised criteria are spelled out in the Stablecoin Report.
As an important bridge between cryptocurrency and fiat currency, FATF clarifies some regulatory rules for stablecoins, which will undoubtedly have an important impact on currency circle users.
Users in the currency circle will be subject to a layer of restrictions on the use of stablecoins. The FATF report pointed out that users need to undergo due diligence to convert stablecoins into legal currency or virtual assets through exchanges or wallet providers. This is undoubtedly a blockbuster for Chinas huge stablecoin holders.
Why does the FATFs stablecoin report need to be given enough attention? Founded in 1989, FATF specializes in the study of the hazards of money laundering, prevention of money laundering and coordination of international actions against money laundering. Its forty recommendations on anti-money laundering and nine special recommendations on anti-terrorist financing are the most authoritative documents on anti-money laundering and anti-terrorist financing in the world. .
The main reason why cryptocurrencies, including stablecoins, have received regulatory attention is their potential money laundering and terrorist financing risks. Therefore, this report can explain the direction of stablecoin regulation from some angles, and it is also related to the trading behavior of users in the currency circle.
This article excerpts Chapters 2 and 3 of the report. Chapter 2 mainly introduces the risks of money laundering and terrorist financing brought about by stablecoins. Chapter 3 mainly introduces the application of FATF’s new standards for stablecoins. The second chapter introduces that the risks brought by stablecoins come from the anonymity of stablecoin transactions, the loopholes in the layered mechanism, and the potential for mass adoption. Chapter 3 introduces the anti-money laundering/anti-terrorist financing obligations endowed by FATF, the new standards for developers and management entities of centralized stablecoins, the issuance, redemption and value and transfer functions of stablecoins, and decentralized stablecoins currency uncertainty.
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Chapter 2 Money Laundering/Terrorist Financing Risks of Stablecoins
FATF first assessed the potential money laundering/terrorism financing risks posed by virtual assets in 2014, and since then has been monitoring changes in risks in this industry through regular surveys of FATF global network members. For the purpose of this report, FATF also specifically examined the current and potential money laundering/terrorist financing risks and vulnerabilities of stablecoins. It is important that money laundering/transfer financing risks are analyzed in an ongoing and proactive manner and mitigated prior to the launch of stablecoins, especially those that have the potential for mass adoption and can be used for peer-to-peer transactions. Once these stablecoins are launched, reducing risk will be more difficult.
Like the broader money laundering/terrorism financing risks posed by virtual assets, FATF believes that anonymity, global coverage and layering are the main weaknesses of stablecoins in money laundering/terrorist financing. The extent to which these risks materialize will depend on the characteristics of the stablecoin architecture, the extent to which jurisdictions have implemented AML/CFT mitigation measures, and most critically, the extent to which stablecoins achieve mass adoption. As mentioned above, certain stablecoin proposals appear to be more likely to be adopted than existing virtual assets.
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anonymity
Anonymity is brought about by virtual assets, the most important potential risk of money laundering/terrorist financing. Many virtual assets have public, permissionless, distributed ledgers. While the transaction ledger may be available to the public, the ledger may not contain any customer identifying information. There may also not be any central administrator monitoring transactions. Other virtual assets are private and/or permissioned, with only a limited set of entities able to initiate transactions or view and verify the ledger. Some virtual assets, known as privacy coins or anonymity-enhancing coins, have additional encryption software that can further obscure transactions. There are also tools available to further increase the anonymity of transactions.
The revised standard works by imposing AML/CFT obligations on entities (such as VASPs or financial institutions) that engage in certain financial activities involving virtual assets. For example, when a customer uses a VASP to conduct a transaction, the VASP must identify the customer and maintain a record of the transaction. However, there is no clear applicability of the revised FATF standard for peer-to-peer transactions that do not use regulated intermediaries such as VASPs. For example, private transactions between users with uncustodial wallets, neither of which is a business. The use of VASPs is not mandatory under the revised standard, so peer-to-peer transactions may be used to avoid AML/CFT controls without the use of VASPs or other AML/CFT intermediaries .
Similar to other forms of payment, such as cash, there is a risk tolerance for some degree of anonymous payments to virtual assets in the revised FATF standard. The ML/CFT risk of particular stablecoins and virtual assets will depend on the extent to which anonymous peer-to-peer transactions without intermediaries are widespread, and whether other AML/CFT controls (such as transaction monitoring) are in place.
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reach the world
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layered
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Potential for Mass Adoption
The degree to which these risks materialize will depend on the characteristics of specific stablecoins, on the extent to which jurisdictions effectively implement AML/CFT risk mitigation measures, and critically, the extent to which stablecoins are adopted at scale. Criminals ability to use a virtual asset as a means of exchange depends on it being freely exchangeable and liquid. In turn, it is difficult to use an asset whose value is highly volatile and not widely accepted and trusted as a medium of exchange. This is consistent with FATF’s observation that criminals tend to use more widely adopted or popular virtual assets in their illicit activities.
To date, the FATF has observed that most money laundering/terrorist financing involves virtual assets that appear to be relatively small in value compared to cases using more traditional financial assets, services and products. Additionally, a small percentage of virtual asset transactions may be used directly to commit crime or money laundering/terrorist financing. While FATF has noticed that some stablecoins have been misused for money laundering/terrorist financing purposes, FATF has not noticed that these stablecoins are being misused to a far greater extent than those of virtual assets that do not have a stabilizing function.
The widespread adoption of existing virtual assets as a means of payment by businesses and consumers has been hampered by several factors including price volatility, complexity of use, concerns about trust and security, and lack of universal acceptance of virtual assets as a means of payment. While the situation is still evolving, certain proposed stablecoins have the potential to overcome several of these limitations. Stablecoins are designed to overcome the price volatility issues typically associated with many virtual assets. Some proposed stablecoins will build on existing communication and information systems that promise simpler, easier usage of stablecoins (e.g., by integrating into messaging or social media applications with simple user interfaces, and has a global user base of hundreds of millions). Doing the same integration with existing suppliers can also benefit from a higher level of trust and security.
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The scope of the revised FATF standard
In June 2019, FATF revised its standards to explicitly apply AML/CFT requirements to virtual assets and their service providers. This is the worlds first anti-money laundering/anti-terrorist financing regulatory standard for virtual assets and their service providers. FATF has also published new guidance on a risk-based approach to virtual assets and value-added services.
The revised FATF standard defines virtual assets and virtual asset service providers (VASPs), and applies the full set of anti-money laundering requirements to virtual assets and virtual asset service providers in accordance with R.15/INR.15 / Counter-terrorist financing requirements. Jurisdictions must assess the money laundering/terrorism financing risks posed by virtual assets, permit and regulate virtual assets and VASP activities, or prohibit virtual assets and VASP activities. If jurisdictions regulate VASPs in accordance with the revised standard requirements, and VASPs should implement the same precautions as other financial institutions and AML/CFT obligated entities, they are subject to the Customer Due Diligence and Wire Transfer Rules ( Travel Rule). Jurisdictions must also have oversight systems in place to enable them to license or register VASPs and to respond to requests for international cooperation regarding VASPs. If a jurisdiction decides to ban VAT, they must take action against violations of the ban.
Assigning AML/CFT obligations to intermediaries, such as financial institutions or VASPs, is a key means by which the new standard mitigates ML/TF risks. The revised standard requires relevant intermediaries to assess and mitigate their money laundering/terrorism financing risks, including by authenticating clients and monitoring transactions. In doing so, they can detect and thwart attempts to misuse the service for money laundering/terrorist financing purposes and ensure that sufficient information is available for law enforcement to trace illicit transactions.
Following the adoption of the standards in June 2019, the FATF has been working to ensure that all jurisdictions implement the revised standards quickly and effectively, and to monitor the money laundering/terrorism financing risks posed by virtual assets. Accordingly, FATF undertook a comprehensive 12-month review of the revised standard.
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Application of FATF Standard (Revised Edition) to Stablecoins
Depending on how they are built, each stablecoin will involve a different ecosystem of entities.
However, each stablecoin typically has three main functions:
a) Issuance, redemption and stabilization of currency value;
b) transfer of currency between users;
c) Interaction with the user (i.e. user interface).
Based on these three functions, it is the management of stable currency, which establishes the rules of stable currency management. The regulatory body can perform the basic functions of the stablecoin (such as managing the stability function), or it can be delegated to other entities. They could also manage the integration of stablecoins and telecom platforms, or facilitate compliance with common rules in stablecoin protocols.
To understand how the revised FATF standards apply to stablecoins, and whether the revised FATF standards are sufficient to mitigate money laundering/terrorist financing risks, FATF assessed the five largest stablecoins (Tether, USDC, Paxos, TrueCoin, Dai) and Two proposed stablecoins (Libra, Gram). As discussed below, this analysis reflects the FATFs current understanding of these stablecoins. This report recommends that the FATF publish guidance on stablecoins that would address in more detail the practical application of FATFs revised standards.
Depending on the form of the stablecoin, financial institutions or VASPs may have AML/CFT responsibilities among a range of businesses operating stablecoins. A key determining factor is whether a stablecoin is centralized or decentralized, and whether there are businesses carrying out activities under the FATF-revised standard.
In centralized stablecoin projects, a single entity manages stablecoin operations and may operate the stabilization and transfer mechanisms, acting as the user interface (e.g., providing custodial wallet, exchange and transfer services). In a decentralized stablecoin project, there may be no central entity that manages the system, and the stabilization, transfer functions, and user interface can be distributed across a range of different entities, or done through software. This is a continuum, and stablecoins could be anywhere along the continuum. In some cases, there may be both centralized and decentralized elements - for example, a governing body and a third party responsible for a specific function (such as a foreign exchange or wallet provider). For example, stablecoin stability can be centrally operated, but the user interface can be distributed among other VASPs. It should be noted, however, that there may be limits to how fully decentralized a stablecoin can be before launch due to the need for someone to drive the development and launch of the project.
Obviously, the revised FATF standards apply to stablecoins. FATF has revised the standards to explicitly apply to virtual assets and their services, ensuring that there is no difference in the applicability of FATF standards. According to the revised standard, according to the different structures of stablecoins, stablecoins will be classified into two categories: traditional financial assets (such as securities) or virtual assets (as a digital representation of value that can be digitally traded or transferred, and can be used for payment or investment purposes). cover. The categories that apply will depend on how each jurisdiction incorporates the revised FATF standards into domestic law, as well as on the individual characteristics of stablecoins. However, there should not be a situation where stablecoins fall outside the scope of the revised FATF standards. The definition of virtual assets was drafted to be broad and technology-neutral, with the aim of making all relevant assets comply with FATFs revised standards. The stablecoins analyzed are covered by the revised FATF standard.
According to the revised FATF standard, any entity in the stablecoin system, once it meets the definition of a financial institution or VASP, has the obligation of anti-money laundering/anti-terrorist financing. As stated in INR.15, VASPs and financial institutions have broadly the same AML/CFT obligations, with specific qualifications in terms of customer due diligence and wire transfer requirements (i.e. the travel rule).
Based on FATFs assessment of different stablecoins, FATF concluded that the newly revised FATF standards apply to all entities involved in the construction of stablecoins, which can mitigate the risks of money laundering and terrorist financing. Where such entities exist and can be adequately identified, central regulators will generally be AML/CFT obligated entities. Other entities, such as exchanges, money transfer services, and providers of custodial wallets also have AML/CFT obligations. Which entities will have AML/CFT obligations will depend on the stage of development and the structure of the stablecoin, especially whether the stablecoin is centralized or decentralized, and what specific responsibilities the entities undertake.
While on the face of it, decentralized stablecoins may pose greater money laundering/terrorist financing risks due to their decentralized operation, these risks are limited because decentralized stablecoins are difficult to adopt at scale . (see below) Centralized stablecoin architectures may have the potential for mass adoption, especially if centralized stablecoins try to integrate with telecom platforms, but they may have clearer entities subject to AML/CFT regulation . Furthermore, as mentioned earlier, even decentralized products require centralized control before they can be released.
Centralized stable currency
Centralized stable currency
Centralized developers and management entities
Developers and administrators of centralized stablecoins are in a unique position to mitigate money laundering and terrorist financing risks. Because they determine how the functions of the stablecoin (such as the stability mechanism, stablecoin transactions and user interface) will work. They make key design and functional decisions, and determine the degree of centralization or decentralization of functions, and whether to incorporate anti-money laundering/counter-terrorist financing precautions into the stablecoin mechanism. They can also control access points (for example, who can participate in a transaction or money transfer service, or whether that user can only access the system through a VASP), and enforce AML/CFT standards for key entities in the architecture, including exchanges and Custodial wallet providers) set expectations or operational requirements, and they are also best placed to take on centralized AML/CFT responsibilities, such as monitoring stablecoin transactions. Other businesses also have AML/CFT obligations under the stablecoin framework.
FATF does not attempt to regulate virtual assets or VASP activities, or technology of software developers, but if the developers or managers of stablecoins are participating in the activities of financial institutions or VASPs, they will become the subject of anti-money laundering/anti-terrorist financing obligations. Since the type of functionality is important for the launch and operation of a stablecoin, there will usually be a central manager or governance body, especially for stablecoins that have the potential for mass adoption. Because an agency is often required to manage integration with a telecom platform or facilitate its mass adoption, especially prior to launch, since the process of creating and developing assets for launch is unlikely to be automated. For such stablecoins, the FATF considers these developers and regulators to be generally a financial institution (for example, as a business involved in issuing and managing means of payment) or a VASP (for example, a business that participates in and provides financial Services relate to the offering and/or sale of virtual assets by the issuer). This is especially the case if the governing body performs other functions, such as managing stabilization functions. The exact designation will depend on the specific functions of the agency and the domestic laws of each jurisdiction.
According to the revised FATF standard, as a financial institution or the central management agency of VASP, it can be responsible for implementing anti-money laundering/anti-terrorist financing control measures and taking measures to reduce the risk of money laundering/terrorist financing (for example, reducing risk in stablecoin design ). This could include, for example, limiting the scope of customers’ ability to transact anonymously with stablecoins (and/or) by ensuring that intermediaries with AML/CFT obligations fulfill their obligations, such as using software to monitor transactions and detect suspicious activity.
However, like many virtual assets, some stablecoins do not have a clear central manager or governing body. On the face of it, decentralized stablecoins carry a higher risk of money laundering/terrorist financing, but the lack of a central authority may be the biggest natural barrier to mass adoption. Because there is no central organization to manage and enhance the integration with the telecommunications platform, it is also impossible to improve the trust in the system. These stablecoins may also have centralized authorities responsible for anti-money laundering/counter-terrorism financing before they are launched. It will be described in detail later.
If there is a central authority at any stage of stablecoin development, a countrys AML/CFT regulator must ensure that appropriate and adequate measures are in place to mitigate ML/TF risks. Pre-launch activities mean that the entity is a financial institution or VASP and has a sustainable footing. Under the newly revised standards, regulators are empowered to conduct surveillance or surveillance, including revoking, restricting or suspending the license or registration of organizations subject to AML/CFT regulation. However, it has a scope of authority. FATF gives guidance on how jurisdictions should supervise the central management agency of stablecoins.
To sum up, developers and management agencies of centralized stablecoins, especially those behind stablecoins that are likely to be adopted on a large scale, are likely to be financial institutions or VASPs under the newly revised standard. The exact designation will depend on the specific functions of the agency and the domestic laws of each jurisdiction.
Issuance, redemption and stablecoin value and transfer functions
Entities involved in managing the issuance, redemption, stabilization and transfer functions of stablecoins may also be subject to AML/CFT obligations under the newly revised standard. This will depend on the functions or activities they undertake, and also on whether they are part of a central governing body or an independent entity. In some stablecoins these functions may be automated and no entity is involved.
Entities involved in issuance and redemption can be companies that “issue and manage means of payment,” or companies that provide or participate in “financial services related to the contracting with issuers of (and/or) the sale of virtual assets.”
Likewise, companies involved in stabilizing the value of stablecoins may be “custodial and manage cash and liquid securities on behalf of others” or “custodial and/or) manage virtual assets or instruments capable of controlling virtual assets” under the revised standard company of. The level of money laundering/payment transfer risk in the custody function itself varies depending on how stablecoins are structured. For example, stablecoin holders have direct or indirect rights to redeem stablecoins for other assets. Then there may be money laundering and terrorist financing risks for the custodian or another participant, the redeemer.
Depending on the function undertaken, the validator node validating the underlying distributed ledger technology may be a VASP or a financial institution. These entities may be part of a stablecoin governing body, or they may be separate entities. According to different architectures, a limited number of participants can become a validator node, and anyone can also become a validator node.
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Decentralized Stablecoins
Decentralized Stablecoins
As mentioned earlier, stablecoins are more or less decentralized. In a fully decentralized stablecoin, there will be no clear governing body. In the most extreme case, there will be no entity of any kind that can implement AML/CFT precautions: administration, stabilization and customer interface can only be done through software, with no ongoing management and maintenance of the system after its release. If these stable currency projects are adopted in large numbers, they will easily expose higher risks of money laundering and terrorist financing. Because it is difficult to mitigate risk with newly revised standards. In fact, this will be a platform for anonymous peer-to-peer transactions through non-custodial wallets.
However, there are practical and technical limitations that may mean that such radically decentralized initiatives are unlikely to achieve the ease of use, security, or stability necessary for widespread adoption. Its unclear how the stablecoin would not be traded through exchanges and money transfer services, or held in custodial wallets (similar to those virtual assets that currently have no central authority). So there has to be some contracting party to drive development and launch before release. If the entity is a business and performs the functions of a financial institution or VASP as described above, this will create room for regulatory or supervisory action in the pre-startup phase.
Stablecoins with a low degree of decentralization will also appear, but the number will not be many. Such a stablecoin would likely include at least some identifiable entities subject to AML/CFT regulation, and the specific functions performed by the regulated entities would depend on the stablecoin design and structure. The FATF believes that those stablecoins that have a chance of mass adoption may be centralized to some extent by an identifiable central authority.
