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FATF Updates its Guidance to Service Providers to Include DeFi

The Financial Action Task Force (FATF) has updated its guidance governing Virtual Assets and Virtual Asset Service Providers (VASPs) with the inclusion of decentralized finance (DeFi).

DeFi Developers Can Qualify as VASPs

Despite the original standards of the FATF not qualifying DeFi apps as VASPs, the intergovernmental monetary watchdog says that there is no room for any virtual asset or financial asset to escape the regulatory oversight of the organization.

“Creators, owners, and operators or some other persons who maintain control or sufficient influence in the DeFi arrangements, even if those arrangements seem decentralized, may fall under the FATF definition of a VASP where they are providing or actively facilitating VASP services,” the updated guidance reads.

DeFi applications have grown in popularity over the past year, with prominent lending platforms springing up across the board. The new guidance from the FATF seeks to cushion the likelihood of the applications being used as a source for money laundering and terrorist financing, thus requiring them to conduct Know Your Customer (KYC) and Anti-Money Laundering (AML) checks.

In addition to DeFi, the new FATF guidance is also applicable to Non-Fungible Tokens (NFTs).

“Given that the VA space is rapidly evolving, the functional approach is particularly relevant in the context of NFTs and other similar digital assets. Countries should therefore consider the application of the FATF standards to NFTs on a case-by-case basis,” the document reads.

The updated guidance highlighted by the FATF features six key areas where the task force needed to exert its position. Amongst these areas is how “the FATF Standards apply to stablecoins and clarify that a range of entities involved in stablecoin arrangements could qualify as VASPs under the FATF Standards.”

Regulating DeFi: A Goodbye to Freedom?

The growth of DeFi and its associated innovations was centred on the fact that transactions within the growing ecosystem were solely in the control of the users. The guidance from the FATF implies that these transactions will no longer be as invincible as they used to be as non-custodial wallets, amongst other DApps will start requesting KYC details from users.

Despite this being a possibility, some industry stakeholders say they welcome regulations and will help usher the digital currency industry into its highly sought mainstream adoption era.

Estonia Shuts Down Crypto Firms

In recent news, Estonia has strengthened its Anti-Money Laundering laws and almost 400 virtual asset service providers (VASPs) have shut down as a result. The amended laws expanded the defined scope of VASPs and increased licensing fees, capital requirements, and information reporting requirements. Additionally, the laws introduced the Financial Action Task Force Travel Rule. The Estonian Financial Intelligence Unit (FIU) announced that almost 200 domestic crypto service providers voluntarily shut down, and another 189 had their authorizations revoked due to non-compliance.

The FIU’s director, Matis Mäeker, noted that the response from the legislator and the supervision activities have been relevant, given the documents submitted by the service providers that lost their authorizations and their methods of operation and risks involved. The FIU also found several general issues within the companies it shut down, including misleading company information. For instance, some companies had registered board members and company contacts without their knowledge, while others had falsified professional backgrounds on their resumes. Additionally, many companies had copy-pasted identical business plans from each other, which were also found to be lacking any logic or connection with Estonia.

Estonia has made significant efforts to implement strong AML laws, primarily due to the discovery in 2018 that around $235 billion worth of illicit capital had been laundered through the Estonian branch of Denmark megabank Danske Bank. The ongoing war between Russia and Ukraine has also had an impact, as Estonia has pushed to cut off revenues supporting Russia’s war machine and protect international financial systems via strong AML regulation as part of its partnership with the U.S. Estonia is a member of the European Union and will soon have to implement the upcoming Markets in Crypto-Assets (MiCA) laws that are slated to come into effect in early 2025. Under MiCA, crypto firms will be subject to stringent AML and terrorism prevention requirements.

In conclusion, Estonia has taken significant steps to ensure the implementation of robust AML laws. The recent enhancement of AML laws has resulted in the closure of nearly 400 crypto firms in Estonia. The FIU found several issues with the companies it shut down, including misleading company information. As a member of the European Union, Estonia will soon have to implement MiCA laws, which will require crypto firms to comply with stringent AML and terrorism prevention requirements.

Taiwan's Legislature Considers Virtual Asset Management Bill to Protect Consumers

On October 25, Taiwanese legislators tabled the Virtual Asset Management Bill before the single-chamber parliament, the Legislative Yuan. This initiative seeks to bolster consumer protection and furnish better oversight over the burgeoning digital asset sector.

The 30-page document delineates several pragmatic obligations for Virtual Asset Service Providers (VASPs). Noteworthy mandates include the segregation of client funds from the firm’s operational reserves, the inception of an internal audit and control system, and membership in local trade associations pertinent to digital assets. Although the bill is seen as moderate, it forgoes the imposition of a 1:1 reserve requirement for stablecoin issuers and does not delve into the realm of algorithmic stablecoins.

The legislation also outlines penalties for unlicensed VASPs operations, establishing fines ranging from 2 million Taiwanese dollars (approximately $60,000) to 20 million TWD (around $600,000). Existing market participants have been granted a six-month window post-enactment to secure the necessary licensure.

This legislative venture follows the September 2023 guidelines issued by the Financial Supervisory Commission (FSC) of Taiwan, which barred foreign VASPs from operating within Taiwanese jurisdiction without requisite approvals. This move comes amidst the formation of a self-regulatory body by major crypto exchanges within Taiwan on September 26. Prominent local exchanges like MaiCoin, BitstreetX, Hoya Bit, Bitgin, Rybit, Xrex, and Shangbito congregated to establish the Taiwan Virtual Asset Platform and Transaction Business Association, aiming to foster a collaborative environment between the crypto industry and regulatory bodies.

In juxtaposition with the more stringent regulatory frameworks seen in neighboring Hong Kong and Japan, Taiwan’s proposal appears more lenient. Unlike Hong Kong’s rigid stance on derivatives and stablecoins, and Japan’s requirement for the employment of custodians by locally accredited exchanges, the Taiwanese bill merely emphasizes the separation of client and company funds.

Furthermore, the bill mandates periodic reporting by exchange operators, although it doesn’t specifically address Proof of Reserves. It leaves room for the regulatory body to devise asset ratio rules post consultations with industry stakeholders. This nuanced approach reflects a measured stride towards establishing a regulatory framework post the collapse of the FTX exchange in November of the previous year, which had garnered a significant user base in Taiwan due to its favorable interest rates on US dollars compared to local banking offerings.

Preliminary feedback from the crypto sector in Taiwan displays a positive outlook towards the inception of formal regulatory supervision, which is seen as a constructive step towards legitimizing the industry.