New FATF Rules: KYC Technology is Critical for Compliance

In this month’s update, we’ll be taking a look at a major topic we covered in our Knowledge Base: the FATF’s updated draft guidance – and who and what may be affected by it.

The FATF has released updated draft guidance that expands the definition of VASPs and VAs, extending the regulatory net to previously opaque areas of the crypto space. 

Following our update last month regarding the new draft guidance, let’s take a deeper analysis of what the key changes mean for the industry:

First, a quick recap. In March, the FATF released updated draft guidance for Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs). Key changes it is proposing include:

  • DEXs and crypto escrow services will be considered VASPs
  • Stablecoins will be treated as VAs subject to FATF Standards 
  • NFTs that can be used for money laundering (ML) and terrorism financing (TF) will be considered VAs
  • VASPs are responsible for evaluating and taking steps to mitigate proliferation financing (PF) risks
  • New methods and approaches for reducing P2P transaction risks
  • VASPs should follow key best practices in order to conduct counterparty due diligence

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Most of the new draft guidelines are expansions to include parts of the industry that have until this point held a vague position when it comes to regulation, such as stablecoins, NFTs, DEXs and escrow services. 

However, the FATF have also made it clear that in order to conduct counterparty due diligence, they recommend a three-phase approach:

  1. Phase 1: Determine whether the VA transfer is with a counterparty VASP or to an unhosted wallet or other service.
  2. Phase 2: Identify the counterparty VASP.
  3. Phase 3: Assess if the counterparty VASP is an eligible counterparty to send customer data to – and to have a business relationship with.

On analysis, this is likely the most challenging guideline to comply with when it comes to the technology that is currently available. Crypto wallets do not provide the identity of an owner. Transactions can be followed, but blockchains are designed in a way that does not include an identity layer like SWIFT does in the fiat system.

In order to verify a counterparty, a large database of known wallet owners must be continuously built up. The downside to this is that new addresses that are not on the database will take longer to verify, leading to delays in the transactions. 

So, the solution provider with the largest database will also offer the greatest value. Attaining this will not only imply running wallet analytics, but also a need to conduct traditional KYC on counterparties.

It may therefore be more efficient to explore an integrated, one-stop solution such as KYC-Chain’s Travel Hub, which can provide all these services in one workflow. We’ll be happy to provide more details on how that can operate upon request.