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Crypto was higher this morning with alt-coins outperforming BTC. Filecoin (FIL) was up in the range of roughly 40% and is now a Top 10 cryptocurrency by market cap.
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In mid-March, the Financial Action Task Force (FATF) published proposed updates to its crypto regulation guidance from 2019. The updates expand the definition of Virtual Asset Service Providers (VASPs) to include those offering “non-custodial” platforms, often referred to as decentralized venues. The new rules add another layer to complex regulatory uncertainty faced by the DeFi space.
The FATF, an organization founded by the G7 in order to develop policies to combat money laundering and other illicit financial activity, released its initial guidance on crypto regulation in June 2019. That guidance’s most notable recommendation was the “FATF Travel Rule,” which advised VASPs to exchange client data, similarly to the SWIFT system, when crypto is transferred from one entity to another.
The FATF defined VASPs, among other characteristics, as entities that custody crypto on behalf of users, as centralized trading venues do. The updated guidance introduces language which states that a decentralized application (“DApp”), i.e. a DeFi trading venue, “is not a VASP under the FATF standards,” however, “entities involved with the DApp may be VASPs under the FATF definition.”
The FATF further states “owners/operator(s)” of the DApp “likely fall under the definition of a VASP, as they are conducting the exchange or transfer of VAs as a business on behalf of a customer.” Under this view, the owner/operator(s) will likely be seen as VASPs even if “other parties play a role in the service or portions of the process are automated.”
The guidance elaborates on determining owners and operators via questions such as: who profits from the use of the service or asset? Who established and can change the rule? Who can make decisions affecting operations? Who generated and drove the creation and launch of the DApp? Who could shut down the product or service?
While the FATFs releases are meant to serve as guidance, a number of countries have adopted elements of the 2019 guidance. For example, the EU’s 5th Anti-Money Laundering Directive, which came into effect January 2020, introduced elements of the travel rule, through data collection obligations. Similarly, FinCEN’s December 2020 proposed rules also added reporting requirements for crypto transactions exceeding USD 10,000 in value, along with data collection requirements for transactions greater than USD 3,000.
DeFi venues have been represented as solutions for users to gain access to financial services, such as loans or insurance, on a peer-to-peer basis and without intermediaries. However, despite claiming to overcome the vulnerabilities of single points of failures inherent to centralized financial services, DeFi platforms have mostly been associated with formal, centralized businesses that seemingly fall under “owners and operators,” as defined by FATF.
For example, while DeFi exchange UniSwap’s launch of the UNI governance token aimed to transfer greater control of the protocol to its thousands of users, the decision to create the token was a centralized one. The protocol’s team would’ve developed a distribution plan, among other decisions.
Furthermore, one could hypothesize that, should a protocol achieve a level of decentralization such that owners and operators can’t be identified, the FATF’s rules could apply to liquidity providers. Considering that concrete examples exist of regulations that have mirrored the FATF’s 2019 guidance, the expectation of further rules that specifically address DeFi adds more regulatory uncertainty to the space.