What Is the Crypto Travel Rule and How Does It Work?

The Travel Rule was initially introduced by the Financial Crimes Enforcement Network (FinCEN) as part of funds transfer rules under the U.S. Bank Secrecy Act on May 28, 1996. Itrequired financial institutions to pass on specific information to the next institution in certain funds transmittals involving more than one institution.

In 2018, the Financial Action Task Force (FATF), an intergovernmental global money-laundering (ML) and terrorist financing (TF) watchdog, incorporated the Travel Rule as part of its FATF recommendations for regulating financial activities involving virtual assets.

On Oct 28, 2021 FATF updated its guidance document, first adopted in 2019 for a risk-based approach, to virtual asset and virtual asset service providers. As such, businesses that conduct crypto-related transactions are now subject to the Travel Rule. 

Such a move was inevitable, due to the increased fraud cases and money-laundering accusations surrounding cryptocurrencies such as Bitcoin and privacy coins such as Monero. 

In this guide, we’ll discuss everything you need to know about the Crypto Travel Rule, how it works, and its implications for the cryptocurrency industry.

Key Statements:

1. The Crypto Travel Rule was established by the Financial Crimes Enforcement Network (FinCEN) to create a fair regulatory environment, reduce money laundering and terrorist financing risks, and safeguard the integrity of the global financial system.

2. The Crypto Travel Rule requires virtual asset service providers (VASPs) to obtain and share accurate originator and beneficiary information before or during a transaction. It’s triggered when a transaction exceeds a certain threshold (usually 1,000 USD/EUR).

What Is the Crypto Travel Rule?

The FATF Crypto Travel Rule requires crypto companies to obtain “the required and accurate originator and beneficiary information” and pass it on to other counterparty VASPs or financial institutions before or during the transaction of virtual assets. It further recommends that countries apply the rule for transfers greater than 1,000 USD/EUR.

For a better grasp of how the Travel Rule works, it's vital to get the right definitions as provided by the FATF in its updated 2021 guidance. 

Virtual Assets

A virtual asset (VA) is a digital representation of value that can be digitally traded, transferred or utilized for payment or investment purposes. 

VAs include:

• Cryptocurrencies (such as Bitcoin, Ethereum and Dogecoin)
• Gaming tokens
• Some stablecoins (depending on their exact nature)
• Non-Fungible Tokens (NFTs), which can be “cashed out” by exchanging for digital or fiat currency. 

This definition does not encompass digital versions of fiat currencies, securities or NFTs primarily intended for collection purposes, or any other financial assets already addressed elsewhere in the FATF recommendations. 

Virtual Asset Service Provider

FATF defines a virtual asset service provider (VASP) as any individual or entity not covered elsewhere under the recommendations and as a business who performs one or more of the following activities for or on behalf of another person:

• Converting between virtual assets and fiat currencies (fiat to crypto exchanges)

• Trading between one or more virtual assets (crypto to crypto exchanges)

• Transferring VAs from one address or account to another

• Safeguarding or managing virtual assets or instruments that allow control over them (crypto custodians)

• Participating in and providing financial services related to an issuer's offer and/or sale of virtual assets

Under this definition, the following would be considered VASPs:

• Virtual asset (VA) exchanges (crypto/crypto or fiat/crypto)

• VA brokerages

• Custodial and transfer services

• Some VA wallet providers (those that host wallets or have custody over other natural or legal VAs, wallets or private keys)

• Bitcoin ATMs

• Stablecoins and ICOs

On the flip side, the following would not be considered VASPs:

• Individual miners

• Consumers

• Peer-to-peer transactions

• Software ancillary service providers

Source: CipherTrace

Personally Identifiable Information (PII)

Personally identifiable information is any data that can be used, either on its own or in conjunction with other data, to distinguish and pinpoint a particular person's identity.

While the implementation structure may vary from one jurisdiction to the other, PII details generally include:

• The sender's and recipient's legal names

• Physical address, national identity number or date of birth of the sender 

• The sender's and recipient's wallet addresses

The objective of providing express definitions of the terms above was to clarify the application of FATF’s standards to VA activities and VASPs.

These objectives aim to create a fair regulatory environment, help jurisdictions reduce ML/TF risks linked to virtual asset activities, and safeguard the integrity of the global financial system.

Crypto Travel Rule Compliance Requirements

As we’ve already discussed, once the set transaction threshold is reached, it activates the Travel Rule, which means the VASP for the sender must share PII with the VASP of the recipient, and vice versa. 

Here are the Travel Rule’s compliance requirements.

For Sender

As a sender, you’ll need to:

• Identify the client

• Collect, retain and share the client's PII, including legal name, account number and address

• Verify the details to confirm the beneficiary is not a sanctioned name

• Monitor transactions and report any suspicious activity

For Receiver

As a receiver, you’ll need to:

• Receive the information from the originator’s VASP, conduct thorough verification of the necessary information and retain a record

• Screen the details to confirm the originator isn’t a sanctioned name

• Monitor transactions and report any suspicious activity

The crypto industry has taken a non-uniform approach in enforcing FATF recommendations. Different countries have interpreted and implemented various Travel Rule thresholds, originator and beneficiary information, and enforcement dates. 

For instance, Singapore began enforcing the crypto Travel Rule on Jan 28, 2020, while South Korea began on March 25, 2022. 

For most countries, the Travel Rule is implemented for a threshold of 1,000 USD/EUR. However, under the BSA Travel Rule, the United States of America implements the same rule for a threshold of 3,000 USD.

This non-uniformity in enforcing the crypto Travel Rule has led to a compliance lag popularly called the“sunrise problem.” The VASPs who have adhered to the rules may find it difficult to transact with VASPs who have yet to enforce the rules, making compliance hard to achieve.

Does the Travel Rule Apply to Private or Unhosted Wallets?

No. For now, the Travel Rule does not apply to the transactions between a VASP and a private or unhosted wallet (also called a self-hosted wallet). A private wallet is not managed by a third-party financial institution or any other regulated entity.

Due to the nature of open, permissionless and decentralized networks such as Bitcoin’s, there’s no way for a blockchain ledger to validate the accuracy of an account holder’s details, or that the account belongs to the claimant. 

Unlike conventional bank account numbers, which contain numerous personal details of the holder, a Bitcoin address or hash does not contain any.

Additionally, bank accounts are created and managed by a centralized authority. In contrast, virtual asset addresses are created in public networks, unlimited and uncontrolled by a centralized authority or intermediary. Revealing the details behind a private wallet would surpass the Travel Rule requirements.

However, there’s a big possibility that this may change in the future. Certain jurisdictions are working on tighter information transparency regulations for certain types of fund transfers.

On Mar 22, 2022, the European Parliament’s Committee on Economic and Monetary Affairs (ECON) and Committee on Civil Liberties, Justice and Home Affairs (LIBE) voted to approve an amendment that requires relevant authorities to be notified if any entity receives an amount above 1,000 EUR from an unhosted wallet. 

On May 18–20, 2022, the G7 Finance Ministers and Central Bank Governors met with the International Monetary Fund (IMF), World Bank Group, Organisation for Economic Co-operation and Development (OECD) and Financial Stability Board (FSB). Their meeting culminated in a joint agreement on the need for faster FATF Travel Rule implementation across the globe and more concerted efforts to create better information transparency policies for the crypto industry.

With the world clamoring for more transparent and accountable financial systems, cooperation between relevant global authorities and the pending amendment, the Travel Rule could rope in the private wallet network sooner than expected.

Advantages of the Crypto Rule

Increased Regulatory Clarity

One of the biggest challenges in the crypto industry is a lack of regulatory clarity. The murky, underregulated environment has led to problems with regulators and the loss of institutional financial partnerships.

With the FATF recommendations for VAs, regulators are required to create a well-thought-out regulatory road map for VASPs. The legal frameworks in some countries like the United States, Switzerland and Singapore are perfect examples that show increased regulatory clarity can attract more risk-averse investors.

Access to Banking Services

Due to the DeFi industry’s low Know Your Customer (KYC) policies, crypto businesses have long been excluded from accessing traditional banking services. Crypto investors often invest copious amounts of time convincing their banks to open an account for them. 

The Travel Rule applies the same rules banks need to follow for VASPs to reduce the business risk associated with crypto. Furthermore, the counterparty VASP due diligence process enhances quality KYC and anti–money laundering (AML) policies that can open up the crypto industry to the mainstream financial ecosystem. 

Improved Global Cryptocurrency Adoption

Compliance provides increased access to local payment systems across the globe. This not only improves cryptocurrency adoption, but also opens up innovations in the DeFi space.

Challenges of the Crypto Travel Rule

The Sunrise Issue

The non-uniformity of the Travel Rule implementation across various jurisdictions brings about the “Sunrise Challenge.” 

Compliant VASPs may find it challenging to conduct business with other VASPs that have yet to establish a compliance framework, leading to the direct loss of business and potentially profitable partnerships.

Data Privacy

The cryptocurrency industry thrives on the very nature of privacy, safety and security of all its transactions. There are concerns that once VASPs share their clients’ personal information, per FATF recommendations, the data may get mined, reused or hacked. 

While there are Travel Rule protocols that utilize encryption and one-way data exchange to minimize security threats, uncertainty remains around the legal pitfalls that the rule brings.

Potentially High Compliance Costs

Implementing the Travel Rule may require VASPs to change various system functionalities that form the core of their businesses. These may include back-end changes and modifications of customer-facing UX screens and APIs.

Also, many VASPs may have to implement the rule from scratch, using available solutions to comply with the new KYC requirements for crypto-to-crypto exchanges, which piles up more business costs.

Closing Thoughts

The FATF Travel Rule looks to inhibit criminals, terrorists and sanctioned individuals from using wire transfers to move money illicitly. While it provides numerous benefits, including combating money laundering for a safer financial system globally, it comes with diverse challenges. 

Moving forward, VASPs will likely utilize multiple technological solutions to decrease the inefficiencies associated with the rule and achieve high-quality compliance standards for better and long-term profitability for the crypto community.

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