Regulation (EU) 2023/1113 of the European Parliament and of the Council of 31 May 2023 on information accompanying transfers of funds and certain crypto-assets and amending Directive (EU) 2015/849, so called Transfer of Funds Regulation (TFR) and also known as one of the two new pillars of the EU crypto-assets regulatory framework (the other one is Markets in Crypto Assets – MiCA) is stating that “the possible anonymity offered by their transfer make virtual assets particularly susceptible to criminal misuse”.
TFR Regulation will be presented in detail in another article. Let’s embark on a regulatory journey before that, to see, how it all started.
Do most cryptocurrencies really deserve their reputation for secrecy and anonymity?
When Bitcoin, the pioneer of cryptocurrencies, was created by the pseudonymous Satoshi Nakamoto in 2009, it was designed to be a decentralized digital currency that operated outside the control of traditional financial institutions and governments. This decentralized nature gave users a certain level of anonymity as transactions were recorded on a public ledger, the blockchain, but did not necessarily require personal information to be linked to wallet addresses.
That actually means that cryptocurrency transactions are not anonymous, but pseudonymous, meaning you’re using a fake name (your wallet address). Instead of everybody going by the name “Vida Petek” or something along those lines, your name is replaced with the numbers and digits of your wallet address.
Pseudonymity was a key selling point of cryptocurrencies, attracting privacy-conscious individuals and those looking to escape the traditional financial system’s prying eyes. However, over the years, this pseudonymity has come under scrutiny from regulators due to concerns about its potential misuse in illegal activities, such as money laundering, tax evasion, and the funding of terrorism. As TFR is stating, “in addition to the pseudo-anonymity of cryptocurrencies, those features of transfers of cryptocurrencies offer criminals the opportunity to carry out at high speed large illicit transfers while circumventing traceability obligations and avoiding detection”.
As cryptocurrency adoption grew, governments worldwide began to take a closer look at the sector and enact regulations to address potential risks. One of the primary regulatory responses that impact anonymity in cryptocurrency include the so called Travel Rule. The Travel Rule requires financial institutions to share certain basic information about their customers when sending funds over a certain amount to another financial institution.
How the development of the international and cross-jurisdictional dimension of the regulatory and supervisory framework for transfers of virtual assets started?
Regulation (EU) 2015/847 of the European Parliament and of the Council of 20 May 2015 on information accompanying transfers of funds and repealing Regulation (EC) No 1781/2006 was adopted to ensure that the Financial Action Task Force (FATF) requirements on wire transfer service providers, and in particular the obligation on payment service providers to accompany transfers of funds with information on the payer and the payee, were applied uniformly throughout the Union. The latest changes introduced in June 2019 in the FATF standards on new technologies, with the aim of regulating virtual assets and virtual asset service providers, have provided new and similar obligations for virtual asset service providers, with the purpose of facilitating the traceability of transfers of virtual assets. Further to those changes, virtual asset service providers are to accompany transfers of virtual assets with information on the originators and beneficiaries of those transfers. Virtual asset service providers are also required to obtain, hold and share that information with their counterpart on the other end of the virtual assets transfer and make it available on request to competent authorities.
Directive (EU) 2015/849 of the European Parliament and of the Council, introduced a definition of virtual currencies and recognized providers engaged in exchange services between virtual currencies and fiat currencies, as well as custodial wallet providers, among the entities subject to anti-money laundering and counter-terrorist financing requirements under Union law.
The definition of crypto-assets in Regulation (EU) 2023/1114 of the European Parliament and of the Council (so called MiCA) corresponds to the definition of virtual assets set out in the revised FATF Recommendations, and the list of crypto-asset services and crypto-asset service providers covered in that Regulation also encompasses the virtual asset service providers identified as such by FATF and considered likely to raise money laundering and terrorist financing concerns.
In order to ensure coherency of Union law in that area, TFR was adopted to use the same definitions of crypto-assets, crypto-asset services and crypto-asset service providers as those used in MiCA.
What does that mean for the Crypto Community
The increasing regulatory oversight has significant implications for users and the broader crypto community. Although TFR Regulation is stating, that “is not intended to impose unnecessary burdens or costs on payment service providers, crypto asset service providers or persons who use their services”, Infra-Investments have already experienced:
- Loss of interested customers as some users who valued the privacy don’t want to adapt to the new regulatory landscape. Personal information are required for transactions and trading, reducing the level of pseudonymity.
- Increased Compliance Costs as cryptocurrency businesses are burdened with compliance costs associated with implementing KYC and AML procedures.
- Compliance Challenges as regulatory requirements are not well defined and represent a challenge for governments as well.
The cryptocurrency landscape is undergoing a transformation, with pseudonymity taking a backseat to regulatory compliance. While this shift may help mitigate the risks associated with cryptocurrencies, it also raises questions about individual privacy and the original principles of decentralization that drove the crypto movement.
As governments and regulators continue to grapple with the challenges posed by cryptocurrencies, it is essential to strike a balance between security and privacy. The evolving relationship between pseudonymity and cryptocurrency will likely shape the future of this innovative financial ecosystem, and stakeholders must adapt to these changes to ensure the long-term viability of cryptocurrencies.