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FATF and the Evolving Crypto Regulatory Landscape

Many have recently tried to apportion a cause to the recent sell-off in the markets, with indications of a tighter regulatory environment (especially in the US) being widely mentioned. Back in March, the Financial Action Task Force (FATF) published their updated draft guidance for how…


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Many have recently tried to apportion a cause to the recent sell-off in the markets, with indications of a tighter regulatory environment (especially in the US) being widely mentioned. Back in March, the Financial Action Task Force (FATF) published their updated draft guidance for how regulators, globally, should be regulating Virtual Asset Service Providers with specific attention focussed on DeFi and NFT’s. In advance of their upcoming plenary to debate their objectives, Mriganka Pattnaik, CEO, Merkle Science, a crypto regtech company, joined Paul Gordon to share his views on the current state, and likely future impact, of crypto regulations.

What is Merkle Science?

(01:43) Merkle Science provides blockchain risk monitoring tools for financial institutions, law enforcement and government agencies, as well as cryptocurrency companies.

The company has a set of tools that its clients combine to achieve specific aims. One of such is a compliance tool that enables a client to monitor incoming and outgoing cryptocurrency funds and get a risk alert on them. Other tools include a forensics tool that helps you track stolen cryptocurrencies, used by law enforcement. Another notable tool used by the industry is “Know your blockchain business” which gives a risk score to a VAST or a crypto company based on their incoming and outgoing crypto transactions.

Why Compliance Is Important

(03:01) The explosion in DeFi over the past year has caused regulators to sit up again and take note, potentially to rewrite the rule book. The new Biden administration in the US has brought with it a general tightening of regulations the space, with the US Treasury for example putting forward a proposal requiring the reporting of any transactions valued over ten thousand dollars

(04:24) The most important reason that regulators are implementing compliance is to keep users safe, Mriganka started. The last thing regulators want is that a drug trafficker uses cryptocurrencies or a money launderer manages to structure his funds in a way that he can transfer them outside of a particular country or between countries easily.

How Are Actors Responding to Regulatory Calls?

(06:29) Actors are becoming more proactive, although it depends on the segments or geography they are based in. To a large extent, cryptocurrency companies are aware of the need to be work on compliance.

(06:53) Earlier they would wait till they grow big to a CoinBase or Kraken size or at least a Series B round of funding before they start bothering with crypto compliance. However, they are now thinking about
about compliance right from day one, Mriganka said.

(07:29) “We’ve seen that trend even with the adoption of our tools where two years ago this was good to have where the larger players would get it for protection but smaller players would still wonder if they needed this like blockchain forensics tools like ours and now it’s very clear that they
require our tools. And there’s a lot many more questions on how can you even go beyond just like looking at just databases or wallet addresses to implementing behavioural analytics that’s used in traditional finance to this space,” Mriganka explained.

Financial institutions are also reconsidering their stance and legal strategy concerning crypto.

(08:14) “Two to three years ago, most large banks had a negative stance on cryptocurrencies or would avoid cryptocurrencies because of regulatory concerns. I think that has changed in just the last six months due to the price rise and all the regulations coming about. Most of the large banks now have a cryptocurrency strategy and they see that as part of the bank staying relevant with the rise of technology. They want to encourage cryptocurrencies, they know their high net worth individual clients are asking for certain services and they’ve made an active push to get them. And you can also see that in the teams they’ve set up, where earlier I think they would just pick the only person in the bank who knows about cryptocurrency, do some experimentation but never really implement anything but now almost every big bank has a crypto custody arm or a digital assets arm where they’ve actively started engaging with regulators and made a compliance system already,” Mriganka stated.

Who's Taking The Lead in the Industry?

(11:05) The US has been quite progressive in terms of knowing cryptocurrencies. All regulators are aware as compared to India or China where they are still battling on whether they’re going to deal with them or not, Mriganka said.

US regulators have accepted that cryptocurrencies are here to stay and that they will regulate them and impose reporting requirements on them. The likes of the UK and Singapore have taken a similar approach to regulating cryptocurrencies.

In the US, the OCC says federally approved banks can provide crypto custody and moves such as those, and the technology act including blockchain as part of new technologies in addition to AI and quantum computing shows how governments and regulators are forward-thinking on these issues.

Singapore and the UK on account of their sizes are taking advantage of the regulatory route as well as the advantage their geography afford them.

(12:08) The UK would probably be the go-to place for a lot of European companies to register their crypto exchange and a lot of the Asian companies or those with an Asia base set up in Singapore to a large extent because of their regulations.

(12:24) Singapore has also been effective at not just coming up with regulations but also constantly iterating and communicating with the industry very clearly on what it intends to regulate and sectors it chooses to see evolve without regulation.

“Shorter-term, I think you’re going to hear a lot of complaints across all these jurisdictions because of the additional regulations but I think longer-term it’s good because you will see a lot more financial institutions being comfortable entering the space because of clear regulatory guidelines,” Mriganka said.

On Associations: Are Regulators Considering the Industry's Voice?

(14:59) “There are a bunch of trade associations and they have members from the biggest crypto companies. I think even regulators understand that it’s more of a collaborative approach where they need to get the industry on board,” Mriganka started.

The key question for regulators would be how they safely regulate the industry without completely stifling it. They should also intend to foster innovation in their particular geographies rather than implementing something so archaic that it leads to a flight of companies outside of their jurisdiction.

FATF Proposal; On Excluding DeFi & NFTs.

The draft guidance from Financial Action Task Force (FATF) was a great way for them to get feedback from the industry, Mriganka said.

FATF has expanded the scope of virtual assets to include decentralized exchanges or DeFi companies. They’ve also mentioned that all the AML-CFT obligations would also apply to DeFi companies and in certain cases NFTs.

(18:14) “I think that’s a very wise move because currently, a lot of the DeFi industry is unregulated to a large extent. The founders are based somewhere, the team is distributed and there’s no clear understanding of which jurisdiction it should be regulated under…The problem with DeFi unlike centralized exchanges is that it is very difficult to enforce how you regulate DeFi and monitor transactions.,” Mriganka said.

Regulatory Liability and Open Source

(20:34) If someone misuses open-source software which is a decentralized exchange, who is culpable, Paul Gordon asked.

“I’m still confused around whether they should be the one because currently, in a lot of use cases the beneficiaries or the owners of a certain instrument are considered liable… in my mind, these things that still need to be figured out in the DeFi space…” Mriganka said.

Building DeFi for Regulations

(20:34) A lot of the larger DeFi protocols that have revealed the names of their founders and want to go the regulated way are considering a split between an unregulated and regulated entity, Mriganka said.

This is to provide more comfort when dealing with different types of institutions like financial institutions.

(24:07) “I think in this case, it is beneficial for them to think about it proactively and try and adopt some types of KYC checks else they could be held liable, even retrospectively. It’s not clear whether they’re liable or not so the sooner they do it the better it is for these protocols,” Mriganka said.

How Hard Should Regulators Press?

(25:47) Unfortunately, most regulators apply similar laws or similar rules that they have applied to financial institutions across these new cryptocurrency companies, Mriganka said.

That’s an unfortunate circumstance of the evolution of the industry because although it would foster it in terms of institutional interest, keeping the customer safe, and reducing the number of harmful events that can potentially happen to users, it would also hamper innovation to an extent.

How the Private Regulatory Industry Evolve.

(27:48) Mriganka admits that regulatory technology companies like Merkel are always lagging so are always working towards the latest problem statements in the industry and where the criminals are migrating toward.

(28:10) “Our long-term mission is to create a crypto infrastructure that enables cryptocurrency companies to transcend and merge with the financial services industry. Our focus for the future is more compliance and risk
based,” Mriganka said.

(28:39) Merkel has also done some analysis of current DeFi liquidity pools where customers or traders can get an idea of the risk profile of certain liquidity pools, to be announced shortly.

“…as privacy becomes inherent on blockchains ML-based behaviour rule engine-based approach is going to become more important so that’s a major piece of the direction as compared to a lot of the other players, focusing more on new opportunities as well as behavioural analytics on top of existing databases,” Mriganka ended.

Paul Gordon
Paul Gordon
Following a 20+ year career in financial markets, Paul first became interested in Bitcoin in 2011 and helped to establish one of the world's first Bitcoin meetup groups, Coinscrum, in 2012 since when he has grown the community to over 6,500 members, hosting over 250 events and introducing many of the leading projects and thought leaders in the industry.  Paul currently produces the weekly Coinscrum Markets video podcast series and is an active investor and advisor to a number of crypto and blockchain related projects.

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