TFR’s Goals for the Trilogues: An Effective Fight Against Financial Crime Requires Preserving Innovation

Recent cases of money laundering and terrorist financing in the European financial sector have highlighted the need for a harmonized and cooperative regulatory framework for national supervisors and financial intelligence units (FIUs) to address such activities more effectively. In this regard, Adan supports the same objectives as the EU and has always advocated for the harmonization of AML/CFT rules for all European companies within the EEA.

According to the Adan, the AML/CFT framework for crypto-asset markets is essential to ensuring financial security and confidence within cryptocurrency markets. However, it would be inappropriate to apply the current AML/CFT framework to this innovative industry without taking into account the specific characteristics of this new asset class. 

However, recent developments in the discussions within the European Parliament and the Council of the European Union have raised significant concerns for ADAN, its members, and all stakeholders in the crypto-asset industry.

The exponential acceleration of negotiations in recent weeks and the desire to bring the TFR into force at the same time as MiCA—even though the latter draft regulation was published by the European Commission a year and a half before the TFR—could lead to a misunderstanding of the real AML/CFT challenges facing crypto-assets. The unjustified equating of crypto-assets with inherently risky assets perfectly illustrates a misconception about blockchain technologies: while AML/CFT risks do indeed exist in the world of cryptocurrencies, the actual level of these risks is often overestimated. 

Furthermore, ADAN regrets the lack of participation by European crypto-asset stakeholders in these discussions, which would help foster a better understanding of their activities. They are, in fact, the best sources for assessing the impacts of new regulatory proposals, highlighting the lack of realism in certain provisions relative to market conditions, and sharing their experiences regarding the opportunities offered by crypto-assets. Having all these elements in place is a prerequisite for implementing an effective anti-money laundering and counter-terrorist financing framework that is tailored and proportionate to the risks posed. 

As currently drafted, the TFR could undermine the EU’s aim of ensuring investor protection while fostering an environment conducive to innovation. To achieve these objectives, Adan believes that the TFR should be strengthened in four key areas:

Adaptations to capitalize on technological opportunities. Imposing existing rules and regulatory frameworks that are ill-suited to innovative blockchain technologies would result in missing the opportunity to genuinely improve AML/CFT in the financial sector and to leverage the possibilities offered by the underlying technologies. Transaction analysis tools (TATs) are becoming increasingly effective and powerful. By leveraging “on-chain” information (such as public addresses, transaction dates, transaction amounts, etc.), combined with external “off-chain” data, TATs enable conclusions to be drawn about the risks associated with a transaction or a group of transactions. Due diligence can then be tailored to the identified risk level. In his report, Michael Morell—former Deputy Director of the CIA—highlights the value of these new tools and encourages their systematic use for monitoring flows. Ultimately, setting the right requirements based on technological opportunities and available tools will enable the creation of an effective and optimal framework.

More proportionate rules based on an accurate risk assessment. The absence of a granular, risk-based approach could result in a scope and set of rules that are too broad to be effective. By assuming by default that all transactions in cryptocurrency markets carry the same level of risk, there is a danger of failing to address the actual risks. The requirement for providers to notify competent authorities of any transfer under 1,000 euros is not consistent with a risk-based approach, given that most transactions conducted via non-custodial wallets pose a very low risk of money laundering and terrorist financing. In crypto-asset markets, the main cases of money laundering are concentrated among a small group of actors who deliberately engage in money laundering activities: “While billions of dollars in cryptocurrencies move each year from illicit addresses, most of them end up at a surprisingly small group of services, many of which appear to be specifically designed for money laundering based on their transaction history. Law enforcement can deal a major blow to cryptocurrency-based crime and significantly hinder criminals’ ability to access their digital assets by disrupting these services.” To stop these activities, it would be more appropriate to investigate these actors further, as they may be able to launder their illicit proceeds due to an overload of irrelevant information.

A level playing field between the crypto-asset sector and the traditional financial sector. Crypto-asset operators should be granted the same exemptions as those in the traditional financial sector. Indeed, while crypto-assets are often cross-border in nature and such transfers can be executed more easily and quickly than traditional fund transfers, it is also necessary to take into account their transparency, one of the many other characteristics inherent to crypto-assets. The transparency of blockchain networks cannot be overlooked when addressing ML/FT risks and could well justify the implementation of a €1,000 exemption, as transaction analysis tools can be used as an alternative to the travel rule for crypto-asset transfers under €1,000

Feasibility. To be fully enforceable, the regulation on fund transfers must reflect market realities and take a pragmatic approach to which provisions can or cannot be implemented. Generally speaking, when a transfer takes place, crypto-asset service providers have access only to the public address of the sender or the recipient of the transfer. To date, market participants do not have a solution that allows them to retrieve the information required by the regulation. In this regard, it appears difficult for crypto-asset service providers to verify that the owner of a non-custodial wallet is indeed the person who controls it, especially if that owner is not the provider’s client. Furthermore, most crypto-asset service providers do not have access to information from other crypto-asset service providers. Consequently, rather than imposing such obligations on service providers, it would be more appropriate to require entities subject to this regulation to comply with targeted financial sanctions and to implement the corresponding appropriate procedures.

A fair balance between combating money laundering and terrorist financing and safeguarding other fundamental rights. The push to include new information when transferring crypto-assets poses significant risks to the protection of users’ personal data and their right to privacy.

Beyond these substantive issues, the regulation on funds transfers raises important broader questions that cannot be ignored:

Undermine innovation, particularly decentralized activities. Premature and ill-suited regulation of crypto-asset markets—particularly decentralized applications—can have a detrimental impact on the sector’s development. Such consequences could have significant implications for the long-term viability of the European crypto-asset industry. However, these decentralized applications offer a wide range of innovative use cases:

• Decentralized Finance (DeFi): defined as a complement to the traditional banking and financial system built on public blockchain networks, DeFi enables greater access to financial services. Although it only emerged in 2018, DeFi has already built valuable services for citizens and economic actors, such as trading, lending, insurance, and more. This is why DeFi is playing an increasingly important role in the ongoing digitalization of the European economy.
• Non-fungible tokens (NFTs): defined as unique tokens that certify ownership of an asset, NFTs span a wide range of economic sectors, including physical assets (such as artworks, real estate, and others) and digital assets (such as collectibles, digital avatars, digital artworks, and others). 

The implementation of the Travel Rule raises significant questions regarding digital sovereignty. Given that the crypto-asset industry is primarily composed of promising small and medium-sized enterprises, negative developments surrounding the TFR could jeopardize the emergence of future European leaders capable of creating a secure and innovative digital economy. Furthermore, since there is currently no European solution for implementing the Travel Rule, all information on new “financial” flows in crypto-assets between European citizens and related data would be concentrated in the hands of foreign operators, who would have complete oversight and control over it. 

The implementation of the Travel Rule raises significant information security concerns. The transmission of information between PCASs requires a secure and accessible communication channel as well as a reporting standard. Furthermore, the risk associated with the protection of crypto-asset users’ personal data must be taken into account. ADAN believes it would be dangerous to require players to automatically transmit highly sensitive information to a CASP that may not be supervised, or may be subject to much less stringent oversight than in France, Germany, Spain, and other countries, or that is established in jurisdictions that may have an economic or strategic interest in exploiting this data.

The implementation of the Travel Rule raises significant questions regarding European competitiveness. Europe’s ambition to take the lead in implementing the Travel Rule in crypto-asset markets through an immediate and, in some cases, more extensive transposition of the rule than called for in previous FATF recommendations will undoubtedly have significant consequences for the competitive freedom of European companies vis-à-vis foreign providers. This regulatory disparity could lead to the exodus of European players, which would significantly harm the EU’s competitiveness in the digital sector.

The Adan remains fully available to discuss these various issues and connect interested parties with professionals in the crypto-asset sector affected by these regulations.