The regulatory industry has been deeply disrupted by the development of various decentralized technologies which allow for pseudonymous-by-design transactions. Already struggling to graft money-laundering rules, FATF, the intergovernmental organization which sets standards and promotes the effective implementation of legal, regulatory, and operational measures for combating any threats to the integrity of the international financial system has recently released an updated draft guidance on a risk-based approach to virtual assets and virtual asset providers. As a result, anti-money laundering and Know-Your-Customer rules are extended to assets such as decentralized finance, stablecoins and non-fungible tokens (NFTs).
Decentralized finance also commonly known as DeFi uses technology to disintermediate centralized models to increase the provision of financial services to anyone anywhere. DeFi services are mainly in Dapps which are apps built on a public blockchain that provides users with more control over their finances. Some of the differentiating factors of a Dapps includes
- Not being managed by an institution. Often once a smart contract which are programs running on the blockchain is deployed, Dapps can run on its own with little human intervention. This is because they can execute certain actions automatically when the criteria are met.
- Interoperable: new DeFi apps can be built to combine with existing DeFi products, making them more efficient and seamless for the consumers.
Under the new regulation, FATF standards do not apply to underlying software or technology and only entities involved with Dapps may now be considered as virtual asset service providers and they must meet the same anti-money laundering requirements as traditional finance.
Moving on to NFTs, non-fungible means unique, and NFTs are cryptographic assets that have unique identification codes that are distinguishable from others. NFT allows for the digital representation of physical assets such as real estate and artworks. Currently, much of its market is surrounding collectibles, notably artworks. Being on the blockchain has propelled the removal of intermediaries when selling these assets, making it easier for sales. NFT mostly runs on Ethereum blockchain and follows the ERC-721 standards which define the minimum interface it should have for ownership and distribution of NFT.
With regards to changes in the regulation of NFT, only NFT that facilitates money laundering and terrorist financing are considered Virtual Assets and will need to comply with FATF standards.
Challenges
With the continuous development of new asset classes, FATF is constantly reviewing and providing more clarity on whether businesses are undertaking VASP activities and are subject to FATF standards. FATF is also consulting professionals in the field to effectively regulate the industry. Companies that are in this field need to keep a lookout for such changes for the risk of non-compliance.
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