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EU financial crime reforms ‘significant blow’ to cryptocurrency privacy

Out-Law News | 25 Feb 2022 | 4:31 pm | 2 min. read

Draft EU plans to force cryptocurrency service providers to carry out due diligence on their users as part of a package of reforms to tackle financial crime would strike a “significant blow” to the market’s key pillars, according to one expert.

David Hamilton, financial crime expert at Pinsent Masons, said proposed reforms outlined by two European parliamentary committees, posed a threat to the privacy that has become synonymous with cryptocurrency transactions. “Cryptocurrencies were created to be decentralised, pseudo-anonymous, mediums of exchange,” he said. “But the draft report represents a significant blow to that idea - and will bring cryptocurrencies in line with regular bank wire transfers.”

The proposed reforms (60 pages / 296 KB PDF), published jointly by the Committee on Economic and Monetary Affairs and the Committee on Civil Liberties, Justice and Home Affairs, would mean service providers like cryptocurrency exchanges would be required to collect their customers' identifying information, including their name, address, date of birth and account number, as well as the name of the intended recipient of the transfer. The change would bring exchanges in line with the ‘know your customer’ rules already imposed on other financial institutions operating in the EU.

The plans would also apply what is known as the ‘travel rule’ to make transactions using bitcoin and other cryptocurrencies traceable and ban anonymous crypto-asset wallets. Service providers would be required to create effective procedures to detect suspicious crypto-assets - including transactions linked with fraud, extortion, ransomware or darknet marketplaces – and establish whether a crypto-asset has passed through anonymising services like ‘mixers’ or ‘tumblers’. The reforms would be overseen by a new EU-wide anti-money laundering authority (AMLA).

Jonathan Cavill, financial services expert at Pinsent Masons, said: “The application of the ‘travel rule’ to the cryptocurrency regime has been an open question for some time. Unlike traditional financial institutions, crypto firms use a decentralised infrastructure to track transactions. The personal information of those involved in the transaction remains unknown. The ‘untraceable’ nature of crypto infrastructure has always been at odds with the travel rule.”

Lindsay Woods, financial services expert at Pinsent Masons, said the innovation in the decentralised financial industry “should not be underestimated”. “The infrastructure to comply with the travel rule across various jurisdictions has been in development by a coalition of crypto firms for several years,” Woods said.

She added: “The industry-driven centralised solution, known as the travel rule universal solution technology (TRUST), allows members to securely transmit customer information in compliance with the travel rule. There are those that oppose the centralised solution and instead favour a decentralised solution. The particulars of a decentralised solution including how it will operate in practice remain unknown.”

Cavill said that similar legislation may soon be introduced in the UK, following the recommendation of the government’s financial action task force to apply the travel rule to financial activities involving virtual assets. “While the scope of the legislation is unknown, it is expected that crypto firms will be required to maintain effective procedures to validate transactions with the aim of promoting consistency across the financial services sector,” he said.

Draft UK legislation is expected to be published in spring 2022.