Is the Travel Rule good or bad for crypto? Both

The "travel rule" officially applies to "virtual asset service providers" (VASPs) as of this month. It requires VASPs, such as crypto exchanges, to record the names of senders and receivers of transactions, as well as the national IDs of the former.

For the crypto sector, whose main value proposition is arguably the (quasi-)anonymity of financial transactions, this development is said to pose an existential crisis. Or it threatens to drive the sector underground.

Organization for Economic Cooperation and Development

advisor

Joseph Weinberg warned that expanding the rules "could drive the entire ecosystem back into the dark ages."

Malcolm Campbell-Verduyn is an assistant professor of international political economy at the University of Groningen in the Netherlands. He is editor of the book Bitcoin and Beyond. Moritz Hütten is a researcher on blockchains and the future of work at Darmstadt Business School in Germany.

Instead, we argue that the rule splits the industry into two parts: one part that is brought into the light of existing international financial regulation, while another part is pushed further into the dark web. To understand this outcome, and why it is both good and bad for cryptocurrency, the concepts of protocological control and financial infrastructures are instructive.

Protocological ControlTheorigin of

the Travel Rule lies in a more than two-decade-old U.S. regulation that requires banks to store and obtain customer information on transactions over $3,000. The expansion to cryptocurrencies highlights the continued international power of the U.S. through the Financial Action Task Force.

Contrary to claims of draconian power, the FATF does not exercise direct control by extending the U.S. "travel rule" to VASPs. This Paris-based intergovernmental organization exercises indirect power by influencing who and where "protocological control" is exercised.

The division of the crypto space into two infrastructures ultimately undermines the FATF's attempt to include the entire ecosystem within its official regulatory purview.

Protocological control refers to how "computer protocols govern how certain technologies are agreed upon, adopted, implemented, and ultimately used by people around the world." Developed in the 2004 book Protocol: How Control Exists After Decentralization, media scholar Alexander Galloway showed how the World Wide Web Consortium (W3C) and the Internet Engineering Task Force influenced the coding of computer protocols that underlie the design of HTML.

The FATF exerts similar influence on the protocols underlying decentralized crypto-networks. Yet this intergovernmental organization does not develop its own protocols to enable the exchange of customer information between VASPs. Nor does it leave the development of protocols to its 39 member states.

Rather, the FATF encourages market competition between crypto startups and major banks to develop protocols to ensure interoperability of information between VASPs. The FATF's indirect power is to act as "market maker," facilitator, and coordinator.

But what does this indirect exercise of power mean for the crypto ecosystem?

Dual infrastructuresOn the one hand,

the FATF's focus on market competition

helps

avoid the typical "cat-and-mouse" chase where "regulatory cats" chase bad industry mice a few steps away from their more nimble opponents. The FATF's multi-year consultations have fostered a level of cooperation and mutual learning between the industry and regulators, rather than a chase where the industry constantly draws the ire of anti-money laundering and counter-terrorist financing authorities.

On the other hand, the FATF's approach divides the crypto ecosystem into two infrastructures.

A more consolidated and centralized infrastructure enables compliance with the Travel Rule and its identification requirements. A more decentralized and privacy-oriented infrastructure, on the other hand, is pushed further into the gray markets and the shadows of the dark web.

The division of the crypto space into two infrastructures ultimately undermines the FATF's attempt to bring the entire ecosystem within the official regulatory purview.

Where do we go from here?

Where this will all end up is anyone's guess. The gap between privacy-friendly and identification-compliant infrastructures in the crypto ecosystem may continue to widen. Emerging protocols like Enigma could gain traction, and privacy tools could turn most traceable cryptocurrencies into anonymous payments.

While this may be highly beneficial for privacy preservation, it is inevitable that regulatory attention will be drawn to this infrastructure as illicit activity grows in scale and scope. Indirect power can be fickle, and the next time around, international regulators may seek more direct forms of control and be less willing to cooperate with the industry.

But gaps between infrastructures could also narrow as protocols are developed based on AML/CFT regulations. Groups like OpenVASP are trying to balance openness with compliance by developing open protocols for consistent information sharing among operators. The Travel Rule could lead to an as-yet-unforeseeable "squaring of the circle" that preserves privacy while enhancing the collection and sharing of identity data.