Introduction
Blockchain has become a stand-in for DeFi or the decentralized finance sector. It means a global network where users can perform all types of financial functions without having to depend on centralized financial enterprises. However, DeFi is a strictly discriminative and ungoverned platform. There is no legal support or backup for the users in case things take an unwanted turn. Therefore, some blockchain proponents support the idea of regulating the DeFi sector to make sure to bring more confidence and strength to the space. VASP is one such effort in introducing DeFi regulations to the network.
What are Virtual Assets?
The definition of an asset is a product that is under the value of a person or a group and holds some value in the market. In the same manner, Virtual Asset is a product or entity that holds value for its owner or owners and is present in a digital form. The most common types of Virtual Assets are cryptocurrencies these days. To implement regulations on DeFi and cryptocurrencies, FATF has issued legal criteria to define Virtual Assets first.
All the entities that match the conditions mentioned as per the FATF affidavit come under the purview of VASP. In this manner, the retail and commercial users would be able to comply with the legal requirements and carry out legislative procedures in the light of VASP. Without the VASP and FATF recommendations, a user can’t confirm whether the cryptocurrency, token, NFT, stablecoin, ICO, IEO, DEX, CEX, or swap are legally approved or not.
Origin of VASP
When it comes to using cryptocurrencies, there are no certain rules or guidance available to the average user. The users can refer to the White Paper or the technical description of the blockchain however it contains technical jargon and is not addressed to the average reader or stakeholder. On the other hand, people are always dealing with issues like bankruptcy, investment risks, hacks, and other threats that are related to cryptocurrency trading. In the event of a mishap, a user can’t make sure that they are contacting the right authorities or seeking legal action.
Therefore, the FATF or Financial Action Task Force released a report called Guidance for Vas and Virtual Asset Service Providers in 2019. The objective of the report was to define the conditions for a digital entity to qualify as a Virtual Asset. Furthermore, the report also seeks to introduce a blueprint of the necessary information on the matter of regulatory guidelines for Virtual Asset enterprises.
What is FATF?
FATF or Financial Action Task Force is a legal term that is used for creating a blueprint for regulatory guidelines and seeking legalizing solutions for a particular financial enterprise or product. The main role of FATF is to deal with the identification of financial crimes such as Money Laundering and introduce legal solutions to deal with them. The first FATF was created in 1989 as an inter-government agency that invited the member countries and electives to collaborate and chair the enterprise. The FATF is responsible for issuing regulations regarding financial procedures and processes for all its member countries.
The countries are audited as per the standard set by FATF and then issued a ranking based on their compliance scores. It is important to note that FATF rankings can affect the trade and economic condition of a country significantly due to pressure from all other member countries. The recommendations issued by FATF are not part of national or international laws. However, countries with a poor FATF ranking can be left out of important trade agreements and foreign investment opportunities. Now that FATF has issued recommendations concerning Virtual Assets, it is going to create a major impact in shaping the DeFi and Blockchain sector internationally.
FATF’s VASP Criteria
FATF has set the following criteria under the umbrella of VASP for any person of interest or legal enterprise that is not registered with any other legal agency and performs the following functions:
- An exchange of Virtual Assets and Fiat Currencies.
- An exchange of one or more types of Virtual Currencies with the view of value transfer.
- One-way transfer, sale, or purchase of Virtual Assets.
- Storing, saving, or administrating Virtual Assets for defined or undefined purposes that allow them to gain full control of these Virtual Assets.
- Taking part or playing any type of role in financial transaction or service under any capacity such as a party to the seller or the purchaser etc.
- Any financial asset or function that falls out of the above-mentioned criteria should be tried under the regulatory guidelines of VASP and FATF.
- The aforementioned regulations are applicable universally and expansively taking the novel nature of the DeFi sector and all the gray areas.
What is a Digital Asset Entity?
To grasp the VASP, everyone needs to understand the term DAE or Digital Asset Entity. The DAE is a commercial enterprise that is partly or wholly connected with virtual assets management or services. Since there are countless gambling sites, fantasy sports platforms, and other incubators that have started to offer Virtual Asset services and they do not have any license or registration to support their qualification. Furthermore, Bitcoin ATMs and Cryptocurrency exchanges that are largely decentralized are also under the coverage of DAE under VASP. In some cases, DAE is also referred to as Virtual Asset Entity or VAE.
What is a Digital Asset Consumer?
Just like the commercial enterprises that are operating independently in the DeFi ecosystem, some users are connected to these firms without any proper registration or identification. Therefore, the FATF has added a definition for Digital Asset Consumer or DAC under VASP recommendations.
A DAC is any DAE that is using the services of a financial enterprise such as banks. The US Department of Treasury used the description of DAC formally in a legal case against Safra Bank in 2020. On the other hand, the Office of Comptroller of Currency which was the judging party in the case issued a sentence in favor of the US Treasury Department and issued a cease and desist order against Safra Bank on charges of money laundering with Virtual Assets.
What is a Virtual Asset Service Provider or VASP?
The FATF defines Virtual Assets and Virtual Assets Service Providers in legal and formal terms. The VASP is a guideline for the financial agencies and government regulators to audit cryptocurrencies and Virtual Assets in the light of recommendations and guidelines in its 2019 report on page 109. The regulators now have a standardized method for screening Virtual Assets and VASPs for money laundering, terror financing, and CFT violations. The FATF regulations of VASP are applicable internationally and in every country that is a member. It is worth noting that Virtual Assets do not include digitized versions of fiat currencies, securities, or any other financial assets.
How will VASP Affect DeFi?
The DeFi or decentralized finance ecosystem is by definition free from the implementation of centralized legalization. However, since the nascent market is so free and independent it also does little to protect the interests and rights of a small and individual investors. Therefore, the presence of some level of regulatory compliance can be a positive change. On the other hand, some cryptocurrency proponents are worried that VASP is a backdoor for government and centralized regulators to sneak into the DeFi sector and gain control over it gradually.
It is worth noting that by definition VASP is a large and visible attempt to bring the decentralized market and enterprises under the purview of financial regulations. At the same time, there is also a question about how much the FATF recommendation is going to cover the DeFi sector and what part of the blockchain market and products will be covered by VA and VASP. Furthermore, there is also a strong chance that Central Banks and financial agencies use VASP as a blueprint for the adoption of stringent legislation of the DeFi sector within their jurisprudence.
Does VASP Apply to NFTs?
The FATF expanded and edited the VASP report in 2021 to redefine whether NFTs were covered under it or not. As per the updated guidelines, the VASP guidelines for NFTs are as under:
- NFTs are truly unique and not interchangeable under any circumstances.
- NFTs are used only as digital collectibles and not as a mode of payment or investment option.
Thus, if an NFT qualifies for both conditions mentioned above it means that they are not included under the purview of VASP. However, the answer to the question is not as straightforward as it may seem. There is a chance that NFTs that are used for secondary exchanges may be tried under the guidelines of VASP. It is more likely that the implementation of VASP on NFTs is going to happen on a case-to-case basis.
Cryptocurrency lawyer Gabriel Shapiro has claimed at one point that NFTs are not unique or one-of-a-kind. He further added that a single NFT is not enough to declare the ownership or copyright of its creator. Henceforth, there are no laws that are stopping other creators to copy them and produce a duplicate NFT. He further pointed out that on a technical level there are no blockades on a blockchain platform to stop any other developer from creating the same NFT that already exists.
Shapiro defined that NFTs are not truly non-fungible and it is merely context-relevant ideology. At the same time, it is not easy to define clearly the true purpose of an NFT purchase that can be an investment option, a payment, or just a collectible item. Here are some of the possible scenarios concerning NFTs:
- Many users purchase NFTs as a way to create a unique virtual identification for them and use them as accessories for gaming.
- On the other hand, other buyers wish to accumulate the latest and most popular NFT collections as an investment that can turn into a profit.
- NFT owners can also use them as collateral for drawing loans or selling them later for a greater profit margin.
It should be clear that all NFTs that are purchased to generate a profit or as an investment is added to VASP guidelines and qualify as Virtual Assets. At the same time, the platforms that are facilitating the sales or purchase of NFT investments are going to qualify as VASPs.
Does VASP Apply to Stablecoins?
Stablecoins are the type of cryptocurrencies that have a fixed value and are backed by a large reserve of their pegs such as fiat currencies or other virtual currencies. Since stablecoins are so popular, they have often ranked as high-risk assets among financial regulators. Typically stablecoins are less volatile in comparison to other digital currencies and they are also more compliant with regulatory agencies. In such cases, the regulated stablecoins such as Tether are not directly defined as VAs.
On the other hand, the financial regulators that are governing these stablecoins are under the siege of FATF and VASP. Meanwhile, the algorithmic stablecoins and those that are governed by decentralized protocols such as MKR tokens need a more complicated and detailed application of FATF guidelines. As per FATF, the following decentralized stablecoins will fall under the purview of its guidelines:
- The stablecoins are created by decentralized protocols and are truly decentralized in their final forms.
- The platforms that are allowing the sales or purchase of these stablecoins such as exchanges.
- Any custodial wallet services provider that keeps the private key under their possession and allows users support for stablecoins storage and management.
Advantages of VASP
The proponents of DeFi are divided on the matter of VASP. It is a great idea to make a list of cons and pros to better understand the merits or demerits of the FATF recommendations on the DeFi sector.
There are thousands of cryptocurrencies and new cryptocurrencies are added to the blockchain sector every day. However, there is no such thing as a proper qualification or goodwill for a company or individual to start operating cryptocurrencies. Therefore, many scammers take advantage of the lack of regulations that could be reduced with VASP.
In case of a clash of opinion among the cryptocurrency community members or users feeling oppressed by cryptocurrency organizations, they have no way to address their concerns. However, VASP will assist affected parties in making a viable case.
The legal definition of Virtual Assets and Virtual Asset Support Providers will allow the users to scrutinize the legitimacy of a DeFi venture before investing in it. VA and VASP can become a basis for Central banks and financial regulators to add the DeFi sector into the legal skeleton of the country.
The stakeholders can be assured that they are not unwittingly participating in any illegal scam or crime with the help of VASP. The community members of a blockchain will have to deal with small financial and smaller risks.
The legal definition of Virtual Assets and crypto enterprises will increase the engagement and investment interest of commercial financial enterprises in DeFi. The VASP can also pave the way for a wider cryptocurrency and DeFi adoption by making it safer for all users.
VASP can allow private and government financial auditors with a legal standard and criteria for screening for financial and technical audits. The VASP can shrink the gap between DeFi and TeFi enterprises such as banks and create a basis for their stronger and more secure operations.
VASP can also serve as a blueprint for government agencies and departments for the adoption of DeFi applications on a national or international scale. VASP can also enable private entities to create B2C DeFi channels that are not private and permissioned that could open up international markets for them.
Limitations of VASP
Despite its many benefits, there are still many cryptocurrency community members who are skeptical about the VASP initiative. Therefore, it is important to be aware of some of the most important risks connected to VASP implementation on DeFi as under:
FATF can enforce different countries to create different criteria for DeFi regulations that can affect the quality of the users and the effectiveness of the platform. VASP can hinder the decentralized status of the digital currency enterprises or products that can dampen the interests of its stakeholders.
VASP can also shape future projects with little room for innovation which can constrain its growth and evolution. VASP can also create more legal complications for the NFT, stablecoin, and cryptocurrency users that can result in more hassle and an increase in expenses.
The VASP guidelines can be complicated and most people might not be able to take advantage of the regulations on account of a lack of knowledge. VASP can also decrease the profit margins generated from DeFi markets that are considerably higher than stock and traditional financial markets.
Conclusion
The Virtual Asset Service Providers and Virtual Assets is an attempt at taming the DeFi sector by FATF. The FATF is not a legal regulator but its recommendation holds a certain amount of value on account of the pressure from its member countries. Only time will tell whether FATF can change the DeFi for the better or if it keeps its independent status despite all such attempts.
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