Kiffmeister’s #Fintech Daily Digest (10/28/2021)

FATF publishes guidance for regulation of cryptocurrency industry

The Financial Action Task Force (FATF) updated its 2019 Guidance for a Risk-Based Approach for Virtual Assets and Virtual Asset Service Providers (VASPs). The FATF standards require countries to assess and mitigate their risks associated with virtual asset financial activities and providers; license or register providers and subject them to supervision or monitoring by competent national authorities. VASPs are subject to the same relevant FATF measures that apply to financial institutions. This guidance is intended to help countries and VASPs understand their anti-money laundering and counter-terrorist financing obligations, and effectively implement the FATF’s requirements as they apply to this sector. The guidance provides relevant examples and potential solutions to implementation obstacles.

DeFi applications are not VASPs under the FATF standards, as the Standards do not apply to underlying software or technology. However, creators, owners and operators or some other persons who maintain control or sufficient influence in the DeFi arrangements, even if those arrangements seem decentralized, may fall under the FATF definition of a VASP where they are providing or actively facilitating VASP services. This is the case, even if other parties playing a role in the service or portions of the process are automated. Where it is not possible to identify a legal or natural person with control or sufficient influence over a DeFi arrangement, there may not be a central owner/operator that meets the definition of a VASP. (It seems quite common for DeFi arrangements to call themselves decentralized when they actually include a person with control or sufficient influence, and jurisdictions should apply the definition without respect to self-description.)

This Guidance does not address central bank-issued digital currency (CBDC). For FATF’s purposes, these are not VAs as they are digital representation of fiat currencies. The FATF Standards however apply to CBDC similar to any other form of fiat currency issued by a central bank. CBDC may have unique money laundering and terrorist financing (ML/TF) risks compared with physical fiat currency, depending on their design. Such ML/TF risks should be addressed in a forward-looking manner before the launch of any CBDC. However, their non- inclusion in this Guidance does not indicate the FATF considers them unimportant. Rather, it is a product of the fact that they are categorized as fiat currency, rather than the VAs that this Guidance addresses. [Read more]

Central bank digital currencies, cryptocurrencies, and privacy: What experiments tell us 

This article reports on laboratory experiments that ask whether privacy is relevant in shaping the demand for digital currencies. The results show that anonymity does indeed matter and increases the overall appeal of a medium of payment. This effect is stronger for risk-prone individuals. There are several possible interpretations for this result. For example, people may not want others to know that they like risk. That is, as risk aversion is the social norm, risk-loving agents may have a greater desire for anonymity. Another possible interpretation is that risk-prone subjects are more prone to illegal deals and therefore might like anonymity more. [Read more]

The Power of Money: Lessons from Introducing Digital Currency to a Barter Community

This paper investigates how digital currency issuance by a private online platform affected the exchange of used goods in a large North American barter community. Since the community banned cash, users initially relied on beer, gift cards, and transit tokens to complete transactions. The community then introduced a digital token that could be transferred among app users and redeemed at designated local stores for retail goods. Using comprehensive transactions data, the paper shows that a large monetary expansion persistently increased transaction volume by 70% but did not create inflation. However, when token redemption was suddenly halted at a subset of stores, a run on the token ensued and transaction volume fell. The paper uses a search-theoretic model of money to interpret these findings. [Read more

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