Definitions of VASPs and VAs

The digital asset landscape, characterized by its rapid evolution and decentralized nature, presents unique challenges for regulatory bodies worldwide. At the forefront of setting global standards is the Financial Action Task Force (FATF), whose updated guidance on Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs) is pivotal for understanding the application of anti-money laundering and counter-terrorism financing (AML/CTF) frameworks within this space.

The FATF's definitions, intentionally broad and expansive, aim to ensure that no financial asset, regardless of its format, escapes regulatory scrutiny. This approach reflects the dynamic nature of digital assets and the need to adapt to emerging risks.

Defining Virtual Assets: Beyond Traditional Currencies

The FATF defines a Virtual Asset as "a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes. Virtual assets do not include digital representations of fiat currencies, securities, or other financial assets that are already covered elsewhere in the FATF Recommendations."

This definition encompasses a wide range of digital assets, including cryptocurrencies like Bitcoin, Ether, Solana, Tether, and Litecoin. However, the application of this definition to emerging asset classes like gaming tokens, Non-Fungible Tokens (NFTs), and governance tokens requires a nuanced understanding.

Examples of Virtual Assets and Their Regulatory Nuances

• Virtual Currencies: These are the most common examples of VAs, serving as digital mediums of exchange.
• Gaming Tokens: Whether gaming tokens qualify as VAs depends on their functionality. If they are used primarily for in-game purchases and have limited transferability or real-world value, they may not be considered VAs. However, if they can be traded on exchanges or used for investment purposes, they fall within the FATF's definition.
• NFTs: The classification of NFTs as VAs is context-dependent. If an NFT is unique and used primarily as a collectible, it may not be considered a VA. However, if it functions as an investment asset or is used for payment purposes, it falls under the FATF's purview.
• Governance Tokens: These tokens, granting holders voting rights in decentralized protocols, may be considered VAs if they are traded or used for investment.

Virtual Asset Service Providers (VASPs): Gatekeepers of the Digital Economy

The FATF defines a VASP as "any natural or legal person who is not covered elsewhere under the recommendations and as a business, conducts one or more of the following activities or operations for or on behalf of another natural or legal person:"

• Exchange between virtual assets and fiat currencies.
• Exchange between one or more forms of virtual assets.
• Transfer of virtual assets.
• Safekeeping and/or administration of virtual assets.
• Participation in and provision of financial services related to an issuer's offer and/or sale of a virtual asset.

This definition captures a broad spectrum of entities operating within the digital asset space.

Examples of VASPs and the Gray Areas of Decentralization

• Custodians: Entities providing safekeeping services for VAs.
• Mining Pools: Collaborative groups of miners that pool resources to validate transactions.
• Wallet Providers: Services offering software or hardware wallets for storing VAs.
• Brokerage Services: Platforms facilitating the buying and selling of VAs.
• Bitcoin ATMs and Kiosks: Machines enabling the exchange of VAs for fiat currency.
• Stablecoin Providers: Entities issuing and managing stablecoins.
• Decentralized Finance (DeFi) Protocols: Platforms offering financial services through smart contracts.
• NFT Platforms: Platforms that facilitate the buying and selling of NFTs.

The decentralized nature of many crypto services, particularly in DeFi, creates ambiguity in applying these definitions.

NFT Platforms and the FATF's Functional Approach

The surge in NFT popularity has prompted the FATF to clarify their stance. The key determinant is the NFT's function:

• If it's unique and used as a collectible, it's not a VA.
• If it's used for investment or payment, it's a VA.

This functional approach necessitates a case-by-case assessment, as the purpose of an NFT can vary significantly.

Stablecoin Providers: Addressing Systemic Risks

Stablecoins, due to their potential for mass adoption, are a focal point for regulators. The FATF emphasizes a risk-based approach, regardless of governance structures.

• Centralized stablecoin providers are clearly VASPs.
• Decentralized stablecoins require identifying entities with "control or sufficient influence."

Decentralized Finance (DeFi): Navigating the Absence of Intermediaries

DeFi's disintermediation challenges traditional AML/CTF frameworks. The FATF clarifies:

• DeFi applications themselves are not VASPs.
• Creators, owners, and operators with "control or sufficient influence" can be VASPs.

This includes entities:

• Maintaining ongoing user relationships.
• Profiting from DeFi services.
• Setting or changing protocol parameters.

The FATF acknowledges the difficulty of identifying controlling entities in some DeFi arrangements and advises countries to adopt risk mitigation measures.

In the FATF’s most recent and fifth “Targeted Update on Implementation of the FATF Standards on Virtual Assets and Virtual Asset Service Providers”, the FATF reports emerging risks and market developments in this area. The FATF notes that global progress in crypto AML/CFT regulations is evident, but implementation lags, especially compared to traditional finance. Despite advances in some key jurisdictions, virtual assets (VAs) and VASPs remain susceptible to illicit use due to widespread non-compliance with FATF standards. The latest targeted report highlights crucial areas needing improvement and offers recommendations for both public and private sectors to bolster regulatory frameworks and mitigate risks.

The Importance of Broad Interpretation and Ongoing Adaptation

The FATF's commitment to a broad and expansive interpretation of VA and VASP definitions underscores the need for regulatory flexibility in the face of rapid technological change. As the digital asset space continues to evolve, ongoing dialogue and adaptation are crucial for ensuring effective AML/CTF measures. By understanding these key definitions and the nuances of their application, stakeholders can navigate the complexities of the digital asset landscape and contribute to a more secure and transparent financial ecosystem.