On the Need for Identity on Smart Contracts

The Financial Action Task Force (FATF) held its FATF Week and Plenary on 19-21 February, officially adopting a new Guidance on Digital ID. One of the common misconceptions in the interpretation of the new FATF Rule 16 (i.e., the Crypto Travel Rule) is that it only applies to exchanges: in fact, they also apply to smart contracts.

FATF defines “Virtual Assets” as a digital representation of value that can be digitally transferred or traded, used for investment or payment purposes (e.g., tokens from ICOs). It also defines Virtual Asset Service Providers (VASPs) as anyone who conducts the exchange, transfer, custody, issuance, offer and/or sale of virtual assets. The keyword here is issuance: deploying a smart contract for a virtual asset on a blockchain without identity and/or that doesn’t comply with the Crypto Travel Rule will be illegal when the FATF Rule 16 becomes mandatory. The fungibility of cryptocurrencies/tokens will be impacted: non-compliant virtual assets will be worth less than vetted virtual assets.

In other words, previous and new ERC-20 tokens on Ethereum or other blockchains will become illegal under the new FATF regulations. For previous tokens, there will be holders with wallet addresses vetted by exchanges by KYC processes and those who don’t: thus, a fraction of the supply of the token will be less valuable because its holders haven’t been vetted and don’t comply with the Crypto Travel Rule.

For new tokens, the issuers must check that all the wallet addresses have been vetted by compliant exchanges: if some addresses aren’t compliant, the issuer will be in breach of the Crypto Travel Rule, transactions from said addresses won’t be compliant and the token supply will become tainted. Notice that in the chain of transactions of a token or cryptocurrency, each and every one of the holders must comply with the Crypto Travel Rule, because there will be no exemptions from the rule of nemo dat quod non habet.

But there is still hope: they can migrate their smart contracts to our blockchain, the only legal blockchain by design in which all the addresses have been vetted by a free KYC process: compliance with this regulation is cheap, brings greater legal certainty and secures the valuation of virtual assets.