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VIRTUAL ASSETS – DRAFT FATF REPORT TO G20 ON SO

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FATF Report to the G20

Finance Ministers and

Central Bank Governors on

So-called Stablecoins

June 2020

The Financial Action Task Force (FATF) is an independent inter-governmental body that develops and promotes

policies to protect the global financial system against money laundering, terrorist financing and the financing of

proliferation of weapons of mass destruction. The FATF Recommendations are recognised as the global anti-money laundering (AML) and counter-terrorist financing (CFT) standard.

For more information about the FATF, please visit

www.fatf-gafi.org

This document and/or any map included herein are without prejudice to the status of or sovereignty over any

territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

Citin g reference: FATF (2020), FATF Report to the G20, FATF, France,

© 2020 FATF/OECD. All rights reserved.

No reproduction or translation of this publication may be made without prior written permission. Applications for such permission, for all or part of this publication, should be made to the FATF Secretariat, 2 rue André Pascal 75775 Paris Cedex 16, France (fax: +33 1 44 30 61 37 or e-mail: contact@fatf-gafi.org).

Photocredits cover: ©iStock / Getty Images.

Table of Contents

Executive Summary 2

Introduction 5

Section 1: So-called stablecoins 6

Section 2: ML/TF risks of so-called stablecoins 7

Anonymity 7

Global reach 8

Layering 8

Potential for mass-adoption 9

Section 3: Application of the revised FATF Standards 10

Scope of the revised FATF Standards 10

Application of the revised FATF Standards to so-called stablecoins 11

Section 4: Residual ML/TF risks

18

Risks from anonymous peer

-to-peer transactions via unhosted wallets 18 Risks from weak or non-existent AML/CFT regulation by some jurisdictions 19 Risks from so-called stablecoins having a decentralised governance structure 20 Section 5: Enhancing the global AML/CFT framework for virtual assets and so-called stablecoins 21 Annex A. Recommendation 15 and its Interpretive Note and FATF

Definitions 23

Recommendation 15 -

New Technologies 23

Interpretative Note to Recommendation 15 23

FATF Glossary 25

Annex B. Central bank digital currencies 26

Risks and risk mitigation for CBDCs 26

REFERENCES 28

2 VIRTUAL ASSETS - FATF REPORT TO G20 ON SO-CALLED STABLECOINS

Executive Summary

1. So-called stablecoins

1 have the potential to spur financial innovation and efficiency and improve financial inclusion. While so-called stablecoins have so far only been adopted on a small-scale, new proposals have the potential to be mass-adopted on a global scale, particularly where they are sponsored by large technology, telecommunications or financial firms. In the same way as any other large scale value transfer system, this propensity for mass-adoption makes them more vulnerable to be used by criminals and terrorists to launder their proceeds of crime and finance their terrorist activities, thus significantly increasing their risk of criminal abuse for money laundering and terrorist financing (ML/TF) purposes.

2. The Financial Action Task Force (FATF) sets international standards to

combat money laundering, terrorist financing and the financing of the proliferation of weapons of mass destruction. The FATF Standards place specific anti-money laundering and countering the financing of terrorism (AML/CFT) obligations on intermediaries between individuals and the financial system, such as financial institutions. To mitigate the ML/TF risks of virtual assets, the FATF revised its Standards in June 2019 to require virtual asset service providers (VASPs) to implement the full range of preventive measures against ML/TF.

3. In October 2019, the G20 asked the FATF to consider the AML/CFT issues

relating to so-called stablecoins, particularly "global stablecoins" (i.e. those with potential for mass-adoption). This report sets out the FATF's analysis of the AML/CFT issues relating to so-called stablecoins. Complementary reports from the Financial Stability Board (FSB), the International Monetary Fund (IMF) consider other implications of so-called stablecoins, including their financial stability and macroeconomic implications.

4. The FATF has found that so-called stablecoins share many of the same

potential ML/TF risks as some virtual assets, in virtue of their potential for anonymity, global reach and layering of illicit funds. Depending on how they are designed, they may allow anonymous peer-to-peer transactions via unhosted wallets. These features present ML/TF vulnerabilities, which are heightened if there is mass- adoption.

5. When reviewing current and potential projects, so-called stablecoins appear

better placed to achieve mass-adoption than many virtual assets, if they do in fact remain stable in value, are easier to use and are under sponsorship of large firms that seek to integrate them into mass telecommunication platforms.

6. The revised FATF Standards clearly apply to so-called stablecoins.

2

Under the

revised FATF Standards, a so-called stablecoin will either be considered to be a virtual asset or a traditional financial asset depending on its exact nature. A range of the entities involved in any so-called stablecoin arrangement will have AML/CFT obligations under the revised FATF Standards. Which entities will have AML/CFT obligations will depend on the design of the so-called stablecoin, particularly the

1 Note on terminology: The FATF considers that the term "stablecoin" is not a clear legal or technical category, but is primarily a

marketing term used by promoters of such coins. In order to avoid unintentionally endorsing their claims, this report therefore

refers to them as "so-called stablecoins". Those coins called "global stablecoins" in other G20 reports are named "so-called

stablecoins with the potential for mass adoption" in this report for the same reason. The FATF uses the defined terms "virtual asset"

to refer to crypto-assets and other such digital assets, and "virtual asset service provider" (VASP) to refer to exchanges, wallet

providers, and other businesses which provide services relating to virtual assets.

2 FATF, Money laundering risks from “stablecoins" and other emerging assets, October 2019

VIRTUAL ASSETS - FATF REPORT TO G20 ON SO-CALLED STABLECOINS 3 extent to which the functions of the so-called stablecoin are centralised or decentralised, and what activities the entity undertakes.

7. In a centralised arrangement, one entity governs the arrangement, and may

operate the stabilisation and transfer mechanism, and act as the user interface (e. g. by offering custodial wallet and exchange and transfer services). In a decentralised arrangement, there may not be a central entity governing the system, and the stabilisation and transfer functions and user interface may be distributed amongst a range of different entities or be done through software. This is a continuum and a so- called stablecoin may sit anywhere along this spectrum. For example, a stablecoin arrangement may operate the stabilisation centrally, but the user interface may be distributed amongst other VASPs.

8. Importantly, central developers and governance bodies of so-called

stablecoins will have AML/CFT obligations under the revised FATF Standards, where they are carrying out the activities of a financial institution or VASP, in addition to the AML/CFT obligations of other entities with AML/CFT obligations, e.g. wallet providers. The central governance bodies of so-called stablecoins are in a unique position to undertake ML/TF risk mitigation, as they determine the functions of the so-called stablecoin, who can access the arrangement and whether AML/CFT preventive measures are built into the arrangement.

For example, they could ensure

that the access to the transfer system is only possible through AML/CFT-compliant regulated VASPs. Not all so-called stablecoins may have a readily identified central body however.

9. Based on current known models, the FATF consider that so-called stablecoins

with potential for mass-adoption will be centralised to some extent, with an identifiable central developer or governance body. The FATF considers that these developers and governance bodies will be, in general, financial institutions (e.g., as a business involved in the ‘issuing and managing means of payment") or a VASP (e.g., as a business involved in the ‘participation in and provision of financial services related to an issuer"s offer and/or sale of a virtual asset") under the revised FATF Standards. This is an important control to mitigate the ML/TF risks poses by such so-called stablecoins. Furthermore, there will be a range of other entities with AML/CFT obligations even in a centralised arrangement, including customer-facing exchanges and transfer services and custodial wallet providers.

10. While decentralised so-called stablecoins without such an identifiable central

body, prima facie, may carry greater ML/TF risks due to their diffuse operation, the

FATF considers that their potential for mass

-adoption is lower than centralised arrangements and, therefore, their associated ML/TF risks are smaller (although still present). However, even in a decentralised structure, there could also be a range of entities with AML/CFT obligations, including customer-facing exchanges and transfer services and custodial wallet providers. Importantly, there are functions that may mean an entity has AML/CFT obligations prior to the launch of a decentralised so- called stablecoin, as the process necessary to bring a product to launch is unlikely to be able to be fully decentralised.

11. The FATF considers that the preventive measures required of intermediaries

under the revised FATF Standards have worked to mitigate the ML/TF risks posed by so-called stablecoins currently in existence. Accordingly, the FATF does not consider that the revised FATF Standards need amendment at this point in time. Nonetheless, the FATF recognises that this is a rapidly evolving area that must be closely monitored and that jurisdictions must be effectively implementing the revised Standards.

4 VIRTUAL ASSETS - FATF REPORT TO G20 ON SO-CALLED STABLECOINS

12. In particular, it is important that ML/TF risks of so-called stablecoins,

particularly those with potential for mass-adoption and increased anonymity, are analysed in an ongoing and forward-looking manner and are mitigated before such arrangements are launched. As so-called stablecoins could quickly become available globally, with their functions decentralised across multiple jurisdictions, international co-operation between jurisdictions is critical to ensure ML/TF risks are appropriately addressed.

13. The FATF has also identified potential risks which may require further action,

including; so-called stablecoins located in jurisdictions with weak or non-existent AML/CFT frameworks (which would not properly implement AML/CFT preventive measures) and so-called stablecoins with decentralised governance structures (which may not include an intermediary that could apply AML/CFT measures) and anonymous peer-to-peer transactions via unhosted wallets (which would not be conducted through a regulated intermediary).

14. Accordingly, the FATF proposes four actions:

a) The FATF calls on all jurisdictions to implement the revised FATF Standards on virtual assets and VASPS as a matter of priority.

b) The FATF will review the implementation and impact of the revised Standards by June 2021 consider whether further updates are necessary. This will include monitoring the risks posed by virtual assets, the virtual asset market, and proposals for arrangements with potential for mass-adoption that may facilitate anonymous peer-to-peer transactions. c) The FATF will provide guidance for jurisdictions on so-called stablecoins and virtual assets , as part of a broader update of its Guidance . This will set out in more detail how AML/CFT controls apply to so-called stablecoins, including the tools available to jurisdictions to address the ML/TF risks posed by anonymous peer-to-peer transactions via unhosted wallets. d) The FATF will enhance the international framework for VASP supervisors to co-operate and share information and strengthen their capabilities, in order to develop a global network of supervisors to oversee these activities.

15. To support these actions, the FATF calls on the G20 to lead by example and

ensure they have implemented the revised FATF Standards and calls on all other jurisdictions to do the same. VIRTUAL ASSETS - FATF REPORT TO G20 ON SO-CALLED STABLECOINS 5

Introduction

16. In October 2019, the G20 asked the FATF to consider the AML/CFT issues

related to so-called stablecoins. In line with G20"s request, this report: a) describes what so-called stablecoins are (Section 1); b) describes the ML/TF risks associated with so-called stablecoins (Section 2); c) analyses how the revised FATF Standards apply to so-called stablecoins (Section 3); d) outlines potential residual ML/TF risks associated with so-called stablecoins (Section 4); and e) sets out the FATF"s next steps to ensure the ML/TF risks associated with so- called stablecoins are appropriately mitigated (Section 5).

17. The FATF is the inter-governmental body which sets international standards

to prevent money laundering, terrorist financing and the financing of the proliferation of weapons of mass destruction. The FATF has agreed that so-called stablecoins are covered by the revised FATF Standards as either virtual assets or traditional financial assets. 3 This followed revisions to the FATF Standards in June 2019 to explicitly apply

AML/CFT requirements

to virtual assets and virtual asset service providers (VASPs) (see Annex A).

18. So-called ‘stablecoins" purport to maintain a stable value relative to some

reference asset or assets. This term is not a distinct legal or regulatory classification for a type of asset and is instead primarily a marketing term. Accordingly, this document refers to them as ‘so-called stablecoins".

19. The G20 also mandated the FSB to examine the regulatory issues raised by so-

called stablecoins and asked the IMF to consider the macroeconomic implications. While this report is focused on AML/CFT issues, the FATF has worked closely with the FSB, the IMF and other standard-setting bodies in this analysis.

20. Like virtual assets more broadly, the FATF recognises that so-called

stablecoins have the potential to spur financial innovation and efficiency and improve financial inclusion. However, they also have the potential to be mis-used by criminals and terrorists for ML/TF purposes, particularly if a so-called stablecoin were to be mass-adopted on a global scale. To ensure these risks are mitigated, it is critical that jurisdictions implement the revised FATF Standards.

3 FATF, Money laundering risks from “stablecoins" and other emerging assets, October 2019

6 VIRTUAL ASSETS - FATF REPORT TO G20 ON SO-CALLED STABLECOINS

Section 1: So-called stablecoins

21. There is no commonly agreed definition of so-called stablecoins. The FSB

considers that so-called stablecoins are a type of crypto-asset 'that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets to other assets". 4

22. So-called stablecoins could be classified as virtual assets under the revised

FATF Standards. Virtual assets is the term the FATF uses to refer to crypto-assets and other digital assets that do not function as legal tender. 5

Depending on the design of

the so-called stablecoin, it may instead be classified as traditional financial asset (e.g. a security) under the revised FATF Standards or national regulations. As all so-called stablecoins are a type of either virtual or financial asset, they are covered by the revised FATF Standards. This is explained in more detail in Section 3.

23. As their name implies, the key distinguishing feature of so-called stablecoins

is that their value is meant to be stable relative to that of an underlying asset or benchmark. The value of a so-called stablecoin may be pegged, for instance, to the value of a fiat currency or a basket of assets that may include fiat currencies, digital currencies, investment securities, commodities and/or real estate. A so-called stablecoin may also employ algorithmic means to stabilise its market value.

24. The characteristics of so-called stablecoins can differ depending on their

underlying technology. They can be permissionless (where anyone can read and write to the underlying transaction ledger) or permissioned (where only selected entities can read and/or write to the transaction ledger). They can also be public (where anyone can use the transaction ledger for transactions) or private (where only selected entities can initiate transactions). Similarly, so-called stablecoins could be used by anyone (retail or general purpose) or used only by a limited set of actors, e.g. a selection of financial institutions (wholesale). 6

25. Some proposed so-called stablecoins have been sponsored by large

technology, telecommunications or financial firms and seem to have the potential for rapid scaling and mass-adoption. By contrast, so-called stablecoins which already exist have not been widely adopted so far. These proposed so-called stablecoins aspire to quickly reach widespread global adoption, by offering global payment arrangements that are purported to be faster, cheaper and more inclusive than present arrangements; and by leveraging the capital and customer-base of their backers through their integration into pre-existing communication platforms. For the purpose of this paper, these are referred to as so-called stablecoins with potential for mass-adoption. 7

26. So-called stablecoins are different from central bank digital currencies. The

revised FATF Standards explicitly exclude central bank digital currencies from the definition of virtual asset, because the revised FATF Standards cover and apply to central bank digital currencies similar to any other form of fiat currency issued by a central bank. Further information on central bank digital currencies is in Annex B.

4 FSB, Addressing the regulatory, supervisory and oversight challenges raised by “global stablecoin" arrangements: Consultative

document, April 2020

5 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 and other

financial assets that are already covered elsewhere in the FATF Recommendations.

6 BIS, Investigating the impact of global stablecoins

, October 2019, p. 1

7 These are sometimes referred to as ‘global stablecoins".

VIRTUAL ASSETS - FATF REPORT TO G20 ON SO-CALLED STABLECOINS 7

Section 2: ML/TF risks of so-called stablecoins

27. The FATF first assessed the potential ML/TF risks posed by virtual assets in

2014 and has since been closely monitoring the evolving risks in this space through

regular surveys issued to members of the FATF Global Network, which comprises the FATF, nine FATF-Style Regional Bodies and their respective members. 8

For the

purposes of this report, the FATF has also reviewed the current and potential ML/TF risks and vulnerabilities of so-called stablecoins specifically. It is important that ML/TF risks are analysed in an ongoing and forward-looking manner and are mitigated before so-called stablecoins are launched, particularly those with potential for mass-adoption that can be used for peer-to-peer transactions. It will be more difficult to mitigate risks of these products once they are launched.

28. As with the ML/TF risks posed by virtual assets more broadly, the FATF

identified anonymity, global reach and layering as being particular ML/TF vulnerabilities for so-called stablecoins. The degree to which these risks materialise depends on the features of the so-called stablecoin arrangement, the extent to which jurisdictions have implemented AML/CFT mitigating measures, and also, critically, on the extent to which there is mass-adoption of the so-called stablecoin. As set out above, certain so-called stablecoin proposals seem to have the potential for much greater adoption than pre-existing virtual assets.

29. While the FATF has concluded that stability of value, on its own, does not pose

a specific ML/TF risk, there may be ML/TF risks associated with the stabilisation mechanism specific to so-called stablecoins (e.g. by creating new mechanisms for market manipulation). Such risks remain theoretical at this point, but could be the subject of more detailed analysis in the future should they emerge.

Anonymity

30. Anonymity is a major potential ML/TF risk posed by virtual assets. Many

virtual assets have public, permissionless, and decentralised ledgers.

While the

transaction ledger may be accessible to the public, the ledger may not include any customer identification information. There may also not be any central administrator monitoring transactions. Other virtual assets are private and/or permissioned, with only a limited group of entities able to initiate transactions or view and verify the ledger. Some virtual assets, known as privacy coins or anonymity-enhanced coins,quotesdbs_dbs20.pdfusesText_26