Web3 way of doing AML? (2 of 6)

The regulatory landscape for AML in Web3 is shaped by evolving global standards, jurisdiction-specific laws, and the complexities of enforcement. While the fundamental principles of AML remain unchanged, their application to decentralized financial ecosystems and virtual asset transactions has proven challenging. The absence of centralized oversight in many Web3 environments has created gaps, inconsistencies, and enforcement difficulties, raising concerns about the effectiveness of existing regulatory approaches.

FATF Guidelines on Virtual Assets and AML (2015–Present)

As the leading global authority on AML standards, the Financial Action Task Force (FATF) has played a crucial role in defining how virtual asset transactions should be regulated. Since its initial guidance in 2015, FATF has reinforced the principle that virtual assets should be subject to the same AML and Countering the Financing of Terrorism (CFT) obligations as traditional financial institutions. Over the years, FATF has revised its recommendations to keep pace with the evolving crypto landscape.

A significant milestone came in 2019, when FATF introduced the Travel Rule, requiring Virtual Asset Service Providers (VASPs) to collect and share customer information for transactions exceeding a certain threshold. However, a 2021 follow-up report revealed that compliance rates remained low, with only a handful of jurisdictions fully implementing the rule. In 2023, FATF issued further guidance, emphasizing the need for stronger enforcement and highlighting risks associated with Decentralized Finance (DeFi) and peer-to-peer (P2P) transactions, which often operate outside traditional compliance frameworks.

Despite these efforts, enforcement remains fragmented and inconsistent across jurisdictions. Many countries have been slow to adopt Travel Rule requirements, and DeFi platforms, which lack central intermediaries, remain largely unregulated. The challenge lies in applying centralized compliance models to decentralized ecosystems without compromising the core principles of Web3.

Regulatory Approaches by Major Jurisdictions

Different jurisdictions have taken varied approaches to AML compliance for virtual assets, reflecting divergent regulatory priorities, enforcement capabilities, and political stances on cryptocurrencies. While some governments have opted for strict licensing regimes, others have struggled to implement effective oversight.

In the United States, regulatory oversight is led by FinCEN (Financial Crimes Enforcement Network) and the Securities and Exchange Commission (SEC). FinCEN classifies crypto exchanges and wallet providers as Money Services Businesses (MSBs), requiring them to adhere to AML/KYC regulations. Meanwhile, the SEC has aggressively pursued enforcement actions, arguing that many tokens qualify as securities and should therefore be subject to existing financial regulations. However, enforcement has been inconsistent, with regulators focusing on high-profile cases rather than establishing clear compliance guidelines.

The European Union has taken a more structured approach with its Markets in Crypto-Assets (MiCA) Regulation, which introduces comprehensive licensing requirements for crypto service providers. Set to take effect in 2024, MiCA represents one of the most cohesive regulatory frameworks for virtual assets. However, it cannot directly regulate DeFi, which remains a loophole in AML enforcement.

In the United Kingdom, the Financial Conduct Authority (FCA) requires crypto firms to register and comply with stringent AML monitoring requirements. However, many crypto firms have struggled to meet these standards, leading to a wave of registration rejections. As a result, businesses have relocated offshore, weakening regulatory oversight rather than strengthening it.

Hong Kong has introduced a Virtual Asset Service Provider (VASP) licensing regime, ensuring that crypto exchanges comply with AML laws. While this move has increased regulatory clarity, the focus remains on centralized exchanges, with P2P and DeFi transactions remaining largely outside regulatory control.

Similarly, in Singapore, the Monetary Authority of Singapore (MAS) has implemented a strong AML framework for crypto firms. However, despite strict regulations, crypto-related financial crimes continue to occur, highlighting the inherent challenges of overseeing decentralized markets.

The Travel Rule and Its Implementation Challenges

The Travel Rule, introduced by FATF, mandates that VASPs must share sender and recipient information for transactions exceeding a specified threshold. While this rule was designed to bring greater transparency to crypto transactions, its implementation has been slow and inconsistent, creating major compliance gaps.

One of the key challenges is the lack of global standardization. Different countries have adopted varying reporting thresholds and enforcement timelines, making it difficult for crypto businesses operating internationally to comply with conflicting requirements. Technical barriers further complicate enforcement, as many crypto transactions via blockchains occur without centralized intermediaries, making data-sharing requirements difficult to implement. Additionally, DeFi and P2P transactions remain largely unaffected by the Travel Rule, as they do not rely on traditional VASP structures.

While the Travel Rule is an important step toward AML compliance, its effectiveness is limited unless regulators develop strategies to address DeFi transactions, P2P financial flows, and privacy-enhancing cryptocurrencies. Without comprehensive enforcement mechanisms, illicit actors can continue exploiting regulatory blind spots.

Challenges in Regulatory Harmonization Across Jurisdictions

One of the most significant obstacles in Web3 AML enforcement is the lack of regulatory harmonization across jurisdictions. Crypto markets operate globally, yet AML regulations differ widely from one country to another, creating compliance gaps that bad actors can exploit.

A major issue is regulatory arbitrage, where crypto firms relocate to jurisdictions with weaker oversight to bypass stricter AML requirements. Without globally aligned regulations, companies can shop for favorable regulatory environments, making enforcement efforts fragmented and ineffective.

Conflicting legal definitions further complicate compliance. Some countries classify cryptocurrencies as securities, others as commodities, and some as unregulated digital assets. These inconsistencies lead to legal uncertainties, making it difficult for businesses to navigate AML obligations and for regulators to coordinate enforcement actions.

Cross-border investigations are another challenge. Money laundering involving cryptocurrencies often spans multiple jurisdictions, requiring collaboration between regulatory authorities, law enforcement agencies, and financial intelligence units. However, due to jurisdictional limitations and differing legal frameworks, international cooperation remains slow and inefficient.

Without global regulatory alignment, AML measures in Web3 will continue to be patchy and ineffective. Governments must work together to develop cross-border enforcement mechanisms, standardized compliance rules, and shared intelligence databases to combat financial crime effectively.

The Need for a Balanced Approach

As regulatory frameworks evolve to address AML risks in Web3, significant enforcement gaps remain — particularly in DeFi, P2P transactions, and cross-border compliance. A balanced approach is needed — one that leverages blockchain’s transparency, integrates compliance solutions into decentralized ecosystems, and ensures that AML measures do not stifle innovation.

Policymakers must recognize that Web3 represents a fundamental shift in financial systems, requiring adaptable, technology-driven solutions rather than rigid, centralized regulations. By fostering collaboration between regulators, industry players, and blockchain developers, the financial system can move toward an AML framework that is both effective and compatible with the decentralized nature of Web3.