Travel Rule: Enhancing the transparency and security of Crypto Assets transactions

The Travel Rule aims to increase the transparency of blockchain transactions by linking on-chain activities with real-world entities and identities, in order to better manage money laundering, terrorist financing, and counterparty risks.

The anonymity of blockchain has been widely used in financial crimes, such as terrorism financing and money laundering. In order to bring blockchain technology into the regulatory framework, regulatory authorities require relevant platforms to comply with basic principles, including "Know Your Customer" ( KYC ), market monitoring, and so on. The Travel Rule further requires knowing the identities of both parties in a transaction.

Before 2019, virtual asset service providers ( VASP ) only needed to conduct KYC for their own clients. This led to VASP being unable to understand the identity of counterparties when sending transactions to other platforms, increasing counterparty risk and the risk of illegal transactions.

The Travel Rule requires VASPs to obtain, retain, and submit necessary information about the sender and the recipient before initiating a blockchain transaction, in order to identify suspicious transactions and take appropriate actions. This allows for the prevention of potential illegal transactions before they enter the irreversible blockchain.

As digital assets and blockchain technology become increasingly important, global regulators believe it is necessary to strengthen oversight to improve the industry's anti-money laundering and compliance framework. There are mainly three reasons for this: protecting consumers, reducing the risks of money laundering and terrorist financing, and enhancing companies' ability to manage counterparty risks.

The Travel Rule is being adopted globally. The Asia-Pacific region is leading in adoption, with Singapore, Japan, and South Korea being the earliest adopters. Recently, the adoption rate has also significantly increased in Europe and the Middle East. Overall, the adoption rate of the Travel Rule has greatly increased over the past six months, with more and more exchanges either complying with or preparing to comply with this rule.

Hong Kong is set to require virtual asset service providers to comply with the Travel Rule starting June 1. Hong Kong's requirements are similar to those of other jurisdictions, but there are several characteristics:

1. The range of information that needs to be collected and shared varies depending on the transaction amount.
2. If the receiving VASP does not receive the required information, it should request the sending VASP to provide it, otherwise the business relationship may be terminated.
3. The Hong Kong Securities and Futures Commission has provided detailed guidance on how VASPs should conduct due diligence on trading counterparties.
4. The exchange needs to verify the ownership of the self-custodial wallet, as well as the ownership when trading with high-risk VASPs/accounts.

The Travel Rule faces some challenges during its implementation:

1. "Sunrise Period" issue: Different jurisdictions have varying regulatory timelines, making it difficult for compliant VASPs to collaborate with counterparties that have not yet implemented the Travel Rule.
2. The lack of interoperability between Travel Rule agreements is especially evident in closed networks.

Despite these challenges, the industry is working hard to address them, and it is believed that over time these issues will be resolved. The implementation of the Travel Rule will help improve the transparency and security of Crypto Assets transactions, driving the entire industry toward a more standardized and compliant direction.