The Estonian Parliament is currently discussing amendments to anti-money laundering laws. This mainly affects cryptocurrencies. At first glance, what the progressive country is up to sounds like a disaster – and a very unpleasant prospect for the rest of Europe. Or is it not eaten as hot as it was cooked?
Last autumn, the Estonian Ministry of Finance presented a draft for an extension of the law to combat money laundering and terrorist financing. At the end of December, the draft was passed on to Parliament, which will still vote on it. The amendment to the law will come into force in March 2022.
If approved, the Baltic country's crypto scene could face a hard landing. Because literally it is the strictest interpretation of the travel rule of the Financial Task Force (FATF) .
Stricter rules for VASPs
In the jargon of the FATF , the document is aimed at “Virtual Service Providers” (VASPs) operating in Estonia. So far, this has mainly included exchanges and wallets, which have required permission from the financial regulator since 2020. With the draft, the country is expanding the definition so that it also includes decentralized platforms, ICOs and some other service providers.
The details are interesting. Estonia will become the first country to formally make DeFi an object of regulation, and possibly wallet providers as well:
Even if an application is not a VASP per se, but “developers, owners, administrators and other people have an influence on the terms of use”, it is considered a VASP, “even if the delivery of the service is organized in a decentralized way and some processes are automated. “People who develop and sell software or technology that allows virtual currencies to be traded may beno VASP if their activity is limited to it. However, a party that directs the development of software or platform for the purpose of providing virtual currency services is considered a VASP, particularly if it retains control or influence over the virtual currency, software, protocol, platform or Business relationships, even if done through a smart contract.”
The rules with which the VASPs have to conform are to be significantly tightened in almost every respect. The license fee increases from 3,000 to 10,000 euros. To do this, the companies must show a capital contribution of 125,000 to 300,000 euros and pay a fee of 1 percent of the capital contribution and 0.035 percent of the transaction volume to the supervisory authority. It costs something to make life difficult for yourself.
Companies in Estonia have already had to submit certain information to the supervisory authority. The planned extension significantly increases the amount of information required. In addition, the extension formulates strict requirements for the supervisory board or management of a crypto startup and a long list of reasons why permission can be denied or revoked. One reason would be that a startup only registered in Estonia to avoid stricter regulation in another country.
Penalties for anonymous wallets
Above all, however, the draft is intended to implement the Travel Rule of the FATF. According to this, service providers who send a transaction for their customers must transmit data to the receiving service provider about the sender. Including name, date of birth, place of birth, postal address and ID card number of the sender.
The central concern of the travel rule is that this information accompanies the money on its journey. This rule has long applied to electronic fiat money such as euros or dollars, but is now to be applied to cryptocurrencies as well. The FATF “recommended” this some time ago. However, how this can be implemented in concrete terms is the problem of the national legislators and supervisory authorities.
They have to ask themselves numerous questions: What infrastructure should the service providers use? What do you do if the recipient is not on your network? And, above all: How do you prevent users from switching to their own private wallets without further ado, where the travel rule cannot apply? Because where a user uses his own wallet, there is no middleman involved and therefore no VASP, and where there is no VASP, there is no travel rule. Over the past year, the “self-hosted” wallets have given supervisors increasing headaches, from the EU to the US to the FATF itself .
The jurisdictions that have tried to implement the travel rule so far have approached the problem differently. Germany imposes obligations on companies and makes transfers to their own wallets a possible suspect case, while South Korea outright prohibits exchanges from paying out coins to such wallets.
In Estonia, the draft law defines penalties for breaking the rules. One of them is this: if someone opens or offers “an anonymous virtual currency account, savings account, wallet or wallet,” individuals will be fined up to €1,200, and businesses or other legal entities up to €400,000.
Estonia bans DeFi and Bitcoin
It is not difficult to interpret this draft in latently hysterical terms: Estonia bans DeFi because anyone who develops and operates a DeFi platform is likely to fall under the law without having a serious chance of meeting the conditions. Strictly speaking, even holders of large amounts of DeFi tokens have an obligation to promote the implementation of the rules if the governance tokens give them the right to do so.
But anyway, Estonians will no longer be allowed to use DeFi in the future. Because DeFi platforms are usually served with self-hosted – i.e. anonymous – wallets like Metamask. According to the draft, getting an account there will violate the rules from March and could result in a fine of 1,200 euros. It becomes more uncomfortable for software developers in Estonia who develop and co-operate such wallets, for example through a server that forwards transactions. You face a fine of 400,000 euros.
In short: Literally, Estonia bans DeFi and also Bitcoin.
But can this really be taken literally?
When crypto volume approaches gross domestic product
To judge that, you should first know what the intention of the design is. Estonia was one of the first countries in the world to issue licenses for VASPs back in 2017. The requirements were relatively mild, which is why there was a boom in applications. The country issued 599 licenses in 2018 and 1,234 in 2019.
However, Estonia has been under international pressure since 2018 at the latest. A financial scandal erupted earlier this year when it was revealed that the Estonian branch of Danske Bank had processed money-laundering transactions worth $200 billion. Since then, the regulator has been monitoring the financial system more closely - and is exercising more restraint in issuing licenses to crypto companies.
The sheer number of licenses already indicates that the crypto industry is rampant in Estonia. The crypto startups manage and send enormous sums of money, according to the Ministry of Finance, 18.5 billion euros between August 2020 and August 2021. This sum accounts for 40 percent of the Estonian banking industry's cross-border payments. For the country, in which 1.3 million inhabitants generated a gross domestic product of 23.7 billion euros in 2020, this volume "began to become a significant risk, also for the business environment in Estonia", according to the Ministry of Finance .
The start-ups are not exactly keen on regulation. Only 10 percent of them have an account in an Estonian bank, while 40 percent use financial institutions in Lithuania and 20 percent in the UK. Many of these companies have no direct connection with Estonia at all, the Ministry of Finance complains, and serve customers from all over the world, whether in Far Asia or South America. These circumstances do not make regulation easy.
In the future, the regulator should therefore require licensed VASPs to operate in Estonia or at least to have a verifiable connection to the country. The strict rules may also act as a deterrent to break the flood of license applicants and relieve supervision. The Treasury behaves like a market player: when the demand for regulation exceeds the capacity of supervision, they raise prices.
The Ministry of Finance reassured
After Parliament's vote sparked significant fears in the crypto industry, the Treasury is now attempting to calm tempers. In a statement, it said that while it is tightening regulation for crypto businesses, it has "no intentions to make cryptocurrency ownership illegal, as has been falsely claimed on social media."
The Ministry of Finance also rules out a ban on private wallets. "The new rules do not apply to consumers or private wallets that are not offered through a VASP from Estonia." -law of Estonia.”
The Treasury Department asserts that lawmakers do not intend to take any action “to prohibit consumers from owning and trading virtual assets” and that they should not be required in any way “to share the private keys of their wallets. Individuals are still free to use non-escrow wallets.” So far, Estonians can breathe easy.
VASPs from Estonia, however, are prohibited from offering and probably using anonymous accounts or wallets. Every crypto service provider from Estonia must verify the people behind an account and, when they receive or send a transaction, collect and share information about that transfer. However, the Ministry of Finance is aware that “not all jurisdictions have already implemented this rule for all service providers, and wallets or transactions do not always have a counterparty who can receive this information.” Therefore, the planned law allows VASPs to receive money from freelancers Receive or send to wallets. To do this, however, the service providers must carry out real-time analyses.
This already sounds a lot better. What is particularly pleasant is that Estonia is very clear about the conditions under which exchanges can continue to make transfers to private wallets. Read like this, Estonia is not implementing the travel rule the strictest, but the most moderate.
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