Travel Rule: A Compliance Tool for a New Era of Financial Regulation

The Travel Rule is essentially aimed at increasing transaction transparency by linking blockchain transactions with real-world entities and identities, in order to better manage money laundering, terrorist financing, and counterparty risks associated with on-chain transactions.

The anonymous nature of blockchain has been exploited by criminals for financial crimes. In order to incorporate blockchain technology into the regulatory framework, regulatory agencies in various regions require relevant platforms to comply with basic regulatory principles, including KYC (Know Your Customer), market monitoring, and more. The Travel Rule further requires the identification of both parties in a transaction.

Before the 2019 Travel Rule regulatory guidelines were issued, virtual asset service providers (VASP) only needed to monitor their clients through KYC. When VASP sends a transaction to a counterparty, it is almost impossible to know the identity of the other party, increasing counterparty risk and the risk of involvement in illegal activities.

The Travel Rule stipulates that VASPs have the obligation to obtain, hold, and submit information regarding the originator and beneficiary related to virtual asset transfers, in order to identify suspicious transactions and take appropriate measures. These obligations must be fulfilled before initiating blockchain transactions, enabling us to prevent potential illegal or sanctioned transactions before they occur.

As digital assets and blockchain technology increasingly become an important part of the financial industry, global regulators believe it is necessary to strengthen regulatory requirements to improve the anti-money laundering and Compliance framework for industry participants. This is mainly due to three reasons: protecting consumers, reducing the risks of money laundering and terrorist financing, and enhancing companies' ability to manage counterparty risk.

The global adoption rate of the Travel Rule has significantly increased recently, especially leading in the Asia-Pacific region. The adoption rate in Europe, the Middle East, and Africa is also growing rapidly. This reflects the regulators' emphasis on Compliance and the industry's gradual acceptance of regulatory requirements.

The Travel Rule that Hong Kong is about to implement is similar to those in other jurisdictions, but there are several noteworthy features:

1. The scope of information collection varies depending on the transaction amount, and more information is required when it exceeds 8,000 HKD.

2. If the required Travel Rule information is not received, the VASP should request the sender to provide it, otherwise the business relationship may be terminated.

3. The Hong Kong Securities and Futures Commission provides detailed guidance on counterparty due diligence.

4. Require verification of ownership of self-custody wallets, especially when trading with high-risk accounts.

Despite the increasing global adoption rate, the implementation of the Travel Rule still faces challenges. The primary issue is the differing "sunrise periods," which complicates cross-jurisdictional cooperation. Currently, only 35 jurisdictions have passed relevant regulations, with about 13 actually enforcing them. This makes it difficult for Compliance VASPs to transact with non-compliant counterparts, potentially limiting their business scope.

Another challenge is the lack of interoperability between Travel Rule protocols, especially in closed networks. Resolving these issues will take time, but it is believed that with the coordinated advancement of global regulation, the Travel Rule will become an important tool for promoting the healthy development of the digital asset industry.