Peer-to-peer Transactions in Crypto Explained in 5 Minutes

Peer-to-peer (P2P) transactions have always been at the heart of crypto. In fact, the very first Bitcoin transaction in 2009 was a direct transfer between two individuals, without any intermediary. 

Nowadays, P2P activity continues to play a significant role in the digital asset ecosystem, but from a compliance perspective, it poses unique risks and regulatory challenges.

Compliance professionals must understand how P2P works, what regulators say about it, and how to mitigate the risks. This article explores the topic, focusing on its implications for compliance teams at Virtual Asset Service Providers (VASPs) and financial institutions.

Peer-to-peer Transactions in Crypto Explained 

Peer-to-peer communication and interaction is a decentralised way of communicating and interacting. In this method, individuals in a network, called peers, can directly engage with each other without intermediaries or central authorities.

In digital asset transactions, this would include transfers between unknown counterparties, such as self-hosted wallets, where no regulated financial institution, like a VASP, is involved. 

With the FATF defining peer-to-peer transactions as “Virtual asset (VA) transfers conducted without the use or involvement of a VASP or other obliged entity (e.g., VA transfers between two unhosted wallets whose users are acting on their own behalf).” 

Peer-to-peer Transactions and the Travel Rule 

Due to their pseudonimity, peer-to-peer transactions are difficult to trace or monitor. Because of this caveat, many frameworks have excluded peer-to-peer transactions from their regulations.

For example, MiCA only regulates centralised entities; P2P transactions are excluded from its scope. Moreover, the TFR only applies to self-hosted wallets if at least 1 regulated entity is involved in the transaction.

Why Peer-to-peer Transactions Are Hard to Monitor

As no Travel Rule data is exchanged, nor are any KYC processes performed in peer-to-peer transactions, traditional transaction monitoring tools become less effective, as they rely on identifiable entities to assess risk. 

Additionally, due to the lack of Travel Rule data, sanctions screening becomes more complicated since wallet addresses may not appear on official lists yet, but still belong to restricted persons. 

However, there is a way around this for VASPs. When a VASP receives a request to withdraw from a self-hosted address, they are able to apply Travel Rule requirements* and glean additional information with the help of blockchain analytics tools.  

The same logic applies if an existing VASP customer transacts with a self-hosted wallet. Via blockchain analytics compliance teams can pinpoint who this previously unknown wallet address has transacted with, if the address is sanctioned, has been part of or made questionable transactions and the like. 

*Depending on the jurisdiction, this can include Travel Rule data and a wallet proof of ownership 

How Compliance Teams Can Face Peer-to-Peer Transactions 

With the help of blockchain analytics tools, risky wallet clusters, transactions linked to darknet markets and sanctioned entities can all be detected, and unusual transaction patterns can be flagged. 

On top of blockchain analytics tools, compliance teams can also apply more practical safeguards, for example, regular staff training sessions to ensure teams know what a red flag looks like and instil reporting obligations when suspicious activity is detected. 

Furthermore, compliance teams can also set internal limits for monitoring P2P activity, such as the volume and frequency of transactions related to certain addresses, and apply enhanced due diligence to these addresses in these instances. 

Take the Next Step 

Peer-to-peer crypto transactions are an integral part of the digital asset ecosystem. They enable legitimate self-custody and direct value transfer, but also create blind spots for regulators and compliance teams.

Compliance professionals need to stay informed and leverage appropriate technology; by doing so, they can be best prepared to handle these sorts of transactions. 

Did you know 21 Analytics’ Travel Rule solution comes with five already-built-in blockchain analytics providers, ensuring complete coverage for all transactions in and out of your exchange. 

Request a demo to see these tools working in real time.