Virtual Currency and Anti-Money laundering Compliance

Last week we explored the timeline for the life of a bitcoin, from creation to transfer in exchange for goods or services. We identified multiple opportunities for crime to occur at each major stage in the life of the bitcoin. The one area which we reserved for this week was the issue of how digital currency impacts money laundering and in the opposite direction, how ant-money laundering regulations may impact the manufacture and use of virtual currencies such as Bitcoin.

Much has changed for digital currency in the regulatory environment over last 18 months. The first significant event came in March 2013, when FinCEN (Financial Crime Enforcement Network) issued guidance on how digital currency would be evaluated with respect to enforcement of the Bank Secrecy Act’s regulations on money laundering. At once we see that FinCEN has established terminology that it will use to differentiate virtual currency (“convertible” virtual currency) from “real currency,” as well as identifying what the agency believes to be the key participants in the system. The agency divides participants into users, administrators, and exchangers. FinCEN’s guidance covers centralized virtual currencies as well as de-centralized ones.

A “user” who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an “money services business (MSB)” (go to definitions in §1010 and scroll down to (ff)) under FinCEN’S regulations. The guidance about what is meant by “obtaining” virtual currency in fn 7 of page 2 , “obtaining” includes earning, harvesting mining, creating, auto-generating, manufacturing or purchasing. That is a pretty broad umbrella for “obtaining” and covers most of the terminology we have used in the class. The ruling states it is not how the person obtains the virtual currency but what they do with it and for whose benefit that governs whether the user has become a MSB.

The guidance establishes that FinCEN is primarily concerned with the “administrators” and “exchangers” and finds they do qualify as money services businesses, specifically money transmitters, under the regulations and must therefore comply with money laundering regulations. A business transmitting convertible virtual currencies would be subject to registration requirements and more importantly, establishing an anti-money laundering compliance program as well as reporting requirements for suspicious activities.

Since the Guidance was issued, many companies have requested rulings from FinCEN that they were not money services businesses and therefore exempt from the registration requirement. In January of this year FinCEN issued a ruling on whether miners were subject to BSA regulations. It reiterated its position from the Guidance that miners were included under “users” and thus not subject to the regulatory framework for MSB, however there was an interesting caution in the ruling. The ruling states it is not how the person obtains the virtual currency but what they do with it and for whose benefit that governs whether the user has become a MSB. However, a user, not otherwise considered an MSB, may have to scrutinize a transaction if at the behest of the sellers, the user has to transfer currency to third parties, as this may constitute money transmission, which would be subject to FinCEN regulations. This raises an interesting question about the decision PayPal made to use its partners to process digital currencies on its behalf. And in fact, a ruling was made just last week that appeared to be a petition from a third party payment processor arguing that it should not be considered a MSB. FinCEN ruled that the payment processer was a money transmitter and therefore a MSB. It will be interesting to see how PayPal handles that decision.

The more difficult regulatory environment is imposed upon “exchangers” and “administrators” if those administrators engage in money transmission. The government uses Liberty Reserve as the poster child for an “exchanger” that flagrantly violated the requirement to both register and meet the anti-money laundering compliance requirements.   In a Treasure Department, Notice of Findings, the government accused Liberty Reserve of using a “network of virtual currency exchangers to move funds. Follow the link, there’s an interesting flow chart in the write up. The company adopted an anti-money laundering policy, which met none of the requirements established by FinCEN and then it flouted even those policies. The action by Liberty Reserve demonstrated that the company knew it had obligations under BSA, but was intentionally disregarding them.

There has been quite a bit of press on the indictment of Silk Road and its owner Ross William Ulbicht. The prosecution of the owner of SiIk Road was not surprising in the least. The Federal government is not going to allow people to sell schedule I narcotics and openly flout the law. The majority of the indictment against Silk Road and Ulbricht is for the conspiracy and drug violations, as one would expect, but it does include one count which covers a money laundering conspiracy (Count 7).

The much more interesting cases to me were the prosecutions of two exchangers in the Silk Road network. Charlie Shrem, a founding member of the Bitcoin Foundation and CEO of BitInstant, an exchange for buying and selling Bitcoin, and Robert Faiella, a bitcoin seller, operating as BTCking seem to be the first two publically known casualties from the fall out over Ulbricht’s indictment. They were both charged with running an illegal money transmission business. Faiella was selling Bitcoin on Silk Road to drug dealers and Shrem knew it, or so the feds allege. In an ironic turn of fate as reported by WIRED, Shrem became aware of Faiella’s identity when he made a purchase by check instead of cash. Shrem banned him from BitInstant and Faiella threatened to go the feds to report BitInstant. Shrem then threatened to tell the feds Faiella was an unlicensed money exchanger. But evidently, the two contacted each other privately and agreed to work together. Ultimately Faiella pled to running an unlicensed money transmitting business and Shrem pled to aiding and abetting Faiella’s business.


I suspect FinCEN will be busy issuing rulings on the virtual currency regulations for the foreseeable future. The recent high profile Bitcoin has achieved may actually end up being its undoing. Will the virtual currency community still want to use Bitcoin if the Feds are watching?


~ by profjacobs on November 5, 2014.

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