How Bitcoin is treated in the context of Anti-Money Laundering Regulation

Virtual Currency (VC) existed before Bitcoin but most of those attempts involved a centralized set up where the processing of payments and control over the currency reside ultimately under the control of some individual figure. Bitcoin operates differently because it’s based around peer-to-peer connections, similar to torrenting, which allow people to anonymously transmit Bitcoins. The Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) uses the term “de-centralized convertible virtual currency” to refer to VC like Bitcoin noting the lack of a central repository and the ability of users to obtain the currency on their own.[1] For Bitcoin this process of obtaining currency without engaging in transactions is called mining. Due to the ability to obtain Bitcoin without engaging in transactions FinCEN makes sure to distinguish between three groups of persons and businesses involved with bitcoin. The first of these groups is a user which is someone who “obtains virtual currency to purchase goods and services” and they are not considered to be money transmitting businesses. The second is an exchanger which is someone who exchanges virtual currency for “real currency, funds, or other virtual currency.” The third is an administrator which is someone who issues or redeems virtual currency. The second and third groups are considered by FinCEN to be money transmitting businesses.

When combating money laundering authorities mainly turn to two different charges, unlicensed operating of a money services business and money laundering. While those charges often overlap (as they do in much of the Silk Road prosecution) there are important differences, starting with that unlicensed money services business does not require the State to prove the defendant had an intent to promote or facilitate unlawful activity. 18 U.S.C. § 1965(a)(1)(A) This expands the reach of anti-money laundering legislation and allows authorities to go after businesses that engage in borderline activity even if when evidence they knew of the illicit transactions is sparse. For both charges a central element is that “funds”, “money”, or a “payment instrument” must be involved, while this might seem self-evident it becomes important because the contention of many defendants is that Bitcoin does not qualify for these definitions and thus not for regulation or sanction under anti-money laundering legislation. See United State v. Ulbricht, 31 F.Supp.3d 540 (S.D.N.Y. 2014); United States v. Murgio, 2016 WL 5107128 (S.D.N.Y. Sept. 19, 2016); Florida v. Espinoza, F14-2923 (Fla. 11th Cir. Ct. July 22, 2016) (https://www.scribd.com/document/322422269/Florida-v-Espinoza)

Two jurisdictions have considered this issue and come to opposite decisions. The District Court of the Southern District of New York, in multiple cases, has determined that Bitcoin does count as money or funds. See Ulbricht, 31 F.Supp.3d 540 (S.D.N.Y. 2014); United States v. Faiella, 39 F.Supp.3d 544 (S.D.N.Y. 2014); United States v. Budovsky, 2015 WL 5602853 (S.D.N.Y. Sept. 23, 2015); Murgio, 2016 WL 5107128 (S.D.N.Y. Sept. 19, 2016). The 11th Circuit Court of Florida has held that Bitcoin is not money and does not fall within Florida’s anti-money laundering legislation. Espinoza, F14-2923 (Fla. 11th Cir. Ct. July 22, 2016).

In Ulbrict the Southern District of New York the United States charged Ulbricht with violating a variety of laws including anti-money laundering legislation based upon his creation and administration of the Silk Road site which acted as a market for illicit goods and services. Ulbricht, 31 F.Supp. 3d at 547. All transactions that occurred on the Silk Road involved Bitcoin rather than more traditional currencies and so if the court agreed with the defendant that Bitcoin is not money than all of those transactions would be unreachable with anti-money laundering legislation. Id. 548. Ultimately the court reasoned that because Bitcoins carry value, act as a medium of exchange, can be exchanged for other currencies, and derive their value from their ability to pay for things they should be treated as money. Id. The court noted the conflict between the view of FinCEN regulations which treats Virtual Currencies like Bitcoin as money and the IRS which treats Bitcoins as property for tax purposes and decided that the IRS’s treatment is irrelevant by looking directly at the statute’s definitions. Id. at 569. The court particularly noted that the anti-money laundering statute was intended by Congress to be broad and able to adapt to new ways that alleged criminals find to wash the proceeds of criminal activity. Id. at 570.

In Espinoza the court dismissed the information against the defendant holding that Bitcoin does not fall within Florida’s money laundering state. Espinoza, F14-2923, slip op. at 5. The defendant was targeted by police because he advertised on localbitcoins.com that he was available for bitcoin trades 24 hours a day under the username “Michaelhack.” Id. at 2. The only suggestion that the defendant was involved in criminal activity was the police asking if he’d be interested in purchasing stolen credit card information so which he responded ambivalently. Id. The court explained that there was “unquestionably no evidence that the Defendant did anything wrong” in this case. Id. at 7. The court argued that Bitcoin did not count as money because of its highly volatility and deferred to the IRS’s treatment of Bitcoin as property rather than currency. Id. at 3, 6. The Southern District of New York in Murgio addressed the decision of the court in Espinoza and expressed their significant disagreement, arguing that even under Florida law Bitcoin acted sufficiently like money to qualify for anti-money laundering regulation. Murgio, 2016 WL 5107128 at *8.

The questions I have for all of you is: (1) Do you believe Bitcoin should fall under anti-money laundering regulations?

(2) What factors and characteristics of Bitcoin make you think it should or should not be considered “money”?

(3) How important is the IRS’s treatment of Bitcoin as property when other parts of the government attempts to treat Bitcoin as currency?

(4) Do you think the lack of criminal activity by the defendant contributed to the Espinoza court’s decision that Bitcoin was not money?

 

[1] https://www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf

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~ by kebowie on October 9, 2016.

9 Responses to “How Bitcoin is treated in the context of Anti-Money Laundering Regulation”

  1. The knowledge I had pertaining to what Bitcoin is, has been very limited. It blows my mind to find out that this virtual currency allows the people using it to be almost untraceable after completing a transaction online, if they so choose to be, leaving no historical records of the transaction behind. [1]. This almost resembles using cash in the “real world” to try and be untraceable. The potential for criminals to abuse this loophole on the internet is huge.

    This paragraph serves to answer both questions 1 and 2. I do believe Bitcoin should fall under anti-money laundering regulations. A bitcoin user is able to go through the three different stages of money laundering with this virtual currency. The three stages are 1) Placement – funds from illegal activity are co-mingled with the financial system; 2) Layering – conducting a transaction with the funds gained from illegal activity to make it difficult for anyone trying to identify the initial source of funds; and 3) Integration – when the funds are disbursed back to the money launderer in what appears to be a legitimate transaction. [2]. If a bitcoin user or exchanger can conduct such transactions and make virtual funds gained from illegal activity appear legitimate, then there is no reason that such virtual currency should be above the law. Especially when the virtual currency can be converted into “real” currency outside of the internet.

    I did find it interesting that Bitcoins are not backed by any government or central bank, yet they continue to carry so much value. [3]. If people around the world are able and willing to except Bitcoin rather than paper money or credit card swipes for their goods or services, then I cannot think of a good reason why Bitcoin should not be considered legitimate currency subject to the anti-money laundering regulations.

    Espinoza did not have a prior criminal history. [4]. His lack of a criminal history alongside the lack of criminal activity definitely contributed to the court’s decision that Bitcoin was not money. It is almost a sure thing that the whole story of what happened at the hotel room where Espinoza met the undercover detectives is not known. There is a possibility that they tried to pressure him into accepting the trade for the stolen credit card numbers they claimed to have; which may be why Espinoza wanted to meet them at a bank. [4]. Even though the court did the right thing by not finding Espinoza guilty, the court could have come up with a way to go around the lack of criminal activity portrayed by Espinoza and still find Bitcoin as constituting money. Had they been able to do so, Bitcoin would have been subject to anti-money laundering regulations in Florida.

    [1] https://bitcoinmagazine.com/articles/financial-action-task-force-issues-bitcoin-guidelines-warns-money-laundering-1435789628
    [2] https://www.protiviti.com/sites/default/files/united_states/insights/guide-to-us-aml-requirements-6thedition-protiviti_0.pdf
    [3] https://www.theguardian.com/technology/2016/jan/20/bitcoin-netherlands-arrests-cars-cash-ecstasy
    [4] https://news.bitcoin.com/laundering-case-bitcoin-legal-status/

  2. I think Bitcoin definitely needs to be applied to anti-money laundering laws. With Bitcoin using encryption and a decentralized platform, it seems it is pretty difficult to trace. Ulbricht from Silk Road was technically only caught because of his own mistake of leaking information about himself in a chatroom, otherwise the FBI wouldn’t have caught him. [1].

    I am still undecided on whether it should be treated as a currency because it is not consider legal tender within the United States. However, I do agree since it is used alot like money it should be applicable to anti-money laundering laws, security laws, etc. It would be a significant threat to our society if we let people get away with crime because it isn’t considered “real currency”.

    As far as the IRS’s treatment of Bitcoin as property, I think it makes sense from a tax standpoint. I think most likely in the future it will be have its own classification or some type of hybrid treatment in order to make it applicable to all laws relevant laws among the different agencies.

    You make a good point about the Espinoza decision and do think the ruling partially had to do with the lack of criminal activity. I feel like if Espinoza was involved with something like Silk Road, the judge might have not ruled the same way. However, I also think the ruling was a result of the lack of uniformity and the unfamiliarity across the country with how Bitcoin should be treated. I think the reason Bitcoin has not been clearly defined and more specific legislation has not been passed is because the courts and legislative branch are still familiarizing themselves with the technology and trying to figure out exactly what it is. As more legal issues arise a decision will have to be made.

    [1] http://www.cnn.com/2013/10/04/world/americas/silk-road-ross-ulbricht/

  3. I think we have long since reached the point where we must recognize Bitcoin as a currency. It’s inherent digital nature along with its fungibility and its increasing liquidity make it highly suitable for online marketplaces, where consumers have used Bitcoin to purchase goods and services. Since it has not yet expanded far beyond the internet, there has been a demand for exchanges convert Bitcoin to more mainstream currencies, and ultimately I believe this is what distinguishes Bitcoin from similar, non-currencies.

    I disagree with the court’s reasoning in Espinoza. There the court differentiated Bitcoin from cash by stressing that Bitcoin was not widely used, that it is not accepted by all merchants, and that its value fluctuates. [1]. However, the same can be said of Discover Card and Chuck E. Cheese tokens. A true “equivalence to money,” as the court seemed to be looking for, cannot be any more obvious than the fact that Bitcoin is already being exchanged for equivalent sums of money. At 8 PM, on October 10, each coin was worth approximately $ 618.68. [2].

    The court in Ulbricht however appeared to understand the importance of liquidity. There, the court’s reasoning was to the point: “Put simply, ‘Funds’ can be used to pay for things in the colloquial sense. Bitcoins can be either used directly to pay for certain things or can act as a medium of exchange and be converted into a currency which can pay for things…And they may be bought and sold using legal tender.” [3]. This is important when we consider that Bitcoin has become a popular tool for money laundering (in the strict sense) and it has the potential to become an even greater threat because of the difficulty in tracing Bitcoin transactions. [4]. This prompted the Financial Action Task Force, an independent intergovernmental organization, to write a 48-page report on the currency, with guidelines recommending that digital currency exchanges be regulated like all other money transfer businesses. [5].

    No matter how the I.R.S. categorizes Bitcoin for collecting tax revenue, the liquidity of Bitcoin and its use to hide transactions should be more than enough to qualify the currency as a form of money subject to regulation. Thus, Bitcoin should at least qualify under a statute covering unlicensed money transmitting business. In addition, the emergence of digital currency startups and the positive use of Bitcoin to cut transaction costs and promote micro transactions [6] should gently encourage courts to think twice before interpreting an overly narrow meaning to their state statutes.

    [1] State v. Espinoza at 5.
    [2] Google bitcoin to U.S. Dollars
    [3] Ulbricht, 31 F.Supp at 570.
    [4] https://bitcoinmagazine.com/articles/financial-action-task-force-issues-bitcoin-guidelines-warns-money-laundering-1435789628
    [5] Id.
    [6] Id. 

  4. 1. I do not believe that Bitcoin should fall under anti-money laundering regulations for the time being and my reasons for this opinion are many so I will simply touch on just a couple. First, I do not believe that it is right to count Bitcoin as money laundering while different regulatory bodies of the federal government have differing definitions for what Bitcoin is. The level of confusion this causes and/or could cause among the general population is immense and results in everyday people not really knowing whether their activity is illegal or not because their own government is sending them mixed signals. I do not believe that Bitcoin should be treated as currency when there is no real legitimacy lent it by having some form of value driving the currency itself. While Bitcoin as a currency may carry value, it is not supported by any real guarantee (indeed that fact has left many holding the bag when the government has confiscated sums of Bitcoins belonging to individuals). Lastly, there is a strong argument to be made that Bitcoin really is the trade of property based on a measure that is not supported like traditional currency and that criminal statutes prohibiting its possession are really banning something that amounts to property, not to legitimate laundering of legitimate money.
    2. I mentioned above my main reason for believing Bitcoin is not money, but rather property, and that is there is no real support of the currency by government or with some form of hard cash. The biggest fact that supports it being counted under money laundering statutes, in my mind, is that it is clearly used as currency or as a “currency-substitute” if you will. However, I do not believe the act of assigning something value and trading based on that value are enough to make Bitcoin an actual currency. It is also nearly unregulated which is peculiar to it, as most all currencies are regulated somehow.
    3. Extremely, in my eyes. Conflicting views of how currency should be treated coming from different agencies of the same government results in confusion among people about whether what they are doing is actually illegal. Additionally, the lack of regulation of Bitcoin in general means that some lay citizens again do not realize that what they are dabbling in may be illegal.
    4. Absolutely, surrounding factors in cases such as this always have some impact. The defendant was a sympathetic defendant, pure and simple. The lack of surrounding facts to negatively paint the issue of Bitcoin as a currency would certainly make it easier for any judge to rule in the defendant’s favor. His situation makes it clear how treating the use of Bitcoin as money laundering could be unfair and lead to many unnecessary and ethically questionable arrests and prosecutions.

  5. Bitcoin should be regulated to avoid money laundering. Clearly some people know how to use Bitcoin for illegal ventures like Mr. Faiella used it for the Silk Road and regulations need to attempt to prevent that from happening. There is no way to prevent money laundering 100% but at least having the regulations in place would tell people that they cannot use virtual currency for anything they want.

    I agree with the court in Ulbricht. Bitcoin should be considered a currency and not a commodity because of how it is used. It is used in exchange for goods and services, it is used in exchange for other currencies, and there is a distinct exchange rate to convert it. Since it has such a widespread across the world from the US to the Netherlands, there needs to be some sort of regulation that keeps it from getting too far out of hand. Whether users use it in a criminal capacity or not, a lack of regulation makes it much more likely that people can find loopholes and backdoors to hide their criminal tracks.

    I think it would be difficult to regulate an online currency and it might take the world to come to some sort of agreement about it. The internet reaches everyone and if virtual currency can be bought and sold in a matter of seconds from across the world, there needs to be some kind of plan to make sure it is kept within reasonable and acceptable standards. If Bitcoin is not held to a certain standard than other virtual currencies will be developed to compete against it and then it will be even harder to reign in two virtual currencies rather than just starting with Bitcoin and sending the message to all other potential virtual currency creators.

  6. I do believe that Bitcoin should fall under anti-money laundering regulations. I agree with the Southern District of New York and the idea that Congress intended for the anti-money laundering statute to be broad and able to adapt to new ways that alleged criminals try to launder funds received as a result of criminal activity. The use of Bitcoin has been linked to an abundance of illegal activity due to the ability of users to trade in Bitcoin anonymously and without having to deal with the same regulation as they would if they were using traditional currency. Not allowing Bitcoin transactions to fall under anti-money laundering statutes provides a simple way for criminals to launder money without having to worry about government regulation.

    I think there are many characteristics of Bitcoin that should lead courts to recognize it as “money”. First I think the value of the Bitcoins, and the factors used to determine the value of the Bitcoins make a strong case that Bitcoin should be considered “money”. Bitcoin’s value like all other currencies, is determined by the confidence the user has in the value of the currency. Bitcoins are currently have significant value and can be used to legally purchase goods or services online. Next I think the way in which Bitcoin is traded should lead courts to classify it as “money”. Bitcoin can be traded online for goods and services just like any other currency.

    Due to many other characteristics pointing towards Bitcoin fitting the definition of “money” in anti-money laundering statutes, I do not believe the IRS’s treatment of Bitcoin as property is important when other parts of the government attempt to treat Bitcoin as currency. Since Bitcoin is used in illegal activity as a form of currency the IRS’s treatment of Bitcoin as property should be over ruled by anti-money laundering statutes.

    I do believe that the lack of criminal activity in the Espinoza case led the court to rule that Bitcoin was not “money”. Since there was no criminal activity there was no reason for the anti-money laundering statutes to over rule the way other government agencies have classified Bitcoin. Since the anti-money laundering statute did not apply the court decided to follow the IRS’s classification of Bitcoin as property.

  7. In general, I would tend to agree with the Ulbricht analysis that Bitcoin is a currency and falls under anti-money laundering regulations. As you summarized the court’s explanation, “Bitcoins carry value, act as a medium of exchange, can be exchanged for other currencies, and derive their value from their ability to pay for things they should be treated as money.” In essence, it’s the old duck test: if it walks like a duck, and talks like a duck, it’s a duck. Here, Bitcoin can be spent like money, exchanged for other types of money, and has value in the same way that money has value, so it is money. Furthermore, considering Congress intended for the anti-money laundering statute to have a broad interpretation in order to reach new ways in which criminal proceeds are laundered, it seems just to apply those statutes to Bitcoin which is a new way in which criminal proceeds are laundered.

    I wonder whether the facts of Espinoza are the reason the court reached a different outcome. It’s a serious charge, but I do wonder whether the judges were acting as a jury? It appears to me that the fact that the defendant in Espinoza did not come anywhere near the level of criminal intent or act that the defendant in Ulbricht did, the court reasoned in his favor. It would be interesting to see if they would be willing to apply the same analysis in a case where there was clearer and/or more evidence that the defendant was engaged in illicit conduct outside of the money laundering.

  8. I believe that the answer to the first question depends highly upon whether one believes that Bitcoin should be treated as actual currency. Personally, I am of the opinion that Bitcoin should be treated like currently. As such, I do believe that Bitcoin should fall under anti-money laundering regulations. If bitcoins are operating like money, then they should fall under the regulations involving money.

    I think that the court in Ulbrict hit on the right factors when they decided that Bitcoin should be treated as currency, or money. Namely, because Bitcoins carry value, act as a medium of exchange, can be exchanged for other currencies, and derive their value from their ability to pay for things. Paper currency carries value, acts as a medium of exchange, can be exchanged for other currencies, and derives its value from its ability to pay for things. Therefore, there does not seem to be anything distinguishing paper currency from virtual currency other than the medium through which it originates and is used.

    Although I do believe that, for the sake of consistency, Bitcoins should be treated the same by all governmental agencies, I am unsure as to whether I would make the claim that the IRS should treat it like money. I just think that it really opens up a very complex can of worms. Does this mean that people need to start claiming Bitcoin as part of their federal income tax? What if the government starts paying people their tax refunds in Bitcoins? I think this just makes things way too complicated and really muddies the waters.

    I agree that the lack of criminal activity by the defendant contributed to the Espinoza court’s decision that Bitcoin was not money. Had there been evidence of actual criminal activity, I am fully convinced that the court would have found a way to justify how Bitcoin was money in order to indict the defendant.

  9. #1 & 2 – I believe Bitcoin should fall under anti-money laundering regulations because as the Court reasoned in Ulbrict, Bitcoin carries value, acts as a medium of exchange, can be exchanged for other currencies, and derives its value from its ability to pay for things that should be treated as money. The Court also noted that the anti-money laundering statute was intended by Congress to be broad and able to adapt to new ways that alleged criminals find to wash the proceeds of criminal activity. Bitcoin, being a nontraditional form of currency has a great potential to be manipulated in such a way to disguise criminal activity. Virtual currency is gaining more and more popularity because it is an inexpensive and flexible method of payment and way to move money. When the anti-money laundering regulations were originally created, the framers could not have predicted all the ways and forms in which currency could manifest itself. However, the regulations were created in such a way to grow with the changing times and embrace new developments like virtual currencies; it’s similar to how traditional rules of evidence have evolved to include the use of evidence from social media platforms. In my opinion, virtual currency is basically money in a different format and should be regulated just like traditional forms of money.

    #3 – I think there needs to be consistency between FinCEN and the IRS’s treatment of virtual currency. It obviously provides a source of conflict for regulators. The IRS treats Bitcoin as property for tax purposes while everyone else treats Bitcoin as currency. I don’t think it’s very important that IRS treats Bitcoin differently because they’re just one agency. In the traditional sense, Bitcoin can be viewed as property but the fact that it acts and functions like money (carries value, acts as a medium of exchange, can be exchanged for other currencies) means that it should be regulated like money for anti-money laundering purposes.

    #4 Yes, I think that played a huge role in the Espinoza Court’s decision that Bitcoin was not money. The Court even said that there was unquestionably no evidence that the defendant did anything wrong. The point of an anti-money laundering regulation is to prevent criminals from cleaning the proceeds of criminal activity. The presence of criminal activity is a major component. If there’s no evidence of criminal activity then it’s more likely that the proceeds came from an actual legitimate source and you can’t criminalize that. I think that if the facts were different and there was evidence of criminal activity, the decision would have mirrored the decision in Ulbrict.

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