United States: FinCEN Issues Convertible Virtual Currency Guidance And Advisory

On May 9, 2019, the Financial Crimes Enforcement Network ("FinCEN") issued a guidance, Application of FinCEN's Regulations to Certain Business Models Involving Convertible Virtual Currencies (CVC) ("Guidance"), together with an Advisory on Illicit Activity Involving Convertible Currency("Advisory"). The Guidance largely summarizes FinCEN's existing regulatory framework regarding the application of the Bank Secrecy Act ("BSA") to virtual currency activities. FinCEN applies that framework to a number of specific business models involving convertible virtual currency ("CVC"),1 including to CVC wallets and to "the issues most frequently raised by industry, law enforcement, and other regulatory bodies within this evolving financial environment." The Advisory warns financial institutions of the use by criminals and other bad actors of CVC schemes involving darknet marketplaces, P2P exchangers, foreign-located MSBs, and CVC kiosks. It also lists so-called "red flags" that may be associated with each typology. These red flags can assist in the detection and reporting of suspicious CVC activity by entities subject to the BSA.

FinCEN Guidance

The Guidance consolidates FinCEN's existing regulatory framework with respect to businesses engaged in the transmission of virtual currency and their obligations under the BSA. Under the BSA, money services businesses ("MSBs"), including persons providing money transmission services (a "money transmitter"),2 are required to maintain an anti-money laundering ("AML") program that includes: (1) policies, procedures, and internal controls; (2) a designated individual responsible for day-to-day compliance with the program; (3) training of appropriate personnel, including regarding the detection of suspicious transactions; and (4) a risk-based independent review function.3

FinCEN regulations define the term "money transmission services" to mean "the acceptance of currency, funds, or other value that substitutes for currency to another location or person by any means."4  FinCEN clarified in 2013 that this definition does not differentiate between CVC and real currencies.5 Thus, persons accepting and transferring CVC are generally deemed money services businesses under the BSA, unless an exemption applies. FinCEN's 2013 VC Guidance clarified that, unlike administrators and exchangers of CVC, mere users of CVC are generally not considered money transmitters.6

The Guidance explains how FinCEN applies its existing regulatory framework to seven categories of business models7 involving the transmission of CVC (so-called CVC business models):

  • P2P exchanges
  • CVC wallets
  • CVC kiosks
  • Decentralized applications ("DApps")
  • Anonymity-enhanced CVC transactions
  • Payment processing services
  • Internet casinos

The Guidance confirms that, under the existing FinCEN regulatory framework, these businesses may be considered money transmitters if they receive and transfer CVC. It illustrates the extent to which existing principles can be applied to emerging business models involving CVC.

The Guidance confirms that natural persons operating as P2P exchangers who engage in money transmission services involving either real currency or CVC must comply with the BSA as money transmitters, although a natural person engaging in this activity on an infrequent basis and not for profit is exempt from the scope of money transmission. With respect to payment processors, the Guidance notes that CVC payment processors fall within the definition of money transmitter, and are not eligible for the payment processor exemption because such businesses do not operate through clearing and settlement systems that only admit BSA-regulated financial institutions.8

In the case of service providers that accept and retransmit CVCs in a manner designed to prevent others from tracing the original source of the transmission (commonly referred to as "mixers" or "tumblers"), the Guidance refers to a 2007 administrative ruling concerning a company that provided an analogous anonymizing financial product to consumers making online purchases. In that 2007 ruling, FinCEN concluded that the so-called "integral exception" would not apply to such a business model.9 As confirmed by the Guidance, in order to be covered by the integral exception, "the person's business must be different from money transmission itself, and the money transmission must be necessary for the business to operate." Applying this reasoning to anonymizing CVC service providers, the Guidance affirms that a person who provides anonymizing services by accepting and transmitting value in a way to conceal the identity of the transmittor is a money transmitter under FinCEN regulations.

The Guidance also illustrates how existing frameworks may not be applicable to CVC business models.  For example, a 2007 FinCEN guidance10 providing that private ATMs do not meet the definition of a money transmitter in certain specific circumstances does not apply to the owner/operator of a CVC kiosk. Unlike private ATMs that come within this narrow exception, CVC kiosks do not link accountholders to their bank accounts. Owner/operators of CVC kiosks that accept and transmit value are money transmitters and must comply with FinCEN regulations.

Regarding CVC wallet providers, the Guidance explains that the regulatory treatment of a person that acts as an intermediary between the value and the owner of that value is not technology-dependent and depends on four criteria:

  • Who owns the value?
  • Where is the value stored?
  • Does the owner interact directly with the payment system on which the CVC runs?
  • Does the intermediary have complete independent control over the value?

The Guidance applies the foregoing criteria to hosted wallets, unhosted wallets, and multi-signature wallets, as follows:

  • Hosted Wallets:  The Guidance confirms that FinCEN considers hosted wallet providers to be money transmitters. These wallet providers generally interact with accountholders through a website or mobile application. They then receive, store, and transmit CVCs on behalf of the accountholders.  FinCEN explains that, with respect to such a business model, "the money transmitter is the host, the account is the wallet, and the accountholder is the wallet owner," and the specific regulatory obligations of the host, as money transmitter, would vary depending on the type of transactions that it facilitates and the nature of the wallet owner.11
  • Unhosted Wallets: Applying the criteria to unhosted wallets that do not require an additional third party to conduct transactions, FinCEN notes that: (a) the value is the property of the owner and is stored in a wallet; and (b) the owner interacts with the payment system directly and has complete control over the value. The person conducting the transaction through such an unhosted wallet is thus not a money transmitter, so long as they are conducting the transaction to purchase goods or services on the user's behalf.
  • Multiple-Signature Wallets: With respect to unhosted multiple-signature wallets, FinCEN explains: (a) the value belongs to the owner and is stored in the wallet; (b) the owner interacts with the wallet software or payment system to initiate the transaction and supplies part of the credentials that are required to access the stored value; and (c) the person that provides additional validation of the transaction at the request of the owner does not have total independent control over the value. In this case, so long as they limit their role to creating unhosted wallets that require a second authorization key, the wallet provider is not a money transmitter because they do not accept and transmit value.12

The Guidance concludes by discussing specific business models that may be exempt from the definition of money transmission, including certain CVC trading platforms and decentralized exchanges, and certain activities relating to initial coin offerings.

The Guidance indicates continued interest by FinCEN in evolving business models and activities relating to CVC. Note that last month FinCEN issued its first-ever civil money penalty against a P2P exchanger for violations of the BSA. In that action, P2P exchanger Eric Powers reportedly conducted over 1,700 transactions as an unregistered money transmitter, purchasing and selling virtual currency "by either physical delivering or receiving currency in person, sending or receiving currency through the mail, or coordinating transactions by wire through a depository institution." Powers' customers included parties doing business on the website Silk Road, a virtual location often associated with illegal activities.13

FinCEN Advisory

In the Advisory, FinCEN cautions financial institutions regarding how criminals and other bad actors exploit CVCs for illicit financing purposes and reminds financial institutions of their obligation to file suspicious activity reports ("SARs"), including with respect to suspicious activities involving CVC. The Advisory summarizes prominent typologies, lists common associated red flags, and identifies information that should be included in the filing of SARs relating to CVCs.

  • Darknet Marketplaces: FinCEN cautions that "the use of CVC in conjunction with darknet market activity may indicate drug purchases or sales, child exploitation, cybercrime, or other criminal activity," and that "detectable darknet marketplace linkages, such as through a customer's online behavior, may indicate CVC use in support of illicit activity."
  • P2P Exchangers: Citing a 2014 guidance concerning funnel accounts,14 the Advisory states that financial institutions may identify P2P exchangers through perceived funnel account activity and explains that "[f]inancial institutions may be able to distinguish P2P exchangers from traditional funnel account activity by identifying frequent interactions with CVC-focused MSBs."
  • Unregistered Foreign-located MSBs:  In the Advisory, FinCEN explains that foreign-located MSBs that do not comply with AML obligations are popular among illicit users of CVC that seek to move funds in and out of the United States and that those MSBs represent a significant money laundering vulnerability.
  • CVC Kiosks: The Advisory cautions that some CVC kiosk operators have "operated in ways that suggest a willful effort to evade BSA requirements" and "have assisted in structuring transactions, failing to collect and retain required customer identification information, or falsely represented the nature of their business[.]"

The Advisory includes thirty common red flags associated with these typologies and other CVC activity. It notes that some of these red flags may be observable during general transaction screening, while others may become apparent during transaction-specific reviews. The Advisory also cautions financial institutions to evaluate indicators of potential CVC misuse in combination with other red flags and expected transaction activity because some red flags may reflect legitimate financial activities.

The Advisory requests that financial institutions reference the Advisory when filing a SAR relating to possible illicit activity involving a CVC and include the following information:

  • virtual currency wallet addresses
  • account information
  • transaction details (including virtual currency transaction hash and information on the originator and the recipient)
  • relevant transaction history
  • available login information (including IP addresses)
  • mobile device information (such as device IMEI)
  • information obtained from analysis of the customer's public online profile and communications

Separately, the Advisory cautions U.S. individuals and institutions involved in digital currency use or transactions that they should be aware of their responsibilities to ensure that they do not engage in unauthorized transactions prohibited by OFAC.

Conclusion

Taken together, the Guidance and Advisory indicate that FinCEN views certain CVC activities as vulnerable to exploitation by criminals and other bad actors. Financial institutions and CVC businesses should consider the instructions and admonitions provided by FinCEN in the Guidance and Advisory and should examine their risk profile and BSA obligations in light of the same.  Businesses should also review and amend, if necessary, controls in place to ensure compliance with their respective OFAC compliance requirements.

Footnotes

1 In a 2013 guidance, FinCEN explained that "virtual currency" is a medium of exchange that operates like a currency in some environments but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction. CVC is a type of virtual currency that either has an equivalent value in real currency or acts as a substitute for real currency.  FIN-2013-G001, "Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies" (March 18, 2013) ("2013 VC Guidance").

2 31 C.F.R. 1010.100(ff)(5).

3 31 C.F.R. 1022.210(d).

4 31 C.F.R. 1010.100(ff)(5)(i)(A).

5 In the 2013 VC Guidance, FinCEN discussed the applicability of BSA requirements to administrators and exchangers under three scenarios: brokers and dealers of e-currencies and e-precious metals; centralized convertible virtual currencies; and de-centralized convertible virtual currencies.

6 The 2013 VC Guidance described an administrator as "a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency" and an exchanger as "a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency."

7 The Guidance emphasizes that it applies "only to the business model the guidance describes and may not apply to any other variety or combination of factors that falls under the same generic label."  In other words, the descriptive name of the activity does not matter; what matters is the substance of the activity.

8 See 31 C.F.R. 1010.100(ff)(5)(ii)(C); FIN-2014-R012 "Request for Administrative Ruling on the Application of FinCEN's Regulations to a Virtual Currency Payment System" (Oct. 27, 2014).

9 "If the funds transmission is removed from the Company's process, there is no consumer privacy interest to be protected by the Company's customer protection scheme. From FinCEN's perspective, therefore, the Company is engaged in the business of offering secure money transmission, rather than security to which money transmission is ancillary. The acceptance and transmission of funds by the Company is thus not integral to the execution and settlement of a transaction other than the funds transmission itself." FIN-2008-R007, "Whether a Certain Operation Protecting On-line Personal Financial Information is a Money Transmitter" (June 11, 2008). The Guidance also cites FIN-2014-R006, "Whether a Company that Provides Online Real-Time Deposit, Settlement, and Payment Services for Banks, Businesses and Consumers is a Money Transmitter" (April 29, 2014).

10 FIN-2007-G006, "Application of the Definitions of Money Services Business to Certain Owner-Operators of Automated Teller Machines Offering Limited Services" (December 3, 2007).

11 For example, if the wallet owner is a user, the host is required to identify and verify the user's identity. If the wallet owner is a financial institution other than an agent, the host must comply with regulatory obligations applicable to correspondent accounts or their MSB equivalents. Where the wallet owner is an agent of the host, the host must comply with requirements concerning a principal MSB's obligations to monitor the activities of its agent.

12 FinCEN notes that in variations of this model – such as where the value is represented as an entry on the accounts of the provider, the owner does not interact directly with the payment system, or the provider maintains total independent control over the value – the provider would qualify as a money transmitter.

13 For additional information regarding that enforcement action, please visit our April 26, 2019 Client Alert.

14 FIN-2014-A005, "Update on U.S. Currency Restriction in Mexico: Funnel Accounts and TBML" (May 28, 2014).

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions