FinCEN Guidance for Cryptocurrency Companies

FinCEN published guidance for all those involved with cryptocurrency on May 9th of 2019. We’ve encapsulated some of the main points of this 30-page statement while also offering a little food for thought as we move forward within the US regulatory environment.

What is the Financial Crimes Enforcement Network (FinCEN)?

As a bureau within the US Department of the Treasury, FinCEN maintains a database of financial transactions. They take that data and analyze it for law enforcement purposes. FinCEN’s mission is to safeguard the US financial system from illegal activities such as money laundering.

The data they handle also carries over as strategic information for other financial and law enforcement authorities to use. In a nutshell, FinCEN is tasked with the detection and deterrence of financial crimes.

The FinCEN Guidance on Cryptocurrencies

FinCEN’s Guidance is essentially an outline to provide direction to lawyers, blockchain companies and regulators. They, in turn, can interpret and utilize the guideline in creating and operating cryptocurrency-based businesses.

The main focus of this guidance was to identify which businesses were acting as money transmitters in a money services business. Additionally, FinCEN provided these guidelines so people can be aware of how Bank Secrecy Act (BSA) regulations surrounding money services businesses apply to digital assets, or convertible virtual currencies (CVCs), as they define them.

There are no new laws or rulings in this guidance. Instead, it is mainly an interpretation of previous laws and rulings so that they can be applied to virtual currencies. However, in the publication, FinCEN comes to several new conclusions about which crypto market participants are subject to Bank Secrecy Act regulations.

Key Concepts in the FinCEN Guidance

We’ll start by defining the key terminology and then move onto a summary of the guidance.

Bank Secrecy Act (BSA)

The Bank Secrecy Act (BSA) is America’s primary Anti-Money Laundering (AML) law. In recent years, it’s been amended to include provisions enabling it to act toward detecting, deterring, and disrupting terrorist financing organizations.

Money Services Business (MSB)

FinCEN issued a final rule (MSB Final Rule) in 2011 which defined a money service business as:

“…a person (…) wholly or in substantial part within the United States operating directly or through an agent, agency, branch, or office, who functions as, among other things, a “money transmitter.”

For the purposes of this guidance, this term does not include those entities already regulated, including banks or any persons or companies currently registered with the SEC or CFTC.

Money Transmitter

The guidance states that money transmitters accept currency (or value substituting for currency) from one person and transmit it to another person or location.

Probably the most important thing to remember as you continue reading is that money transmitters are a type of regulated money services business under the Bank Secrecy Act.  

Money Transmission Services

To qualify as a money transmission service, two criteria are considered. Either or both could cause a company to fall under money transmission services regulations:

  • The acceptance of currency, funds, or other value that substitutes for currency from one person; and,
  • The transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.

What is interesting here is the whole idea of money transmission and how the FinCEN Guidance is applying it to virtual currencies. Because, as Andreas Antonopoulos aptly put it in his video on the Five Pillars of Blockchain, virtual currencies are never being transmitted from place to place, as with fiat currency.

For example, a bank’s money transmission might involve a foreign wire that sends money from one bank to another. Or a fund manager might receive funds for a specific group’s pension. In both cases, the money is pretty clearly flowing from one place to another. Here it is easy to understand what money transmission is.

But what about with a peer to peer bitcoin trade? Or a BTC/LTC trade on a decentralized exchange? Where is the money located? Does it even have a location? Antonopoulos suggests that digital currencies like bitcoin are not in fact currency, they are information.

While FinCEN provided a guideline that may help crypto companies steer their operations and compliance, they may also do well to create new rulings and guidelines that better fit the quickly evolving virtual currency landscape.

Summarized points of interest

The 30-page guidance is full of legalese so we’ve tried to notch it down into some of the key points. Again, the FinCEN guidance is up for interpretation by each reader. While we’re certainly not lawyers or financial regulators, we’ve done our best to cover the basic points and the ramifications they might have on the crypto industry.

Using virtual currencies for goods and services

Despite what we mentioned earlier about money transmitting being a little fuzzy with cryptos, the guidance basically puts forth that money transmission happens in every crypto to crypto trade, except when using it for goods and services.

Again, things get a little confusing because as far as the IRS goes, all crypto trades, be it for investment purposes or purchases, are now considered taxable events. Hopefully, this guide will serve as an impetus to update the IRS tax rulings on virtual currencies.

Reminder to Money Transmitters

The guidelines included a reminder to those people and businesses who act as money transmitters. These entities must register with FinCEN’s Anti-Money Laundering compliance programs. As such, they would need to have the necessary staff and/or software to carry out the following:

  • Full compliance, including having a dedicated compliance officer
  • Internal controls
  • Independent testing
  • Employee training
  • Customer due diligence.

Essentially, if a company does not have control of a user’s funds, and it never touches the user’s fund, then it does not fall under the ‘money transmitter’ rule and so can continue without compliance.

2 Crypto business models that may continue unregulated

  • Hard wallets are not money transmitters. The reasoning is that the person maintains sole control of their funds at all times. Hard wallet providers never accept or transfer their customers’ virtual assets. A hosted wallet on the other hand, where custody of the virtual assets is in the hands of the host (or wallet provider), is a different story. These ‘wallets’ are considered money transmitters, even though some now offer offline or cold storage (as in hard wallets).
  • Decentralized finance platforms like decentralized exchanges (DEXes) or bitcoin lenders are not money transmitters according to FinCEN. That’s because they only host a forum where participants settle matched transactions themselves.
  • Mixers and tumblers on their own are not money transmitters. Instead, FinCEN views them as tools for users who want to anonymity with their transactions.  
  • Most retail crypto traders who trade virtual assets just for their own accounts and not on behalf of anyone else are investors and not money transmitters. (However, they may still fall under other guidelines such as for tracking capital gains and submitting to KYC (Know Your Customer regulations) on centralized crypto exchanges.)

P2P Exchangers

Crypto arbitrageurs and those engaging in peer-to-peer trading do fall under ‘money transmitter’ guidelines according to FinCEN. This seems quite confusing. Because platforms like LocalBitcoins would fall under the ‘money transmitter’ designation but they do not hold any of the users’ cryptocurrency.

“How will government differentiate between regulated “P2P exchangers” and unregulated traders legitimately arbitraging LocalBitcoins? If traders who buy and sell for their own accounts are mere investors, why can’t LocalBitcoins arbitrageurs be investors too?” –  Attorney, Jake Chervisky  

A different stance on coders

FinCEN does not believe that coders, open source or otherwise, are liable for what happens after their code is launched. This is true at least when it comes to money transmission.

Some obvious “Money Transmitters”

There were a few areas where it was easy to see why a certain entity would be a money transmitter. And FinCEN’s guideline aptly pointed them out. ICOs definitely fall under the guidance if they are selling tokens (which they all do) which are not securities and which they can retain, issue and redeem. Bitcoin ATMs are another example of entities that are pretty clearly acting in a way that transmits money. So they will fall under Bank Secrecy Act regulations according to this guidance.

FinCen Guidance has strange take on DApps

We covered earlier in the article how decentralized exchanges could be exempt from AML programs because they merely host a forum where participants settle their own matched transactions.

So why DApps would be considered money transmitters is a little mystifying. Like DEXes, they do not have an owner or operator, so no one is there holding that money in between two parties. And as Attorney Chervinsky questions, “How could a piece of software implement an AML compliance program?”

Yet the guidance clearly states that DApps must meet the same regulatory requirements as crypto ATM’s (page 18 of FinCEN Guidance). Perhaps future clarification will amend this point of dissension.

Bad news for privacy coins

Tumbling (or mixing) services on their own are not subject to compliance with the Bank Secrecy Act and AML rules. But privacy coin protocols like Monero, who are money transmitters in FinCEN’s eyes, are subject to the same regulatory obligations as ATM’s.

“In other words, a money transmitter cannot avoid its regulatory obligations because it chooses to provide money transmission services using anonymity-enhanced CVC.”  – FinCEN

It will be very intriguing to see how this plays out with hugely popular privacy coins. More and more people all over the world are getting a taste of financial freedom and privacy. And many of them are now considering these freedoms a right in the same sense that freedom of speech is a right.

In Conclusion

All in all, there does seem to be a glimmer of hope. This FinCEN Guidance did not proceed in setting up a legal infrastructure to enable the banning of cryptocurrencies in the US. Some level of understanding and a bit of leeway when it comes to decentralization are apparent. Up until now, we have not really seen this in the US cryptocurrency regulatory landscape.

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Also published on Medium.