Virtual Currency and Bitcoin

How to manage your virtual currency compliance and licensing programs

On March 18, 2013, FinCEN issued Guidance on Virtual Currencies and Regulatory Responsibilities. This was followed by multiple high-profile legal actions, seizures and regulatory outreaches to virtual currency companies, which has led to a heavy focus in news media and compliance pundits on the future (or lack thereof) of virtual currency, particularly Bitcoin.

While the compliance risks associated with virtual currency are real, and potential and actual money laundering activity through these systems is undoubtedly present, virtual currencies are not going away. It is essential for consumer protection and key anti-money laundering outcomes to create legitimate ways to use the advantages of these payment systems. And, if you are prepared to stick your toe in the water and transaction test one of these systems, you will see just how clear and transparent they can be.

Recent Events

FinCEN’s ruling in March has been followed by additional excitement in the virtual currency world:

On May 14th, 2013, Homeland Security seized a single account for Dwolla that was used in a payments flow for MtGox (a Bitcoin exchange). The seizure was based on MtGox’s failure to register in the U.S. as a money transmitter with FinCEN, and involved a ‘Confidential Informant’ who provided information that law enforcement later corroborated. Filing a FinCEN registration is a very simple process and can be done electronically and immediately — this case has a very small scope and implication of wrongdoing: it served as a “shot across the bow”.

More recently, on May 27th, 2013, Liberty Reserve (a private virtual currency exchange) was shut down by a number of cooperating law enforcement agencies, and its founder was arrested on charges of money laundering. Transaction testing revealed that there were no controls on identification of users of the system, and no controls for blatant illegal use. The indictment indicated that the activity through Liberty Reserve was “overwhelmingly criminal in nature”. Liberty Reserve is not the best example for the thrust of this article – it appears to be the quintessential shady techno-Hawala (and thanks to due process, time will tell). The important part here is how diverse the virtual currency market is – Liberty Reserve is nothing like Bitcoin, and Bitcoin is nothing like e-gold.

What is ‘Virtual Currency’?

The definition of virtual currency is based upon it lacking one of three characteristics of ‘true’ currency: currency [1] “is designated as legal tender”, by a country as its “coin and paper money” [2] “circulates” and [3] “is customarily used and accepted as a medium of exchange in the country of issuance.” Virtual currency doesn’t meet criteria number one. So long as no country makes a given virtual currency its formal currency, transactions made with it can be effectively considered a money transmission activity. “Users” of these systems are not regulated, but “exchangers” and “administrators” (those in the business of exchanging or issuing virtual currency) are.

For the sake of compliance, virtual currency exchanges and administrators should be thought of like any money transmitter. In most cases, while the funds are held in a ‘virtual currency’ and may involve complex concepts such as cryptography (particularly in the case of Bitcoin), the user experience is the ultimate driver of compliance outcomes. Who uses it, how, and how funds might be laundered through such a system are generally quite simple to assess for legitimate exchanges and administrators. Just transaction test them: they are trying to sell the service to consumers, if you go to their website and can’t figure out how to buy one unit of what they’re selling – something is very wrong.

So, how do I manage my Virtual Currency compliance program?

Precisely as you would a money transmission compliance program! That’s what they are, after all… for now. Some of the user experiences are a lot like prepaid access, but for FinCEN purposes, it is definitely not that. I digress…

If you are a bank serving virtual currency customers, treat them as you would any money transmitter. Hold them to the same standards – they need to know their customers, have controls in place, designate a compliance officer, and must register as an MSB with FinCEN. Go down your MSB checklist. They need an anti-money laundering program, and they need to show you how it works (if it isn’t moving, it’s probably dead).

If you are a virtual currency exchange or administrator, develop the same things your bank is going to ask you for, above. Look at the requirements and check all the boxes, then put on your ‘criminal’ hat and try to play your own system. If you can, create a business-reasonable solution that keeps you from doing it tomorrow, and you’ve just demonstrated the efficacy of your ‘risk-based, transaction-tested’ compliance program. (Feel free to use those words, they will probably impress regulators if they’re true.)

Look at the strengths of your virtual currency, and pivot the weaknesses. Take Bitcoin for example: it has powerful cryptography – that cryptography does not make transactions anonymous, it makes it virtually impossible (outside user error) to steal, despite being available in a giant public record of all transactions ever (the “block chain” is publicly available, and has a record of every transaction). The anonymity is a byproduct, and a creative solution to that problem can net you one of the most transparent, safe means of processing a transaction available in the world today. Sell it to your regulators and your bank just like you sell it to your consumers.

FinCEN wants Bitcoin regulated, not destroyed – innovation is essential for our economy, and closing all of the exchanges down would just push them underground. The same is true of other virtual currencies: so long as they serve a true market need and not a wholly clandestine purpose – take the risks, and mitigate them properly.

State Licensing

While the feds have now weighed in quite heavily, state requirements for virtual currency money transmitters are as yet largely undefined. There are idiosyncrasies to each state and its potential applicability to a given virtual currency model. Even where it is clear that a state’s rules don’t apply, amendments to relevant regulations are likely to follow recent events, and soon.

Proactive movement toward state money transmission licensure is something all virtual currency providers should work towards promptly. Options available include:

Noah Payton, CAMS, is a financial services program manager with several years of experience in state licensing and creation of anti-money laundering compliance programs for money service businesses.


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