WSGR ALERT

Virtual Currency Guidance + Enforcement Actions = AML Regulators Are Watching1

May 28, 2019

Introduction

A few days before thousands of blockchain industry participants poured into New York for “Blockchain Week,” the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued guidance on virtual currencies and anti-money laundering rules.2 The guidance was not the only warning about the importance of anti-money laundering compliance. It probably was not a coincidence that the guidance came shortly after two recent enforcement actions for failure of two different virtual currency exchangers to comply with anti-money laundering rules. FinCEN initiated one enforcement action, and the Department of Justice (DOJ) initiated the other, with the latter resulting in imprisonment for two years and forfeiture of $823,357.3

In case there was any doubt about the compliance-is-important message, that message was reiterated on the first day of Blockchain Week by Sigal Mandelker, the Department of Treasury’s Under Secretary for Terrorism and Financial Intelligence. If an individual or entity engages as a business in virtual currency transmission, she said, then that individual or entity generally (absent a specific exception) must 1) register with FinCEN as a money services business; 2) develop, implement, and maintain an anti-money laundering program designed to prevent funds from being used to facilitate money laundering and terrorist financing; and 3) establish recordkeeping and reporting measures that cover filing Suspicious Activity Reports and Currency Transaction Reports.4

FinCEN 2019 Guidance

These requirements have remained true since 2011, when FinCEN issued its final rule defining a money services business to include, among other things, “a person wherever located doing business, whether or not on a regular basis or as an organized or licensed business concern, wholly or in substantial part within the United States,” who functions as a “money transmitter,” i.e., a person who provides money transmission services or engages in the transfer of funds.5 However, it was not until FinCEN issued guidance in 2013 that the blockchain industry was formally put on notice that FinCEN’s 2011 rule applies equally to individuals and entities providing virtual currency transmission services or engaging in transfers of virtual currencies.6

The 2013 guidance set forth two categories of these individuals or entities that FinCEN would consider to be money services businesses: “administrators” or “exchangers.”7 An “administrator” is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (or withdraw from circulation) that virtual currency, while an “exchanger” is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.

In the new FinCEN 2019 guidance, after summarizing FinCEN’s existing legal framework for virtual currencies, FinCEN then explained how it applies that framework to a number of virtual currency business models. Frequently emphasizing the fact-specific nature of the determination as to whether an individual or entity is or a money services business, FinCEN indicated that the following are among the types of businesses that generally do need to register as money services businesses:

  • peer-to-peer (P2P) exchangers;8
  • hosted digital wallet providers;9
  • anonymizing services providers;10
  • payment processors of virtual currencies;11
  • virtual currency exchanges that automatically match buyers and sellers;12
  • mining pools that host digital wallets;13 and
  • decentralized applications (dApps) that accept and transmit fiat or virtual currency.14

FinCEN also explained how it applies its legal framework to a number of virtual currency business models that generally do not need to register as money services businesses. Again, emphasizing the fact-specific nature of the determination as to whether an individual or entity is or is not a money services business, FinCEN indicated that the following types of businesses often are not:

  • unhosted digital wallet providers;15
  • anonymizing software providers;16
  • P2P virtual currency trading platforms that only allow buyers and sellers to find one another;17
  • mining pools that do not host digital wallets;18 and
  • dApps that do not accept or transmit fiat or virtual currency or that can rely on an exemption from registration as money services businesses.19

FinCEN reiterated throughout its guidance that, not only is the regulatory inquiry fact-specific, but also the business’ categorization may be subject to change if the activities of the business change or the features of the business’ products change.

Participants in the blockchain industry that are thinking of forming or are currently running businesses that fall within one or more of the business models above should carefully review FinCEN’s guidance.20 They should also remember that FinCEN will always look to the actual activities that an individual or entity is engaged in. Any departure from the specific activities that FinCEN described in its guidance could alter that individual’s or entity’s status as a money services business.

Recent Actions by Federal Anti-Money Laundering Regulators

Before FinCEN released its recent guidance, the DOJ brought an action against Jacob Burrell Campos (Mr. Burrell).21 The DOJ’s action against Mr. Burrell, for operating an unlicensed money transmitting business, resulted in a sentence of two years in prison and forfeiture of $823,357 in illicit profits.22 Separately, FinCEN brought another action against Eric Powers (Mr. Powers).23 Mr. Powers had a $35,350 civil money penalty assessed against him for failing to register as a money services business and comply with applicable anti-money laundering obligations.24 These actions highlight the risk to individuals and businesses transmitting virtual currency without regard to anti-money laundering laws.

As noted in FinCEN’s new guidance, P2P exchangers, like Mr. Burrell and Mr. Powers, generally provide services that, in most instances, qualify as “money transmission services,” i.e., the acceptance of funds from one person and the transmission of funds to another location or person by any means.25 Both Mr. Burrell and Mr. Powers engaged as businesses in providing money transmission services to others, and both failed to register with FinCEN as a money services business and comply with anti-money laundering obligations applicable to money services businesses, as described below.

  • Story of Mr. Burrell: From late 2016 to early 2018, Mr. Burrell sold hundreds of thousands of Bitcoin to thousands of customers in the United States. He advertised his business on Localbitcoins.com, communicated with clients through email and text messaging (including through encrypted means), and charged a five percent commission per transmission above the prevailing exchange rate for Bitcoin to U.S. dollar. Mr. Burrell would accept a client’s fiat currency “with no questions asked” in person, through nationwide ATMs and through MoneyGram. In operating his business, Mr. Burrell also facilitated the transmission of over $1 million in U.S. dollars into the United States from Mexico in increments small enough to avoid currency reporting requirements.
  • Story of Mr. Powers: From December 2012 to September 2014, Mr. Powers similarly conducted close to 2,000 transactions as a money services business, purchasing and selling Bitcoin to and from others. He posted about his services on bitcointalk.org and bitcoin-otc.com, had Bitcoin wallet addresses associated with over a hundred transactions with clients doing business on Silk Road,26 and had clients using The Onion Router (TOR), a method to access the darknet through an anonymizing torrent service that conceals a user’s location and identity.27 Mr. Powers would physically deliver or receive fiat currency in person, through the mail or by wire through depository institutions. He also held himself out as willing to transact on crypto exchanges on behalf of others.

Neither Mr. Burrell nor Mr. Powers ever registered with FinCEN as a money services business, adopted an anti-money laundering compliance program or performed any “know-your-customer,” anti-money laundering or other checks on clients or the source of their funds.

Conclusion

It is no secret at this point that the federal anti-money laundering regulators will treat individuals or entities transmitting virtual currencies in the same manner as individuals transmitting fiat currencies.28 The Special Agent in Charge for Homeland Security Investigations in San Diego echoed FinCEN’s guidance, stating during the sentencing of Mr. Burrell that anti-money laundering laws “apply to crypto currency dealings just as they do to other types of financial transactions.”29 FinCEN’s latest guidance and these recent actions indicate that both the DOJ and FinCEN are putting resources behind their words and enforcing anti-money laundering laws that apply money services businesses.30

If any individual or entity is engaged as a business in providing money transmission services to others, whether the funds transmitted are virtual currencies or fiat currencies, then that individual or entity must register with FinCEN as a money services business (unless a specific exception applies), and must also comply with other applicable anti-money laundering obligations. We expect to see more individuals and businesses that transmit virtual currencies caught in similar enforcement actions until anti-money laundering compliance becomes more common in the virtual currency industry. This is especially so in light of FinCEN’s continued efforts, evidenced by its recent guidance, to inform the blockchain industry about various business models that require money services business registration.


1For more information on AML regulations, please contact Stephen Heifetz or Julie Krosnicki; and for information regarding virtual currency regulations more broadly, please contact Rob Rosenblum, Amy Caiazza, or any member of the blockchain and cryptocurrency practices at Wilson Sonsini Goodrich & Rosati.
2FinCEN Guidance: Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies, FinCEN FIN-2019-G001 (May 9, 2019) [hereinafter, 2019 guidance], https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf.
3 See News Release Summary, Bitcoin Dealer Indicted on Money Laundering Charges; Held without Bond, Dep’t Justice (Aug. 17, 2018) [hereinafter, Burrell Indictment:  DOJ Press Release], https://www.justice.gov/usao-sdca/pr/bitcoin-dealer-indicted-money-laundering-charges-held-without-bond; News Release Summary, Bitcoin Dealer Pleads Guilty & Agrees to Forfeit Ill-Gotten Gains, Dep’t Justice (Oct. 29, 2018) [hereinafter, Burrell Pleads Guilty:  DOJ Press Release], https://www.justice.gov/usao-sdca/pr/bitcoin-dealer-pleads-guilty-agrees-forfeit-ill-gotten-gains; News Release Summary, Bitcoin Dealer Sentenced to Two Years in Prison and Ordered to Forfeit Ill-Gotten Gains, Dep’t Justice (Apr. 8, 2019) [hereinafter, Burrell Sentencing: DOJ Press Release], https://www.justice.gov/usao-sdca/pr/bitcoin-dealer-sentenced-two-years-prison-and-ordered-forfeit-ill-gotten-gains; News Release, FinCEN Penalizes Peer-to-Peer Virtual Currency Exchanger for Violations of Anti-Money Laundering Laws, FinCEN (Apr. 18, 2019) [hereinafter, Powers: FinCEN Press Release], https://www.fincen.gov/news/news-releases/fincen-penalizes-peer-peer-virtual-currency-exchanger-violations-anti-money; In the Matter of Eric Powers, Assessment of Civil Money Penalty:  No. 2019-01, FinCEN (Apr. 18, 2019) [hereinafter, Powers:  FinCEN Assessment], https://www.fincen.gov/sites/default/files/enforcement_action/2019-04-18/Assessment%20Eric%20Powers%20Final%20for%20Posting%2004.18.19_1.pdf.
4 See Remarks of Sigal Mandelker, Under Secretary for Terrorism and Financial Intelligence, FinCEN: Statements & Remarks (May 13, 2019), https://home.treasury.gov/news/press-releases/sm687.
5 BSA Regulations—Definitions and Other Regulations Relating to Money Services Businesses, 76 F.R. 53585 (July 21, 2011), https://www.govinfo.gov/content/pkg/FR-2011-07-21/pdf/FR-2011-07-21.pdf.
6 See Applications of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, FinCEN (FIN-2013-G001) (Mar. 18, 2013) [hereinafter, 2013 guidance], https://www.fincen.gov/resources/statutes-regulations/guidance/application-fincens-regulations-persons-administering.
7 See 2013 guidance, note 6.
8 P2P exchangersare typically individuals who buy and sell virtual currencies on behalf of others. They generally facilitate transfers from one virtual currency to another type of virtual or fiat currency (sometimes called “real currency”). If an individual operates as a P2P exchanger, engaging in money transmission services involving virtual or fiat currency, then it generally is a money services business and must have an anti-money laundering program in place. See 2019 guidance, note 2.
9 Digital walletsare interfaces for storing and transferring virtual currencies, which can vary greatly in design. Hosted digital wallets are fully digital and always online, and the hosts or providers of these digital wallets must typically register with FinCEN as money services businesses, as the hosts or providers receive, store, and transmit virtual currencies on behalf of digital wallet holders. See 2019 guidance, note 2.
The status of the developer or provider of a digital wallet will vary, however, based on the technology employed and depends on: 1) who owns the virtual currencies; 2) where the virtual currencies are stored; 3) whether the owner of the virtual currencies interacts directly with the blockchain or other payment system; and 4) whether the individual or entity acting as intermediary has total independent control over the virtual currencies. See 2019 guidance, note 2.
10 Anonymizing services providers offer services to conceal information about the origin and transfer of virtual currencies. See 2019 guidance, note 2.
11 Payment processors are entities that facilitate the purchase of goods or services. So long as these payment processors operate through regulated clearance and settlement systems, then the payment processor does not generally need to register as a money services business. Because there are no regulated clearance and settlement systems for payments in virtual currencies though, FinCEN clarified that payment processors in virtual currencies are currently unable to rely on this exemption. See 2019 guidance, note 2.
12 Virtual currency exchanges are trading platforms for virtual currencies that enable buyers and sellers of one or more virtual currencies to find each other or automatically match with each other. If a platform automatically matches transactions between buyers and sellers, then that platform and/or its operator must register as a money services business. See 2019 guidance, note 2.
13 Mining pools aretypically groups of individuals who have combined their computer processing resources to form a virtual currency mining pool, which allows the individuals involved to receive larger virtual currency rewards. If the leader of the mining pool hosts digital wallets for members of the pool, then it is engaging in account-based money transmission and generally must register as a money services business. See 2019 guidance, note 2.
14 A dApp is a software program that runs on a decentralized blockchain. If a dApp accepts and transmits fiat or virtual currency, then the dApp and/or its owner-operator must register as a money services business. This remains true even if the dApp does not charge any fees or generate any profits. See 2019 guidance, note 2.
15 Unhosted digital wallets are software hosted on a person’s computer, mobile, or other device. While these wallets allow people to store and conduct transactions in virtual currencies, they do not require an additional third party to actually conduct the transactions. The owner of the digital wallet typically interacts with the payment system directly and has control of whether anything that is stored in the wallet gets transferred to another party. Providers of these unhosted digital wallets are generally not money services businesses, and owners of these wallets that use the wallet to purchase goods or services for their own benefit are also generally not money services businesses. See 2019 guidance, note 2.
16 While providers of anonymizing services must typically register with FinCEN as money services businesses, developers of software that performs these same anonymizing functions are not money services businesses. A user of that software, however, may be a money services business, depending on how it uses the software. See 2019 guidance, note 2.
17 A virtual currency trading platform is generally not a money services business if it only provides a forum for buyers and sellers of virtual currencies to post their bids and offers without automatically matching them. On these platforms, buyers and sellers have to manually find their matches and settle those transactions off of the platform. FinCEN explained in its guidance that these types of platforms only provide “the delivery, communication, or network access services used by a money transmitter to support money transmission services.” 31 C.F.R. § 1010.100(ff)(5)(ii)(A). See 2019 guidance, note 2.
18 The leader of a mining pool will not be considered a money services business so long as they do not combine their managing and renting services with the service of hosting digital wallets for members of the pool. See 2019 guidance, note 2.
19 There are many dApps that do charge fees and generate profits that are not money services businesses, because they do not accept and transmit fiat or virtual currency. The status of a dApp depends on its features and functions. Even if a dApp might constitute an administrator or exchanger under FinCEN’s regulations, it may be able to rely on an exemption from registration as a money services business. FinCEN noted in its 2013 guidance and reiterated in its 2019 guidance that an administrator or exchanger of virtual currency may still be exempt from money services business registration if it qualifies for one of the exemptions from registration provided in 31 C.F.R. § 1010.100(ff)(5)(ii)(A)–(F). For example, some dApps may still find relief from registration under the communications exemption (31 C.F.R. § 1010.100(ff)(5)(ii)(A))—because they provide the delivery, communication, or network access services used by a money transmitter to support money transmission services—or the integral exemption (31 C.F.R. § 1010.100(ff)(5)(ii)(F))—because they accept and transmit funds only integral to the sale of goods or the provision of services, other than money transmission services, by the person who is accepting and transmitting the funds. See 2019 guidance, note 2, and 2013 guidance, note 6.
20Besides the list of business models set forth here, the 2019 guidance also addressed virtual currency kiosks and internet casinos. Virtual currency kiosks (or automated teller machines (ATMs) for virtual currencies) enable the owner-operator to facilitate the exchange of one virtual currency for another type of virtual or fiat currency; these owner-operators may need to register as money services businesses depending on the features of the ATM. Internet casinos (and e-gaming platforms) are online virtual platforms that allow users to bet on the possible outcome of events as if they were in a traditional casino. Users will deposit fiat or virtual currencies to initiate a bet and, depending on their success in betting, will receive virtual currencies as payout. For example, winners of a blackjack game online might get paid out in Bitcoin or winning betters on an e-gaming match might get paid out in Ether. Both of these platforms are facilitating the betting and payout of virtual currencies and would need to register with FinCEN as money services businesses, although the type of money services business they register as may vary.
21 See Burrell Indictment: DOJ Press Release, note 3. The DOJ charged Mr. Burrell with 1) conducting an unlicensed money transmitting business in violation of 18 U.S.C. § 1960 (punishable by up to five years in prison and a $250,000 fine); 2) failing to maintain an anti-money laundering program in violation of 18 U.S.C. § 5318(h) and 5322(b) (punishable by up to 10 years in prison and a $500,000 fine); 3) multiple counts of engaging in international money laundering in violation of 18 U.S.C. § 1956(a)(2) (punishable by up to 20 years in prison for each count and a $500,000 fine); and 4) engaging in a conspiracy to structure international instrument transactions in violation of 18 U.S.C. § 371 and 31 U.S.C. § 5324(c)(3) (punishable by up to five years in prison and a $250,000 fine). Mr. Burrell only pled guilty to the first charge—conducting an unlicensed money transmitting business in violation of 18 U.S.C. § 1960(a).
22 See Burrell Pleads Guilty: DOJ Press Release, note 3.
23 See Powers: FinCEN Press Release, note 3.
24 In assessing this relatively modest civil money penalty, FinCEN considered “penalties, sanctions, and remedies imposed on Mr. Powers by other state or federal agencies, including civil or criminal forfeitures imposed in the amount of $100,000 and 237.53575 bitcoin.” In other words, Mr. Powers had, in addition to this FinCEN penalty, already forfeited $100,000 and over one million dollars’ worth of Bitcoin at today’s market prices owing to other state or federal actions against him. See Powers: FinCEN Assessment, note 3, at 8.
25 31 C.F.R. § 1010.100(ff)(5)(i)(A).
26 Silk Road was a darknet website that was shut down and seized by federal law enforcement authorities in 2013, due to it serving as a marketplace for drug trafficking, malicious software, and other illegal products and services. Mr. Powers’ penalty is noticeably lighter than Mr. Burrell’s, which may be due to Mr. Powers’ reported cooperation with FinCEN with respect to his dealings with persons through the Silk Road.
27 FinCEN noted in its action against Mr. Powers that the “use of TOR in and of itself is not suspicious,” but “transactions through a torrent service may be a strong indicator of potential illicit activity when no additional due diligence is conducted to determine customer identity and whether or not funds are not derived from illegal activity.” Powers: FinCEN Assessment, note 3, at 6.
28 See, e.g., 2019 guidance, note 2 and 2013 guidance, note 6.
29 Burrell Sentencing: DOJ Press Release, note 3.
30 Federal agencies are not the only regulators taking AML laws seriously. Last month, the New York Department of Financial Services (NYDFS) rejected the application of Bittrex, Inc. (Bittrex), a well-known crypto exchange associated with Tether (a virtual currency marketed as a stablecoin with each backed by one U.S. dollar), for a virtual currency license (also known as the BitLicense) and a money transmitter license to operate in the state. NYDFS cited deficiencies in Bittrex’s AML compliance program as one of the primary reasons for its rejection. See Letter from NYDFS to Bittrex Re: Application of Bittrex, Inc. for a License to Engage in Virtual Currency Business Activity Pursuant to Part 200 of Title 23 of the New York Codes, Rules and Regulations, and to Engage in Money Transmission Activity under the Article 13-B of New York Banking Law (Apr. 10, 2019), https://www.dfs.ny.gov/system/files/documents/2019/04/dfs-bittrex-letter-41019.pdf.