A Bitcoin Further Down the Road


The world of virtual currencies has been changing at Internet speed over the last six months, since ACAMS Today published an article about Bitcoin and the implications for anti-money laundering compliance in its March–May 2013 issue.

The Catalysts

While the previous ACAMS Today article was being written, the European Central Bank (ECB) was busy issuing a report examining the current and future potential impact of virtual currencies on national economies, regulators and consumers.1 The ECB report, in addition to categorizing the different types of virtual currency, profiles the two most prominent virtual currencies, Bitcoin and Linden Dollars.

Perhaps the most notable part of the report, however, is its final sentence:

Given that the current assessment of risks is highly dependent on relatively small-sized virtual currency schemes, the assumption that virtual currency schemes will continue to grow means that a periodical examination of the developments is needed in order to reassess the risks.

This statement is both a confirmation of one of conclusions of the previous article in ACAMS Today, as well as a call to arms to maintain vigilance before any impact of virtual currency economies on traditional national economies spirals beyond the ability of regulators to exert effective control, should the need arise.

Then, within weeks after the publication of the previous article about Bitcoin in ACAMS Today, the U.S. Department of Treasury's Financial Crime Enforcement Network (FinCEN) issued regulatory guidance on applying AML regulations to those who use, administer or exchange virtual currencies,2 noting in the very first paragraph:

A user of virtual currency is not an MSB under FinCEN's regulations and therefore is not subject to MSB registration, reporting, and recordkeeping regulations. However, an administrator or exchanger is an MSB under FinCEN's regulations, specifically, a money transmitter, unless a limitation to or exemption from the definition applies to the person. An administrator or exchanger is not a provider or seller of prepaid access, or a dealer in foreign exchange, under FinCEN's regulations.

The Consequences

The impact of FinCEN's guidance on Bitcoin was swift and dramatic. The price of the currency spiked to a peak of approximately US$266 per coin (in contrast to the US$15 price quoted in ACAMS Today and US$30 price at the time of publication). The price ultimately collapsed to about US$105 soon after due to system problems with Mt. Gox, the largest Bitcoin currency exchange, related to its inability to keep up with the trading volume. However, as this article is being written, the price is still around US$95, or over three times the price less than six months earlier. Why the price remains at an elevated level remains unclear. It is a likely due to a combination of greater visibility of the virtual currency, the allure of its anonymity features and the attraction of something vaguely illicit, if not illegal.

U.S. regulators, meanwhile, practiced what they preached. In May, the Department of Homeland Security seized Mt. Gox's account with the Dwolla payment service3 because the exchange company had failed to register with FinCEN as a money services business (MSB).4

Less than two weeks later, Liberty Reserve, a Costa Rica-based virtual currency network, was seized and its owners were indicted for helping its over 200,000 users launder over US$6 billion during its seven year history.5 Like Bitcoin, Liberty Reserve's allure was the anonymity of its users and transactions.

Most radically, at the end of July, the Bank of Thailand made the purchase, sale and use of Bitcoins illegal.6

For every action, however, there is an equal and opposite reaction. Toward the end of June, Mt. Gox registered as an MSB with FinCEN.7 As news of this got out, it caused some flight from Bitcoins, as the price dipped from over US$100 per coin to about US$70 in the two weeks after the registration. The price has stabilized since this drop.8 It is likely that having Mt. Gox's dollar transactions, which, according to the firm's web site, comprises 80 percent of Bitcoin trade, subject to the prying eyes of U.S. regulators made the currency less valuable to both currency speculators and potential users drawn by the anonymity of the Bitcoin blockchain.

In addition, at the end of July, Finextra reported that a number of virtual currency operators, including BitPay, Hub Culture and Yoyocard, have been discussing creating a self-regulatory body called Digital Asset Transfer Authority (Data).9 The group's stated goals are "promote the prudent, responsible development of emerging payment networks, establish common rules to protect users, and work as a liaison among businesses, customers and public officials." Data intends to develop "technical standards and best practices intended to prevent money laundering and ensure compliance with applicable laws."

A Wildcard

In June, U.S. President Obama issued Executive Order 13645,10 which permits the United States to sanction foreign financial institutions who:

(i) knowingly conducted or facilitated any significant transaction related to the purchase or sale of Iranian rials or a derivative, swap, future, forward, or other similar contract whose value is based on the exchange rate of the Iranian rial; or (ii) maintained significant funds or accounts outside the territory of Iran denominated in the Iranian rial.

While this may seem to have no commonality with virtual currencies, this new sanction represents the first time that the United States is extending its oversight to currencies other than its own. Although it is, in some respect, an extension of previous sanctions placed on purchases by foreign governments of Iranian petroleum products, it opens up additional possibilities for new regulatory responses in relation to virtual currencies.

Next Steps Outside the United States

It is reasonable to expect that FinCEN's regulation of virtual currencies will be mirrored around the world. In the short run, there are two sets of jurisdictions that are likely to enact new regulations.

While it is part of the European Union, the United Kingdom is not part of the eurozone. As such, it has more freedom to act independently to issue new regulations and more leverage to give them teeth. In a similar fashion, it is likely that FINTRAC in Canada, and AUSTRAC in Australia will issue similar restrictions in the name of restricting financial system access to Iranian and terrorist financiers.

It is also likely that the United States will look to influence leaders of Latin American countries that are major sources of and way stations for the narcotics trade to restrict the use of virtual currencies within their economies. Look for new regulation of Bitcoin and its brethren in Mexico, Colombia and, less likely, Bolivia.

Thailand's recent action brings up an interesting possibility: Will there be a rash of "Ban the Bitcoin" actions around the world? Certainly, it's low-hanging fruit. On the other hand, it's unlikely to deter criminals, who will just find another virtual currency to abuse, and will only truly inhibit legitimate low-value commerce — exactly the opposite of the desired effect. While such a ban would address some of the other potential deleterious effects of virtual economies, like the crowding-out effect that virtual currency commerce could have on the national currency-based economy, none of the current virtual currencies currently have the scale to effect national economies on a macro scale.

In the long run, transnational and international bodies are likely to address the risks of virtual currency-based money laundering and terrorist financing. Due to the longer time to implement such changes, it is conceivable that individual governments will implement new regulations, rather than waiting for an EU 5th Money Laundering Directive or new recommendations from the Financial Action Task Force (FATF) or the Wolfsberg Group.

Next Steps for FinCEN and OFAC

The United States has a number of options for further ratcheting up the pressure on those who abuse virtual currencies. While Mt. Gox's registration with FinCEN may have lessened the impetus for further regulation, shifting of Bitcoin traffic to other exchangers, other national and international currencies instead of the U.S. dollar, or to other virtual currencies may require additional measures in the future. Which of those additional regulations is actually enacted depends on whether the focus of U.S. regulators is combating money laundering, or in further inhibiting the activities of already-sanctioned individuals who would be likely to use virtual currencies in their schemes.

The most limited enhancement to regulation would be for the Office of Foreign Assets Control (OFAC) sanctions on Iran, transnational criminal organization (TCOs) and/or narcotics traffickers to be extended to bar transactions in specified virtual currencies to those on the Specially Designated Nationals (SDN) List for those sanctions programs. The recent sanctioning of transactions denominated in the Iranian rial sets a precedent for such an action. By limiting the sanctions to dealings with those who are already sanctioned, OFAC would not inhibit legitimate commerce in virtual currencies.

Another, more far-reaching step that could be taken is in FinCEN's court. It is within the limits of current regulation for financial organizations that deal in virtual currencies to be designated as institutions of primary money laundering concern (PMLC) under Section 311 of the USA PATRIOT ACT.

In similar fashion, financial organizations that transact in virtual currencies could be sanctioned by enacting new regulations that contain sanctions similar to those in the Iran Sanctions Act of 1996 (ISA), most notably the foreign exchange and banking transaction sanctions. Should these measures not prove onerous enough, those who dealt virtual currencies to those on OFAC's SDN List could find themselves on that list themselves, as facilitators of sanctioned activity or evasion of sanctions regulations.

Next steps for money launderers?

Do these potential turning of the regulatory screws mean that virtual currencies' days as money laundering vehicles are numbered? Perhaps not.

Consider that the goal of money laundering is to obscure — whether it is the source of funds or the beneficial owners of assets. Who is to say that there isn't a way to reasonably make a virtual currency look like something that isn't a currency?

Say, for example, that, instead of exchanging euros for Bitcoins, one bought shares in Bitcoin LLC, or "invested" in a Kickstarter-like venture. Once a person made their original purchase, the shares or investment could be "sold" to other shareholders at a mutually-agreeable price, regardless of their nominal value. Are the ownership stakes a virtual currency and thus subject to AML oversight, or are they not?

In that regard, Bitcoin and Liberty Reserve were victims of their transparency as virtual currency systems. One day, we may look back at 2013 as merely the first, easy round of a perpetual game of electronic Whack-a-Mole, where the little critters seem to get more numerous and seem to pop and disappear increasingly frequently.

Eric A. Sohn, CAMS, principal engagement manager, BankersAccuity, Skokie, IL, USA, eric.sohn@BankersAccuity.com

  1. "Virtual Currency Schemes", European Central Bank, October 2012, 24 July 2013 <http://www.ecb.int/pub/pdf/other/virtualcurrencyschemes201210en.pdf>
  2. "Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies", Financial Crimes Enforcement Network, 18 March 2013, 24 July 2013 <http://fincen.gov/statutes_regs/guidance/pdf/FIN-2013-G001.pdf>
  3. "Dwolla", Dwolla, n.d., July 24, 2013 <https://www.dwolla.com/>
  4. Kashmir Hill,"The Feds Are Cracking Down On Mt. Gox (Not On Bitcoin)", Forbes, 15 May 2013, 24 July 2013 <http://www.forbes.com/sites/kashmirhill/2013/05/15/the-feds-are-cracking-down-on-mt-gox-not-on-bitcoin/>
  5. Dominic Rushe, "US prosecutors: Liberty Reserve ran $6bn money-laundering scheme", The Guardian, 28 May 2013, 24 July 2013 <http://www.guardian.co.uk/business/2013/may/28/liberty-reserve-accused-money-laundering>
  6. "Exchange claims Thailand has outlawed bitcoin", Finextra, 30 July 2013, 30 July 2013 <http://www.finextra.com/News/FullStory.aspx?newsitemid=25066 >
  7. Jeremy Bonney, "Mt. Gox registers with FinCEN as a money services business", CoinDesk, 29 June 2013, 24 July 2013 <http://www.coindesk.com/mt-gox-registers-with-fincen-as-a-money-services-business/>
  8. "Bitcoin Charts / Markets", bitcoin charts, n.d., 24 July 2013 <http://bitcoincharts.com/markets/>
  9. "Virtual currency industry preps self-regulatory organisation", Finextra, 30 July 2013, 30 July 2013 <http://www.finextra.com/News/FullStory.aspx?newsitemid=25069>
  10. Barack Obama, "Authorizing the Implementation of Certain Sanctions Set Forth in the Iran Freedom and Counter-Proliferation Act of 2012 and Additional Sanctions With Respect To Iran", Federal Register, 3 June 2013, 24 July 2013 <http://www.treasury.gov/resource-center/sanctions/Programs/Documents/13645.pdf>

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