The meteoric rise of cryptocurrency and its attendant community show no signs of slowing. Having started on the fringes of the financial sector, digital currencies are winning over hearts from Main Street to Wall Street. Crypto exchanges are seeing record growth as coins, both new and established, expand exchange accessibility and gain legitimacy. Even long-time crypto skeptic JP Morgan¹ is now recommending clients to include crypto in their portfolios. With incredible growth, there has arisen sentiment within the crypto community that the regulators are taking increasingly stronger measures against them. Exchanges have operated largely unimpeded until recently; in the last six months, there has been a surge in enforcement actions from the U.S. federal and state governments against many of the industry’s most impactful players. This article will highlight the recent actions from regulators as well as what to expect from the Biden administration.

Recent Notable Actions Taken by Regulators

• The Office of Foreign Assets Control (OFAC) fined BitPay $507,375² and BitGo $98,830.³
• New York’s Attorney General settled with Bitfinex and Tether for $18.5 million.⁴
• The Commodity Futures Trading Commission (CFTC) charged BitMEX,⁵ announced a probe of Binance⁶ and fined Coinbase $6.5 million.⁷
• The U.S. Securities and Exchange Commission (SEC) filed an action against Ripple.⁸

In the waning hours of the Trump administration, the Financial Crimes Enforcement Network (FinCEN), a federal agency under the jurisdiction of the U.S. Treasury Department and then Treasury Secretary Steven Mnuchin, attempted to push through an overreaching notice of proposed rulemaking (NPRM) aimed at the crypto industry.

The revised rule targeted money services businesses (MSBs), such as crypto exchanges and financial institutions (FIs), requiring them to submit reports, keep records and verify the identity of customers and potential recipient beneficiaries completing transactions in crypto assets held in digital wallets that are not hosted by the FI. These digital wallets are known as “unhosted wallets.”

The public comment period was limited to only 15 days over the Christmas and New Year’s holidays, in stark contrast to the agency norm of 30 to 60-day review periods. The rush job was met with upheaval from the industry in a way that FinCEN has likely never experienced. FinCEN received over 7,500 responses, prompting various extensions.⁹ The consensus across the industry was that adopting the NPRM would impede innovation, infringe consumer privacy and levy unnecessary costs on the market participants without effectively achieving the stated goal of closing anti-money laundering (AML) and illicit financing loopholes.

It is no surprise that the crypto industry would be on edge over such actions. It appears that the industry is on the defense from a multitude of regulators. At the same time, it is confusing for many exchanges as to why the government has not taken actions against certain rogue exchanges. For example, Coinbase is a U.S. licensed exchange that highlighted the difficulty in competing with competitors that do not adhere to the same licensing and regulatory requirements. Specifically, in the Coinbase S-1¹⁰ filing, they cite that they “compete with a number of companies that solely focus on the crypto market and have varying degrees of regulatory adherence, such as Binance.” A blunt critique in a public filing against an industry heavyweight.

It is important to consider the context regarding high growth companies and the timeline to which regulators must adhere. It is not abnormal for high growth companies to give less weight to the efficacy of regulatory compliance in favor of focusing on business growth.

FIs opting for even minimally licensed operations still must maintain robust compliance programs to meet applicable regulations. These obligations can be daunting for new industry entrants and stifle innovation. In complex regulatory programs, it is not unusual for shortcomings to occur. High growth companies are often slow in hiring mature compliance staff and devoting adequate technological resources to ensure that appropriate controls are in place.

Explanation for Recent Regulatory Actions

A point lost by many is that it often takes years for a regulator to identify, investigate and ultimately enforce a potential violation. For example, BitPay’s IP address weakness stems from 2013 to 2018. Yet, the settlement with OFAC did not occur until 2021. Explanations for recent actions include the following:

• OFAC alleged BitPay and BitGo did not have appropriate IP address controls for blocking heavily sanctioned countries.
• As New York’s Attorney General Letitia James stated, “Bitfinex and Tether recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines.” ¹¹
• The CFTC charged BitMEX for targeting U.S. customers while skirting its registration and AML compliance obligations. It is currently investigating Binance for targeting U.S. customers without registration. The CFTC also settled with Coinbase over allegations of self-trading digital assets as the company prepares to go public.
• The SEC charge of Ripple pertains to a more complex issue of asset securitization.

The industry is still reeling from FinCEN’s out-of-character NPRM proposal, even now as a new administration settles into its step. As a pervasive financial regulator, FinCEN is typically more thoughtful and deliberative when releasing new regulation, especially sweeping regulation such as this.

The Biden Administration

It is unclear what the Biden administration will mean for the crypto industry. It can be assumed that the Biden administration will approach regulatory and enforcement actions like prior Democratic administrations including President Obama’s administration. Within the crypto industry new regulations can initially be perceived as problematic; however, increased regulatory clarity and set parameters would actually help the industry.

This does not mean that the industry will always agree with regulations. Nonetheless, the industry can feel more assured that regulation will not be as rushed, and that the industry will be consulted. It cannot be understated how pivotal regulatory clarity is for the industry. Understanding the playing field will enable the industry to innovate at an even faster rate. For example, simply clarifying which cryptocurrencies are securities vs. commodities would be a positive first step that would dramatically help the industry. There also seems to be rising optimism that Congress may take up industry-specific legislation during this administration that could help clarify agency rulemaking efforts as well.

Enforcement Actions

Despite the cautious optimism for regulatory clarity, it is plausible that the Biden administration will be more forceful in its enforcement actions against all FIs, including crypto. Enforcement actions from many regulators dropped off to historic lows during the Trump administration. According to the enforcement section of FinCEN’s website,¹² there has been a significant reduction in actions, from 18 in the four years prior to Trump, to only eight during his term.

This represents a 62% decrease in enforcement actions during the Trump administration when compared to the second term of the Obama administration. Also, there were fewer blockbuster settlements. It is difficult to discern if the lack of enforcement actions was dereliction of duty or simply a different approach to regulatory enforcement.

President Biden’s 2022 fiscal year budget¹³ requests additional funding for several areas of increased enforcement including the IRS and FinCEN. This discretionary budget requests hundreds of millions for FinCEN to combat the use of corporate structures to shield illegal activity and for the IRS to increase its tax enforcement. Biden’s budget requests strongly indicate that his administration will be putting greater focus on enforcement actions than the Trump administration.

Conclusion

This administration’s regulatory and enforcement push will have a major impact on the crypto industry. This transformation period will require the industry to mature. The upcoming changes will be felt more heavily by rogue exchanges, but legitimate exchanges will become more prosperous. Ultimately, the opportunity exceeds the costs for those exchanges that adhere to the law.

David Zacks, chief compliance officer, bitFlyer USA, CA, USA, David.Zacks@bitflyer.com

Conner Freeman, compliance analyst, bitFlyer USA, CA, USA, Conner.Freeman@bitflyer.com

1. Joanna Ossinger, “JPMorgan Says Investors Could Make Bitcoin 1% of Portfolios,” Bloomberg, February 25, 2021, https://www.bloomberg.com/news/articles/2021-02-25/investors-could-add-up-to-1-of-bitcoin-to-mix-jpmorgan-says
2. “Settlement Agreement between the U.S. Department of the Treasury’s Office of Foreign Assets Control and BitPay, Inc.,” U.S. Department of the Treasury, February 18, 2021, https://home.treasury.gov/policy-issues/financial-sanctions/recent-actions/20210218
3. “Settlement Agreement between the U.S. Department of the Treasury’s Office of Foreign Assets Control and BitGo, Inc.,” U.S. Department of the Treasury , December 30, 2020, https://home.treasury.gov/policy-issues/financial-sanctions/recent-actions/20201230_33
4. “Attorney General James Ends Virtual Currency Trading Platform Bitfinex’s Illegal Activities in New York”, Letitia James NY Attorney General, February 23, 2021, https://ag.ny.gov/press-release/2021/attorney-general-james-ends-virtual-currency-trading-platform-bitfinexs-illegal#:~:text=NEW%20YORK%20%E2%80%93%20New%20York%20Attorney,trading%20activity%20with%20New%20Yorkers
5. “Founders And Executives Of Off-Shore Cryptocurrency Derivatives Exchange Charged With Violation Of The Bank Secrecy Act,” United States Department of Justice Southern District of New York, October 1, 2020, https://www.justice.gov/usao-sdny/pr/founders-and-executives-shore-cryptocurrency-derivatives-exchange-charged-violation
6. Benjamin Bain, “Binance Probed by CFTC Over Whether U.S. Residents Traded,” Bloomberg, March 2021 https://www.bloomberg.com/news/articles/2021-03-12/crypto-exchange-binance-investigated-by-u-s-over-who-s-trading?utm_campaign=socialflow-organic&utm_content=crypto&utm_source=twitter&utm_medium=social
7. Nikhilesh De, “Coinbase Settles With CFTC for $6.5M Over Old Trading Practices,” Coindesk, March 19, 2021 https://www.coindesk.com/coinbase-settles-with-cftc-for-6-5m-over-old-trading-practices
8. “SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering,” U.S. Securities and Exchange Commission, December 22, 2020, https://www.sec.gov/news/press-release/2020-338
9. “FinCEN Extends Reopened Comment Period for Proposed Rulemaking on Certain Convertible Virtual Currency and Digital Asset Transactions,” Financial Crimes Enforcement Network, January 26, 2021, https://www.fincen.gov/news/news-releases/fincen-extends-reopened-comment-period-proposed-rulemaking-certain-convertible
10. “Form S-1 Registration Statement, Coinbase Global, Inc.,” sec.gov, February 25, 2021, https://www.sec.gov/Archives/edgar/data/1679788/000162828021003168/coinbaseglobalincs-1.htm
11. “Attorney General James Ends Virtual Currency Trading Platform Bitfinex’s Illegal Activities in New York,” Letticia James NY Attorney General, February 23, 2021, https://ag.ny.gov/press-release/2021/attorney-general-james-ends-virtual-currency-trading-platform-bitfinexs-illegal#:~:text=NEW%20YORK%20%E2%80%93%20New%20York%20Attorney,trading%20activity%20with%20New%20Yorkers
12. “Enforcement Actions,” Financial Crimes Enforcement Network, www.fincen.gov/news-room/enforcement-actions
13. “The President’s FY 2022 Discretionary Request,” Office of Management and Budget, https://www.whitehouse.gov/omb/fy-2022-discretionary-request/