Speed Read: This piece looks at the attitude of the regulatory bodies in the UK towards cryptocurrency and how the fifth EU anti-money laundering directive (5MLD), when transposed, will be the first step to regulating virtual currency within the UK. To date, regulators have shied away from taking responsibility for the AML implications of this new currency form.

In July 2017, one of the owners of the Bitcoin Exchange (BTC-e), Alexander Vinnik, was arrested in Greece while on holiday with his family for allegedly laundering money to a tune of more than $4 billion from the hack of failed Bitcoin exchange.[1] This arrest led to a political battle between France, USA and Russia as to which country Vinnik should be extradited to. Russia won the battle in the Supreme Court of Greece in September 2018.[2]

This is not the first case in which virtual currency is alleged to have been used to launder money. A recently published American study has suggested that between $80bn and $200bn of cash generated by cyber-crime is laundered every year. A huge amount of this cash is said to have been laundered through crypto-currencies and digital payment systems.[3]

So what is virtual currency?

The term ‘virtual currency’ is potentially a misnomer because it is not a legally established currency at all. The European Union defines “virtual currencies” as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.” [4]

Notwithstanding the vagaries inherent in the definition, the popularity and use of virtual currency is not surprising. This is because of the various benefits attached to it which include:

  • It is easily accessible to the general public;
  • It is a cheaper way of transferring money;
  • It is faster because it does not require the use of a middleman or intermediary;
  • It is more secure as no one can steal your personal information;
  • It is more transparent because the individual is in charge of their money as no third party is involved.

Despite these benefits, internet companies such as Facebook and Google have banned the advertising of virtual currency on their platforms for fear of consumers being duped. Furthermore, the Financial Conduct Authority (FCA), has issued statements warning consumers of the risks involved in buying them.[5] For some, the statements have been inadequate. [6] Responsible cryptocompanies are now also taking matters in to their own hands and have formed a self-regulatory body.[7]

The perceived limited action by the FCA to date is said to be attributed to virtual currencies being treated as ‘assets’ and therefore not presently within their regulatory remit.[8] However, the FCA has set up a taskforce to conduct further research into whether virtual currency is of social value and thus should be regulated.[9] The taskforce is comprised of representatives from government and the financial regulators such as HM Treasury, FCA and the Bank of England.[10] In their first meeting in May, it was agreed that their objectives would be “exploring the impact of crypto assets, the potential benefits and challenges of the application of distributed ledger technology in financial services, and assessing what, if any, regulation is required in response.”[11] Apart from the the existence of this taskforce, very little is known about their agenda and mode of exploration.

Virtual currency and money laundering rules

In the anti-money laundering sphere, the benefits of virtual currency can be a double-edged sword. On the one hand, anti-money laundering efforts are strengthened by leaps in technology and, at its simplest, the ability to trace the use of either an asset or currency online. On the other, the combination of speed, anonymity and lack of regulation makes a good platform for illegal activities. ‘Virtual currency’ or ‘virtual assets’ fall outside of cash and asset seizure and forfeiture powers in Part 5 of the Proceeds of Crime Act 2002. Virtual currency can facilitate money laundering because user identities are protected and since transactions can be conducted quickly through multiple jurisdictions, it can be difficult to ascertain the specific jurisdictions from which transactions emanate. All this potentially makes it easy to introduce illegal money into the economy as the purchase of virtual currency can then later be exchanged for fiat currency.

The extent to which this is a problem is a matter of keen debate. When questioned about the need for regulations, the FCA’s response has been that cases of money laundering and terrorist financing using virtual currency were not widespread and as such this was a further area that their taskforce would look into.[12]

Global developments

With the UK taskforce underway, the question arises as to the approach by regulators to virtual currency elsewhere. Recently, the Financial Action Task Force (FATF), the intergovernmental body that sets the standards for combatting money laundering and terrorists financing globally, identified the different regulatory approaches to virtual currency amongst G20 participants, which they simplified into four categories. [13] The first group includes China, India and Indonesia who have prohibited the use of all virtual currency. The next group regulates intermediaries/exchanges using their existing anti money laundering laws. France, Germany and the United States are examples of countries in this category. The third group which includes Argentina and South Africa do not necessarily regulate the area but have included virtual currency transactions in their suspicious transaction reporting only. The final group which the UK finds itself in alongside countries like Russia and Saudi Arabia are in the process of preparing and regulating this area.

As for jurisdictions in which virtual currency is regulated, Japan is amongst the most advanced. In 2014, a Tokyo-based cryptocurrency exchange was hacked resulting in the loss of 650,000 bitcoin worth $390 million. Following this, they stepped up their regulation efforts, legally defining virtual currency as a form of payment and requiring any business operating as a virtual currency exchange to register with the country’s Financial Services Agency (FSA).[14] Such businesses are obliged to be transparent by being accountable to customers, separating customer assets from assets of the exchange, undergoing annual audits and many more responsibilities.[15] There also exists a Japanese Virtual Currency Exchange Association, a self-regulatory body. This self-regulatory body differs from that of the UK in that, it was borne out of an agreement between the Japan’s FSA and virtual currency exchange businesses.

Japan’s regulation of virtual currency exchanges is likely to be followed by the UK following the implementation of the European Union’s Fifth Anti-Money Laundering Directive (5AMLD). This directive came to pass June of this year and member states have until 10th January 2020 to implement the directive within national law. Notwithstanding its departure from the European Union, the UK has announced that it will be implementing this directive.[16] Notably, the directive provides that:

“(29) in Article 47, paragraph 1 is replaced by the following:

  1. 1. Member States shall ensure that providers of exchange services between virtual currencies and fiat currencies, and custodian wallet providers, are registered, that currency exchange and cheque cashing offices, and trust or company service providers are licensed or registered, and that providers of gambling services are regulated.”[17]

The directive goes on to define a custodian wallet provider:

“custodian wallet provider” means an entity that provides services to safeguard private cryptographic keys on behalf of its customers, to hold, store and transfer virtual currencies.”[18]

Accordingly, in 2020 crypto currency service providers will be ‘obliged entities’ required to be supervised by a supervisory body and subject to a range of anti-money laundering and counter-terrorist financing duties such as the need to conduct a risk assessment of their business, each customer and to undertake proportionate Customer Due Diligence. 5MLD is in line with recommendations made by the FATF when they issued their “Guidance of Risk-Based Approach to Cryptocurrencies” in 2015.

5MLD acknowledges that including providers engaged in exchange of services between virtual currencies and custodian wallet providers within the scope of obliged entities for regulating money laundering falls short of fully addressing the issue of anonymity associated with virtual currency transactions. This is because virtual currency users could still transact without such providers. To bridge this gap, one proposal is that national Financial Intelligence Units (FIUs) have access to information “allowing them to associate virtual currency addresses to the identity of the owner of virtual currency”[19] and that users of virtual currency should have a framework open to them to “self-declare to designated authorities on a voluntary basis”[20]. Arguably, such suggestions by the EU are a little simplistic not least because sophisticated criminals using virtual currency users are unlikely to leave an online ‘trail of crumbs’ or volunteer their identities to the authorities. Such proposals appear to be stepping stones and suggest that more work needs to be done to understand how virtual currencies operate. In this way, it is understandable why the FCA says it will only regulate this sector once they have all the information they need.