The US Treasury’s Financial Crimes Enforcement Network (FinCEN) has issued guidance on how its regulations apply to money transmission involving convertible virtual currencies (the FinCEN Guidance) and an Advisory on Illicit Activity Involving Convertible Virtual Currency (the FinCEN Advisory). Together, the FinCEN Guidance and FinCEN Advisory clarify how existing anti-money laundering (AML) laws and regulations such as the Bank Secrecy Act (BSA) apply to virtual currencies and provide indicators of suspicious activity related to virtual currency.
Regulators around the world have issued guidance documents with respect to AML risk and virtual currencies. For example, the Financial Action Task Force recently issued its Guidance for a Risk-Based Approach to Virtual Currencies (the FATF Guidance). The FATF Guidance seeks to identify money laundering and terrorist financing risks posed by virtual currencies and recommends certain implementation requirements for effective AML regulation and supervision of activities involving virtual assets.
The Government of Canada also last year proposed changes to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) and its Regulations. These changes were influenced by “developments related to virtual currencies, which offer new ways to move value with anonymity; the development of new financial technologies (Fintech) which are changing the ways Canadians interact with the financial system; and digital identity recognition, which can facilitate the customer due diligence process which is a cornerstone of the framework.” For more information please see our blog post summarizing the changes.
Convertible Virtual Currency
The FinCEN Guidance defines convertible virtual currency (CVC) as a medium of exchange “that either has an equivalent value as currency, or acts as a substitute for currency, and is therefore a type of “value that substitutes for currency.” This includes digital currency, cryptocurrency, cryptoassets, and digital assets. FinCEN regulations apply to transactions involving the acceptance and transmission of value substituting for real currency by any means. Consequently, the FinCEN Guidance provides that CVC transactions are subject to FinCEN regulations regardless of the type of token, ledger, or technology used to exchange value.
The FinCEN Guidance notes that the way an asset or business model is labeled will not be determinative. Instead, what regulations will apply is determined through a factual analysis of the business’ operations and commercial dealings. Thus, calling an asset a utility token will not alone exempt the asset from applicable FinCEN regulations.
Money Services Businesses and Money Transmission
The FinCEN Guidance reiterates the definition of money services business engaging in money transmission as a “person that provides money transmission services,” or “any other person engaged in the transfer of funds.”
Money transmission services is defined as “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.” The FinCEN Guidance reaffirms that this definition is broad enough to include situations in which CVCs constitute the “other value that substitutes for currency”. As such, businesses that deal with CVCs should be aware that different business models may attract different regulatory requirements for compliance.
To the extent that any of the money transmitter’s transactions constitute a “transmittal of funds” under FinCEN’s regulations, then the money transmitter must also comply with the “Funds Transfer Rule” and the “Funds Travel Rule.” Canada has a similar “travel rule” in respect of prescribed electronic funds transfers which applies to, among others, money services businesses.
The FinCEN Guidance specifically addresses the application of US AML laws to business models involving the transmission of CVC such as:
- Peer-to-peer (P2P) exchangers;
- CVC Wallets;
- Hosted and Unhosted Wallet Providers;
- Multiple-signature wallet providers;
- CVC Kiosks;
- Decentralized Applications (DApps);
- Providers of anonymizing services for CVCs;
- Money tranmitters that accept CVCs;
- Payment Processing Services involving CVC Money transmission; and
- Internet Casinos involved in CVC Money Transmission.
The FinCEN Guidance also address business models that may be exempt from application of US AML laws depending on the particular circumstances including:
- CVC Trading Platforms and Decentralized Exchanges;
- Initial Coin Offerings;
- Distributed Applications Conducting CVC Transactions; and
- CVC Money Transmission Performed by Mining Pools and Cloud Miners.
Advisory on Illicit Activity involving Convertible Virtual Currencies
The FinCEN Advisory provides insight into typologies by which illicit activities involving CVCs take place. These include darknet marketplaces, unregistered P2P exchangers, unregisterted foreign-located money service businesses, and CVC kiosks.
- Darknet marketplaces, such as AlphaBay, are websites operating on the dark web that enable the purchase and sale of illicit goods and services using virtual currency to users who have the requisite specialized software to access the overlay network.
- Unregistered P2P exchangers are basically middlemen who exchange fiat currencies for virtual currencies without registering as money services businesses. These transactions are often intermixed with those of other users to conceal the source and destination of the funds.
- Unregistered Foreign Money Service Businesses also exchange fiat currencies with CVCs in jurisdictions which do not have robust AML governance applicable to virtual currencies.
- CVC kiosks, commonly known as crypto ATMs, enable users to exchange cash and virtual currency. This is problematic if there is inadequate collection of required customer identification information.
Red Flag Indicators
The FinCEN Advisory provides examples of are several red flags of suspicious activity in virtual currencies including:
- Use of CVC addresses or wallets linked with darknet marketplaces;
- Transactions initiated from IP addresses associated with Tor, indicating use of a darknet overlay network;
- Multiple cash deposits or wires from disparate jurisdictions, or financial institution branches followed by uses of the funds to acquire virtual currency;
- A series of deposits or transfers within a short period of time which in aggregate correspond to funds transfers on a virtual currency exchange platform;
- Funds transfers from unregistered foreign virtual currency exchanges or money services business with no relation to where customers lives or conducts business;
- Use of CVC kiosks in locations with a high incidence of criminal activity;
- Transactions just beneath the CVC kiosk daily limit to the same wallet using multiple machines; and
- A customer significantly older than the average age of platform users opens an account and suddenly engages in large numbers of transactions, suggesting possible role as a money mule or elder financial exploitation
The FinCEN Guidance and FinCEN Advisory provide useful AML guidance on activities inovoving virtual assets. Entities operating in Canada may wish to review their practices and policies based on this guidance.