FinCEN tackles regulation of virtual currency

It might be hard to imagine drug traffickers and terrorists laundering illegal proceeds by converting funds into virtual currencies, but the possibility has occurred to the regulatory, law enforcement and financial services communities. Based on concerns raised by entities within those communities, the Financial Crimes Enforcement Network (FinCEN) issued guidance on the responsibilities of virtual currency providers and intermediaries to comply with the anti-money laundering (AML) regulations of the Bank Secrecy Act.

FinCEN defines virtual currency as "a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency." In contrast, FinCEN characterizes real currency as "the coin and paper money of the United States or of any other country" that is considered "customarily used and accepted" legal tender in circulation within countries. However, FinCEN does not make a distinction between types of currency, virtual or otherwise, when it comes to regulating them.

FinCEN's guidance addresses "convertible" virtual currency, which the agency defines as having either an "equivalent value in real currency, or acts as a substitute for real currency."

'Virtual' MSBs

For purposes of regulation, FinCEN also does not distinguish between "money transmitters" –otherwise known as a money services business (MSB) – of real currency and business that deal with virtual currency. "Accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA," FinCEN said.

FinCEN categorized the three participants in a virtual currency transaction as the user, exchanger and administrator. The user, or consumer, who transacts using virtual currency, is not an MSB and therefore not subject to regulations. But exchangers (entities that exchange virtual currency for real currency) and administrators (entities that issue and redeem virtual currency) are bound by the AML mandates because they either accept and transmit virtual currency or they buy and sell it, FinCEN said.

Types of convertible virtual currencies

FinCEN gave three scenarios for how administrators and exchangers of virtual currency would be regulated.

• E-currencies and e-precious metals

  FinCEN stated that brokers that facilitate the trading of e-currencies or e-precious metals between buyers and sellers are not considered MSBs. But if an entity is involved in the transfer of electronic value from a customer to the account of a third party, or to the account of another customer, then that entity is deemed by FinCEN to be an MSB and therefore open to regulation under the BSA.

• Centralized virtual currencies

  Businesses that manage or have access to convertible virtual currencies that are transferred in and out of centralized repositories are also BSA-defined MSBs. "The administrator of that repository will be a money transmitter to the extent that it allows transfers of value between persons or from one location to another," FinCEN said. The same goes for exchangers, which are granted access by administrators "to accept and transmit the convertible virtual currency on behalf of others, including transfers intended to pay a third party for virtual goods and services," the agency added.

• Decentralized virtual currencies

  FinCEN said entities that engage in the transfer of decentralized convertible virtual currencies, which have no central repository and no single administrator, are also open to regulation. Once again, FinCEN distinguishes between users of virtual currency and administrators and exchangers.

"A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter," FinCEN said. "By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter."

The problem with bitcoins

FinCEN spokesman Steve Hudak said the most obvious example of a decentralized virtual currency is the bitcoin. "It's traded like real money for real money," he said. "And there's no government backing it. There's no company backing it. It's decentralized."

Hudak called bitcoin a "cryptocurrency." This involves "a string of very difficult equations that you need computer processing power to churn through," he said. "And that computer processing benefits the bitcoin network because it adds to its security and produces something called bitcoin chains. … And if people are trading it and exchanging it for real currency, then there are existing regulations at FinCEN that cover this type of activity. And that's what we tried to make clear in the guidance."

Hudak cited an FBI report that said bitcoins are being used to buy illicit drugs on the online black market. "Bitcoins has a high degree of anonymity," he said. "And there's great concern that people could use bitcoins to purchase drugs or child pornography or other illegal things."

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