A new proposal would subject financial institutions and exchanges to onerous recordkeeping and reporting requirements for certain digital currency transactions.
By Miles P. Jennings, Benjamin A. Naftalis, Eric S. Volkman, Margaret Allison Upshaw, and Deric Behar
In a surprise release in the waning days of the Trump administration, the Financial Crimes Enforcement Network (FinCEN) division of the Department of the Treasury issued a proposed rule (the Proposal) that would impose significant new obligations on market participants in the cryptocurrency and digital asset market (Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets). The Proposal “would require banks and money service businesses (MSBs) to submit reports, keep records, and verify the identity of customers in relation to transactions involving convertible virtual currency (CVC) or digital assets with legal tender status (LTDA) held in unhosted wallets, or held in wallets hosted in a jurisdiction identified by FinCEN.”
Under the Proposal, CVC and LTDA, such as Bitcoin and Ether, would be deemed ‘‘monetary instruments’’ under the Bank Secrecy Act (BSA). This classification would bring them under the BSA’s existing anti-money laundering and countering the financing of terrorism recordkeeping and reporting requirements for currency transactions. The Proposal would also establish a new recordkeeping requirement for certain CVC and LTDA transactions, similar to the recordkeeping and travel rule regulations applicable to funds transfers.
Invoking “significant national security imperatives,” FinCEN issued the Proposal to curtail what it perceives as various “illicit finance threat[s]” facilitated by anonymous transactions involving CVC and LTDA, such as money laundering, drug trafficking, terrorist financing, weapons proliferation, cybercrime, and sanctions evasion.
What Would the Proposal Require?
The Proposal would require banks and cryptocurrency trading platforms to:
- Comply with enhanced know-your-customer (KYC) and recordkeeping requirements for any transactions involving unhosted wallets (i.e., self-hosted, self-custodied, or private wallets) exceeding US$3,000, including information about the customer and the counterparty
- File a Currency Transaction Report with FinCEN within 15 days for any transactions involving unhosted wallets exceeding US$10,000 in a 24-hour period, including information about the customer and the counterparty
- Report multiple CVC and/or LTDA transactions involving a single person within a 24-hour period if exceeding US $10,000 in aggregate, across all of a bank or MSB’s offices and records, “wherever they may be located,” in order to preclude anonymous virtual currency transactions and illicit “structuring” (breaking large transactions into smaller ones to evade reporting requirements)
Virtual currency transactions between hosted wallets held at financial institutions subject to the BSA would be exempt from these requirements.
Criticism of the Proposal
Market responses to the Proposal have been vocal and generally disapproving. In particular, commentators and market participants have made the following criticisms:
- The Proposal would require companies to keep records of and report certain cryptocurrency transaction information beyond what is currently required for cash transactions.
- There are significant technical barriers to requiring MSBs to collect KYC information for non-customers using unhosted wallets.
- MSBs are not completely capable of determining whether a wallet is “hosted” or “unhosted,” and the Proposal may, therefore, force entities to develop a whitelist of “hosted” wallets, or worse, report information about all transactions to comply with the Proposal.
- MSBs may have no existing ability to obtain and verify the identity of counterparties and persons associated with an unhosted wallet address with which the MSB’s customer wishes to transact.
- The Proposal will incentivize cryptocurrency users to move away from regulated crypto transaction services and use non-custodial wallets or unregulated services outside the US to carry out transactions.
- The Proposal could reduce FinCEN visibility and enforcement capability by indirectly reducing transparency of cryptocurrency transactions.
- The Proposal would create an uneven playing field that will benefit more traditional financial institutions with more resources and established KYC and recordkeeping capabilities.
- The Proposal could inhibit adoption of cryptocurrencies and stymie development and innovation.
- The Proposal could cause US-based market participants to move operations and jobs offshore to avoid the requirements.
- The Proposal could diminish America’s role and competitiveness in the digital asset space, leaving innovation to countries where greater access to blockchain technology is allowed.
- The Proposal could compromise consumer privacy by requiring the collection of excess data and personally identifiable information.
- The Proposal could undermine the financial inclusion benefits of the crypto economy.
- The Proposal could significantly hinder fundraising by nonprofit and non-government organizations.
- The Proposal is vague and introduces legal uncertainty (e.g., it is unclear whether customer IP addresses or blockchain addresses must be collected and reported along with names and addresses; it is unclear how smart contracts and DeFi platforms would be treated under the Proposal).
- The Proposal fails to provide economic impact analysis and estimates for the cost of implementing the rule, contrary to common practice in proposed rulemaking.
- The Proposal’s comment period is inadequate, and indicates a lack of earnestness on the part of the Treasury to engage with cryptocurrency market participants.
- Finalization of the Proposal without a compliance phase-in period or delay of effectiveness will deny market participants the adequate runway needed to update internal controls, policies, and procedures.
Are the Proposal’s Provisions Inevitable?
The Proposal, published in the Federal Register on December 23, 2020, ostensibly allowed for a public comment period of 15 days from date of publication, but FinCEN stated in the release that because the Proposal involves a foreign affairs function of the US, the “notice-and-comment rulemaking requirements are inapplicable.” Thousands of markets participants from individuals to exchanges have since submitted comments.
On January 14, 2021, FinCEN announced that it was extending the comment period for two provisions of the Proposal: (i) an additional 45 days for comments on the proposed requirements that banks and MSBs report certain information regarding counterparties to transactions by their hosted wallet customers, and on the proposed recordkeeping requirements, and (ii) an additional 15 days for comments on the proposed reporting requirements regarding information on CVC or LTDA transactions greater than US$10,000.
The comment period extension comes in the wake of Congressional enactment of the National Defense Authorization Act for Fiscal Year 2021 on January 1, 2021, an omnibus bill that includes the Anti-Money Laundering Act of 2020 (the Act). Several provisions of the Act serve to update the existing anti-money laundering regime in order to help safeguard the financial system from developing threats and account for emerging technologies and payment methods, such as virtual currencies. The Act, for example, expressly includes financial institutions and businesses engaged in the exchange or transmission of “value that substitutes for currency” — such as cryptocurrencies — within the scope of regulated entities. (See The Anti-Money Laundering Act of 2020: 5 Key Takeaways.)
The extended comment period for the Proposal may indicate that on matters related to the anti-money laundering regime, the Treasury is “continuing its active engagement with the cryptocurrency industry” in good faith. Market participants are hopeful that FinCEN will consider the substantive comments and criticisms of the Proposal before making any final determinations.
For further information on the Proposal, please see Latham’s comment letter submitted on behalf of a trio of concerned clients.
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