The unchartered and unregulated seas of virtual currencies have until now provided rich pickings for those peddling illicit goods, sanctions and tax evaders and money launderers. With the notable exception of the rulings provided by FinCEN and the ‘Bit Licensing’ of the NY DFS and a few other states in the US, the response and narrative that has been provided by international regulators to the use of virtual currencies (“VC”) could be characterised as being reluctant, and in many cases still absent. And so, the criminals in the form of pirates have prospered from unfettered intervention.
To regulate or not to regulate, that has been the question for international government and financial service regulators, but finally in 2017 we have seen a sea change, and the reluctant acceptance and acknowledgement that the status quo could not continue unchecked.
During the tail-end of 2017 we saw the regulation of VC exchanges in Japan from 1st October (in the form of amendments to the Act on Prevention of Transfer of Criminal Proceeds (Act No. 22 of 2007)) and not long after on 13th December we learned that the AML and CFT Amendment Act had received Royal Assent in Australia, recognising digital exchange activities and bringing these activities under the supervision of AUSTRAC.
Seven days later, and not wishing to miss the boat, we received notification that an agreement had been reached between the European Parliament and the Council on the text of the amendments that have been proposed to the Fourth EU Anti-Money Laundering Directive (the so-called AMLD 5) that was proposed by the European Commission back in July 2016.
And so, in twelve short weeks we have witnessed not one, but three significant milestones in regulatory developments that cast a net around the VC pool of activity that touches upon fiat currencies, and that signals a new phase of regulation for VC operators. And there will be more from South Korea, maybe one day even in the UK. It signifies the emergence of common standards for regulating virtual currencies that was first muted by the Financial Action Task Force back in June 2015.
What does this all mean though?
Well, the semaphore has been hoisted and appears to signal to all except those who wish to continue to exercise ‘Nelsonian wilful blindness’ that VC is here to stay. That notwithstanding the sporadic and unwelcome raids by ‘Dread Pirate Roberts’ and his shipmates, VC has achieved a degree of recognition and grudging acceptance by the establishment.
It also signals a welcome start to the process in the adoption and implementation of global standards for AML/CFT regulations that will be applicable internationally to VC exchange activity and providers of custodian wallet services, in the same way that they have been applied previously to sectors such as gambling services and the money value transfer sectors of the economy.
Critically, this means that those persons and entities who are actively engaged in the exchange of VC with the fiat currencies, and who wish to continue to swim in these waters, must decide whether they wish to plan and prepare to meet the challenge of being authorised, and operate within the formal regulated sector, or else migrate and lurk within the unregulated sector and run the gauntlet of being identified and criminally prosecuted later on.
For those who choose to operate lawfully there is likely to be some considerable commercial opportunity, as most ‘marginal’ players in the current market will either gather their tackle, and stop operating or else ‘go deep’. The obvious difficulty for governments is that those who choose not to comply with regulations, and who intend to use Bitcoin for example for illegal purposes, are likely to; operate on a peer to peer basis that avoids the use of exchanges altogether; or will utilise other well-documented means of disguising their identity and location.
It is likely however that those who do choose to avoid the costs, intrusion and disclosure that is required in order to seek authorisation, are likely to face a significant risk of personal and corporate prosecution as regulators and representatives of law enforcement ‘hunt-down’ illicit operators.
Just how realistic is this threat?
In July 2017 FinCEN assessed a $110 million fine against BTC-e, a non-US Internet-based money transmitter that exchanged fiat currency as well as the convertible virtual currencies Bitcoin, Litecoin, Namecoin, Novacoin, Peercoin, Ethereum, and Dash. FinCEN also assessed a fine against Russian national Alexander Vinnik, one of the operators of BTC-e, for his role in the violations.
This does not appear to have been a one-off event. This is what the US Under Secretary for Terrorism and Financial Intelligence, Sigal Mandelker, recently stated about VC operators who choose not to comply with regulatory requirements: “The effectiveness of this (AML/CFT) structure depends on compliance by the regulated entities, and so we aggressively pursue virtual currency exchangers and others who do not take these obligations seriously.”
If that was not enough to dissuade errant behaviour, it was disclosed that FinCEN has prioritized engagement with, and is examining, more than 100 VC entities who have registered with FinCEN as money transmitters as required, as well as those that have not.
The message is clear for firms who wish to continue to prosper in the VC markets. They should prepare now for authorisation, and take steps to implement the policies and procedures that are required to guide firms to be compliant, and that keep them out of harms way! Any decision not to do so would appear to be both commercially disadvantageous, and dangerous. Just ask ‘Dread Pirate Roberts’ of Silk Road fame, and Alexander Vinnik!
The one issue that I believe will require careful consideration, and which will be interesting to monitor, is whether the regulated sector and in particular the banks, are actually willing and able to accept their newfound bed-partners. What will the response be from banks when these operators seek to bank the proceeds from their lawful regulated business? Up until now the banks have been able to deflect this responsibility on the grounds that the activity is not recognised, but what will the rationale be thereafter.
There is already evidence from Australia that regulated VC operators are finding it difficult to open accounts. The FATF and the FCA for example are alert and sensitive to the issue of -de-risking, and noted that banks should not decline to provide services to VC businesses who offer blockchain related technology, rather than fiat exchange services.
A glimpse in to the future for those seeking the safety of dry land should look no further than to Japan, where I have been able to witness first-hand how the regulated sector and the VC sector appear to have reached a degree of accord and understanding that means that the aims of all stakeholders are being satisfied.
It is going to be an interesting year of change and opportunity, and that must be monitored, and one in which I for one look forward to keeping my feet dry.
Lee Byrne is the Global Head of Financial Crime Compliance for Coinfirm Limited