The Financial Action Task Force (FATF) first began weighing in on Cryptocurrency and Virtual Assets in June, 2014.  In 2015 the FATF’s guidance was focused on the interfaces between fiat currency and virtual currency. Since that time, the FATF and its 39 member countries have evolved their approach to Virtual Assets (VAs).  With the release of its June, 2019, Guidance For a Risk-Based Approached:  Virtual Assets and Virtual Asset Service Providers, the FATF has adopted a like-for-like approach to regulations with virtual assets.  Virtual Asset Service Providers (VASPs) must comply with the same regulations as traditional Financial Institutions.

To that end, the FATF has provided detailed guidance defining virtual assets, virtual asset service providers, and how regulations should apply.  While cryptocurrency is included under the umbrella of virtual assets, the definition is not limited to cryptocurrency. virtual assets are digital representations of value “that can be digitally traded or transferred and can be used for payment or investment purposes.” (pg. 13)  It is important to note that virtual assets do not include digital representations of fiat currency or securities and also do not include closed-loop systems such as airline miles, credit card awards, or other loyalty point systems. (pg 17)

Virtual asset service providers include any business that conduct one or more of the following activities: (pg 13-14)

1. Exchange between virtual assets and fiat currencies;
2. Exchange between one or more forms of virtual assets;
3. Transfer of virtual assets;
4. Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets;
5. Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset. 

This includes businesses that maintain custody or control of a 3rd party’s funds or wallets, which includes virtual asset escrow services, online wallet services, and brokerage services, regardless of whether they are centralized or decentralized. The FATF makes some clear distinctions as to which types of businesses are required to follow industry-standard AML/KYC processes:

• Software and hardware providers of cryptocurrency wallets where the end-user stores and owns their private keys are not considered VASPs
• Manufacturers of Bitcoin ATMs are not VASPs, but the operators of those machines may be considered VASPs based on the limitation of the value of the transactions allowed.
• Decentralized Exchanges (DeX) may or may not be classified as a VASP depending on whether or not they facilitate trades.  If a DeX serves only as a message board or meeting place for offers and bids for trades where the trades take place outside of the system, the DeX is not a VASP.  If the DeX processes or facilitates the trade, it is a VASP and must comply with appropriate AML/KYC requirements.

Much of the June 2019 guidance is directed toward countries and their Financial Intelligence Units (FIUs).  The FATF maintains a perspective that due to the anonymity of users and the potential to obfuscate transaction flows, virtual assets pose greater money laundering and terrorist financing risk and therefore may require enhanced due diligence and additional regulatory scrutiny.  This may be manifested as additional regulations for VAs and VASPs, but it also may include complete bans on VAs, VASPs, or both.

As part of the like-for-like approach that FATF has taken with VAs and VASPs, the FATF is recommending countries require VASPs to comply with the same rules including:

• Freezing funds associated with money laundering or terrorism;
• Confiscating funds or property that have been directly laundered, are the proceeds from financial crime, or have been used (or are intended to be used) for terrorist or terrorist financing;
• Requiring VASPs to be licensed and/or registered by appropriate regulatory bodies;
• Providing appropriate sanctions against VASPs that do not comply with AML/KYC policies;
• Requiring VASPs to submit Suspicious Activity Reports (SARs), Suspicious Transaction Reports (STRs), and CTRs (Currency Transaction Reports (CTRs);
• Providing monitoring of VASPs by regulatory bodies to ensure compliance with AML/KYC regulations;
• Maintaining transaction records;

In addition to these policies, the FATF and its member countries are recommending implementation of the “Travel Rule”, which requires VASPs to gather, simultaneously and securely, details on the originator and beneficiary of all transactions between two VASPs.  This includes names, wallet addresses, account numbers, physical addresses, national ID numbers, and other details that may be applicable such as device identifiers, IP addresses, and transaction hashes.  There is currently no mechanism in place for this information exchange between VASPs. For traditional, fiat currency, this information is included as part of the SWIFT message. As cryptocurrency transfers occur on the blockchain itself, these details cannot be sent as part of those messages.  This poses a significant challenge for the entire cryptocurrency industry. There must be a balance between reducing the risk of money laundering and terrorist financing and the open nature of cryptocurrency.

It is important to note that the FATF does not have regulatory power, nor can it implement any sanctions against countries that do not follow its guidance.  Only weeks after the FATF guidance, member states of the G20 met at the G20 Summit in Tokyo, Japan and agreed to implement these recommendations within a year and other countries are likely to follow suit. Additionally, the FATF’s guidance is only intended to address AML/KYC concerns, not issues of taxation (except for issues of tax evasion as per the AML4 directive), consumer protection, securities, banking, or commodities.

About iComply Investor Services Inc.
iComply Investor Services Inc. (iComply) is Regtech for Fintech, an award-winning software company focused on reducing regulatory friction in the digital finance. With powerful data, verification, tokenization solutions, iComply helps companies overcome the cost, complexity, and risks of multi-jurisdictional compliance in order to effectively access new markets. Learn more: iComplyIS.com

On May 9th, 2019, FinCEN released interpretive guidance on how existing regulations impact cryptocurrencies, which are referred to as Convertible Virtual Currencies.  While the “guidance does not establish any new regulatory expectations or requirements,” it does clarify existing regulations and the obligations of many crypto businesses.  

The guidance serves to explain which types of businesses must register as Money Services Businesses (MSBs) and thereby comply with FinCEN MSB regulations, including compliance with the Bank Secrecy Act  (BSA). Compliance with the BSA requires businesses to screen their customers, third party relationships, and transactions to mitigate money laundering or terrorist financing risk. These regulations also require the filing of Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs) when those risks have been identified. The guidance does not however cover regulatory obligations associated with securities, commodities, taxes, or other possible government regulations which are managed by other government entities such as the SEC, OCC, CFTC, IRS, and others.

FinCEN’s policy on what constitutes an MSB is clear: “whether a person qualifies as an MSB subject to BSA regulation depends on the person’s activities and not its formal business status.”  Put more simply, it is the function of the business, not the form it takes or the name it is given.  The same policy applies to all types of currencies: money is considered “currency, funds, or other value that substitutes for currency.”

FinCEN has clarified that organizations that do business “in whole or in substantial part within the United States,” are subject to BSA regulations, even if they have no physical presence in the United States.  This will make it more difficult for companies headquartered overseas to skirt AML obligations if they are doing business in the US. However there are cases where an individual or business may not be subject to MSB requirements, and that is if they perform certain MSB activities, but do so infrequently and not for gain or profit.

Key Takeaways:

• Exchanges, whether crypto-to-crypto or fiat-to-crypto, must register as an MSB and comply with the BSA (including having a complete AML program and SAR/CTR reporting).
  
• Hosted Wallets must comply fully with BSA requirements.  Unhosted Wallet providers, such as deployed software or hardware wallets, are not required to comply with BSA and FinCEN AML requirements.
• Cryptocurrency ATM providers must comply with BSA and FinCEN AML requirements.
• DApps (decentralized apps such as Ethereum Smart Contracts) may or may not be required to comply with the BSA depending on whether the DApp performs money transmission (31 CFR § 1010.100(ff)(5)(i)(A)).
• Privacy Coins (zCash, Monero, etc.) and anonymization services (such as mixers or tumblers) must comply with BSA and FinCEN AML requirements.
• Cryptocurrency Payment Processors (also known as Fiat Gateways) do not qualify for the BSA exemptions provided to fiat payment processors as they may process payments from individual wallets, unlike fiat payment processors who only process payments from financial institutions through credit card payments or bank transfers.  Because of this, cryptocurrency payment processors must comply with BSA and FinCEN AML requirements.
• Decentralized Exchanges (DeX) do not need to comply with BSA and FinCEN AML requirements as long as the DeX does not facilitate the transfer of funds or hold any user funds.
• Mining Pools may have to comply with BSA and FinCEN AML requirements if the pool hosts the wallets that receive the proceeds of the mining.  If there is no wallet hosting provided by the mining pool, they most likely do not have to comply with BSA/AML requirements.
• Token Offerings (Initial Coin Offerings, Initial Exchange Offerings, Security Token Offerings, et al) provide the most complex scenarios for determining AML/BSA requirements.  Based on the organization type of the issuer, intermediary, or investor, the FinCEN obligations may align more closely with a bank, broker-dealer, futures commission merchant, commodity dealer, or mutual fund.  Each of these types of institutions have different AML/BSA requirements and will differ from those of an MSB.

Organizations issuing ICOs should work closely with trusted issuance vendors, accountants, and lawyers to determine the appropriate regulatory compliance based on the type of issuance and the potential investor pool.

While the guidance does clearly outline how the US Department of Treasury views many virtual asset business models, it does not cover all possible crypto businesses.  It is important to consider that just because a business does not fall neatly into one of the categories described does not mean it does not have FinCEN compliance obligations.  Where things may be unclear, the business should reach out to an experienced compliance lawyer or reach out directly to FinCEN.

Compliance obligations are not going away.  BSA requirements, including AML/KYC are a critical component of reducing crimes such as terrorist financing, money laundering, fraud, sexual exploitation, slavery, and many other crimes.  Financial institutions working with regulators are a critical component to reducing the impact of bad actors. As early movers in the industry that will one day take over traditional financial markets, it is critical for us to work together to ensure the solutions, businesses, and technology we build are creating a future we can look forward to living in. 

About the author: Greg Pinn, Head of Product Strategy at iComply Investor Services, has over a decade of experience leading global best practices in the anti-money laundering (AML) and know-your-customer (KYC) industry. Greg specializes in building industry leading products, including Thomson Reuter’s World-Check – now Refinitiv, to help financial institutions, both traditional and crypto, to scale operations, reduce risk and ensure compliance with global regulations. At iComply, Greg works to with industry leading virtual asset service providers to develop, build, and maintain best-in-class compliance programs.

About iComply Investor Services Inc.
iComply Investor Services Inc. (iComply) is an award-winning software company focused on reducing regulatory friction in financial markets. With powerful data, verification, and blockchain interface solutions, iComply helps companies overcome the cost and complexity of multi-jurisdictional compliance to effectively access new markets. Learn more: iComplyIS.com