Hot Takes

FinCEN raises major licensing problem for ICOs in new letter to Congress.

Nearly a year ago Coin Center released a report highlighting a looming ambiguity in FinCEN’s interpretation of federal anti-money-laundering laws: whether or not token sellers are money transmitters who are subject to the Bank Secrecy Act and need to do “know your customer” compliance with respect to their buyers, and arguing that any such interpretation would require formal rulemaking. We issued the report in part because we felt that the separate but related discussion over whether token sellers might be issuing securities had overshadowed this issue and left many unaware of the serious legal consequences that could stem from potentially violating the Bank Secrecy Act rather than the Securities Acts.

As it happens, our concerns were well-founded. Today FinCEN released a letter to Senator Ron Wyden clearly indicating that they interpret the relevant laws and regulations such that token sellers are money transmitters:

A developer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply.

Make no mistake, this is a highly consequential interpretation. Accordingly, any group or individual developer who both (A) sold newly created tokens to buyers (i.e. had an ICO) involving U.S. residents and (B) failed to register with FinCEN as a money transmitter,and perform the associated compliance KYC/AML obligations, can be charged under a federal felony criminal statute, 18 U.S.C § 1960, with unlicensed money transmission. If found guilty one could face up to five years in prison. Criminal liability may also extend to employees of, and investors in, the business that sold the tokens.

There are important public policy questions at stake here:

  1. Is it wise or appropriate under relevant administrative law to make this substantial change/clarification in interpretation through a letter to a member of Congress interpreting guidance, rather than a public rulemaking or new legislation?
  2. Is it constitutional to mandate private data collection from people who are not financial intermediaries in the traditional sense, and may be better analogized to persons selling a new invention to buyers in a person to person transaction?

It is very difficult to take this letter and derive from it a clear picture of FinCEN’s interpretation. Only one footnote is given to explain their legal reasoning:

See, FIN-2013-G001 (explaining that convertible virtual currency administrators and exchangers are money transmitters under the BSA), and FIN-2014-R001, Application of FinCEN’s Regulations to Virtual Currency Mining Operations, January 30, 2014 (explaining that persons that create units of virtual currency, such as miners, and use them in the business of accepting and transmitting value are also money transmitters).

This footnote does not tell us whether FinCEN classifies these sellers as “exchangers” or “administrators,” two distinct types of money transmitter identified by the 2013 guidance. As we describe in our 2015 paper, there are compelling reasons why a developer selling a token is not an administrator: they cannot both issue and redeem the tokens that they sell, like a Bitcoin miner they merely put them into circulation and cannot claw them back (assuming they have sold an actual decentralized token and not some promise of future tokens). There are also good reasons why a developer selling a token is not an exchanger. They may sell but they do not do so as a business dedicated to exchange; they sell as one individual or entity would sell any valuable investment or commodity to another person, for their own purposes rather than to provide third-party money transmission services between two customers or people.

The bulk of the cited 2014 guidance on miners explains why a Bitcoin miner is not a money transmitter if they merely create the units. To be a money transmitter a miner must also sell them as part of an exchange business, rather than merely sell them on their own behalf. We can only assume that FinCEN believes that developers selling tokens are “in the business of accepting and transmitting value” in addition to creating new tokens. No doubt a developer selling tokens is accepting value, but who are they transmitting it to aside from themselves?

This is a complicated and consequential legal interpretation, and one that should be discussed, unpacked, and eventually finalized in a more formal and transparent setting, e.g. a rulemaking. A footnote in a letter to a Congressman should not suffice.

In the conclusion to our report from last May we outlined Coin Center’s position on these matters:

Common understanding suggests that money transmission is an act performed by an intermediary, a person who stands between two parties accepting money from one and transmitting it to another. When a person transacts directly with another person, giving them money for any reason—as a gift, a payment, a donation, a grant, a tip—she does not play this intermediary role. She does not hold herself out as a trusted third party. She is engaged in private, personal transactions rather than being engaged as a third party to the transactions of others.

Deputizing third-party intermediaries to surveil their users on behalf of the government is a policy choice Congress made long ago; one that carries risks to individual privacy but also potential benefits to national security and peace. It’s a tradeoff Congress made back in the 1970s and it isn’t going away anytime soon. However, mandating the same kind of surveillance from individuals who are not intermediaries—who are merely transacting on their own account with another citizen—is a considerable recalibration of the balance between privacy and security. It tips the scales against personal privacy and may even be unconstitutional.

This is not a recalibration that should be made merely by issuing administrative rulings or guidance, the approach thus far taken by FinCEN when dealing with these questions. Instead, FinCEN should clarify that selling decentralized virtual currency on one’s own account does not constitute money transmission, regardless of whether the purpose of that sale is to pay a merchant, to sell tokens received through mining, or—indeed—to sell one’s own newly invented decentralized token.

Should FinCEN or Congress wish to regulate this activity for financial surveillance purposes, that change must be the subject of a larger, more public debate within a notice and comment rulemaking or an amendment to the statutory law itself. Only those formal processes can enable necessary debate over financial surveillance and the constitutionality of warrantless search.

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Experts weigh in the the state of cryptocurrency regulation.

At a recent event hosted by Andreessen Horowitz and #Angels, Coin Center Senior Policy Counsel Robin Weisman joined former federal prosecutor and now lead of a16z’s crypto fund Kathryn Haun on stage to talk through recent movements in cryptocurrency policy and the effect they may have on the development of this technology.

The session was recorded. Listen here:

(Photo courtesy of @beLaura on Twitter)

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A top SEC official said that Ether is not a security.

Speaking today at a conference, the U.S. Securities and Exchange Commission’s Director of Corporate Finance, William Hinman, revealed in a speech that the SEC does not consider Ether, the Ethereum network’s native cryptocurrency, to be a security:

"Based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions."

We are glad the SEC agrees with our long held analysis of how securities law applies to decentralized cryptocurrency networks like Bitcoin and Ethereum (See, in particular, our analysis of Ethereum here). We are thrilled to see it take strong pro-innovation approach to this nascent technology. With this guidance, the SEC is showing that taking a pro-innovation approach does not have to come at the expense of protecting investors.

Director Hinman’s analysis was based on an appreciation for the nuances of how decentralized technology really works, something we laid out years ago in our framework for securities regulation of cryptocurrencies. He used his speech to explain the Howey Test for determining whether a financial instrument is an investment contract and concluded that his analysis was that Ethereum failed the Howey test and, therefore, could not be considered a security:

When the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. ... the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.

It is a very good day for US policy toward the technology of innovation.

For more information on Ethereum, please see this explanation written by Ethereum’s founder, Vitalik Buterin, on Coin Center’s website: What is Ethereum?

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CFTC Commissioner recognizes the “transformative” nature of cryptocurrency.

During his speech at the United Nations last week, Commissioner Behnam spoke at some length about the potential value that this new technology can bring to the United States and other nations. He noted that cryptocurrency has the potential to be an effective runaround the problem of corruption in International Development:

Here is our chance to put money directly into the hands of those who need it, without bribery, rake-offs, graft, and shakedowns. Virtual currencies could transform the economic and social landscape. It could mean a massive, and equitable, shift of wealth. Technology could be transformational, without a military take-over, civil war, or political or religious creed.

Benham also spoke about sectors of the United States economy that have tremendous potential to apply this new technology. Here is what he said about agriculture:

Through blockchain technology, finding solutions to these challenges may become significantly more attainable. Food could arrive on grocery shelves faster, using an intricate system of measures meant to trace location from the farm to the table, with the additional bonus of providing abundantly more information about the product source… we could eliminate food waste and even improve distribution through networks domestically and internationally.

And about healthcare:

Blockchain could allow patients to create smart records that gather and harmonize information, leading to better continuity of care and even new models of care. Blockchain could also address medical fraud and waste. And, as a result, help contain the rising cost of health care.

In 2016, we published a report in which we explain why open, permissionless blockchain technology is essential for powering identity and digital cash use-cases that are inherent to addressing the supply chain and charitable aid issues Benham discussed. Indeed, we are cautiously optimistic about proclamations that imply these technologies are the skeleton key to unlocking greater equality and efficiency in global markets.

Behnam also spoke about the importance of pursuing legal action against fraudsters, and the challenge and importance of correctly categorizing specific tokens. Furthermore, Commissioner Behnam signaled that the CFTC was completely convinced that cryptocurrency is primed to permanently disrupt financial and economic sectors. In fact, he is so confident in cryptocurrency’s staying power that his rhetoric ascended from the analytical to the prophetic:

These currencies are not going away and they will proliferate to every economy and every part of the planet… We are witnessing a technological revolution. Perhaps we are witnessing a modern miracle.

We couldn’t agree more, Commissioner.

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Coin Center raises $1.2 million spurred by Kraken matching pledge.

Last week we announced on Twitter that we have reached and exceeded our goal of raising funds to match a generous $1 matching offer from cryptocurrency exchange Kraken (in addition to their already unprecedented $1 million donation), bringing our total fundraise in May to over $3 million.

This enormous outpouring of support from the cryptocurrency community is three times Coin Center’s annual budget, which will help us step up our education and advocacy work at a time when government interest in these technologies is the highest it’s ever been.

In addition to donations from the 100+ individuals, here are the companies that helped us hit our goal: 1Confirmation, Andreessen Horowitz, Ausum Ventures, Autonomous Crypto, Baroda Ventures, Blockchain Capital, Blockchange Ventures, Chia, Digital Currency Group, Dispatch Labs, DRW/Cumberland Mining, eToro, Hudson River Trading, itBit/Paxos, Kik, Medici Ventures, Polychain Capital, Protocol Labs, Ripple, SIG, SolidX, Steemit, Tlon, and Union Square Ventures.

Thanks to all of you who supported us. Your confidence in our work continues to humble us.

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The New York State Department of Financial Services just approved the trading of privacy-protecting cryptocurrency.

Gemini will become the first BitLicensed exchange to offer trading in Zcash.

The DFS press release summarizes Zcash in the following way:

The Zcash network supports two kinds of transactions, transparent and shielded. Transparent transactions operate similarly to Bitcoin in that the balance and the amounts of the transaction are publicly visible on the blockchain. Shielded transactions utilize z-addresses and are entirely private. Transactions associated with z-addresses do not appear on the public blockchain. Zcash is the digital cryptography-based asset of the Zcash network, similar to how bitcoin is the digital cryptography-based asset of the Bitcoin network.

Earlier this year, the Japanese Financial Services Agency (FSA) strongly encouraged the Japanese cryptocurrency exchange, Coincheck, to ban trading on privacy protecting coins. They claim that privacy protecting coins such as Zcash and Monero are more likely to be employed in transactions for illicit purposes.

We’ve previously explained why there’s no reason an exchange wouldn’t be able to compliantly deal in privacy protecting cryptocurrencies.

Financial institutions are legally required to comply with anti-money laundering and anti-terrorist financing laws and regulations. Can these institutions use a payment system and currency that leaves no record of individual transactions? Absolutely! That system is called cash and just about every financial institution in the world uses it. Cash transactions are still much more opaque than any cryptocurrency transaction, even a Zcash transaction from a shielded address.

And it is encouraging to see New York’s DFS resist much of the panic around privacy-protecting coins, and recognize the potential value they may bring to users. The forward thinking spirit of the decision is capsulated best by this statement by DFS Superintendent Maria T. Vullo:

"This action continues New York’s longstanding commitment to innovation and leadership in the global marketplace. With smart and thorough regulatory oversight, the development and long-term growth of the industry will remain thriving.”

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Photos from the 2018 Coin Center Annual Dinner now available

Thank you to everyone who came out for our most successful fundraising gala yet. It was a pleasure to host some of the best and brightest from the cryptocurrency world for a lighthearted night of fun.

Here are some pictures from the event.

A lot of you have been asking for a copy of the remarks made by keynote speaker Joe Weisenthal. Those are available here.

Stay tuned for next year’s dinner. Hope to see you there!

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SEC Commissioner doesn’t want to pick cryptocurrency winners and losers.

Commissioner Hester Peirce added herself to the list of SEC officials making sensible comments about the agency’s role in regulating cryptocurrencies. At the Medici conference in Los Angeles last week she revealed a nuanced view. Here’s some of what she said, per Axios:

“On a beach, you have a lifeguard…. but she’s not sitting with the sand castle builders,”

For years now many have pointed to the need for regulatory “sandboxes” wherein an innovator can obtain binding agreements from a regulator: e.g. “we (the regulator) will regulate you differently than the underlying law would otherwise require if you commit to sharing data or designing your project in a specified manner.” While that could lighten the compliance load for some folks in the ecosystem; it also creates risks that some projects will get prefferatory treatment and an unfair advantage over other projects or technologies.

Peirce’s preference to be a lifeguard over a sand castle architect is laudable. In general, it’s best that regulators only get involved in emergencies, when there are grave risks to consumers or investors that can only be addressed through the law. Regulators should avoid making legally binding pronouncements that dictate specifics about how consumer or financial technologies should be built. Cryptocurrencies are at a nascent stage where any action from regulators could create far reaching consequences for development and U.S. competitiveness.

We would like to see policymakers approach these new networks similarly to how the early internet was approached: hands off policy calibrated to encourage developer experimentation. We are glad to see Commissioner Peirce shares these sentiments. Be sure to read some more of what she said.

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Based in Washington, D.C., Coin Center is the leading non-profit research and advocacy center focused on the public policy issues facing cryptocurrency and decentralized computing technologies like Bitcoin and Ethereum. Our mission is to build a better understanding of these technologies and to promote a regulatory climate that preserves the freedom to innovate using permissionless blockchain technologies.