Rapidly Shifting Regulatory Landscape for Virtual Currencies | Market Participants: Stay Tuned

US regulators have been busy of late in virtual currency regulation. We focus on three important virtual currency-related regulatory updates:

• On February 7, 2018, New York State Department of Financial Services (DFS) issued guidance (Guidance) discussing the reporting requirements for all “virtual currency business entities that are either licensed under 23 NYCRR Part 200 (Bitlicense) or chartered as a limited purpose trust company under the New York Banking Law (collectively, “VC Entities”).
• On February 13, 2018, (publicly released on March 6, 2018) the United States Department of the Treasury, Financial Crimes Enforcement Network (FinCEN) authored a letter (FinCEN Letter) to Senator Ron Wyden, a Ranking Member of the Committee on Finance, which provides that “generally, under existing regulations and interpretations, a developer that sells convertible virtual currency, including in the form of [an] ICO (initial coin offering) [of] coins or tokens, in exchange for another type of value that substitutes for currency, is a money transmitter” and “an exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat currency, or other value that substitutes for currency, would typically also be a money transmitter.”
• On March 6, 2018, the United States District Court for the Eastern District of New York ruled that “virtual currencies can be regulated by CFTC as a commodity” but left the door open for other regulatory bodies to regulate virtual currency concurrently. CFTC v. McDonnell, et al., No. 18-cv-361, ECF No. 29, at 24 (E.D.N.Y. Mar. 6, 2018).

Market participants nevertheless continue to seek clarity in determining which regulator(s) and regulatory regime(s) may apply to them.

DFS Guidance

DFS issued Guidance requiring expeditious reporting for VC Entities. The Guidance is focused on fraud detection and prevention and requires all VC Entities to “implement measures designed to effectively detect, prevent and respond to fraud, attempted fraud and similar wrongdoing.” The Guidance requires immediate reporting upon “discovery of any wrongdoing” and follow-up reports. The Guidance also states that it expects such follow-up reports to be submitted in 48 hours in most cases.

While it is not clear how the Guidance will be enforced, it is likely that it will increase the reporting burden on the VC Entities subject to DFS jurisdiction. Any such reporting would be in addition to reports, such as suspicious activity reports, required by other regulators. We encourage VC Entities to have a coordinated internal process.

FinCEN Letter

The FinCEN Letter discusses money transmitter issues relating to virtual currency generally, reminding market participants of their obligations if they meet the definition of money services business. Of particular note was the FinCEN Letter’s reference to potential obligations of ICO projects in the event the project engages in money transmission.

Subject to various exceptions, if a person or entity engages in a “money transmission” it must be a licensed “money transmitter” or “money service business” on both the federal and state levels. Under federal law, “[t]he statute defines ‘money transmitting’ to include ‘transferring funds on behalf of the public by any and all means.’” United States v. Murgio, 209 F. Supp. 3d 698, 706 (S.D.N.Y. 2016) (quoting 18 USC § 1960(b)); see also 31 CFR 100.100(ff)(5) (“The term ‘money transmission services’ means the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.”). Generally speaking, if a person or entity is in the business of moving money from one place to another, exchanging one sort of currency for another, or issuing a currency while maintaining the ability to withdraw such currency from circulation, then that person or entity likely meets the definition and should register with FinCEN. See Department of the Treasury, Financial Crimes Enforcement Network, FIN-2013-G001, Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (March 18, 2013).

There are several significant exceptions to the money transmitter licensing requirements, such that if a person or entity fits one of the exceptions, it would not need to be licensed, even though it otherwise meets the definition of money transmitter. See 31 CFR 1010.100(ff)(5)(ii); See also Department of the Treasury, Financial Crimes Enforcement Network, Application of FinCEN’s Regulations to Virtual Currency Mining Operations, FIN-2014-R001 (Jan. 30, 2014).

The FinCEN Letter appears to focus specifically on Initial Coin Offerings. In the FinCEN Letter, FinCEN states that it is “working closely with the Securities Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) to clarify and enforce the [anti-money laundering/combating the financing of terrorism] obligations of businesses engaged in Initial Coin Offering (ICO) activities that implicate the regulatory authorities of these agencies.” The SEC and CFTC previously indicated that those agencies were working in tandem to regulate ICOs and had a meeting on February 6, 2018, to discuss such regulation. See Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission, (Feb. 6, 2018); see also US Securities and Exchange Commission, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017); US Commodities Futures Trading Commission, A CFTC Primer on Virtual Currencies (Oct. 17, 2017).

The FinCEN Letter further complicates the regulatory landscape for ICOs in that it appears to indicate that most companies engaging in ICOs may be engaged in money transmission:

Generally, under existing regulations and interpretations, 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 with AML/CFT requirements that apply to this type of [money service business]. An exchange that sells ICO coins or tokens, or exchanges them for virtual currency, fiat currency, or other value that substitutes for currency, would typically also be a money transmitter.

The FinCEN Letter, however, does reference FinCEN’s prior guidance on the subject, so presumably that guidance, including relevant exceptions, remains intact.

There is no discussion in the FinCEN Letter of any of the exceptions, despite the fact that prior FinCEN Guidances specifically discussed such exceptions and determined that such exceptions applied to certain virtual currency companies. Department of the Treasury, Financial Crimes Enforcement Network, FIN-2014-R012, Request for Administrative Ruling on the Application of FinCEN’s Regulations to a Virtual Currency Payment System, at 4 (Oct. 27, 2014); Department of the Treasury, Financial Crimes Enforcement Network, FIN-2014-R012, Request for Administrative Ruling on the Application of FinCEN’s Regulations to a Virtual Currency Payment System (Oct. 27, 2014); Department of the Treasury, Financial Crimes Enforcement Network, Application of FinCEN’s Regulations to Virtual Currency Mining Operations, FIN-2014-R001 (Jan. 30, 2014); Department of the Treasury, Financial Crimes Enforcement Network, Application of FinCEN’s Regulations to Virtual Currency Software Development and Certain Investment Activity, FIN-2014-R002 (Jan. 30, 2014).

Nevertheless, entities engaging in ICOs should be aware that FinCEN has taken the position “generally” that such activity “typically” constitutes money transmission.

CFTC v. McDonnell, et al.

The Honorable Jack B. Weinstein of the United States District Court for the Eastern District of New York ruled that virtual currency is a “commodity” subject to the CFTC’s regulatory authority. See CFTC v. McDonnell, et al., No. 18-cv-361, ECF No. 29, at 24 (E.D.N.Y. Mar. 6, 2018).

The CFTC sued defendant Patrick McDonnell for his role in a company called Coin Drop Markets, which the CFTC claims was operating a “deceptive and fraudulent virtual currency scheme . . . for purported trading advice” and “for virtual currency purchases and trading . . . and simply misappropriated investor funds.” Id. at 3. The defendant argued that the CFTC does not have standing because virtual currency is not a commodity and the CFTC does not have jurisdiction over fraud that does not directly involve the sale of future or derivatives contracts. The court soundly rejected both arguments. The court held that “a ‘commodity’ encompasses virtual currency both in economic function and in the language of the statute.” Id. at 4 (citing 7 USC § 1(a)(9)). And that “CFTC’s broad authority extends to fraud or manipulation in derivatives markets and underlying spot markets.” Id. at 4 (citing 7 USC § 9(1)).

The court went through a detailed description of the history of virtual currency and blockchain. Id. at 4-7. It described what the court referred to as “increased fraud and criminal activity” in connection with virtual currency and referenced various criminal cases and reports of hacking and theft. Id. at 8-9.

There was also a discussion of the often overlapping regulations currently in place concerning virtual currency companies. The court notes that “Congress has yet to authorize a system to regulate virtual currency.” Id. at 9. “The CFTC, and other agencies, claim concurrent regulatory power over virtual currency in certain settings, but concede their jurisdiction is incomplete.” Id. Interestingly, the court sets forth nine options concerning which regulatory body should be regulating virtual currency: (1) none; (2) Department of Justice (DOJ); (3) CFTC; (4) SEC; (5); FinCEN; (6) IRS; (7) private exchanges; (8) state regulators; and (9) a combination of any of the above. Id. at 10-12.

Ultimately, the court determined that “virtual currencies can be regulated by CFTC as a commodity” and that it “fall[s] well-within the common definition of ‘commodity’ as well as the CEA’s definition of ‘commodities.’” Id. at 24. However, the court specifically stated that the CFTC does not have exclusive jurisdiction. It stated that “the jurisdictional authority of CFTC to regulate virtual currencies as commodities does not preclude other agencies from exercising their regulatory power when virtual currencies function differently than derivative commodities.” Id. at 24. As such, the decision does not choose amongst the nine agencies it listed.

Conclusion

Navigating virtual currency regulation in the United States is complex. Without any controlling guidance as to which regulation or regulator is most applicable to any given business, it is increasingly difficult for market participants to comply. As Judge Weinstein writes: “until Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency.” Id. at 3 (emphasis added). We have argued that the context in which blockchain technology is implemented should dictate which regulation applies. Market participants must tread carefully and stay abreast of regulatory news as the regulatory environment continues to shift.