Bitcoin Regulation: Cryptocurrencies, AML/KYC and Compliance

Is Bitcoin legal? Is it a security, currency, digital token, a form of property, or a vehicle for money transmission? To add to the complexity, Bitcoin is only one cryptocurrency, and each has its own structure, governance, purpose, backers and technology.

The answers are quickly becoming more than a theoretical issue as billions of dollars roll into Bitcoin, Ether, other cryptocurrencies and new ICOs (Initial Coin Offerings). Many call it a bubble that will soon burst, resulting in huge losses. Others consider it the start of the one of the biggest opportunities in our lifetime. With all the speculation and hype, you know regulators are closely monitoring the situation.

As with many new technologies, in the beginning Bitcoin had few participants and no regulation. But, as the stakes get higher, involving more people, a legal framework begins to take shape. As it has been around since 2009, there are already laws that cover it in certain jurisdictions.

While Bitcoin is legal in certain countries, that’s not the end of the regulation question. How are you using it? Are you a money services business (MSB)? Are you trying to raise funds and need to consider security regulators? What are the tax liabilities? Many of these issues need clarification, as different regulators examine the ramifications.

US Bitcoin Regulation

In the US, Bitcoin exchanges are considered MSBs. FinCEN issued a guidance regarding Persons Administering, Exchanging, or Using Virtual Currencies: “In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.”

As a “financial services institution,” MSBs are required to comply with Bank Secrecy Act laws and regulations, including AML (Anti-Money Laundering) requirements. They also need to comply with KYC (Know Your Customer) rules.

As the licensing of these is done a state by state level, the complexity is a substantial issue for startups. Recently though, the OCC (Office of the Comptroller of the Currency) announced they will start allowing fintech firms to apply for a national charter. This will allow one national license to cover all the states, without requiring the burden of a full bank license.

For other roles in the cryptocurrency space, Peter Van Valkenburgh, notes in a Coin Center Report , “Subsequent administrative rulings clarified several remaining ambiguities: cryptocurrency miners are not money transmitters, neither are investors or software developers.”

Regarding taxation, the IRS made a determination in 2014 that, for federal tax purposes, virtual currency is treated as property. Since then, numerous issues have been pointed out about tracking and reporting simple transactions, the fairness of treating this type of currency different from other currencies, and the hindrance it has on the growing field. In a May, 2017 Bitcoin investigation letter to the IRS from Members of Congress, they ask, “Will the IRS consider a de minimis exemption or other action to remove practical obstacles to such moderate, transactional use of digital currencies?”

Initial Coin Offerings

As Bitcoin was the first cryptocurrency, its legal situation is the most developed. Other cryptocurrencies are bringing up whole, new compliance considerations. Is an ICO a security offering? If it is deemed so, the SEC is the regulator and any company doing them must ensure they comply with their regulations.

An ICO is often described as a mix of a Kickstarter campaign with an IPO (Initial Public Offering). Companies raise funds by distributing coins (AKA tokens) that can be redeemed later for the service the company plans to offer. Or, they could sell the coin to someone else for a profit, if the value has risen.

It is this last part that is getting attention from the SEC and similar regulators. If the reason people are investing in an ICO is that they think they can profit, that might fall under an ‘investment contract’, according to the US Supreme Court Howey Test. If that is the case, then an organization issuing an ICO needs to comply with security laws and all that in entails.

Ari Levy, Senior Tech Reporter for CNBC, interviewed Naval Ravikant, a venture partner at digital currency firm MetaStable Capital, regarding ICOs “If the SEC doesn’t crack down, this party will be amazing, the biggest party in town for a long time. If they do crack down, a lot of people are going to feel a lot of pain.”

“He doesn’t know when the regulators will come knocking, but he’s certain that these companies will eventually have to exist within the confines of securities law,” according to Levy.

As we can see from the situation in the US, there’s numerous considerations and changes are happening fast. In April, 2017 Japan amended their Payment Service Act to enact the Virtual Currency Act. This Act allows the use of Bitcoin and Etherium as legal means of payment, becoming the first country to do so. This enables buying those currencies without paying an 8% consumption task and also clarifies the rules for cryptocurrency exchanges.

Cryptocurrency Regulation

There’s no doubt that even more innovation will happen, with a whole host of other regulatory questions to consider. While the technologies are new, it doesn’t imply that there are no laws for the field. Existing regulations are already in place to protect investors, prevent fraud and ensure illicit funds doesn’t get laundered.

Any business that wants to succeed in the long run, and not just take the money and run, needs to understand the existing legal framework and ensure compliance with it. The introduction of the internet created new communication possibilities, but that didn’t negate hate-speech or libel laws. New ways to transfer funds, make payments and other cryptocurrency opportunities does not negate Anti-Money Laundering and Know Your Customer laws.

As global law firm Norton Rose Fulbright states in their global legal and regulatory guide to cryptocurrencies, “As a general rule, where no specific steps have been taken to regulate cryptocurrencies in the relevant jurisdiction, it would be necessary to refer to the existing legal and regulatory frameworks to understand how they might apply to the new circumstances that the technology enables. This is particularly important where cryptocurrencies arise in the context of industries that are already significantly regulated.”

As the industry evolves, regulators will create new rules that reflect the specific situation of cryptocurrencies. Until then, do your due diligence, create compliance procedures that are defendable under the existing regulations. This includes procedures for complying with AML and KYC regulations; governments have a powerful imperative to fight money laundering, terrorist funding, fraud, and corruption and ignoring these rules will invite a crackdown by the authorities.

The potential for cryptocurrencies to innovate in areas such as payments, fundraising, and new forms of value creation is enormous. However, cryptocurrency innovators need to keep the needs of society and consumers in mind. They need to ensure legal compliance to protect their community and ensure trust and safety online. Innovators that defy compliance will be fined, shut down, or face prosecution. Innovators that deliver compliance can proceed to create interesting, useful products and services and reap the rewards.

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