As a result of money laundering risks, many governments put in place systems to ensure that Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations are in place to identify individuals carrying out Bitcoin transactions. These regulations are often aimed at exchanges or financial institutions that facilitate Bitcoin transactions. AML regulations are enacted to prevent the conversion of money obtained from illegal activities into legitimate assets. KYC regulations are intended to ensure that financial institutions are aware of the identities of their customers to ensure that unauthorized individuals (such as minors or criminals) don’t have access to certain services.
The Financial Crimes Enforcement Network (FinCEN), an agency within the US Treasury Department, published guidelines about Bitcoin as early as 2013, which suggested that although using Bitcoin for purchasing legal goods and services was not illegal, the mining or trading of Bitcoin as well as the operation of exchanges on which Bitcoin is traded would fall under the label of “money service businesses” and would therefore be subject to the same Anti-Money Laundering (AML) and Know Your Client (KYC) measures as other financial institutions.
FinCEN also took action against Ripple in 2013 (which was later settled), arguing that Ripple had failed to implement an effective AML program and failed to report suspicious activity relating to financial transactions on their system, therefore implying that cryptocurrency operators are subject to the Money Service Business (MSB) regulations. However, it should be noted that Ripple operates on a more centralized platform than Bitcoin and many other cryptocurrencies. Therefore it is extremely unlikely that an ‘operator’ of Bitcoin could be identified and made subject to the MSB regulations. FinCEN’s powers also extend beyond the territorial USA, taking action again the Russian-domiciled BTC-e exchange for a breach of US AML laws, which was the first action against a non-US-based exchange.
The European Union has also recently taken steps to ensure that exchanges fall under KYC and AML requirements. The European Commission adopted proposals that ensure that cryptocurrency exchanges and wallet providers would fall within the EU’s anti-money laundering framework, effective from July 2017. However, these requirements are only applicable to such exchanges that allow for exchange between cryptocurrency and fiat currency, which effectively would exclude many of the most popular exchanges operating today. The provisions also only apply to cryptocurrency wallet providers that offer custodial services of private keys.
These provisions require exchanges and wallet providers to carry out KYC and AML checks on customers and any beneficial owners, requiring them to collect, process, record personal data and share the same with public authorities.
Singapore is currently in the process of creating a regulatory framework to address money laundering and terrorist financing concerns relating to cryptocurrency, with the Minister in Charge of the Monetary Authority of Singapore (MAS) stating that although the government does not have the power to regulate cryptocurrencies themselves, it can “restrict the activities that surround them if those activities fall within our more general ambit as a financial regulator.”
In January 2018, South Korea announced a system intended to ban anonymous accounts in cryptocurrency transactions. Until now, Korean banks have allowed customers to trade through virtual accounts issued by Korean banks. However, as a result of an opinion from South Korean authorities that such bank accounts. The government also announced that banks would have additional AML obligations regarding cryptocurrency exchanges, including reporting any suspicious transactions relating to cryptocurrency exchanges.
Regulation of Exchanges
As exchanges are the primary entry points by which cryptocurrency traders and customers interact with the blockchain, the regulation of these is considered to be of paramount importance. As a result, many jurisdictions focus on the regulation of exchanges, thereby ensuring that they are required to apply KYC regulations to their customers at the registration or time of transaction. This includes a requirement to have verified accounts or an upper limit to which accounts may remain unverified. In terms of AML regulations, the successful application of the regulations on cryptocurrency exchanges is dependent on the exchanges being required to report suspicious transactions to the financial authorities.
Below, this section will consider the approach in the US, Europe, and Asia.
- THE US*
The US Commodity Futures Trading Commission (CFTC) has designated Bitcoin to be a commodity. Although the CFTC does not regulate Bitcoin directly, it has authority regarding commodity futures directly connected to Bitcoin. For example, the CFTC recently accepted a proposal by the Chicago Mercantile Exchange to allow Bitcoin and another cryptocurrency to be cleared in the same manner as other products, which could have a major effect on the value of Bitcoin.
As noted earlier, the trading of Bitcoin would fall under the label of “Money Services Businesses,” according to FinCEN.
There have been various approaches taken by individual States at a State level, particularly with the regulation of exchanges or other money transmitters. Some states, such as New York, have made specific licensing regimes that apply to cryptocurrency exchanges. In contrast, other states, such as Texas, continue to apply existing financial laws and cryptocurrencies. However, the effect of this license in New York was considered by some to be a stifling of the fintech industry’s use of cryptocurrency in that State.
The European Central Bank has classified Bitcoin as a ‘convertible decentralized virtual currency. The European Banking Authority (EBA) has advised European banks not to trade in any cryptocurrencies until a regulatory regime was put in place. In 2016, the European Parliament agreed to set up a task force to monitor cryptocurrencies to combat money laundering and terrorism. The European Commission has further proposed that cryptocurrency exchanges and digital wallets would be subject to regulation to prevent tax evasion.
Although the MAS does not regulate cryptocurrencies themselves, it restricts their activities, such as exchanges.
Shanmugaratnam explained that MAS, which functions both as Singapore’s central bank and financial regulating body, lacks the authority to impose rules on cryptocurrencies themselves. It can, however, restrict “the activities that surround them if those activities fall within our more general ambit as a financial regulator.” In addition to money laundering and funding terrorism, these activities also include holding token offerings that issue coins doubling as securities. In the case of such an offering, he elaborated, “The requirements of having to register a prospectus, obtain intermediary or exchange operator licenses, will apply,” as will “rules on anti-money laundering and countering terrorism financing.” He pledged that MAS would continue to examine the need for “more targeted legislation” on token offerings in addition to the securities laws that are already on the books.
The South Korean regulators have been actively investigating some exchanges in recent months, especially after the high-profile hackings and subsequent closure of the Youbit exchange.
To operate legally, the regulators have stated that exchanges must ensure that the following procedures are in place:
- ensure that customers’ funds must be kept separately.
- provide users with thorough explanations of investment risks.
- confirm users’ real names.
- establish an adequate anti-money laundering system.
- have an asset protection system such as dispersion of cryptographic keys.
- increase transparency by disclosing transaction details to the public.
In addition, South Korea has also limited the rights of financial institutions to offer virtual, anonymous bank accounts and place the responsibility on exchanges to report any large cryptocurrency transactions. The new regulations also restrict non-nationals and minors from making any cryptocurrency transactions.