To address a perceived gap in regulatory treatment of increasingly popular virtual currencies, including Bitcoin, the U.S. Department of the Treasury Financial Crimes Enforcement Network (FinCEN) released new guidance on March 18, 2013. The guidance represents the first step toward formal regulation of decentralized currencies. However, the guidance also extends beyond just decentralized currencies, impacting prepaid and virtual currency programs more broadly by introducing significant changes to the commonly understood application of FinCEN’s regulations to virtual currencies and prepaid programs. Companies should carefully evaluate the regulatory and compliance impact of the new guidance on their virtual currency and prepaid programs, and seek clarification regarding fundamental questions raised, but not answered by, the guidance.
The Bank Secrecy Act (BSA) and corresponding regulations subject financial intuitions and Money Services Businesses (MSBs) to a wide range of anti-money laundering obligations. Among other things, MSBs must establish anti-money laundering programs, file currency transaction reports and suspicious activity reports, and collect and maintain customer information and transaction records. Most types of MSBs must also register with FinCEN. Regulated MSBs include, among other entities, providers of prepaid access and money transmitters.
The prepaid access rule governs “access to funds or the value of funds that have been paid in advance,” a definition broad enough that it appeared to govern many virtual currency programs. However, the prepaid access rule is designed to govern only provider and sellers of prepaid access, and exempts certain forms of prepaid access from regulation. The recent rise in popularity of certain decentralized crypto-currencies, such as Bitcoin, appears to have caused federal concern that the prepaid access rule left federal authorities without enforcement power over users, administrators and exchangers of such currencies. If a virtual currency program is not regulated by the prepaid access rules (either because no entity could be said to act as a provider or seller of the program, or because the program qualified for the closed loop exemptions) that program is not subject to the anti-money laundering and customer information program requirements.
In an apparent attempt to address this gap, FinCEN released guidance regarding the “Application of FinCEN’s Regulations to Persons Administering Exchanging, or Using Virtual Currencies” (Virtual Currency Guidance) on March 18, 2013. The Virtual Currency Guidance explains FinCEN’s interpretation of the MSB regulations as applied to virtual currencies and directs that “convertible virtual currencies” be subjected to the rules governing money transmission, while suggesting that prepaid products denominated in “real currency” be governed by the prepaid access rules.
Scope of Virtual Currency Guidance
Convertible Virtual Currency
FinCEN limited the Virtual Currency Guidance to “convertible virtual currency.” FinCEN defines “virtual currency,” in contrast to “real currency,” as “a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.” In particular, FinCEN notes that virtual currency lacks the status of legal tender in any jurisdiction. “Convertible” virtual currency is further defined as either having “an equivalent value in real currency, or act[ing] as a substitute for real currency.” Ostensibly then, FinCEN envisions that some virtual currency might not exhibit either of these attributes and therefore fall outside the scope of the guidance. Bitcoin clearly appears to be covered by the guidance. The guidance is unclear, however, on what types of virtual currency would fall outside of the definition of “convertible.” The resulting ambiguity leaves an open question as to whether the guidance creates a dichotomy between Internet-based prepaid access and traditional card-based prepaid access or a dichotomy between prepaid access denominated in legal tender and prepaid access that is not. Open questions therefore remain as to whether programs involving "points," "miles" and similar units are regulated under the prepaid access rule or under the money transmitter regulations going forward.
Administrators and Exchangers
Even where a program involves convertible virtual currency, the guidance primarily applies to participants in the program that act as either administrators or exchangers. An administrator “is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.” An exchanger “is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.” Importantly, a single entity might fulfill both the administrator and exchanger roles.
Changes and Issues Raised by Virtual Currency Guidance
The six pages of detailed FinCEN guidance contain interpretations of the MSB regulations that represent important shifts for the industry. The following issues are among the most important raised by the Virtual Currency Guidance:
Points, Credits, Miles and Other Virtual Currencies May Be Considered Centralized Virtual Currencies, Subject to Regulation: The Virtual Currency Guidance splits virtual currencies into three categories: (1) e-currencies and e-precious metals; (2) centralized virtual currencies; and (3) decentralized virtual currencies. FinCEN has taken prior enforcement action against e-currencies, but the definitions of centralized and decentralized currencies offer some surprising implications. For example, centralized virtual currencies are defined as a “convertible virtual currency that has a centralized repository.” To the extent that prepaid programs otherwise meet the definition of “convertible virtual currency,” such systems would be captured in the centralized virtual currency category—with the entity hosting and/or backing the prepaid program acting as the centralized repository. This might be read to capture prepaid programs, such as credits, in-game points, airline miles and other programs previously considered prepaid access.
Money Transmitter Regulations Apply to Convertible Virtual Currencies: According to the guidance, an administrator of a centralized virtual currency is a “money transmitter to the extent that it allows transfers of value between persons or from one location to another.” Similarly, an exchanger of centralized virtual currency acts as a money transmitter when it accepts real currency in exchange for virtual currency and when it resells or anonymizes the sale of virtual currency by acting as an intermediary between the user and the administrator of the central repository. Furthermore, a person may be deemed an exchanger of decentralized currency if (a) the person mines the currency and then sells it rather than uses it to purchase goods and services, or (b) the person accepts the decentralized currency from one person and transmits it to another.
Loading Convertible Virtual Currency Accounts Is Money Transmission and the Goods and Services Exemption Does Not Apply: FinCEN’s guidance states that the mere act of selling or exchanging convertible virtual currency for real currency, or of loading a virtual wallet with convertible virtual currency in exchange for real currency, constitutes money transmission. FinCEN claims that this activity is money transmission because even though the money is transferred to the same person, it involves real currency being transferred from one location to another (the person’s real bank account to the person’s virtual account). Importantly, FinCEN expressly states that the traditional exemption for money transmission as part of the provision of goods and services does not apply to the sale of virtual currency.
The Term “Users of Virtual Currencies” Is Limited to Use for Purchases: Although the guidance does not focus on users of virtual currencies, it is important to note that FinCEN limits the definition of a “user” to “a person that obtains virtual currency to purchase goods or services.” This raises the question of what actions might cause a person to cross over from an unregulated user to a regulated administrator or exchanger. Sending virtual currency to another user? A few sales of virtual currency? Large volumes of virtual currency sales? Use of virtual currency to purchase other currencies, whether real or virtual? It is unclear whether FinCEN intended to import into the user requirements the concept contained within the definition of "exchanger" that one must be “engaged as a business” in order to be regulated. This issue may be of particular importance to users of decentralized virtual currencies.
Prepaid Access Must Be Denominated in Real Currency: The Virtual Currency Guidance dismisses what has been common industry understanding of the MSB regulations—namely that the definition “funds or the value of funds paid in advance” can include virtual currencies. Instead, the guidance limits prepaid access to “real currency.” FinCEN reaches this conclusion by noting the absence of the phrase “other value that substitutes for currency” from the prepaid access definition, as opposed to its specific inclusion in the money transmitter definition. This conclusion has several important ramifications. For instance, when read together with FinCEN’s previously issued list of Frequently Asked Questions (FAQs) regarding the prepaid access rules, the guidance suggests that prepaid cards denominated in downloads or minutes no longer fall under the prepaid access rules.
The Definition of “Exchanger” Covers Anyone Selling Convertible Virtual Currency: To the extent any entity is engaged as a business in selling or reselling convertible virtual currency, the guidance suggests it would be regulated as an MSB engaged in money transmission.
It Is Unclear Whether Wholesale Purchases of Virtual Currency Are Covered: The Virtual Currency Guidance does not address whether its analysis applies to business purchases of convertible virtual currency on a wholesale basis from an administrator or exchanger. The prepaid access rule similarly did not address wholesale transactions until FinCEN released answers to certain FAQs. Industry participants should seek clarification whether a similar wholesale exemption extends to the interpretation expounded in the Virtual Currency Guidance.
Clear Need for Formal Rule-Making on Virtual Currency Issue: For the purposes of this guidance, FinCEN created new terms and definitions for those terms, such as “user” in the context of virtual currency, “administrator,” “exchanger,” “convertible virtual currency” and “centralized repository.” As is evident from the issues discussed above, the definitions of these terms and their appropriate application to existing prepaid programs is far from clear. In fact, the definitions may create more questions than they answer. For example, is a centralized repository the same as a centralized ledger? When does a user “obtain” virtual currency as opposed to “creating” it? Further, the guidance proposes new interpretations of existing regulations, the regulatory purpose of which remains murky. For example, if the guidance applies to prepaid programs such as in-game points, what is the regulatory purpose for regulating such programs as money transmission rather than prepaid access? In other words, how is selling 1,000 “points” for $10 for use within a game any higher risk, requiring a different regulatory regime, than selling $10 of prepaid merchandise on a card? The net result of the ambiguity created by the Virtual Currency Guidance is a clear need for FinCEN to engage in the formal rule-making process regarding these issues. In addition to allowing FinCEN an opportunity to clarify the regime it intends to apply to virtual currencies, and which virtual currencies it intends to cover, the rule-making process would allow industry players the full panoply of due process protection to which they are entitled—an opportunity to object, comment and respond to the proposed rules.
The Regulatory Landscape for Prepaid Programs Is Left Unsettled
Ultimately, in light of the issues discussed above, the Virtual Currency Guidance creates a dichotomy between different types of prepaid programs—with some, yet-to-be-clarified types of prepaid programs and virtual currencies falling under the guidance and others governed by the prepaid access rules. The guidance is not clear, however, as to where the dividing line lies. Are all prepaid programs denominated in legal tender governed by prepaid access while all others are governed by the money transmission regulations? Or, are all “virtual” (a term FinCEN did not define) prepaid programs subject to the money transmitter regulations while more traditional, card-based programs are governed by the prepaid access rules? In light of the unsettled regulatory landscape left in the wake of the Virtual Currency Guidance, all administrators and exchangers of virtual currencies and prepaid programs, including those that might have previously been characterized as prepaid access programs, should reevaluate their compliance and related regulatory risk and be warned that their former assumptions about the regulatory landscape may need reassessment.
Contact counsel for more information regarding the FinCEN’s Virtual Currency Guidance.
 See, 31 C.F.R § 1010.100(ff)(4)(i) (providers); Id. § 1010.100(ff)(7) (sellers); Id. § 1010.100(ff)(4)(iii)(A) (closed loop exemption).
 See, e.g., Federal Bureau of Investigation, Intelligence Assessment, Bitcoin Virtual Currency: Unique Features Present Distinct Challenges for Deterring Illicit Activity (Apr. 24, 2012), available here.
 FinCEN, Guidance: Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, FIN-2013-G001 (Mar. 18, 2013).
 “Real currency” is defined by FinCEN regulations as “the coin and paper money of the United States or of any other country that [i] is designated as legal tender and that [ii] circulates and [iii] is customarily used and accepted as a medium of exchange in the country of issuance.” Id. at 1 (citing 31 C.F.R. § 1010.100(m).
 Id. at 2 & n. 6. Although FinCEN defines a user of virtual currency as “a person that obtains virtual currency to purchase goods or services,” id. at 2, the guidance unequivocally opines that obtaining and using virtual currency to purchase goods or services does not qualify a user as an MSB. Id.
 Id. at 3. The Virtual Currency Guidance amends prior instructions from FinCEN regarding broker-dealers in the virtual currency landscape. Id.
 FinCEN, Frequently Asked Questions: Final Rule - Definitions and Other Regulations Relating to Prepaid Access, available here.