On December 18, 2020, the Financial Crimes Enforcement Network (FinCEN) issued a Notice of Proposed Rulemaking (NPRM) to establish new requirements for convertible virtual currency (CVC) and legal tender digital asset (LTDA) transactions. The NPRM is a response to the rise in illicit financial threats posed by alleged bad actors taking advantage of the anonymity offered by CVC and LTDA transactions. The proposed rule, which would affect US banks and money services businesses (MSBs), would expand existing reporting, verification and recordkeeping obligations under the Bank Secrecy Act (BSA) to CVC and LTDA transactions, add a new prohibition on “structuring” to avoid reporting obligations, and expand the definition of “monetary instrument” to include CVC and LTDA transactions.
Background
CVC is a medium of exchange, such as cryptocurrency, that either has an equivalent value as currency or acts as a substitute for currency, but lacks legal tender status. Blockchain-based CVCs (e.g., Bitcoin) are peer-to-peer systems that allow parties to transfer value directly, without the need for a centralized intermediary, such as a bank or MSB. While some individuals use financial institutions to facilitate CVC transactions on their behalf or to provide custody services for their CVC (hosted wallets), others store their private key in a software program or written record (unhosted wallets).
CVC wallets are interfaces for storing and transferring CVC. Hosted wallets are provided by account-based “money transmitters” that receive, store, and transmit CVC on behalf of accountholders. Money transmitters doing business in the United States and US banks that provide hosted wallets already are subject to the BSA’s anti-money laundering and counter-financial-terrorism program requirements and must conduct consumer due diligence with respect to accountholders and reporting suspicious activity. By contrast, users of unhosted wallets (i.e., individuals who conduct a transaction to purchase goods or services on their own behalf) are not “money transmitters” and currently are not subject to those same BSA requirements.
The proposed NPRM seeks to increase visibility into transactions involving these currently anonymized unhosted wallets, thereby bolstering investigators’ ability to analyze blockchain data to identify illicit activity.
Proposed rule
Existing currency transaction reporting (CTR) regulations impose verification, recordkeeping, and reporting requirements on banks and MSBs. The proposed rule would expand these obligations to certain deposits, withdrawals, exchanges, or other payments or transfers of CVC or LTDA by, through, or to a bank or MSB that involve an unhosted or otherwise covered wallet (an “otherwise covered wallet” would be defined as a wallet held at a financial institution that is not subject to the BSA and is located in a foreign jurisdiction identified by FinCEN).
The NPRM proposes four key changes to existing regulations:
- Extend verification and recordkeeping requirements to transactions with unhosted or otherwise covered wallets valued at more than $3,000. The proposed rule would require banks and MSBs to identify and verify hosted wallet customers when those customers conduct transactions above the equivalent of $3,000 in CVC or LTDA with an unhosted or otherwise covered wallet counterparty. Banks and MSBs also would be required to collect the name and physical address of the customer’s counterparties.
- Extend reporting requirements to transactions with unhosted or otherwise covered wallets. The proposed rule would cause banks and MSBs to generate reports containing the transaction hash and identity of both senders and recipients using unhosted or otherwise covered wallets. This reporting requirement would apply even if the user of the unhosted or otherwise covered wallet also holds a hosted wallet with the financial institutions. Like existing CTR reporting requirements, only transactions valued at more than $10,000 (or several transactions within the same 24-hour period aggregated to a collective value of more than $10,000) would trigger reporting obligations.
- Add a prohibition on “structuring” to avoid reporting requirements. The proposed rule creates a new prohibition on structuring virtual currency transactions to avoid reporting requirements. Structuring is a method used by some bad actors to avoid detection by law enforcement of their illicit activities.
- Expand the BSA definition of “monetary instruments.” The rule expands the BSA definition of “monetary instruments” to include CVC and LTDA. The proposed rule makes clear, however, that “the proposed determination is not intended to affect the regulatory definition of ‘monetary instruments’ . . . or the use of that regulatory definition elsewhere in FinCEN’s regulations.”
FinCEN has proposed two exemptions to the reporting requirement for:
- Transactions between hosted wallets held at financial institutions subject to the BSA; and
- CVC or LTDA transactions where a foreign financial institution hosts the counterparty wallet, unless that institution is located in a jurisdiction on the new “Foreign Jurisdictions List,” which FinCEN will establish and maintain.
Unlike the CTR reporting requirement, which exempts a non-bank financial institution (including an MSB) from the obligation to file a report otherwise required with respect to a transaction in currency between the institution and a commercial bank, the proposed rule would not extend this exemption to the proposed reporting requirement related to CVC and LTDA transactions between a bank’s or MSB’s hosted wallet customer and an unhosted or otherwise covered wallet.
Key takeaways
The proposed rule would affect the way banks and MSBs operating in the United States engage in CVC and LTDA transactions, and would expand their obligations under the BSA. Financial institutions that frequently engage in these transactions should stay apprised of the status of the proposed rule and comment submissions, as FinCEN has proposed an expedited notice and comment window. The 15-day window for public comment will close on January 4, 2021, so those wishing to submit comments must do so on or before that date.
Should these rules come into effect, financial institutions will need to reevaluate the sufficiency of their current corporate compliance programs to ensure they can effectively respond to these expanded requirements.
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