February 12, 2014
Last month, there were two important developments with respect to the regulation of virtual currencies like Bitcoin. On January 30th, the Financial Crimes Enforcement Network (FinCEN) issued two administrative rulings, which provided further interpretive guidance about when virtual currency-related conduct will cause an entity to qualify as a "money services business" (MSB) subject to the requirements of the U.S. Bank Secrecy Act (BSA). At the state level, the New York Department of Financial Services (NYDFS) held two days of hearings on the regulation of virtual currencies. This Client Alert discusses these two developments.
I. FinCEN Administrative Rulings
The BSA is the United States’ primary anti-money laundering and counter-terrorist financing regulatory regime. It requires that entities that meet the definition of MSBs register with FinCEN, comply with various recordkeeping rules, establish and maintain anti-money laundering programs, and file currency transaction and suspicious activity reports. One way that an entity can qualify as an MSB is by engaging in "money transmission services," defined as 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."
In a March 2013 guidance document, FinCEN sought to clarify what types of conduct by handlers of virtual currency would constitute money transmission services. The guidance created three categories of persons engaged in virtual currency-related conduct:
An administrator is a person that is engaged as a business in issuing (putting into circulation) a virtual currency, and that has the authority to redeem (to withdraw from circulation) such virtual currency.
An exchanger is a person that is engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.
A user is a person that obtains virtual currency to purchase goods or other services. In a footnote to the guidance document, FinCEN explained that a person might obtain virtual currency in many ways, including by purchasing it or "mining" it. The method by which a person obtains virtual currency is "not material" to the legal characterization of his or her conduct.
The guidance document concluded that persons acting as virtual currency administrators or exchangers are engaged in money transmission services and, consequently, are MSBs subject to the regulatory requirements of the BSA. Users of virtual currency, on the other hand, are not engaged in money transmission services and are therefore not subject to the BSA.
FinCEN’s January 2014 administrative rulings seek to locate two types of conduct within this interpretive framework. The first ruling states that a person that "mines" virtual currency and uses it solely for his or her own purposes qualifies as a "user" of virtual currencies, and is therefore not an MSB. The second explains that a company that purchases and sells virtual currency as an investment, exclusively for its own benefit, enjoys the same status.
The first FinCEN ruling had been sought by a company that mines Bitcoins. The company wrote to FinCEN seeking assurances that the company’s planned uses for those Bitcoins – using them to purchase goods and services, exchanging them for legal tender that could then be used to purchase goods and services, or transferring them to the owner of the company – were not money transmission services that would bring the company within the BSA regulatory regime.
FinCEN explained that mining virtual currency is one permissible way to obtain it. The legal status of the person doing the mining then depends on "what the person uses the . . . virtual currency for, and for whose benefit." Using the currency to purchase goods and services is conduct typical of the virtual currency user. The ruling continues to state that, even if the miner must exchange the virtual currency for legal tender before purchasing goods and services, the miner is not engaged in money transmission services "so long as the user is undertaking the transaction solely for the user’s own purposes and not as a business service performed for the benefit of another."
The ruling, however, also indicates that if a third party stands to benefit from the exchange, the miner may be engaged in money transmission services and therefore qualify as an MSB. In a footnote, the ruling cites older FinCEN administrative rulings that, although not directly applicable because they interpret an earlier version of the MSB definition, found payments to third parties not involved in an original transaction significant to a determination of MSB status. The ruling states that "a user wishing to purchase goods or services with the Bitcoin it has mined, which pays the Bitcoin to a third party at the direction of a seller or creditor, may be engaged in money transmission."
The second FinCEN ruling had been sought by a company that intends to produce software, for internal use only, that would automate the trading of virtual currency for legal tender and vice versa for purposes of advancing the company’s investment strategy. The company requested FinCEN to clarify whether this automated exchange would constitute money transmission services.
According to FinCEN, "when the Company invests in . . . virtual currency for its own account, and when it realizes the value of its investment, it is acting as a user of that . . . virtual currency within the meaning of the guidance." In other words, the automated exchange for the company’s own account does not qualify as money transmission services, and so the company is not an MSB. Similar to its first administrative ruling, however, FinCEN cautioned that any related transfers to third parties "at the behest of the Company’s counterparties, creditors or owners entitled to direct payments" would be "closely scrutinized." In addition, a decision to "provide services to others" that involved the accepting and transmitting of virtual currency for legal tender could alter the company’s regulatory status. And if the Company began to engage in a business of an exchange for virtual currency against currency of legal tender, the Company would become a money transmitter and be required to register with FinCEN.
Taken together, FinCEN’s recent rulings clarify that producing virtual currency or exchanging virtual currency for legal tender or vice versa is not in itself sufficient to confer MSB status – so long as the transaction is carried out solely for that person’s own benefit. Carrying out such transactions for third parties, however, may well result in an MSB finding and a basis for subjecting the company to the BSA and its regulatory requirements.
II. NYDFS Hearings
In its two-day hearings on virtual currencies, the NYDFS heard from representatives of the industry, legal practitioners and academics, and, perhaps most importantly, law enforcement, with New York County District Attorney Cyrus Vance, Jr. and Richard Zabel, the Deputy U.S. Attorney for the Southern District of New York, both testifying. Their testimony was made more poignant by the indictment, the day before, of Charlie Shrem, the Vice Chairman of the Bitcoin Foundation, for alleged money laundering violations. Both Direct Attorney Vance and Deputy U.S. Attorney Zabel contended that the nature of virtual currencies makes them susceptible to abuse by criminal actors and urged the NYDFS to be vigilant of this propensity in crafting a regulatory scheme.
The ultimate question for the NYDFS is how the State of New York will regulate Bitcoin and other virtual currencies. For many of the reasons that acting as an "exchanger" of virtual currencies can result in an MSB finding for FinCEN purposes, operating a Bitcoin exchange can trigger the money transmitter licensing requirements of many of the U.S. states. NYDFS Superintendent Lawsky has spoken publicly of perhaps requiring a special license (a "Bit-license") for virtual currency exchanges, due to the special law enforcement issues that have followed virtual currencies.
Because of the lack of clarity of virtual currencies’ status under U.S. federal regulatory schemes, the states may well take the initial lead in its regulation, just as with prior new financial services technologies, such as PayPal. As a result, the burdens that NYDFS ultimately imposes may be well be significant as Bitcoin and other virtual currencies continue to seek to gain wider acceptance. In the end, the stability of Bitcoin’s value – it has undergone significant volatility, indeed as late as February 7th, when the Japanese Bitcoin exchange, MtGox K. K., suspended withdrawals, leading to a plunge in the currency’s price – will likely be the most crucial determinant of Bitcoin’s position, and that of other virtual currencies, in the payment system.
From these developments, it is apparent that the regulator that is currently proceeding in the most meaningful manner on Bitcoin and other virtual currencies is FinCEN. No other substantial activity has occurred at the U.S. federal level, in part because of the continued difficulty in making virtual currencies fit neatly into the baskets that give federal authorities their jurisdiction to regulate. For virtual currency businesses that seek to provide transactional services for third parties, state money transmitter licensing is the most obvious manner in which to proceed, but as the NYDFS hearings indicated, much work still needs to be done in New York itself to give industry participants the necessary clarity.
 See 31 C.F.R. § 1022.380 (2012) (creating registration requirements); id. at § 1022.210 (creating requirement to establish and maintain an anti-money laundering program); id. at § 1010.311 (creating requirement to file currency transaction reports); id. at § 1022.320 (creating requirement to file suspicious activity reports).
 Fin. Crimes Enforcement network, U.S. Dep’t of the Treasury, FIN-2014-R001, Application of FinCEN’s Regulations to Virtual Currency Mining Operations (Jan. 30, 2014) [hereinafter FinCEN Ruling #1].
 Fin. Crimes Enforcement Network, U.S. Dep’t of the Treasury, FIN-2014-R002, Application of FinCEN’s Regulations to Virtual Currency Software Development and Certain Investment Activity (Jan. 30, 2014) [hereinafter FinCEN Ruling #2].
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding the above developments. Please contact the Gibson Dunn lawyer with whom you usually work, any of the following lawyers, or any member of the firm’s International Trade Regulation and Compliance Practice Group or Financial Institutions Practice Group.
Judith A. Lee – Washington, D.C. (+1 202-887-3591, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner - Washington, D.C. (+1 202-887-3632, [email protected])
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