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Bitcoin and Other Digital Currencies: The Latest Issues in Regulation and Enforcement

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Bitcoin and Other Digital Currencies: The Latest Issues in Regulation and Enforcement

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Presentation of October 10, 2014 by Jay Postma, CAMS and Paul Soter, Esq. during the Financial Service Centers of America (FiSCA) Annual Conference. Covering basics of digital currencies, bitcoin, regulatory and compliance issues, including BSA/AML, OFAC, etc.

Presentation of October 10, 2014 by Jay Postma, CAMS and Paul Soter, Esq. during the Financial Service Centers of America (FiSCA) Annual Conference. Covering basics of digital currencies, bitcoin, regulatory and compliance issues, including BSA/AML, OFAC, etc.

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Bitcoin and Other Digital Currencies: The Latest Issues in Regulation and Enforcement

  1. 1. Bitcoin and Other Digital Currencies: The Latest Issues in Regulation and Enforcement Jay Postma, CAMS President, MSB Compliance, Inc. Paul Soter, Esq. Law Office of Paul Soter
  2. 2. What is Money?  Store of Wealth  Medium of Exchange  Unit of Accounting
  3. 3. What is Virtual Currency?  A scrip?  A note system?  An e-wallet?  A commodity?  An automatic record-keeping system  A better form of money?  A diminution of power of central banks?  A manifestation of the sharing economy?
  4. 4. What is Virtual Currency NOT?  A mechanism for anonymous transactions  A system for laundering money  A way of getting off the grid  A Ponzi scheme  Backed by anything external  An organization: formal or informal  An ideology
  5. 5. What’s the BIG Idea? Digital Currencies as a New Enabling Technology Value store and payments architecture Internetification of money / money as an IP address Potential to significantly reduce friction in payments Eliminate / Reduce Identity Theft / Payments Fraud
  6. 6. Just what is Bitcoin? Bitcoin is a decentralized, peer-to-peer payments technology bitcoin (BTC) is a digital currency / medium of exchange
  7. 7. Ideology of Bitcoin It’s not really an ideology - it’s a protocol Early adopters and advocates… Libertarian Belief in limits / restrictions on gov’t Strong privacy advocates Fear of gov’t wealth confiscation Desire for monetary stability Vision for global reduction in payments friction; massive potential societal benefits Growing up massive VC interest / funding regulatory interest
  8. 8. What makes Bitcoin Valuable? Bitcoin’s value is based on its scarcity, divisibility and the consensus of those who find it to have utility Not backed by central monetary authority Distributed peer-to-peer network Open, math-based, transparency - trusted Common interest - not subject to government manipulation via inflation “Miners” verify and maintain integrity of system Rewarded with new BTC and BTC fees
  9. 9. How does Bitcoin work? Peer-to-peer network maintaining common ledger - the “blockchain” Public / Private Key Encryption Every transaction is maintained on the blockchain Private but not anonymous “Good funds” - like cash Transfers not subject to chargeback
  10. 10. Why so much excitement? Significantly reduce payments friction and associated expenses to businesses and consumers. Elimination of payments related identity theft and significant reduction of payments fraud. “Good funds” / irreversible payment transactions Digital money for Internet Expand market opportunities for businesses - emerging markets Increase ability to monetize assets / micro-payments Privacy, Protection of individual rights and freedoms Protection from Government monetary policies (confiscation, inflation, debasement, etc.) Potential for BTC value appreciation Mobile Payments
  11. 11. Is Bitcoin Anonymous? Privacy VS Anonymity The “blockchain” contains the entire history of every bitcoin transaction ever conducted and is publicly available. An Analysis of Anonymity in the Bitcoin System - Bitcoin is Not Anonymous, by Fergal Reid and Martin Harrigan (2011) “ Bitcoin is not inherently anonymous. It may be possible to conduct transactions in such a way as to obscure your identity, but, in many cases, users and their transactions can be identified.” “Anonymity is not a prominent design goal of Bitcoin.” T”he actions of many users are far from anonymous.” A Fistful of Bitcoins: Characterizing Payments Among Men with No Names, seven authors, University of California, San Diego, and George Mason University Significant information can be obtained by researchers; and significantly more by persons having subpoena powers One’s anonymity is quite a lot less than what you might imagine.
  12. 12. Risks of Bitcoin? Loss of value Like physical currency - subject to theft or loss Reputational risks may undermine confidence Federal, State, International regulators could prohibit use and/or implement onerous regulations Countries could issue competing digital currencies Market may determine BTC doesn’t have sufficient utility; other better solutions may arise
  13. 13. More Bitcoin Risks? Regulation FinCEN - money transmittal States - money transmittal… or other… OFAC, CFPB, SEC, CFTC, other? Consumer Protection Potential abuse for money laundering / terrorist financing Potential for OFAC violations Credit risk - BTC “good funds” given in exchange for payments subject to chargeback
  14. 14. What do the Regulators say? FIN0-2013-G001, March 18, 2013 – Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies “Digital currencies are just a financial service and those who deal in them are a financial institution. Any financial institution and any financial service could potentially pose an AML threat. It depends on whether folks have the controls in place to deal with those money laundering threats and that they are meeting their AML reporting obligations.” – Jennifer Shasky Calvary, FinCEN Director States working to understand and address Hearings, proposed additional regulations
  15. 15. Before March 18, 2013 Virtual Currencies in murky, uncertain “gray area” Depending on model - likely “money transmittal” but maybe “prepaid access” and perhaps involving “Dealer in Foreign Exchange” Not a “currency” or “monetary value” Often governed by contract between issuers and users
  16. 16. FIN 2013-G-001 • Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies Interpretive Guidance of existing statutes and regulations not a new “rule-making” Issued under existing authority No prior request for public comments knowledge of virtual currency models uncertain issued in vacuum without benefit of industry participation errors, omissions, ambiguities remain to be settled Identifies which parties involved in virtual currency are MSBs Identifies which of various MSB categories apply (money transmitter)
  17. 17. FinCEN’s New Definitions “Real currency” - 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. “Virtual currency” - a medium of exchange that operates like currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction. “Convertible virtual currency” - a type of virtual currency that either has an equivalent value in real currency, or acts as a substitute for real currency.
  18. 18. More FinCEN Definitions “User” - A user is a person that obtains virtual currency to purchase goods or services. “Exchanger” - An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency. “Administrator” - A person engaged as a business in issuing a virtual currency and who has authority to redeem such virtual currency, i.e. release and withdraw from circulation. “Centralized virtual currency” - A convertible virtual currency having a centralized repository. “Decentralized virtual currency” - A convertible virtual currency (1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort.
  19. 19. “Users” of Virtual Currency If virtual currency is used to purchase real or virtual goods or services, the User is not an MSB or money transmitter. Method of obtaining not material may be via purchase, mining, manufacturing, earning, etc. What one does with the virtual currency matters spending - not MSB selling / exchanging for “real” currency… if “mined” - may be money transmittal if selling to others probably not if exchanged via registered Exchange if exchanged at a registered Exchange, probably not
  20. 20. Administrators / Exchangers of Virtual Currency A person that creates units of convertible VC and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. 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.
  21. 21. Requirements of Exchangers / Administrators FinCEN registration as a “money transmitter” Agent list, if applicable State Licensure, where so required “4 pillars” - Policies, Procedures, Controls risk-based BSA/AML/OFAC program reasonably designed to protect, prevent, detect and report potential abuse for money laundering and/or terrorist financing. BSA recordkeeping, as applicable… CTRs, SARs, CMIRs, FBAR, MIL Record of Funds Transfers of $3,000 or more (Travel Rule) Customer Identification and Due Diligence OFAC
  22. 22. Risk Mitigation for VC Businesses FinCEN registration Strong “4-Pillars” BSA/AML program CIP / CDD Source/Use of funds - $ and BTC Transaction monitoring / reasonable limits Block chain analysis Including before receipt of BTC Including post disbursement of BTC State licensing (where applicable) Systems and Asset Protection
  23. 23. Alternatives?  Ripple: International Transfers • Advantage: Cost • Disadvantage: Only Bank-to-Bank  Gold: Store of Value • Advantage: historical value, utility, scarcity • Disadvantage: volatility similar to Bitcoin  US$: • Advantage: the full faith and credit of the United States • Disadvantage: inflation/deflation/Fed manipulation  €: A Distant Follower • Advantage: the currency of the world’s largest market • Disadvantage: lack of fiscal policy leads to unpredictability  Everything Else: Ideas?
  24. 24. Opportunities for Financial Service Centers ?  Exchanges/Sales/Redemptions  Accounting/recordkeeping/record retrieval mechanism  Migration of certain classes of transactions to Bitcoin?  International remittances?  Domestic money transfers?  Customer Bank account alternatives?  MSB Bank account alternatives?
  25. 25. Operational Issues  Volatility  Convertibility  Taxation of exchange Rate increases  Other tax issues  AML compliance issues  Accounting: net worth; profit/loss; money transfer records  Post-mortem issues: location, access, escheat, etc.  Secure storage
  26. 26. Where can I learn more? Bitcoin.org BitcoinFoundation.org en.bitcoi.it/wiki/Main_Page Blockchain.info WeUseCoins.com CoinDesk.com BitcoinMagazine.com LetsTalkBitcoin.com BitcoinCharts.com KhanAcademy.org Udemy.com
  27. 27. Questions? Jay Postma, CAMS President MSB Compliance Inc. Jay.Postma@MSBComplianceInc.com (678) 389-9068 www.MSBComplianceInc.com www.Twitter.com/MSBCompliance Weekly: paper.MSBComplianceInc.com Paul Spoter Law Offices of Paul Soter Psoter@sonic.net (415) 333-3193 www.LawOfficesofPaulSoter.com

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