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

What is Money?

Store of Wealth

Medium of Exchange

Unit of Accounting

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?

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

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

What’s the BIG Idea?

Bitcoin is a decentralized, peer-to-peer payments technology

bitcoin (BTC) is a digital currency / medium of exchange

Just what is 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

Ideology of Bitcoin

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

What makes Bitcoin Valuable?

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

How does Bitcoin work?

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

Why so much excitement?

Privacy VS Anonymity

The “blockchain” contains the entire history of every bitcoin transaction everconducted and is publicly available.

An Analysis of Anonymity in the Bitcoin System - Bitcoin is Not Anonymous, byFergal Reid and Martin Harrigan (2011)

“ Bitcoin is not inherently anonymous. It may be possible to conducttransactions 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, sevenauthors, University of California, San Diego, and George Mason University

Significant information can be obtained by researchers; and significantly moreby persons having subpoena powers

One’s anonymity is quite a lot less than what you might imagine.

Is Bitcoin Anonymous?

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

Risks of Bitcoin?

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

More Bitcoin Risks?

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 ShaskyCalvary, FinCEN Director

States working to understand and address

Hearings, proposed additional regulations

What do the Regulators say?

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

Before March 18, 2013

• 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)

FIN 2013-G-001

“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.

FinCEN’s New 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.

More FinCEN Definitions

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

“Users” of Virtual Currency

A person that creates units of convertible VC and sells those unitsto another person for real currency or its equivalent is engaged intransmission to another location and is a money transmitter.

A person is an exchanger and a money transmitter if the personaccepts such de-centralized convertible virtual currency from oneperson and transmits it to another person as part of theacceptance and transfer of currency, funds, or other value thatsubstitutes for currency.

Administrators / Exchangersof Virtual Currency

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

Requirements ofExchangers / Administrators

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

Risk Mitigation for VC Businesses

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?

Alternatives?

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?

Opportunities for Financial Service Centers ?

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

Operational Issues

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

Questions?Jay Postma, CAMSPresidentMSB Compliance Inc.Jay.Postma@MSBComplianceInc.com(678) 389-9068

www.MSBComplianceInc.comwww.Twitter.com/MSBComplianceWeekly: paper.MSBComplianceInc.com

Paul SpoterLaw Offices of Paul SoterPsoter@sonic.net(415) 333-3193

www.LawOfficesofPaulSoter.com