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Crypto, Virtual and Digital Currencies and FinCEN: A Comprehensive Breakdown of the Agency’s Interest and Oversight in the Space, Including Recent Decisions Regarding Classification as a Money Transmitter

Jacob Farber

Senior Counsel

Perkins Coie LLP

June 24-25, 2015

Amy Davine Kim

Counsel

BuckleySandler LLP


March 2013 Guidance

• Defined “virtual currency” • “a medium of exchange that operates like a currency in

some environments, but does not have all the attributes of real currency”

• Key is that it is not legal tender

• Focused on “convertible virtual currency” • “equivalent value in real currency” or “acts as a

substitute for real money”

• “Clarified” that convertible virtual currency is not “prepaid access” or “foreign exchange” because it is not legal tender


March 2013 Guidance, cont.

• Defined three sub-categories: • “E-precious metals” and “e-currencies”

• “Centralized” convertible currencies

• “Decentralized” convertible currencies

• The relationship between them is left murky

• E-currencies and e-precious metals are likely a sub-category of centralized virtual currencies



• Applied existing definition of “money transmitter” under Money Service Business (MSB) regulation

• Money transmission is very broadly defined: • Accept from one person:

- currency,

- funds, or

- other value that substitutes for currency; AND

• Transmit any of the above to another person or another location; OR

• “Transmit funds”

• There are several key exceptions (more on this later)



• Defined an entirely new lexicon for virtual currency activities

• “Exchanger”: “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 (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency”

• “User”: a “person that obtains virtual currency to purchase goods or services”



• An exchanger or administrator that “(1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations, unless a limitation to or exemption from the definition applies to the person”

• By contrast, “a user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an MSB under FinCEN regulations”



• The distinction between centralized and decentralized is key

• A centralized virtual currency is a convertible virtual currency that has a “centralized repository,” but that term is not defined nor is it used by the industry

• FinCEN assumes the centralized repository will have an administrator

• Unclear whether FinCEN intends this category to include virtual currencies involving a centralized ledger, those involving a single issuer, or both



• The Guidance left many open questions: • Status of miners

• Where to draw the line between exchangers and users engaged in direct sales

• The distinction between centralized and decentralized convertible virtual currencies

• Relationship between centralized virtual currencies and e-precious metals and e-currencies


Mining

• FIN-2014-R001 (Jan. 30, 2014)

• FinCEN explicitly confirmed that miners are users, reiterating that it is not how bitcoins are obtained but rather how they are used that is relevant

• “To the extent that a user mines Bitcoin and uses the Bitcoin solely for the user’s own purposes and not for the benefit of another, the user is not an MSB under FinCEN’s regulations …”

• This “is the case whether the user mining and using the Bitcoin is an individual or a corporation and whether the user is purchasing goods or services for the user’s own use, paying debts previously incurred in the ordinary course of business, or (in the case of a corporate user) making distributions to shareholders.”


Mining, cont.

• Addressed the dividing line between users engaging in occasional direct sales of their mined bitcoins and exchangers “engaged as a business” in the sale of bitcoins: • “[F]rom time to time . . . it may be necessary for a user to convert Bitcoin that it has

mined into a real currency . . . because the user wishes to diversify currency holdings in anticipation of future needs or for the user’s own investment purposes.”

• FinCEN found that in doing so: • “the user is not acting as an exchanger, notwithstanding the fact that the user is

accepting a real currency or another convertible virtual currency and transmitting Bitcoin, 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.”


Mining, cont.

• FinCEN went on to specifically affirm that a miner would be treated as user and not an exchanger to the extent that it: • uses Bitcoin it has mined: (a) to pay for the purchase of goods or services, pay

debts it has previously incurred (including debts to its owner(s)), or make distributions to owners; or (b) to purchase real currency or another convertible virtual currency, so long as the real currency or other convertible virtual currency is used solely in order to make payments (as set forth above) or for [the miner]’s own investment purposes.

• Thus, sales of mined bitcoins do not constitute money transmission under federal law, unless the sales are of such a character that the seller can be said to be “engaged as a business in the exchange of” bitcoin for real currency


Mining, cont.

• FinCEN did not offer any guidance as to where to draw that line

• Relevant factors may include: • Whether sales are regular and frequent

• Whether transactions are private

• Whether the seller holds itself out to the public as a seller of Bitcoin

• Whether the seller has a standing offer or an ongoing obligation to sell bitcoins

• Whether sales are independent transactions, reflected in a stand-alone bill of sale, with terms agreed to on a one-off basis, with no guarantee that any future sales will be conducted at the same price and terms

• Whether all of the counterparties to the transactions are sophisticated virtual currency businesses, as opposed to consumers

• Whether the sales are made only to fund the seller’s own operations and pay its own obligations

• In no case can the proceeds be directed to or benefit a third party


Rental of Mining Hardware

• FIN-2014-R007 (April 29, 2014)

• FinCEN affirmed that the rental of mining hardware does not constitute money transmission

• Relied on an exception for the provision of “network data access” and communications services to money transmitters

• Predicated on • Payment is for time

• Renter receives all proceeds

• Operator has no access to renter’s wallet


Rental of Mining Hardware, cont.

• What about mining pools themselves?

• FinCEN has not to date attempted to regulate the operation of a Bitcoin mining pool as money transmission

• Arguably, the purpose of the transaction is not to transmit monetary value from one person to another but rather to distribute revenue among persons who have entered into an agreement to do so

• Arguably, the pool does not receive value “from one person” in a coinbase transaction as the coinbase transaction is sent by the Bitcoin protocol

• Arguably, mining pools fall under an explicit exemption for money transmission integral to the provision of goods or services (more on this later)


Software Development and Investment Activity • FIN-2014-R002 (Jan. 30, 2014)

• The production and distribution of software, in and of itself, does not constitute acceptance and transmission of value, even if the purpose of the software is to facilitate the sale of virtual currency.

• A company purchasing and selling convertible virtual currency as an investment exclusively for the company’s benefit/own account is not a money transmitter.

• Company acting as a user.


Trading Platforms

• FIN-2014-R011 (Oct. 27, 2014) • Exchange maintains accounts in U.S. dollars and virtual

wallet. • Matches offers to buy and sell convertible virtual currency

for legal tender. • Customer funds exchange and submits an order to

purchase or sell the currency deposited at a given price. Platform attempts to match each purchase order to a sell order. If a match is found, Company purchases from Customer acting as seller and sell to the Customer acting as buyer, without identifying one to the other.

• Maintains set of book accounts so prospective buyers or sellers of one type of currency or the other can deposit funds to cover their exchanges.


Trading Platforms, cont.

• No element of conditionality to be a money transmitter. • A person that accepts currency, funds, or any value that

substitutes for currency, with the intent and/or effect of transmitting currency, funds, or any value that substitutes for currency to another person or location even if a certain predetermined condition established by the transmitter is met, is a money transmitter under FinCEN’s regulations.

• Each trade conducted through the Platform two money transmission transactions occur: one between the Company and the Customer wishing to buy virtual currency, and another between the Company and the Customer wishing to sell such virtual currency at the same exchange rate.


Trading Platforms, cont.

• An exchanger will be subject to the same obligations under FinCEN regulations regardless of whether the exchanger acts as a broker (attempting to match two simultaneous and offsetting transactions involving the acceptance of one type of currency and the transmission of another) or as a dealer (transacting from its own reserve in either convertible virtual currency or real currency).


Payment Systems

• FIN-2014-R012 (Oct. 27, 2014) • Receive payment from the buyer in “real

currency” via credit card, and transfer the equivalent in Bitcoin from own reserves to the seller.

• Argued that Company made payment from own reserves, rather than funding each transaction.

• FinCEN found Company was an exchanger because it engages as a business in accepting and converting customer’s real currency into virtual currency for transmission to merchant.


Exceptions? Integral to the Sale of Goods and Services • In both cases, “Payment processor” and “integral to

the sale of goods and services” exceptions did not apply.

• Three conditions for the exemption to apply: 1. The money transmission component must be part of the provision of

goods or services distinct from money transmission itself. 2. The exemption can only be claimed by the person that is engaged in the

provision of goods or services distinct from money transmission. 3. The money transmission component must be integral (that is, necessary)

for the provision of the goods or services.

• In FinCEN’s view, the Company is facilitating the transfer of value, both real and virtual, between third parties --the sole purpose of the Company’s System, and is not a necessary part of another, non-money transmission service.


Exceptions? Payment Processor • Four conditions for the payment processor exemption to apply:

• (a) The entity providing the service must facilitate the purchase of goods or services, or the payment of bills for goods or services (other than money transmission itself);

• (b) The entity must operate through clearance and settlement systems that admit only BSA-regulated financial institutions;

• (c) The entity must provide the service pursuant to a formal agreement; and

• (d) The entity’s agreement must be at a minimum with the seller or creditor that provided the goods or services and receives the funds.


Exceptions? Payment Processor • Failed to meet certain conditions:

• [Trading platform only]: Customer not receiving payment as a seller or creditor from a buyer or debtor for the provision of non-money transmission related goods or services (providing virtual currency for real currency or vice versa is not a non-money transmission related service); and

• [Both trading and payments]: Company is not operating through a clearing and settlement system that only admits BSA-regulated financial institutions as members (payments of convertible virtual currency to and from the Customers, by definition, take place outside such a clearance and settlement system).


The Future?

•More enforcement actions

•More clarification who/what is excluded

• SEC/CFTC jurisdiction

• Software/smart contracts


Jacob Farber Senior Counsel Perkins Coie LLP 202.654.6268 [email protected]

Amy Davine Kim Counsel BuckleySandler LLP 202.461.2903 [email protected]

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