On December 23, 2020, the U.S Department of Treasury released for comment a proposed anti-money laundering ("AML") rule on Requirements for Certain Transactions Involving Virtual Currency or Digital Assets (the "Proposed Rule").
The Proposed Rule would require banks and money service businesses ("MSBs") to submit reports, keep records, and verify customers in connection with specific transactions involving unhosted virtual currency wallets and "otherwise covered wallets" in respect of convertible virtual currencies ("CVCs") or legal tender digital assets ("LTDAs").
On May 9, 2018, the Financial Crime Enforcement Network ("FinCEN") released guidance on Application of FinCEN's Regulations to Certain Business Models Involving Convertible Virtual Currencies (the "Guidance"), to provide direction to those subject to the Bank Secrecy Act ("BSA") on the framework relating to MSBs and how it applies to business models, specifically, to CVCs. The Guidance discusses CVC Wallets, the vehicle by which CVCs are stored and transferred through, and their regulatory treatment. The Guidance provides that application of BSA obligations would differ based on the whether a CVC is within a "Hosted Wallet" or an "Unhosted Wallet":
- Hosted wallets:
Account-based money transmitters may provide services to
customers' CVC in Hosted Wallets. The money transmitter is the
host that transacts on the blockchain on behalf of the customer or
wallet owner. Money transmitters doing business in whole or
substantial part in the United States, including banks within the
United States, that are hosted wallet providers, are subject to the
BSA's AML requirements. This includes enhanced due diligence
and reporting protocols.
- Unhosted wallets: A person may independently use a private key controlling the CVC to transact directly on the blockchain, without using a financial institution or third party to conduct the transaction. The private key, in this scenario, is stored in an Unhosted Wallet. Unhosted Wallets, where a person is transacting on their own behalf, are not subject to regulatory requirements under the BSA that are applicable to financial institutions, as they are not money transmitters. These types of transaction may not have a regulated financial intermediary involved in the transaction.The Proposed Rule introduces recordkeeping, verification, and reporting requirements 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 an "otherwise covered wallet". An "otherwise covered wallets" would mean wallets that are held at a financial institution that is not subject to the BSA and is located in a foreign jurisdiction identified by FinCEN on a list of foreign jurisdictions (which would initially include jurisdictions of concern from an AML perspective, e.g. Iran and North Korea).
The Proposed Rule
The Proposed Rule introduces recordkeeping, verification, and reporting requirements 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 an "otherwise covered wallet". An "otherwise covered wallets" would mean wallets that are held at a financial institution that is not subject to the BSA and is located in a foreign jurisdiction identified by FinCEN on a list of foreign jurisdictions (which would initially include jurisdictions of concern from an AML perspective, e.g. Iran and North Korea).
This Proposed Rule would bring Unhosted Wallets and "otherwise covered wallets" within the scope of AML regulation. The Proposed Rule includes the following requirements:
requirement: Banks and MSBs would be required to file a
report with FinCEN within 15 days from the date on which the
reportable transaction occurs. The report will include information
related to a customer's CVC or LTDA transaction and the
counterparty. There is an additional requirement to verify the
identity of the customer if a transaction is greater than $10,000
and the counterparty is using an unhosted or otherwise covered
- Record keeping
requirement: Banks and MSBs would be required to keep
records of a customer's CVC or LTDA transaction and the
counterparties. This includes verification of the customer if the
transaction is greater than $3,000 and the counterparty is using an
unhosted or otherwise covered wallet.
- Prohibition on structuring: The creation of a new prohibition on engaging in transactions in a manner that avoids reporting requirements.
The brief comment period initially expired January 4, 2021 (subsequently extended to January 7, 2021). The Proposed Rule elicited strong feedback from the industry with nearly 7,500 comment letters. Industry participants generally recognized the objectives of FinCEN, while expressing concern on substantive and procedural aspects of the Proposed Rule. The following highlights broad themes in relation to the feedback received in the comment letters from key industry participants:
- Privacy concerns: The comment letters highlight a strong concern with cybersecurity and the privacy of sensitive financial information, the recording of this information, and the potential for data breaches. With regard to the latter, the comments focused on the increased incidence of cybersecurity breaches, the deleterious consequences of them, and the increased potential threats to those who have personal or unhosted wallets.
- Cost benefit concerns: Industry participants expressed concern about staying competitive in the financial technology sector, and hindering cryptocurrency adoption in the United States when this industry in still in its infancy. The comment letters strongly noted that the Proposed Rule would be financially burdensome to compliance teams, and this could drive cryptocurrency transactions and financial innovation out of the United States. Industry participants stressed the need for further consideration on the substantial burden and costs the Proposed Rule would introduce to a relatively new industry, while in their view, the benefits are minimal.
- Procedural concerns: Almost every industry participant conveyed a very strong concern for the shortened 15-day comment period over the holidays in relation to the complex Proposed Rule. The industry noted that rushed rule-making created potential for undue consequences and could hinder the development of the financial technology ecosystem in the United States. Every comment letter included a strong request that the period be extended and meet the standard of at least 60 days.
Canada does not currently distinguish between hosted and
unhosted wallets. As of June 1, 2021, reporting entities will be
required to file a large virtual currency transaction report where
$10,000 or more in virtual currency is received in a single
transaction, or in multiple smaller transactions, over a 24 hour
period. Dealers in virtual currency will also need to perform
certain KYC verification for the exchange of virtual currency for
fiat currency, fiat currency for virtual currency or one virtual
currency for another which exceeds $1,000, and determine whether a
person who receives or transfers $100,000 or more in virtual
currency is a politically exposed person.
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