The Justice Department sent jolts of concern through virtual currency providers last week, with its indictment against Liberty Reserve – a shadowy and anonymized virtual currency that, according to the Indictment against it, was “a financial hub of the cyber-crime world,” facilitating “a broad range of online criminal activity, including credit card fraud, identity theft, investment fraud, computer hacking, child pornography, and narcotics trafficking.” The evidence is mixed, however, as to whether the Indictment is a shot across the bow to the virtual currency world, or simply a bold strike against what the Treasury Department has called the “biggest U.S. money laundering [outfit] in U.S. history.”
The Liberty Reserve Indictment
Liberty Reserve was indicted under a provision of federal law, 18 U.S.C. § 1960, making it a crime to operate an unlicensed money transmitting business. (That provision also was used back in 2007 against e-Gold, an analogous e-currency that was alleged to have supported and anonymized illegal transactions.) At the core of the Indictment was Liberty Reserve’s efforts to anonymize its users’ identities and transactions – thus appearing to enable and encourage criminal transactions. Liberty Reserve’s service thus “was designed to attract and maintain a customer base of criminals and, in fact, became the online service preferred by cyber-criminals around the world for distributing, storing and laundering the proceeds of their criminal activity . . . .” (Indictment ¶ 14.)
For instance, according to the Indictment:
- “Liberty Reserve did not require users to validate their identity information, such as by providing official identification documents or a credit card” (Indictment ¶ 9). Thus, “accounts could . . . be opened easily using fictitious or anonymous identities” (Id.);
- For an additional 75 cents per transaction (called a “privacy fee”), Liberty Reserve would permit a user to “hide his own Liberty Reserve account number when transferring funds, effectively making the transfer completely untraceable,” even within Liberty Reserve’s own system (Indictment ¶ 10);
- To add an “additional layer of anonymity,” Liberty Reserve did not permit users to fund their accounts directly, “such as by issuing a credit card payment or wire transfer to Liberty Reserve.” (Indictment ¶ 11.) Rather users were required to make deposits and withdrawals through third party “exchangers” – “thus enabling Liberty Reserve to avoid collecting any information about its users . . . that would leave a centralized financial paper trail.” (Id.) When a user “wished to withdraw funds from his account, the user was required to transfer LR from his Liberty Reserve account to an exchanger’s Liberty Reserve account.” The exchanger would then arrange for the user to reserve actual currency. (Indictment ¶ 12.)
- The “exchangers” were themselves concentrated in places without much oversight or regulation – such as Malaysia, Russia, Nigeria and Vietnam. (Indictment ¶ 13.)
- Thus, the “primary function” of Liberty Reserve was simply “to launder money” (unlike, for instance, virtual currency associated with other platforms or transactions) (Indictment ¶ 25).
Roughly subsequent to the Indictment, FinCEN issued a Notice of Proposed Rulemaking labeling Liberty Reserve a money-laundering concern, effectively prohibiting other financial institutions from doing business with it.
The Future for Virtual Currencies post-Liberty
It remains to be seen whether the Liberty Reserve Indictment reflects a new focus by FinCEN on “virtual” currency – a term that itself varies in meaning depending on its functionality and use – or simply targets the egregious and purposeful criminal activities of Liberty Reserve. In 2007, many believed that the federal takedown of e-Gold foretold a new prosecutorial focus on virtual currency, but by and large, civil and criminal prosecutions have remained focused only on the most egregious actors.
A top Treasury Department official offered some clues in a recent interview. In an interview late last week with American Banker, Jennifer Shasky Calvery, Director of FinCEN (the U.S. Department of Treasury’s law enforcement division), indicated that FinCEN considers virtual currency providers to be in effect financial institutions, saying: “FinCEN has been out front in issuing our guidance to make it clear that we see virtual currency as a type of money services business. It’s as much a part of the financial framework as any other type of financial institution, and it has the same obligations as those financial institutions, the same obligations as any money services business out there.” Likewise, “For those that choose to act outside of those obligations and outside of the law, they are going to have to account for that.”
On the other hand, Calvery indicated that not all virtual currency providers would be under the sort of microscope used for Liberty Reserve: While Calvery indicated that the Treasury is closely examining the digital currency market and all of its players, she also suggested that the Indictment was not a shot across the bow to all virtual currencies: “[A]re we worried that the fact there’s been criminal enforcement, as well as regulatory, action against the biggest money launderer in U.S. history is going to lead banks now to do now overly aggressive [things] and de-risk … all virtual currencies? I’m not particularly worried . . . . If that ends up creating a broad-brush reaction that’s inappropriate, that is something that would be, first of all, unanticipated. Secondly, that’s something that would be addressed in the national conversation on the developing financial services industry in the weeks, months and years to come.”
A potential cause for concern by some providers is Guidance issued by FinCEN on March 18, 2013, which to some degree foreshadowed the Liberty Reserve Indictment. That Guidance stated, among other things, that “convertible” virtual currency — virtual currency that “has an equivalent value in real currency, or acts as a substitute for real currency”—would be treated akin to actual money under the Bank Secrecy Act, i.e., potentially subjecting transmitters to money transmitter regulations. FinCEN warned in that Guidance that:
“An administrator or exchanger 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.”
(“Money Transmission” means “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.”)
However, as that March 18th Guidance acknowledged, not all virtual currencies are created equal: first, “whether a person is a money transmitter is a matter of facts and circumstances”; second, there are multiple instances identified in the underlying regulations under which “a person is not a money transmitter, despite accepting and transmitting currency, funds, or value that substitutes for currency,” see 31 CFR § 1010.100(ff)(5)(ii)(A)-(F); third – and for many current businesses, most relevant — FinCEN has exempted from the definition of “money transmitter” the acceptance and transmission of funds (or virtual currency) where “integral to another transaction not involving money transmission.” The March 18th Guidance, significantly, confirmed that this exemption has “not materially changed.”
Recommendations
In the wake of the Liberty Reserve Indictment and the March 18th Guidance (as well as the takedown of the Mt. Gox Bitcoin exchange earlier in May), virtual currency platforms should carefully review their policies for any cracks in identification, anti-money-laundering, or money transfer procedures. These platforms should also carefully review federal and state law (FinCEN regularly issues and makes available online Guidance, letters and administrative rulings) to determine whether they fall under an applicable category under the Bank Secrecy Act (or state law) – whether as a money transmitter, a stored value or pre-paid access provider, or a currency exchange, and likewise to determine whether any exceptions apply.
