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Matt Stankiewicz continues with this two-part publication on the DOJ’s cryptocurrency guide.
The DOJ Cyber Digital Task Force report, “Cryptocurrency: An Enforcement Framework,” provides a comprehensive picture of the growing partnerships between DOJ and other offices within the executive branch. We have seen these partnerships expand into other legal areas and the continued advancement of these relationships continues to build an impressive judicial strength
FinCEN
FinCEN has long been involved in the cryptocurrency industry, as one would expect. FinCEN is responsible for implementing and administering the Bank Secrecy Act (“BSA”). FinCEN regulates monetary services activities (“MSBs”), which include cryptocurrency exchanges, along with various other services related to cryptocurrencies. FinCEN even tackled “virtual currency” directly in 2013, during the industry’s early childhood.
As the report explains, the DOJ’s relationship with FinCEN falls into two main categories: crime prevention and investigative assistance. FinCEN is responsible for receiving and analyzing information relating to money laundering and terrorist financing, through suspicious activity reports (“SARs”). FinCEN also acts as a conduit for financial intelligence information obtained from its foreign counterparts.
To highlight this partnership, the DOJ discusses a collaboration between FiNCEN and the US Attorney’s Office for the Northern District of California. After a parallel investigation with the DOJ, FinCEN fined Ripple Labs Inc. in 2015 for over $ 700,000 as a civil fine for violations of the BSA. Ripple Labs created and sold the XRP cryptocurrency. Ripple Labs failed to register with FinCEN and deliberately violated several requirements of the BSA by selling XRP. Ripple Labs also failed to implement an AML program. At the time of the breaches, it was the second largest cryptocurrency by market capitalization, behind only Bitcoin.
Ripple wasn’t happy about being highlighted in this report, and the San Francisco-based tech company has been threatening to move overseas ever since.
I’M DOING
OFAC has the task of administering and enforcing economic and trade sanctions. These sanction schemes target malicious actors to serve US foreign policy interests and national security objectives. Put simply, US Persons – a broad definition – are prohibited from engaging in transactions with sanctioned parties. Unsurprisingly, these sanctioned entities are constantly looking for ways to get around these limitations and restrictions and have turned an eye to cryptocurrency in an effort to facilitate those desires. OFAC has followed suit and has also turned its attention to the sector, even going so far as to sanction individual Bitcoin wallet addresses, as well as the Venezuelan Petro as a whole, the cryptocurrency developed by the government of Venezuela.
The DOJ’s relationship with OFAC has grown significantly in recent years overall. Its joint focus on cryptography comes as no surprise as sanctioned entities continue to explore it as an option to bypass restrictions. In August 2019, the DOJ and OFAC worked together against several Chinese citizens for their roles in the distribution of fentanyl. The DOJ had previously indicted and charged several of these entities for their roles, and had coordinated with OFAC to have them all sanctioned under the Foreign Narcotics Kingpin Designation Act. OFAC also partnered with the DOJ to prosecute criminal charges. against North Korean entities associated with ransomware and hacking of a major cryptocurrency exchange.
SEC
The SEC has been something of a bugbear in the cryptocurrency industry for years, as investors worried whether or not their favorite cryptocurrency would be considered a security. Concerns came to a head when initial coin offerings (“ICOs”) grew exponentially and billions of dollars were poured into unregulated and unregistered investment offerings. As such, the SEC has devoted significant resources to this area and released a set of guidelines to help issuers and investors better understand what is and what isn’t, with their interpretation adapted to virtual assets.
The DOJ has maintained a strong working relationship with the SEC for several years now. Longtime readers of our blog know this, as we have written extensively about their teamwork in prosecuting violations of the Foreign Corrupt Practices Act (“FCPA”). As such, these two are a scary tandem for would-be title violators. Look no further than the 2018 case against AriseBank and its executives. While the SEC filed civil lawsuits to stop an alleged fraudulent ICO, the FBI and SEC coordinated a search of AriseBank’s headquarters and executed a freeze order. Meanwhile, the DOJ has filed a criminal suit against the CEO and COO in which the two plead guilty, while a corresponding civil action by the SEC resulted in millions of dollars in fouling.
CFTC
The CFTC takes its authority from the Commodity Exchange Act, which provides a broad definition for “commodities”. The CFTC has released guidance to this end, concluding that some cryptocurrencies fall within their “commodity” scope. This conclusion has been reinforced by a handful of court rulings determining it. The clearest implication of CFTC jurisdiction occurs when fraud or manipulation occurs in cryptocurrencies traded in interstate trade – these are the “pump-and-dump” schemes that have plagued the altcoin boom.
We know the CFTC has maintained a strong relationship with the DOJ, especially recently. So it’s no surprise that the two are working well together in the cryptocurrency industry. The two pursued parallel proceedings against Blake Harrison Kantor and Nathan Mullins, among others, who were selling ATM Coins in the United States. The conduct involved a fraud scheme that convinced customers to buy binary options and / or transfer funds into ATM Coin. The two therefore embezzled most of these funds. In the CFTC action, Kantor and Mullins were forced to pay over $ 4 million, while the DOJ action resulted in 86 months of imprisonment.
Also recently, the DOJ filed charges against BitMEX and several members of its executive team for BSA violations. In its press release, the DOJ noted its partnership with the CFTC and thanked their investigators for their work and experience.
IRS
Put simply, the federal government wants their cut. The IRS said the cryptocurrency will be treated as “property” for tax purposes and noted that cryptocurrency (including cryptocurrency) operations are considered taxable events. The IRS has provided various other forms of guidance relating to the tax treatment of cryptocurrencies, including guidelines relating to “hard forks” and resulting assets.
Office of the Comptroller of the Currency (“OCC”)
The OCC “establishes, regulates and controls national banks and federal savings associations”. Specific to cryptocurrency, the OCC has issued guidelines regarding cryptocurrency custody services for banking clients. In this guide, the OCC noted that holding private keys for their customers is a modern version of a traditional banking business.
State regulations
Outside of the federal government, state regulators are also pursuing their own regulations and frameworks. New York has been at the forefront of this work with their Bitlicense and other efforts, including the Virtual Markets Integrity Initiative.
International regulation
The Financial Action Task Force (“FATF”) is an intergovernmental organization focused on combating the financing of terrorism, international money laundering and various other threats to the international financial system. The United States is a founding member and has been a key player in promoting an international guide to cryptocurrency. In recent years, the FATF has continued to provide international guidelines and structures for the management of cryptocurrencies, while minimizing money laundering and terrorist financing activities. This report notes that DOJ attorneys played a key role in drafting many of these documents.
Challenges underway
Privacy and anonymity will continue to be an important battleground for the application, as I have written in the past. This has always been a central tenet of the technology since its inception. As such, while regulators continue to improve their resources to “follow the money,” there are many in the industry struggling to stay one step ahead. This has led to a number of innovations that the DOJ highlights in this report.
The DOJ has focused many of its regulations on cryptocurrency exchanges, as they tend to be the primary gatekeeper as a channel between fiat and crypto for many people. As such, they are tasked with meeting KYC requirements, along with reporting and monitoring activities. That said, we are now starting to see the rise of decentralized exchanges and this DeFi movement will remove that centralized exchange from the equation. How regulators will address this new challenge remains to be seen.
Outside of exchanges, there are a variety of other ways for people to transact with cryptocurrency or trade fiat in cryptocurrency. These include peer-to-peer and crypto-kiosk services (essentially, crypto ATM). These are all required to adhere to certain KYC and AML requirements.
Mixers and glasses are another threat that will be difficult to deal with. Put simply, these tools blur the origin and destination of cryptocurrency transactions. These tools function as intermediaries in multiple transactions and all transactions send their coins into the mixer, and the mixer then randomly transmits the coins to their intended destination. This makes it difficult, if not impossible, to identify who the actual intended recipient was in a transaction. Earlier this year, the DOJ announced an indictment and the arrest of the operator of Helix, a mixing service that helped launder nearly $ 300 million worth of Bitcoin. The DOJ warns that these services are considered MSBs, which means they are subject to a number of regulations.
Likewise, we continue to see an increase in privacy-focused cryptocurrencies. Monero is one of the oldest examples, but other types continue to appear. While Bitcoin maintains a public ledger, in which each transaction is available for the world to see (albeit anonymized based on wallet addresses, which can ultimately be linked to individuals or entities with some legwork), the privacy coins keep their transactions hidden from the public. So, although Bitcoin was previously used on Darknet markets, we have seen a shift to these privacy coins to further hide the source and destination of these funds. The DOJ identifies these coins as “high risk assets” and does not liquidate any of these seized funds, to prevent them from getting back into the flow of trade.
Conclusion
Overall, the report provides welcome clarity on the enforcement priorities of the DOJ and the U.S. federal government as a whole. The report is more a historical look at previous actions in the cryptocurrency industry with accompanying descriptions of how they came about and under what legal authority they were brought. While there are still many unanswered questions, this report offers guidance for professionals moving forward.
