Evolution of FinCEN's Crypto Guidance

Introduction to FinCEN and The BSA

If you’re a U.S. business dealing with cryptocurrencies on a frequent basis, you’re most likely familiar with the legal concepts “money transmitter” and “money service business” (MSB). If not, you’re potentially opening yourself up to a world of hurt by failing to comply with federal and state anti-money laundering (AML) and know-your-customer (KYC) regulations, and should hire a lawyer yesterday. Failure to comply with applicable rules and regulations can lead to significant fines, and in some cases, criminal charges.

If you are familiar, then you know one of the most notable federal agencies regulating crypto is the Financial Crimes Enforcement Network, or FinCEN. FinCEN is responsible for enforcing the Bank Secrecy Act (BSA), which requires MSBs to register and obtain appropriate licenses at both the state and federal level, as well as implement robust KYC and AML programs, maintain transaction records, and report suspicious activities to appropriate authorities.

The BSA is a vital cornerstone in the U.S.’s fight against money laundering and terrorism funding, and its influence has even permeated to help shape global regulations like the Financial Task Force’s Travel Rule, which mandates that financial institutions and virtual asset service providers (VASPs) share certain information during transactions, enhancing transparency and accountability in cross-border transfers.

The integration of BSA principles into global regulatory initiatives underscores the significance of coordinated efforts in addressing the transnational nature of financial crime. By establishing common standards and fostering international cooperation, the BSA continues to serve as a linchpin in safeguarding the integrity of the global financial system against illicit activities, thus reinforcing the collective resilience of nations in combating money laundering and terrorism financing.

Despite its overarching influence and adaptability, applying the BSA to crypto presents a unique set of challenges. Unlike traditional financial instruments, crypto often operates in a decentralized and pseudonymous environment, complicating the identification and tracking of transactional activities.

The anonymity afforded by blockchain technology not only facilitates legitimate financial innovation, but also provides a fertile ground for illicit actors to exploit regulatory gaps and evade detection. As a result, regulatory authorities face the formidable task of reconciling the principles of the BSA with the inherent complexities of the crypto landscape, seeking innovative solutions to enhance transparency and compliance—all while preserving the core tenets of privacy and decentralization.

Since at least 2011, FinCEN has released three different attempts at providing guidance on the application of its regulations to virtual currencies. This article will provide a brief history of FinCEN’s guidance on cryptocurrency and shed light on some of its complexities and the implications it has for the industry and its future.

Relenting Revision

In 1999, FinCEN revised existing rules of how non-bank financial institutions are classified by the BSA. Certain financial institutions were grouped together into a category called “Money Service Businesses,” of which “money transmitters” were a type.

In 2011, FinCEN issued the “MSB Final Rule” to define a money service business as “a person wherever located doing business, whether or not on a regular basis or as an organized or licensed business concern, wholly or in substantial part within the United States,” operating directly, or through an agent, agency, branch, or office, who functions as, among other things, a “money transmitter.”

Broadly speaking, FinCEN defines a money transmitter as someone that acts as an intermediary between two parties that send or exchange money for another currency. To operate as a money transmitter, a business is legally required to be registered on a federal level and licensed in each state in which it operates.

After years of legal and regulatory ambiguity, FinCEN finally extended this requirement to the virtual currency industry.

In its 2013 guidance, Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, the AML watchdog made clear that in terms of money transmission legislation, it did not differentiate between fiat currency and virtual currency such as Bitcoin.

According to FinCEN, a “money transmitter” is defined as a person who provides money transmission services, or engages in the transfer of funds. “Money transmission services” equal 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.” FinCEN made clear that the phrase “other value that substitutes for currency” specifically accommodates virtual currencies, and the phrase “another location” is interpreted very broadly to include moving funds from a traditional bank account to an exchange account or a crypto wallet, even if belonging to the same individual.

FinCEN’s 2013 guidance aimed to clarify and provide regulatory certainty for the virtual currency industry by creating 3 separate classifications for crypto entities:

Users: persons who obtain virtual currency to purchase goods or services on the user’s own behalf (non-money transmitters)
Exchangers: persons engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency (money transmitter)
Administrators: persons engaged as a business in issuing (putting into circulation) a virtual currency, and who have the authority to redeem (to withdraw from circulation) such virtual currency (money transmitter).

The 2013 guidance also made clear that the method by which virtual currency is obtained—creating, mining, earning, purchasing, etc.—does not determine whether a person qualifies as a user, exchanger, or administrator. Finally, it confirmed that the regulations apply regardless of whether exchangers are directly brokering the transactions between two parties, or acting as a party to the transaction by using their own reserves.

This meant that companies who accepted virtual currency from one party and sent it to another party, or exchanged fiat currency for any digital currency, or even just accepted crypto from customers on behalf of a merchant, were considered money transmitters. Individuals and businesses, however, who simply exchanged crypto like Bitcoin for products and services, and vice versa, were not.

Despite providing much-needed clarification to the industry, plenty of ambiguity remained after the 2013 guidance. Thus, in 2019, FinCEN released its latest guidance, which expanded on the 2013 categories, providing further examples of each, and summarizing the development and content of its 2013 guidance. For example, FinCEN clarified that hosted wallet providers, as well as anonymizing service providers and payment processors qualify as money transmitters. For a further analysis of FinCEN’s latest guidance, and a discussion on the questions that remain for the crypto industry, see our article Navigating FinCEN’s Latest Crypto Guidance.

Given the five years that have passed since FinCEN’s latest guidance, one would expect another piece of guidance to come at any moment. In the meantime, it is up to experienced attorneys and judges to interpret FinCEN’s guidance and extrapolate its examples to the incessant wave of novel developments the crypto industry has come to appreciate.

Conclusion

The evolution of FinCEN’s crypto guidance reflects the regulatory landscape’s dynamic nature and the agency’s efforts to adapt to emerging technologies. From its early recognition of virtual currency exchanges as money transmitters to the more recent focus on wallet providers and decentralized finance, FinCEN’s guidance has aimed to provide clarity and address the risks associated with crypto-related activities.

As the crypto industry continues to innovate and expand, it is essential for those involved in the space to stay informed about regulatory developments and compliance obligations. By staying proactive and engaging with regulators, businesses can navigate the evolving regulatory environment and contribute to the responsible growth of the cryptocurrency ecosystem.

Whether you are an investor, entrepreneur, or business involved in cryptocurrency, our team is here to provide the legal counsel needed to maneuver this complex landscape. If you believe we can be of assistance, schedule a consultation here.