U.S. Treasury Promised New Cryptocurrency Regulation: What May Come Along?

News and Analysis

On February 12th, Treasury Secretary Steven Mnuchin said that the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) is going to release new cryptocurrency regulations with “significant new requirements” regarding crypto.

The statement took place in a hearing before the Senate Finance Committee. Senator Maggie Hassan pointed out the difficulties of fighting illegal activities with cryptocurrencies and asked Mr. Mnuchin how the Treasury’s budget increase helps the cause. 

“How will the Treasury’s proposed budget increases assist the Department in monitoring suspicious cryptocurrency transactions and prosecuting terrorists and other criminal organizations financing illicit activities with cryptocurrency,” Senator Hassan enquired.

Without noting any significant details, Treasury Secretary Mnuchin said that the work on new regulation is being done and we may see it soon:

“Specifically on cryptocurrencies, we’re spending a lot of time on this both on interagency basis and with the regulators. We’re about to roll out some significant new requirements at FinCEN.” 

Mr. Mnuchin also assured the Senate that they will be seeing “a lot of work coming out very quickly.”

We’ve ventured on a quest to find leads and establish the context to help see the picture better. In this piece, we share our findings and suggest our educated guesses on the matter.

U.S. Regulator’s Scope For Crypto

An important element of this discourse is the 2020 National Strategy for Combating Terrorist and Other Illicit Financing (2020 Strategy) issued by the U.S. Department of the Treasury on February 6th. This document describes key threats and vulnerabilities related to the AML/CTF regime and is at least somewhat representative of the efforts to regulate cryptocurrencies in 2020.

The strategy acknowledges “the challenges of intermediation and the globally dominant role of U.S. banks in facilitating cross-border payments” and notes that inferior AML/CFT supervision in some foreign jurisdictions is likely “facilitate the flow of illicit proceeds into or through the U.S. financial system.” There are three strategic priorities for the 2020 Strategy, according to the Treasury’s press release:

  1. Increasing transparency and closing gaps in the U.S. AML/CFT legal framework;
  2. Improving the efficiency and effectiveness of the U.S. AML/CFT regulatory and supervisory framework for financial institutions; and
  3. Enhancing current AML/CFT operational capabilities. 

Digital assets are included in the Strategy as a vulnerability exploited to circumvent the authorities’ restrictions. To clarify, the document explains “digital assets” as a term broadly encompassing digital currencies (including certain convertible virtual currencies) and “digital assets that are securities, commodities, and derivatives.”

The document also points out the fact that digital assets, and national digital currencies, in particular, may facilitate sanctions evasion. It highlights the example of Venezuelan Petro, stating that it “was designed explicitly to evade U.S. sanctions on Venezuela’s government.”

“Additionally, there are cross-border digital currency efforts, decentralized applications or distributed/disintermediated platforms that could enable cross-border digital currency in lieu of major fiat currencies like the U.S. dollar without adequate AML/CFT controls,” the Strategy warns.

In terms of enforcing the rules, the document mentions that AML/CFT obligations are imposed “based on a person’s or entity’s activity, not self-description or business status or label.” Depending on the nature of the financial service involving digital assets, regulatory requirements can be different. It is also stated that different activities with digital assets will be dealt with by different authorities:

“Digital asset activity involving securities by SEC-regulated institutions, commodities by CFTC-regulated institutions, or any other type of financial service would fall under authorities based on that classification.”

The Strategy broadly describes the initiative to “clarify or update” the existing regulations so they can cover digital assets along with the old-school finance. 

“Treasury and other U.S. agencies will also use all tools at their disposal to prevent individuals and entities from providing financial services involving digital assets or other novel technological financial products that we believe do not effectively mitigate illicit financial risks,” the document reads.

It appears that the Department of Treasury, FinCEN, and “other agencies” are as keen as ever on dealing with cryptocurrency regulation, at least in terms of monitoring and restricting whatever can’t be monitored.

The European Example: 5AMLD

Whatever are the nuances of the actual “significant new requirements” teased by Mr. Mnuchin, the big question is “how will this work out for the crypto-industry?”

There is the not-quite-reassuring case with the EU amending the existing AML rules with the 5th Anti-Money Laundering Directive or 5AMLD. The new rules require businesses to enforce higher KYC/AML standards and place cryptocurrency service providers like crypto-exchanges and custodial wallets in regulators’ scope. 

The impact of the 5AMLD on the European crypto-businesses was apparently felt even before January 10th when the amendments came into force. A wallet provider Bottle Pay, previously based in the U.K., was forced to move to Panama:

“The amount and type of extra personal information we would be required to collect from our users would alter the current user experience so radically, and so negatively, that we are not willing to force this onto our community,” said the company’s blog post published last December.

Another example is a cryptocurrency derivatives exchange called Deribit. Previously operated by a Netherlands-based company Deribit B.V., the exchange is now officially run by DRB Panama Inc., a full subsidiary of the Dutch company.

Yet, despite the relocation to Panama, the clients will still have to pass KYC, including the submission of their legal name, name, date of birth, address, and country of residence.

It appears that for European crypto-businesses the new strict AML requirements are harmful and hard to comply with, at least in the short term. If the U.S. rolls out a similar framework, then many businesses in the crypto-industry will have to find alternatives to those obviously significant jurisdictions.

Optimistic Perspective

The business within the industry will have to adapt or move to new places yet untouched by the regulators. The decentralized systems, which have no particular owner or even jurisdiction to be pinned to, will still feel the consequences, as no legally operating service provider will be able to use them. 

In the future, all the potentially “outlawed” systems like anonymous coins and coin mixers may exist in isolation from national money. The government can’t kill anonymous crypto powered by a decentralized network, but they can make such coin very hard to use and exchange for national currencies.

Although, regulation may eventually turn out to be beneficial for cryptocurrencies. Galaxy Digital CEO and a famous crypto-investor Mike Novogratz, said that the set of rules to be rolled out by the Treasury “puts some guardrails around Bitcoin” and will be positive for the first cryptocurrency. According to Blockonomi, there are at least a few influential people who believe that the regulation will “actually end up helping Bitcoin.” 

Indeed, if cryptocurrencies have to coexist with traditional finance and the respective authorities, there has to be clear regulation. We are seeing such regulation being formed and put to use across major jurisdictions, albeit slowly and somewhat painfully. 

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