Classifying Convertible Virtual Currencies as Money: A New Tool to Counter Financial Crimes

In January 2021, the U.S. government passed the Anti-Money Laundering Act of 2020 (“AMLA”) which has critical implications for the future of virtual currency transactions. Under the primary objective of addressing money laundering, the Act alters how money is regulated under the Bank Secrecy Act (BSA) by expanding the definition of money to include convertible virtual currencies and digital assets such as cryptocurrencies like Bitcoin—which were previously less affected by regulation.

These changes to the BSA are intended to help law enforcement more directly counter threat financing—the procurement of money for activities that threaten national security—and money laundering. According to federal data, the proposal affects more than five thousand banks, over 5,000 credit unions, and nearly 13,000 money transmitters. The act entails a rather drastic time and resource investment from both federal agencies and financial institutions.

Although the changes are unprecedented and create administrative burdens, the current volume of convertible virtual currency (CVC) transactions deserves attention. The Federal Register estimates that the volume of transactions amounts to over $300 billion in 2020 for just January through August for Bitcoin alone—not even accounting for other CVCs. Though illicit Bitcoin transactions accounted for only 1% of all economic Bitcoin activity in 2018, this criminal activity has become very advanced. Chainalysis reports that “exchange hacks have generated billions of dollars in criminal proceeds, darknet market activities have netted hundreds of millions of dollars in illicit revenues, and scams targeting individuals have stolen tens of millions of dollars.”

Now, the passage of the AMLA represents significant strides towards addressing this threat. The additional regulatory oversight under the AMLA will help control malicious transactions and devastating adverse events. The Act alone cannot serve as a panacea, but it is certainly a helpful starting point towards the goal of developing stricter CVC regulation.

This move to regulate CVCs was well supported by organizations around the world. Consider the research of the Financial Action Task Force (F.A.T.F.), an intergovernmental organization developed by the G7 which aims to counter money laundering, terrorist financing, and financing for weapons of mass destruction. In a year-long review of standards on virtual assets, the organization concluded that “countries should apply the relevant measures under the F.A.T.F. Recommendations to virtual assets and virtual asset service providers.” As defined by the F.A.T.F., virtual assets include cryptocurrencies and other digital assets. The organization, along with many CVC experts, recommends increased regulation to support anti-money laundering efforts and combating terrorist financing.

The Bank Secrecy Act and Its New Changes

To begin with a brief introduction to the BSA, it is a regulation originally passed in 1970 to establish a series of laws to counter money laundering. Widely known to be the most important Anti Money Laundering (A.M.L.) related act, the BSA outlines compliance regulatory requirements that ensure financial institutions build internal controls and report certain transactions to authorities. The BSA supports several aspects of A.M.L. efforts, but of particular importance are the Recordkeeping and Travel aspects of the BSA These two provisions of the BSA determine what kinds of financial transactions are overseen, retained, and reported.

On one hand, the Recordkeeping Rule is designed to help law enforcement and regulators monitor and investigate financial crimes by collecting information about a person’s monetary transfers. Towards a similar purpose, the Travel Rule requires banks and other financial institutions to retain information on monetary exchanges in which the financial institution is involved. Before cryptocurrencies and other virtual currencies were included in the purview of both rules, such transactions were not properly overseen.

The AMLA’s revised definition of money under the BSAdirectly impacts which transactions are monitored and to what extent they are regulated. As explained by the National Law Review, the BSA’s change in definition has expanded the Recordkeeping Rule and Travel Rule’s definitions of payment order and transmittal order to also include transactions and exchanges made using CVCs as well as legal digital tender such as government-backed coins. Agencies believe convertible virtual currencies already carry “an equivalent value in real virtual currency” and “act as a substitute for real currency.” It is important to note that in 2019, FinCEN had already advised that CVC transfers may fall in the purview of the Recordkeeping and Travel Rules, so this proposal has effectively codified a prior interpretation.

Previous Definition of Money & Significance of CVCs

Previously, the Recordkeeping and Travel Rules defined money as “a medium of exchange currently authorized or adopted by a domestic or foreign government.” CVCs were not included under such a definition as most were not endorsed by any government or used in an official way. CVCs include all mediums of exchange that function like a currency but are not technically legal tender, like bitcoin, cryptocurrencies, and other alternative digital currencies.

One might wonder why CVCs warrant so much attention, or why their current inclusion within a definition of currency is significant. The answer is that these virtual currencies are often under-regulated and are more easily used for nefarious purposes. Some of the characteristics that make virtual currencies risky include the fact that transactions are often anonymised. For example, many CVCs have cryptographic enhancements, as they are global in nature and are very quickly and widely distributed. These characteristics make it more difficult for law enforcement to regulate crimes facilitated through cryptocurrencies, such as money laundering, extortion, drug and human trafficking, cybercrime, and sanctions evasion. Given that CVCs can be such a pervasive threat when not overseen, their further oversight has been a welcome shift.

It is important to note that criminals are not always isolated actors who are working against state interests—sometimes, criminal actors can be other large and powerful governments. For example, although most cryptocurrencies are not officially affiliated with any country, Venezuela designed its own sovereign cryptocurrency named the ‘Petro’ which was allegedly intended to help the country get around sanctions and more easily launder money that was made from activities related to fraud, embezzlement, and unsanctioned transactions. Although ties to the Petro were explicitly prohibited in the United States by an Executive Order by President Trump, many other digital currencies are used for criminal purposes. Unsurprisingly, other countries such as Russia and Iran are interested in using digital currencies to fund criminal activities and evade sanctions. Cryptocurrencies have typically been harder to identify and regulate than a standard foreign tender for the reasons described above.

Perspectives from Financial Institutions

Despite the benefits that will be derived from bringing CVCs under closer regulation, there has been pushback. The new definition of money may be burdensome to financial institutions but the degree of burden is unclear. Under the new rules, banks and other financial firms would have to collect information on many new transactions that were not previously subject to the Recordkeeping and Travel Rules. In addition, the institutions’ BSA compliance programs are requiring updates to their oversight and reporting procedures based on the new rules. Although the additional cost of compliance, including information technology costs, reporting costs, and recordkeeping costs is not known at this time, financial institutions will surely bear some of these burdens.

So far, some banks have been concerned with how they can interpret the new definition of money in practice. The intentionally vague definition of convertible virtual currencies presented in the proposal acts as a “catch-all,” but the somewhat obscure definition also may be difficult for smaller financial institutions to interpret. The act also promises that banks and non-bank financial institutions will receive practical training and guidance as to how to interpret the new definition of money.

There are almost 4,000 small banks, 5,000 small credit unions, and thousands of small money transmitters that are affected by the new rules under the AMLA of 2020. Burdens on small financial institutions are worth understanding because these entities usually find regulatory requirements more difficult to adapt to. Although the Federal Reserve and FinCEN believe that both small and large banks already keep records of all fund transfers, and that technology advances may alleviate compliance difficulties, more research on the costs to businesses is needed.

Perspectives from the CVC Community

Some CVC users objected to the new rules because they believed new regulations interfere with virtual currencies’ independence and popularity. For example, the Chamber of Digital Commerce,the world’s largest blockchain trade association, wrote a statement prior to the passage of the AMLA expressing that the definition of money should not be broadened. They stated that CVCs “fall outside the definition of funds” and that a definition of money should only include “transactions involving...currencies that are not backed by a physical commodity such as the American dollar.”

Many groups in the CVC community had interests in containing the definition to only include fiat currency because it would have preserved virtual currencies’ status as a less regulated, less tractable medium of exchange. CVCs are still less tractable and less regulated than sovereign currencies, but AMLA indicates that even CVCs cannot entirely escape scrutiny.

Of course, preferences vary. For example, a Blockchain and Digital Asset Tax Lead at a major tax and auditing firm endorsed new regulation prior to the AMLA’s passage. The Tax Lead argued that “the proposed rules give greater clarity and regulatory certainty to those operating with CVCs. This will be a positive for the industry.” Although the ongoing trend towards more transactional transparency may be viewed as intrusive, it is also possible that new regulations will encourage bigger businesses, banks, and countries to endorse CVCs.

For example, El Salvador recently voted to make bitcoin legal tender signaling the potential for wider acceptance. Until now, however, many businesses and countries have been reluctant to endorse Bitcoin because of its complex nature and its regulatory issues. Perhaps more regulation, including through AMLA, would lead to wider-spread adoption for legitimate transactions.

Reconciling Disparate Policy Interests

On one hand, AMLA creates additional regulatory and compliance requirements which may be viewed as burdensome by financial institutions. On the other hand, the additional transparency will help law enforcement prevent and punish threatening transactions.

In understanding the divergent interests, it is very helpful to consider the written comments on the proposed changes which were collected by FinCEN and the Federal Reserve prior to the passage of AMLA. It becomes clear that the new Act is in the interest of financial cybersecurity; however, to assuage the concerns of small banks and blockchain groups, agencies should provide further assistance with implementation. For example, agencies can offer training for financial institutions to teach them how virtual currencies are transacted and how they can be monitored. It is not yet clear that ongoing support from federal agencies has been provided.

Some additional support from FinCEN and the Federal Reserve may be required as convertible virtual currencies are not as easily monitored as traditional currencies. Overall, as long as the agencies can provide support and guide financial institutions through the new compliance requirements, I believe broadening the definition of money and lowering the threshold for reporting under AMLA is a very positive change. From a quantitative perspective, FinCEN estimates that changes to the BSA will ultimately cost the parties involved approximately $80 million annually, not including information technology costs.

The costs of not having moved forward with the proposals under AMLA, however, would have been far greater. As just one small example, in August 2020, the U.S. government seized approximately $2 million dollars from Al Qaeda, ISIS, and the Al Qassam Brigades. The Federal Register pointed out that if changes to the BSA could reduce the annual probability of a major $30 billion terrorist attack by even a quarter of a percent, the decision is justified.

I completely align with this analysis. From my perspective, the changes implemented through AMLA will ultimately help curb financial crimes such as money laundering, terrorist financing, and sanctions evasions and impose justified costs on the involved parties. The Federal Reserve and FinCEN can now more easily curb financial crimes and terrorist activities, and I look forward to more such reforms that balance regulation with financial innovation.

Kavi Patel is a student in Columbia’s Master of International Affairs program, concentrating in International Finance and Economic Policy. Under SIPA’s dual degree program, she will spend her second year at the London School of Economics where she will also earn a Master of Public Administration. Before graduate school, Kavi worked as a Third-Year Corporate Governance Analyst at Goldman Sachs in New York City and prior to that worked as an Economic Litigation Analyst in Boston. She loves animals and the highlight of her academic year has been fostering dogs.

Kavi PatelJuly 6, 2021