Virtual currencies such as Bitcoin and Ethereum turned 10 years old in 2018. As virtual currencies become more mainstream, governments around the globe have brainstormed ways to regulate and tax virtual currencies. Fluctuations in prices, difficulties using or converting to cash, and new types of exchanges have brought both challenges to governments and investors alike. The IRS and the Financial Crimes Enforcement Network (FinCEN) recently begin enforcing federal laws relating to virtual currencies, holding virtual currency exchanges and participants liable for associated taxes, regulations, and tax crimes.

In March 2013, FinCEN issued guidance (FIN-2013-G001) advising the public that exchangers of convertible virtual currency are “money transmitters” for purposes of the Bank Secrecy Act, making them subject to registration, reporting, and recordkeeping regulations. Since 2013, however, there have been few indicators that the U.S. government has attempted to enforce the 2013 guidance. Until now.

On April 18 and May 9, 2019, FinCEN released a series of documents reminding those involved in virtual currency transactions of applicable U.S. regulations and the risks of virtual currency misuse. Among the guidance, FinCEN announced that it imposed a civil money penalty against an individual for willfully violating the anti-money laundering laws of the Bank Secrecy Act. The individual advertised his intent to sell bitcoin on the internet, completed transactions by receiving or delivering currency, processed numerous suspicious transactions without completing required Suspicious Activity Reports, conducted business related to “Silk Road,” a known darknet marketplace, and failed to take steps to determine customer identity and whether funds were derived from illegal activity. The individual failed to file Currency Transaction Reports, even though he conducted numerous in-person cash transactions greater than $10,000. The individual failed to register as a money transmitter, failed to file any Suspicious Activity Reports and Currency Transaction Reports, and knowingly and willfully failed to conform his business to U.S. regulations. He was assessed a $35,000 fine and is prohibited from ever again providing money transmission services or similar activities.

In a separate announcement (FIN-2019-A003), FinCEN laid out a comprehensive discussion about the risks posed by virtual currencies, virtual currency abuse typologies, red flag indicators, and the reporting requirements for suspicious activities. Of concern was the lack of transparency of both the identity of buyer/seller and the source of the funds. Given that virtual currency has historically been used globally in furtherance of crimes, including money laundering and funding terrorism, the lack of transparency frustrates law enforcement efforts. Legitimate but unregistered virtual currency exchange businesses may be exploited by criminals seeking to further illicit activity.

In 2017, the U.S. Department of Justice and government of Thailand dismantled one of the largest darknet marketplaces, AlphaBay, arrested its creator, and froze millions of dollars’ worth of virtual currency for forfeiture proceedings.  Earlier in 2017, unregistered foreign-located exchange BTC-e and its owner were indicted for, among other crimes, money laundering and engaging in unlawful monetary transactions, and FinCEN separately assessed civil penalties of $122 million.

Red flags indicating reportable suspicious activity include such instances as: (i) any type of link to darknet marketplaces or other illicit activity; (ii) use of anonymity-enhancing services such as mixing or tumbling, intending to obscure identification of the customer or source of funds; (iii) use of a virtual currency exchange in a high-risk jurisdiction or having no relation to where the customer lives; (iv) use of a an exchange in a jurisdiction that has a reputation as a tax haven; (v) a large number of exchanges by a single customer, suggesting that customer is acting as an unregistered exchange; (vi) structuring transactions just beneath the $10,000 threshold for filing a cash transaction report, including through multiple virtual currency kiosks or multiple identities tied to the same phone number; (vii) transactions between a customer and any entity linked to illicit activity such as extortion or ransomware; (viii) transactions initiated from or to a suspicious IP address or IP address of a sanctioned jurisdiction; (ix) use of a virtual private network (VPN) or an ISP-anonymizing service such as Tor to access virtual currency exchange accounts; and (x) when a customer declines to provide information regarding their identity or source of funds. For these and other red flags, a financial institution must file a Suspicious Activity Report providing detailed information and a narrative. A new Suspicious Activity Report form has been published, effective January 1, 2019.

Announcement FIN-2019-G001 provides further guidance on the application of FinCEN’s regulations to certain business models involving convertible virtual currencies, in order to aid industry participants. Holding substance over form, the guidance outlines the types of persons or businesses liable as a “money services business” under the Bank Secrecy Act. Generally, the designation depends on the activities of the person or entity; namely, whether they are transmitting money or other value in the same or a different form to another person or location, by any means. A person can be liable even if the business is located in another jurisdiction, so long as a substantial part of the business is conducted within the U.S. If liable, the person or entity must register with FinCEN as a “money services business,” implement and comply with a written anti-money laundering program, keep records, monitor customer transactions, and file required reports, such as Suspicious Activity Reports and Currency Transaction Reports. The regulations may apply differently depending on the type of business the person or entity is engaged in.

In conclusion, taxpayers involved in virtual currency transactions in any fashion should understand the risks and requirements of engaging in this emerging market. Financial institutions should be well-versed in the requirements and red flags listed in FinCEN guidance and train all employees to conform. While ownership of virtual currency or participation in transactions is not per se illegal, the U.S. government has recently begun an initiative to hold accountable those responsible for abusing the virtual currency framework or using it for illicit purposes. Financial institutions and any person acting as a virtual currency exchange must register, submit required reports, and keep records about customers and transactions as required by law. Owners and investors of virtual currency must take care to avoid inadvertently engaging in activities that may be deemed suspicious and limit transactions to avoid being categorized as an “exchange” or “money service business.”

For further information about virtual currency regulations, please review the guidance published by FinCEN on their website or contact the author to discuss.

Sandra Mertens
[email protected]