Virtual Currency: CDD Requirements Surrounding Crypto

The following article originally appeared on March 1st in the Sterling Navigator.

On December 23, 2020, FinCEN published a notice of proposed rulemaking proposing requirements for financial institutions and money services businesses (MSBs) related to certain transactions involving convertible virtual currency (CVC) or digital assets with legal tender status (legal tender digital assets or LTDA). Before you skip to the next article because you’re not a tech geek and don’t really understand all this “stuff,” you should know you’re in good company!

But you should read on…

Many community financial institutions have not yet fully embraced what are now mainstream technologies for delivery of financial products and services such as electronic signatures, online applications and online account opening. They tend to dismiss articles and agency bulletins involving cryptocurrency and blockchain as information that is not relevant to their current or planned operations. However, if you are not keeping an eye on this as part of our BSA/AML monitoring, you could be overlooking significant risk. It’s a concept that can be hard to wrap your head around. Someone decided that a bunch of ones and zeros have value and suddenly they can be traded for goods and services as currency. Today, crypto is quickly becoming more mainstream.

According to the Independent Community Bankers of America (ICBA)’s Cryptocurrency Primer for Community Banks:

“PayPal recently announced that it will support cryptocurrency transactions. JPMorgan Chase created its own digital currency, JPM Coin. Notably, Visa also launched the Coinbase Visa debit card, which allows clients to spend digital assets anywhere Visa is accepted and in nine different cryptocurrencies. With all this activity, community banks should consider the impact of cryptocurrency on their payments strategy.”

“Around the globe, central banks are considering digital currency.
Overall, the International Monetary Fund estimates more than 50
countries are researching or developing a central bank digital

And, “The Federal Reserve is exploring different forms of a Central Bank Digital Currency (CBDC). The Federal Reserve Bank of Boston is collaborating with the Massachusetts Institute of Technology (MIT) to investigate the potential of a digital dollar.”

A little background for the crypto neophyte in all of us: Bitcoin was launched on January 3, 2009 as 30,000 lines of code. It was designed as an efficient way to transfer money over the internet. Initially, the concept mainly piqued the interest of investors – and still does. It is more widely used now for person-to-person (P2P) payments. It is legal in many countries throughout the world, including the U.S. Nonetheless, it is ultimately a digital entry in a distributed ledger system.

Interestingly, it takes an enormous amount of power (electricity) to mine for Bitcoin. According to Arvind Narayanan, an Associate Professor of Computer Science, Princeton University in written testimony to the United States Senate, Committee on Energy and Natural Resources Hearing on Energy Efficiency of Blockchain and Similar Technologies on August 21, 2018: “Bitcoin mining consumes slightly under 1% of the world’s electricity, or slightly more than the electricity consumption of the state of Ohio or New York.” That was almost 3 years ago…

Bitcoin mining operations are located in warehouses or data centers on large tracts of land, often with their own elaborate dedicated power grid to support the huge amount of energy for the level of computing power required. If someone comes into your branch to open an account and tells you they mine Bitcoin on their laptop, a hefty bit of skepticism is in order.

Now, back to our regularly scheduled programming. The AML Act of 2020 amended 31 U.S.C. 5312(a)(3), the definition of “monetary instruments” in the Bank Secrecy Act (BSA), on which Treasury proposed to determine that CVC and LTDA are monetary instruments. Specifically, CVC and LTDA are both value that substitute for currency and are therefore “monetary instruments” under the BSA. The IRS defines CVC as virtual currency that has a value in real currency.

The rule aimed at closing anti-money laundering regulatory gaps for certain convertible virtual currency and digital asset transactions. Under the Notice of Proposed Rulemaking (NPRM), banks and money services businesses (MSBs) would be required to submit reports, keep records and verify the identity of clients in relation to transactions above certain thresholds involving CVC/LTDA wallets not hosted by a financial institution (also known as “unhosted wallets”) or CVC/LTDA wallets hosted by a financial institution in certain jurisdictions identified by FinCEN. Proposed reporting requirements include information on CVC or LTDA transactions greater than $10,000, or aggregating to greater than $10,000, that involve unhosted wallets or wallets hosted in jurisdictions identified by FinCEN.

This takes the questions to be asked at account opening in a little different direction than what we have recommended in the past. Currently, financial institutions should be asking whether the client derives income from or invests in cryptocurrency as part of CDD processes at account opening. If this rule is finalized, you should also ask whether the client maintains a digital wallet for crypto. If so, you will want to know what it is. That way, you can either decline to open the account or verify whether the wallet is hosted or unhosted and decide whether the open the account based on your institution’s risk appetite.

In terms of ongoing monitoring, it gets a little tricky. For banks that use an AML system like BAM+ or Verafin, the companies have been working on ways to screen for wallet IP addresses. You may want to contact your AML vendor about that. If you do not currently use an automated AML system, you could look for key words when monitoring the accounts to determine whether crypto is involved. Transfers to known digital wallets could be one way.

FinCEN reopened the comment period for its recent proposed rulemaking regarding certain transactions involving convertible virtual currency (CVC) or digital assets with legal tender status (LTDA) until March 1, 2021.

Source: Sterling Compliance

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