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Rules & Regs, Virtual Currencies

The Hidden Rule that Could Kill Bitcoin’s Irrevocability

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If federal anti-money laundering rules ‘killed’ Bitcoin’s anonymity, could consumer protection rules ‘kill’ its irrevocability?

Last March, the crypto-currency world was struck dumb when the Financial Crimes Enforcement Network (FinCEN), the United States federal agency responsible for enforcing anti-money laundering and anti-terrorist financing regulations, issued the now famous interpretive guidance equating exchangers and administrators of ‘convertible virtual currencies’ to money transmitters.

Although some of us saw it coming, crypto-preneurs are just now slowly waking up to the reality of what it really means to be this particular species of non-bank financial institution.  See the final section for a compendium of risks and obligations.

One set of regulations that I included in the laundry list of obligations last April but has yet to come to the fore are the federal consumer protection rules emanating from the Dodd-Frank Act and being enforced by the recently created Consumer Financial Protection Bureau (CFPB).  Similar consumer protection rules are enforced by the state regulators that license money transmitters.

If federal anti-money laundering rules ‘killed’ Bitcoin’s anonymity by requiring the identification of all parties to a transaction, these consumer protection rules could ‘kill’ its irrevocability by demanding, among other things, that transactions be delayed for an extended period of time so consumers have the choice of cancelling them and getting refunds.

The Next Big Regulatory Hurdle

The crypto-community has received FinCEN’s guidance and public statements on virtual currencies as reassuring forms of legitimization, collectively as a stamp of approval of sorts, and is certainly relieved that things have so far not gotten worse.  However, as Bitcoiners are learning, being labeled a money transmitter is a rather heavy load to carry.  It has already undermined one of Bitcoin’s primary features –anonymity, and it may soon get worse.

I say may because the Consumer Financial Protection Bureau (CFPB) has not yet publicly confirmed whether and to what extent the implementation of Regulation E by money transmitters, known as the Remittance Transfer Rule, will be applicable to virtual currency providers as well.  However, as long as the U.S. government continues to equate convertible virtual currency operators to money transmitters, I suspect it will.

Even if federal consumer protection rules do not apply, there are still the state ones.  Until Dodd-Frank, consumer protection had traditionally been the realm and focus of state regulation.  Obligations such as providing for transparency in fees and foreign exchange rates, including a transaction receipt, establishing and clearly communicating cancellation and refund procedures, protecting consumer funds via surety bonds and a fiduciary obligation, and requiring financial safety and soundness are some of the duties and obligations arising from the official authorization to operate a money transmitter business granted by state regulatory agencies to selected providers in the form of a money transmitter license.

As of October 28, 2013, all money transmitters will also have to comply with the Remittance Transfer Rule and implement measures that largely overlap with the ones currently in force at the state level (the subject of an entirely different future article).  The new federal obligations include:

(a)    Providing a prepayment disclosure (that is, to be provided before the customer pays), which must contain:

      • The exchange rate
      • Fees and taxes collected by the companies
      • Fees charged by the companies’ agents abroad and intermediary institutions
      • The amount of money expected to be delivered abroad, not including certain fees charged to the recipient or foreign taxes
      • If appropriate, a disclaimer that additional fees and foreign taxes may apply

(b)    Providing a receipt that repeats the information in the prepayment notice.

(c)    Providing certain disclosures and establishing specific processes in the case of scheduled and recurring payments.

(d)    Investigating if a consumer reports problems or errors with a payment.

(e)    Assuming full liability for mistakes made by certain people who work for them.

In spite of the obvious cost and complexity implications for all money transmitter providers, these rules will make sense to anyone familiar with financial services, whether on the provider or consumer side.  Does the following obligation, however, which I highlighted above when describing state consumer protections, not smack Bitcoin right in the face?

(f)     Providing for 30 minutes (and sometimes more) for a consumer to cancel a transfer.  Consumers can get their money back if they cancel.

I understand that it is technically possible to delay the execution of (i.e., schedule) a transaction.  I doubt that it is possible, however, to void a transaction once it has been executed.  And when canceling a transaction, just as with terminating a payment, the foreign exchange rate applied to the conversion has to be the one applicable at the time of the purchase decision.  This means that some kind of intra-transaction settlement mechanism will need to be found.  If elegant solutions to this ‘problem’ already exist in the crypto-world, I would be more than happy to know the details.

To those of us in the electronic payments industry, it is a fact of life that the consumer safeguards described here need to be embedded in our products and services.  It is no surprise that regulation and compliance often set the boundaries of product design.  In the case of crypto-currencies, however, don’t these rules cut through the fundamental features of digital P2P payments that make them so disruptive?

What Being a Money Transmitter Really Means

Let’s now review what being a money transmitter entails.  Over the past few weeks, crypto-preneurs-turned-money transmitters have learned that:

(a)    Operating an unlicensed money transmitting business is a federal offense.

E-Gold and Liberty Reserve were not aware of this, and suffered the consequences.  This has caused a surge in alliances between virtual currency start-ups and financial institutions already legally authorized to operate in the U.S., including banks, credit unions and licensed money transmitters.  Behind the obligation to obtain state licenses lurks the above consumer protection rules that pose additional product design challenges to crypto-preneurs.

(b)   All financial institutions (FIs) in the U.S. must implement AML and BSA Compliance Programs, including Know Your Customer Policies.

One of the primary responsibilities of FIs is to assist the U.S. government in the detection and prevention of financial crime by instituting anti-money laundering (AML) programs, maintaining records of certain data and transactions, and filing reports with FinCEN.  These obligations are spelled out in the Bank Secrecy Act (BSA) of 1970, and in the USA PATRIOT Act of 2001.  This has triggered a spike in the demand for compliance training and consulting services, including a Compliance Conference targeted specifically to virtual currency operators.  One of these obligations, in particular, has got under the skin of the hardest-core Bitcoiners –the need to identify both the sender and recipient of a transaction, known as Know Your Customer (KYC) policy, thus ridding virtual currencies of their highly desired anonymity.

(c)    Consumer financial protection rules must be part of the equation.

(d)    Compliance with (a), (b) and (c) is necessary but not sufficient to stay in business.

Virtual currency operators are learning the hard way, just as we ‘veterans’ have for decades, that one of the biggest threats to their ventures is the denial and loss of bank accounts. Examples in the virtual currency world abound –BitfloorCanadianBitcoinLibertyBitBitSpend.  Barclay’s imminent termination of 80 money transmitter accounts in the UK is a stark reminder that the problem still persists in the traditional money transfer industry.  A complex issue with no end in sight, this threat, together with Bitcoin’s overall consumer acceptance challenge, is probably the biggest threat facing financial crypto-ventures today.

As Jerry Brito so aptly put it last week, “given that regulation is inevitable, attempting to make it less onerous on the margin for those within the mainstream financial system is a worthy endeavor.”  We should collectively and individually be doing that all the time in our kitchens.  Not doing it is not an option.

[Here is the full text of Regulation E, and here is a two-page summary of the Remittance Rule.

For those still unaware, unless explicitly stating otherwise, I only write about Bitcoin (and any other crypto-currency) as a medium of exchange, and as a value transfer system alternative to the traditional ones, and its interface with fiat currencies, NOT as a commodity, asset class, or even an alternative currency.  In addition, I generally use Bitcoin to mean any and all crypto-currencies.

Before any of you gets riled up, do I really need to explain that I use ‘kill’ figuratively?]

About Juan Llanos

Innovative compliance, operations and technology executive leveraging emerging technologies, management and leadership best practices (and, above all, common sense!) to empower businesses and compliance professionals for success.


24 thoughts on “The Hidden Rule that Could Kill Bitcoin’s Irrevocability

  1. What a load of crap.

    Posted by Zigfight | 2013/07/22, 6:47 pm
  2. The article itself looks good but whoever wrote the headline seems to have got over-excited. The whole point of Bitcoin is that you don’t need a third-party money transmitter in the middle to transact in it, so you can avoid all the regulatory problems that make it hard to do irrevocable transactions.

    It looks like another PITA for the exchanges (especially US ones) to add to an already long list of pains they’re feeling in that place, but as making actual payments goes it’s yet another handicap for Bitcoin’s centralized competitors that doesn’t apply to Bitcoin.

    Posted by edmundintokyo | 2013/07/22, 11:12 pm
    • Hi, Edmund. I knew the title would be a stretch, but I needed to use some kind of hook to draw people to something so dry, uninteresting yet important as US regs. My whole quest is about creating awareness of what it really takes to be able to do business in the US in a sustainable way. That’s it. If you want to start a crytp-business in the US, you’d better be prepared to embrace regulation, or you won’t get too far.

      I don’t disagree with your explanation of what “the whole point of Bitcoin is.” All I’m saying is, whatever it is, US regulators will try to make it fit into the existing regulatory frame, or create new rules to mitigate the potential perceived and real risks. And they may often have good reason to do so, don’t you think? Or would you prefer there to be zero controls (in anything you may think of)?

      Whether we like it or not, whether any alt coin is centralized or not, as long as the risk of financial crime exists, it WILL be regulated.

      Thanks for taking the time to comment!

      Posted by Juan Llanos | 2013/07/23, 12:20 am
  3. The hitch with writing a silly title to get attention is that the people who wouldn’t have read the article without the it don’t read the rest, they just look at the headline and post “What a load of crap”. Your call, anyway…

    I don’t think I particularly disagree with the rest. Clearly regulators are going to regulate, and if you’re running a legal business you have to know what they’re regulating. As far as what should happen goes I don’t think any non-bonkers person would advocate the current rats-nest of byzantine, overlapping rules that people unlucky enough to live in the US have to deal with, but it is what it is.

    Bitcoin works around a lot of this stuff by cutting out the middleman, who is usually the target of the legacy regulations. Clearly some businesses like exchanges that create value by providing a bridge to the traditional banking system still have to deal with it. But how the regulations affect those guys is a totally different question to how it affects normal transactions within the bitcoin ecosystem, and we need to keep that distinction clear if we’re going to have a meaningful conversation about the regulatory impact.

    Posted by edmundintokyo | 2013/07/23, 12:57 am
    • I agree with you on the title, Edmund. However, my mission is accomplished -I got the world to talk about something that nobody was even thinking about, and still is a real regulatory risk in the U.S.

      Posted by Juan Llanos | 2013/07/23, 3:42 pm
  4. The elegant solutions that you are looking for would involve protocol changes, thereby creating GovCoin. Not saying that the market doesn’t want this, but a toaster is just a toaster — it only makes toast. If you ask it to do something else, then it’s no longer a toaster.

    Posted by Jon Matonis (@jonmatonis) | 2013/07/23, 5:02 am
  5. The U.S. is a compliance prison, why any smart person remains is beyond me, pay your renunciation tax if you’re required but leave as soon as you can and get rid of that noose around your neck called U.S. citizenship. Don’t look back, don’t touch the U.S.D. and don’t do business with U.S. persons, the world is a big place and there is plenty of money to be made elsewhere.

    Posted by statelessman | 2013/07/23, 5:31 am
    • Nice. I think I might know you…. well you are right – and many parts of the world couldn’t care less about America unless it comes to being bombed by them (which certainly happens enough).

      Posted by Jack | 2013/07/26, 10:21 am
  6. The more US squeezes, the more BTC and other crypto currencies will just flourish elsewhere, in jurisdictions that are more friendly (many are already are) as is the case today with online gambling, or where people are already distrustful of their government.

    WRT irreversibility: “In the case of crypto-currencies, however, don’t these rules cut through the fundamental features of digital P2P payments that make them so disruptive?”
    … how is this any different than cash?
    Wouldn’t the onus be on the parties involved in the exchange and not the medium of exchange itself?

    This is why I think you cannot completely divorce its more commodity or currency-like aspects from its use as a payment system

    Posted by np | 2013/07/23, 5:51 am
  7. The rule on being able to cancel a transfer: An escrow service that allows the consumer to cancel and have returned (up to the specified period) but also automatically releases the BitCoins if no cancellation is made. That is one way that the regulatory requirements that are incompatible with the underlying technology can be solved: Middleware. This of course sounds ironic given what attracts some to BitCoin, but this will allow BitCoin to remain fundamentally as it is and have middleware handle legal issues on a case-by-case basis. Not perfect, but better than the alternatives.

    Posted by Antonio Lorusso (@amlorusso) | 2013/07/23, 9:46 am
    • If we’re looking for technical ways to make it possible to cancel a payment there are some ways to do it. For example the customer can share a transaction with a lock time in the future and double-spend the funds to themselves to cancel.

      But I don’t really see the use-case that we need a technical way to solve here; Exchanges already hold your funds for you, so they could hold them for another 30 minutes. Whereas if you’re doing a regular transaction on the blockchain there’s no money transmitter involved, so whole thing is irrelevant.

      Posted by edmundintokyo | 2013/07/23, 10:08 am
      • I’m glad the solution already exists! If it’s then a question of working the solution out at the outer layer of the service (customer interface), that’s the only thing to worry about.

        Posted by Juan Llanos | 2013/07/23, 3:45 pm
  8. I think it unlikely that individuals using bitcoin to transact qualify under the right-to-refund clause, in the same way that I don’t have right to refund if I hand you cash for your used lawnmower. However, the operators of online wallets could easily get tripped up in RTR and other money transmitter regs. This certainly would complicate their roles.

    Posted by Kurt Thams (@thams) | 2013/07/23, 1:13 pm
  9. Thanks for pointing to this issue. It seems to be relevant for service providers like Bitpay.

    What they would need to do, they would need to delay irrevocability of the payment for thirty minutes after the consumer instructs them to pay. There are several ways to do that.

    A blanket solution would be to just send off an e-mail to the consumer who has requested the payment, informing them that their instructions have been entered into the process, and that he can cancel the process by clicking on some link.

    An even simpler solution would be to just wait for that half hour before actually going through with the transaction.

    Another solution would be to have two groups of costumers. If the payment provider has reason to trust the customer (past performance, small amount of the payment) they could just go ahead with the payment to the payee and hope that the consumer doesn’t initiate any fraudulent reversals.

    Posted by Karl-Friedrich Lenz (@Kf_Lenz) | 2013/07/23, 8:40 pm
  10. Is there any chance guys like BitPay would be covered by this? They certainly don’t think they’re a money transmitter or a money services business:

    Posted by edmundintokyo | 2013/07/24, 7:02 am
    • The jury is still out on many of these providers. If you see them suspending the service, it’s probably because they’ve received a cease-and-desist letter, and their lawyers have counseled them to stop. The best way to know if they’re operating legally is to check out FinCEN’s MSB registration search page. Every company that registers is mandated to disclose which juriadictions (states) they operate in.

      As to Bitpay, I don’t know their business model in detail, but if they’re making that claim it must be because it really fits in one of the exceptions.

      Posted by Juan Llanos | 2013/07/24, 9:08 am
  11. OK, this US only.
    Lets wait what may come for Europe, especially countries like Switzerland/etc. have already very strong regulations for this – lets see, what they may think/tell about that. Sure, for US-bitcoiners this may be a problem…

    Posted by Lelala | 2013/07/26, 6:45 am
  12. Quite a nice article with a lot of thought. Bottom line the US is a disaster. Everything, all resources down on how to control our people and as much of global money as possible. Really the whole thing just gets me sick and I am glad I live overseas.

    Posted by Jack | 2013/07/26, 10:29 am
  13. Many people including myself are just starting to hear about Bitcoins even though they have been around since 2008-2009. They are a very new “currency” and will allow you to profit without ANY fees of transfer, any freezing of funds, doesn’t require banks and is currently feared by established financial institutions to the way of trying to ban it. The funny thing is that is it`s impossible to ban or prohibit because no one owns it!

    There are a group of clever developers are working on a tool that will allow people to make bitcoins every single day! There is a nice short to the point video that explains the “Human Greed” factor and why this is an entirely new and unexplored market!

    This is unlike anything you have ever seen or heard off and it makes perfect sense that early birds knowing this info will make a lot of money off the backs of people that come into a new moneymaking market too late. The beauty of this is that you stay anonymous and in nowadays world flying under the radar is important. The recent scandals of governments spying on its citizens are making “transparency” a scary thing so don`t let anyone meddle in your private affairs!

    Posted by Glenn Diecedue | 2013/07/29, 6:03 pm
  14. Have customers agree to a waiver like. “All sales final” , “I do not recognize ____ as a legitimate political entity”. Or I agree to arbitration rather than any political body for handling disputes.

    Might this not be a way around the regulation blocade?

    Posted by Joe Baker | 2015/07/28, 2:02 pm
  15. its very hard to verbalize Darwinian evolution approach to monetary species like Crypto Currency. The article is a good foundation to be kept in view by all “thinkers” willing to try this new tech wave. The benefit of transparency for the end consumer vs the thousands years old established culture of crime needs to be addressed in ways as manual as possible.
    Its always about “balance”…….

    Posted by Farooq Ali | 2016/03/03, 11:23 am

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