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Last Friday’s news that the Internet Archive Federal Credit Union (IAFCU) had shut down Tradehill’s account must have sent chills down the spine of every virtual currency entrepreneur. If it didn’t, it should. The IAFCU was supposed to be one of the few, if not the only, Bitcoin-friendly financial institution in the U.S. rescuing virtual currency exchangers from ‘banking oblivion’. At this point, we can only speculate about the true causes of this unfortunate situation, and we certainly hope it gets resolved favorably, promptly and permanently.
Let’s hope it’s another case of entrepreneurial immaturity, as that would be the lesser evil compared to other potentially more devastating ones. However, with all due respect to the parties involved in this particular case, there is, in general, a fine line between immaturity and stupidity; one that cannot be ignored in a nascent industry that is riddled with risks, and in which a few bad apples could set the entire industry basket back by years. My point is: Are convertible virtual currency exchangers doing their homework?
News flash #1 to virtual currency exchangers: you are financial institutions!
Being a financial institution requires a heightened degree of governance –organization, discipline and control– as well as excellent stakeholder communications. Even if exchangers choose to partner with a licensed financial institution rather than to obtain their own licenses, a famously daunting and onerous process, they have to remember two things: (1) they still are financial institutions in the eyes of the government, which means they will need to comply with most federal AML regulations, and (2) by extending their licenses to them, their principal partners will be taking on additional risks which, by virtue of the halo effect, could have repercussions in their own existing operations and banking relationships.
In today’s environment, where even non-financial accounts are being closed, how do you think an existing master account depositary institution will react when they find out that their corporate client will be partnering with a Bitcoin exchange?
No Compliance, No Banking
This corollary to the main title has been a well-known necessary, yet not sufficient, condition in the money transmitter industry for a long time.
News flash #2 to virtual currency exchangers: There is a strong correlation –and even causality– between being a money transmitter and being unable to obtain and maintain a bank account.
Having opened, been denied, maintained, and lost dozens of bank accounts in dozens of countries within several money services businesses over the past decade, this is what it all boils down to: No compliance, no banking; no banking, no business. I know that many in the space would prefer things to be different, but TODAY these are the rules of the game.
When FinCEN officially declared on March 18, 2013 that certain ‘convertible virtual currency’ operators were money transmitters, crypto-preneurs fitting this definition had to add the following two items to their long list of problems to be solved:
- How to legally operate in or service citizens of the United States, which has an archaic, convoluted licensing regime
- How to build formally and substantially sound internal policies, procedures and controls (collectively, programs) to comply with applicable regulations of various kinds, including anti-money laundering, anti-terrorist financing, privacy and consumer protection
Applying for and expecting to be granted the luxury to maintain a bank account before completing both of the above is naïve and unrealistic. And it gets worse, even when exchangers have checked the boxes on the two items above, a third condition will be required: the revenue must be large enough to outweigh the bank’s internal risk management costs. I’m sorry if I’ve burst anyone’s bubble, but that has been the story of our lives in the money transmitter industry for a long time.
Tough Choices
As if dealing with the myriad risks and adoption challenges inherent in the technology itself was not enough, ‘convertible virtual currency’ operators have been confronted with decisions so tough that many may soon be out of business –either because they chose to ignore the FinCEN guidance and its attendant obligations, or because they chose to take them as seriously as expected. The former would get them in trouble with the law. The latter, too deep in the red.
The good news is that, in spite of the tight budgets and the limited options, it is possible to obtain and maintain bank accounts in the United States. It just requires a lot of hard work, and it all starts with a fundamental cornerstone: a world-class risk management and compliance program.
This challenge can be approached in various ways. There are a lot of smart and experienced lawyers that can help understand the details of what must be done. In general, however, they will not be able to help much with how to make it all work within the unique confines of a company, operation and product. In my experience, nobody better to build a solid, sustainable, risk management program than one’s own internal engineers and product owners with the full support of an enlightened leadership.
What are you waiting for, crypto-preneurs? Are the stakes not high enough?
Juan's Blog 
There are other solutions to the problem beyond the ones you have expressed. We can build resilient, distributed and unregulatable networks that can provide individuals and businesses with a superior and less expensive alternative to compliance with the arbitrary and capricious whims of bureaucrats.
http://www.reddit.com/r/Bitcoin/comments/1lmtjt/announcing_project_praesto/
Posted by NinjaBanker | 2013/09/03, 12:49 pmI enjoyed your article. I’m certain that in order for virtual currencies to enjoy inclusion into the broader market, it will start state by state, with significant learning being required along the way. Moreover, brick-and-mortar seem to be the most likely route to success in building and addressing regulatory issues, and in following comprehensive AML and KYC programs.
Beyond that, the issue of transmission through the current banking system is daunting. Banks have no incentives to work with an MSB, let alone any virtual currency exchange. As you and others here know, MSB accounts are considered high risk, and even traditional MSBs have a hard time finding banking partners who are willing to work with them.
Then what of Virtual Currencies & Bitcoin?
Then what, indeed. I think the answer is that brick and mortar agents (such as check cashing locations, pawn shops, etc) will have few choices in the future, and will mostly be limited to accounts with the money transmitter partner bank. Worst case (or best case, depending on where you stand), something like Ripple will have to be used, with on-site drop safes (standard for brick and mortar MSBs), as well as real time, site specific, automated pricing of Virtual Currency.
TL;DR
Raising 1m USD & having a compliance team and program isn’t enough. Just because you’re operating legally, doesn’t mean that you can find or keep a banking partner. Alternatives to banks MUST be considered and developed (like Ripple) as an option for emerging payments companies for their back-end and business purposes.
Banks cannot be eliminated unless there’s something better to replace them.
Thanks again for the great articles, Juan
Posted by Jon | 2013/09/04, 12:05 pmThanks, Jon, for your kind feedback and your insightful comment.
Posted by Juan Llanos | 2013/09/04, 9:26 pmjuan, we met monday evening, i was the attorney guy who introduced myself after the meeting.
I watched your youtube interviews and have been reading your blog and doing some more research on bitcoin regulation.
Thank you for your work on all this, it’s very interesting.
the real politics of your approach are interesting. but I think when you look at the distributed nature of Bitcoin, the only ones interested enough in paying the cost of high regulatory and compliance programming are large excahanges.
Mtgoc, Circle, and Ripple, and other exchanges are the only businesses making enough money to be able to , let alone, WANT , to pay the overhead of regulation.
in typical fashion, only large players can accomodate absurd growing costs of compliance. this has been the story for the u.s. for about a decade now. On one hand, financial DEREGULATION has taken over since reagan and especially clinton. alan greenspan deregulated all of wall street and basically made in the wild west with the SEC and DOJ running cover for the biggest players. however on the other hand, the costs and requirement for participating in this wild west game —if you want to play with the big boys—–are higher than ever.
Financial services regulation in the wake of the massive money laundering scandals with wachovia and other banks simply being ‘bought up’ instead of punished demonstrates this point.
http://www.theguardian.com/world/2011/apr/03/us-bank-mexico-drug-gangs
i’m not just being a ‘naysayer’. practically speaking, there are a lot of small time participants in bitcoin that might want to participate and either are not ‘big enough’ or simply don’t want to take the risk of being ‘big enough’. why invest millions of dollars into building a large centralized exchange when the RULES of compliance can put you out of business after youve been in compliance for a long time. people in the bitcoin space anticipate that the government will continuously be changing the rules to make it ever more difficult for them to meet compliance and regulatory standards because this is a new and changing game.
the end result is that many people would rather open a small and cheap excahnge and float under the radar until they are closed. OR —WAIT until they think the compliance landscape has settled into a predictable set of political risks. The new young breed of crypto entrepreneurs are mostly personalities that believe government financial regulations is directed by banks that are interested in squashing bitcoin as a threat to their business model. And mostly, I would say they are correct in this assessment. so the risk to companies like circle is that they will either be regulated out of existence, OR they will be bought up by the banks and forced to sell themselves. after which point, it remains difficult to say what the banks will do with them.
In any case, most small time entrepreneurs in this space are not interested in ‘compliance’ and see it merely as an external burden and obstacle preventing progress in meeting the internal challenges to bitcoin—-such as building more secure protocols for transacting in bit-coin to prevent hacker thefts and deceptions.
Furthermore, one of the main implications of the regulatory dynamics in this space—-is that bitcoin entrepreneurs are frequently looking past digital currency, to examine the entire distributed computing space and its relationship to the government controlled internet choke points. These same entrepreneurs are examining the ican system as one of them and working on distributed Domain Name Servers such as DNScrpty and Namecoin. Others are further working on Tor , Anonymous Email , and secure anonymous networks generally. So much of what you see occurring now is part of a bigger picture that puts into question government control generally.
Many people I’ve listened to are beginning to say that in order to control the banking and money system adequately, the government of the world are simply going to have to become MUCH more tyrannical over their own internets, perhaps even requiring bio-metric Identification to access the internet.
this is a complex and shifting landscape and I think the idea of large compliance programs is only going to fly in front of Venture Capitalists in tech with money to spend who think they are able to purchase legitimacy. I think those VC’s in tech are dummies . The only VC’s that belong in this space are people already in banking and money services. and those types are VERY conservative unlike conventional VC’s in the tech space.
bitcoin thus presents a very challenging VC landscape.
Posted by zeev | 2013/12/05, 11:20 amZeev, thanks for taking the time to write such a thoughtful note. You raise very valid and interesting points. I don´t have much to add other than I agree with your comments. The only thing where I might disagree slightly is in that you assume compliance programs need to be “big” or expensive. By definition, compliance programs have to be risk-based or commensurate with the risks, so it´s possible and advisable to tailor and design a program to any size exchange or operation. I have done it several times, so I can attest to the fact that you can operate legally and in compliance regardless of your size. However, as you correctly point out, it´s a matter of business choice by the crypto-preneur whether to take this (legal) path or fly under the radar.
Posted by Juan Llanos | 2013/12/06, 10:17 am