DOJ Cryptocurrency Guidance Outlines Enforcement Partnerships (Part II of II)
Matt Stankiewicz continues with this two-part posting on DOJ’s cryptocurrency guidance. Matt can be reached at firstname.lastname@example.org.
DOJ’s Cyber Digital Task Force’s report, “Cryptocurrency: An Enforcement Framework,” provides a comprehensive on the growing partnerships between DOJ and other offices within the executive branch. We’ve seen the expansion of these partnerships in other legal areas, and the continued advancement of these relationships continues to build an impressive prosecutorial force
FinCEN has long been involved in the cryptocurrency industry, as one would expect. FinCEN is tasked with implementing and administering the Bank Secrecy Act (“BSA”). FinCEN regulates money services businesses (“MSBs”), the ambit of which cryptocurrency exchanges fall under, along with various other crypto-related services. FinCEN even directly addressed “virtual currency” all the way back in 2013, during the early infancy of the industry.
As the report explains, the DOJ’s relationship with FinCEN falls into two main categories: crime prevention and investigatory assistance. FinCEN is responsible for receiving and analyzing information relating to money laundering and terrorist financing, through suspicious activity reports (“SARs”). FinCEN also acts as a conduit for financial intelligence information obtained from its foreign counterparts.
To highlight this partnership, the DOJ discusses a collaboration between FiNCEN And the US Attorney’s Office for the Northern District of California. After a parallel investigation with DOJ, FinCEN fined Ripple Labs Inc. in 2015 over $700,000 as a civil monetary penalty for violations of the BSA. Ripple Labs created and sold the cryptocurrency XRP. Ripple Labs failed to register with FinCEN and willfully violated several requirements of the BSA by selling XRP. Ripple Labs also failed to implement an AML program. At the time of the violations, it was the second largest cryptocurrency in market capitalization, behind only Bitcoin.
Ripple was not happy with being highlighted in this report, and the San Francisco-based tech company has since threatened to relocate overseas.
OFAC is tasked with administering and enforcing economic and trade sanctions. These sanctions schemes target malicious actors to serve US foreign policy interests and national security goals. Put very simply, US Persons – a broad definition – are restricted from transacting with sanctioned parties. Unsurprisingly, these sanctioned entities are constantly seeking ways to circumvent these limitations and restrictions, and have turned an eye towards cryptocurrency in attempt to facilitate those desires. OFAC has followed suit and turned their attention to the industry as well, even having gone so far as to sanction individual Bitcoin wallet addresses, as well as the Venezuelan Petro as a whole – the cryptocurrency developed by the government of Venezuela.
The DOJ’s relationship with OFAC has grown significantly in recent years in general. Its joint focus on crypto comes as no surprise as sanctioned entities continue to explore it as an option to help circumvent restrictions. In August 2019, the DOJ and OFAC worked together against several Chinese nationals for their roles in fentanyl distribution. The DOJ had previously indicted and charged several of these entities for their roles, and coordinated with OFAC to have all of them sanctioned pursuant to the Foreign Narcotics Kingpin Designation Act. OFAC has further worked with the DOJ to pursue criminal charges against North Korean entities associated with ransomware and the hacking of a prominent cryptocurrency exchange.
The SEC has been something of a boogeyman in the crypto industry for years, as investors worried whether or not their favorite cryptocurrency would be considered a security or not. The concerns came to a head as initial coin offerings (“ICOs”) grew exponentially, and billions of dollars poured into unregulated and unregistered investment offerings. As such, the SEC has devoted significant resources into this area, and has released a variety of guidance to help issuers and investors better understand what is and what is not a security, with their interpretation tailored to virtual assets.
The DOJ has maintained a strong working relationship with the SEC for several years now. Long time readers of our blog know, as we’ve written expansively on their teamwork in prosecuting violations of the Foreign Corrupt Practices Act (“FCPA”). As such, these two are a frightening tandem for would-be securities violators. Look no further than the 2018 case against AriseBank and its executives. While the SEC filed civil complaints to halt an allegedly fraudulent ICO, the FBI and SEC coordinated a search of AriseBank’s place of business and a executed a freeze order. Meanwhile, the DOJ brought a criminal case against the CEO and COO where the two plead guilty, while a corresponding civil action by the SEC led to disgorgements of millions of dollars.
The CFTC takes their authority from the Commodity Exchange Act, which provides an expansive definition for “commodities.” The CFTC has released guidance to that end, concluding that certain cryptocurrencies fall under their ambit as “commodities.” This conclusion has been buttressed by a handful of court rulings determining the same. The clearest implication of the CFTC’s jurisdiction occurs when there is fraud or manipulation in cryptos traded in interstate commerce – these are the “pump-and-dump” schemes that plagued the altcoin boom.
We know the CFTC has maintained a strong relationship with the DOJ, especially as of recent. So it’s no surprise that the two are working well together in the crypto industry. The two pursued parallel proceedings against Blake Harrison Kantor and Nathan Mullins, among others, peddling ATM Coin in the US. The conduct involved a fraud scheme that convinced customers to purchase binary options and/or transfer funds into ATM Coin. The two then misappropriated much of these funds. In the CFTC action, Kantor and Mullins were forced to pay over $4 million, while the DOJ action resulted in 86 months’ imprisonment.
Even recently, the DOJ brought charges against BitMEX and several of its executive team for BSA violations. In its press release, the DOJ noted its partnership with the CFTC and thanked their investigators for their work and expertise.
Put simply, the federal government wants their cut. The IRS has declared that cryptocurrency will be treated as “property” for tax purposes, and noted that cryptocurrency trades (even crypto-to-crypto) are considered taxable events. The IRS has provided various other forms of guidance relating to the tax treatment of crypto, including guidance relating to “hard forks” and the resulting assets.
Office of the Comptroller of the Currency (“OCC”)
The OCC “charters, regulates, and supervises national banks and federal savings associations.” Specific to cryptocurrency, the OCC has issued guidance relating to crypto-asset custody services for bank customers. In this guidance, the OCC has noted that holding private keys for their customers represents a modern version of a traditional banking activity.
Outside of the federal government, state regulators are pursuing their own regulations and frameworks as well. New York has been at the forefront of this work with their Bitlicense and other endeavors, including it’s Virtual Markets Integrity Initiative.
The Financial Action Task Force (“FATF”) is an intergovernmental organization focused on combating terrorist financing, international money laundering, and various other threats to the international financial system. The US is a founding member and has been a key player in pushing for international guidance for cryptocurrency. Over the past several years, FATF has continued to provide guidance and international framworks for handling cryptocurrency while minimizing money laundering and terrorist financing activities. This report notes that DOJ attorneys have played an instrumental role in drafting many of these documents.
Privacy and anonymity will continue to be a major battleground for enforcement, as I’ve written about in the past. This has always been a central tenet of the technology since its inception. As such, as regulators continue to improve on their own resources to “follow the money,” there are several in the industry fighting to stay one step ahead. This has led to a variety of innovations that the DOJ highlights in this report.
The DOJ has focused a lot of its regulations on crypto exchanges, as they tend to be the major gatekeeper as the conduit between fiat and crypto for many people. As such, they’re tasked with complying with KYC requirements, along with reporting and monitoring activities. That said, we’re now beginning the see the rise of decentralized exchanges, and this DeFi movement will remove that centralized exchange from the equation. How regulators will deal with this new challenge is still to be seen.
Outside of exchanges, there are a variety of other ways for individuals to transact with cryptocurrency, or exchange fiat to crypto. These include peer-to-peer services and crypto-kiosks (essentially, crypto ATMs). These are all required to adhere to certain KYC and AML requirements.
Mixers and tumblers are another threat that will be difficult to deal with. Put simply, these tools obfuscate that origin and destination of cryptocurrency transactions. These tools operate as an intermediary in multiple transactions, and all of the transactions send their coins into the mixer, and the mixer then randomly transmits the coins to their intended destination. This makes it difficult, if not impossible, to identify who was the actual intended recipient in a transaction. Earlier this year, the DOJ announced an indictment and arrest of the operator of Helix, a mixing service that helped launder nearly $300 million worth of Bitcoin. The DOJ warns that these services are considered MSBs, which mean they are subject to a variety of regulations.
In this same vein, we’re continuing to see a rise of privacy-focused cryptocurrencies. Monero is one of the older examples, but other types are continuing to pop up. While Bitcoin maintains a public ledger, where every transaction is available for the world to see (although anonymized based on wallet addresses, which can ultimately be linked to individuals or entities with some leg work), privacy coins keep their transactions hidden from the public. So while Bitcoin was previously used on Darknet marketplaces, we’ve seen a shift to these privacy coins to further hide the source and destination of these funds. The DOJ identifies these coins as a “high-risk activity” and does not liquidate any of these seized funds, to prevent them from returning to the stream of commerce.
Overall, the report provides welcome clarity on the enforcement priorities of the DOJ and the US federal government as a whole. The report is more of a historical look back at prior actions in the cryptocurrency industry with the accompanying descriptions of how they came about and under what legal authority they were brought. While there are still plenty of questions left unanswered, this report does offer guidance for practitioners moving forward.
Read Part I here.