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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 currencies to money transmission, 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 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, the consumer safeguards described here are 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, maintain records of certain data and transactions, and file 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 –Bitfloor, CanadianBitcoin, LibertyBit, BitSpend, and Barclay’s imminent termination of 250 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 their 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?]
