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The Brave New World of Cryptocurrency Regulation

White Collar Crime and Internal Investigations Alert Luke Cass, Hector Diaz, Andrea Tazioli

Cryptocurrency, is defined by the United States, as a "digital unit of exchange that is not backed by a government-issued legal tender." Cryptocurrency can exist anywhere digitally – on the Internet, on a cloud-based server, or even on a flash drive. Cryptocurrency can be exchanged directly from person to person, or customer to merchant through an exchange or by using intermediaries. Parties can pay one another using digital cash, by peer-to-peer network, without ever having to use the services of a financial institution.

It has been estimated that there are over 4,000 types of cryptocurrencies globally so how transactions are effectuated may differ depending on the type of digital currency, but the basics are as follows. Cryptocurrency transactions are performed using public and private "keys." A public key is shared by users with other individuals who are receiving payment. A private key allows users to access cryptocurrency. A number of authors have described the public key as akin to a bank account number and the private key as being like an ATM PIN. These transactions are memorialized in a "blockchain," which is a public record of the transaction whose past entries cannot be edited. Cryptocurrencies transactions can often be traced by these public blockchains. Certain cryptocurrencies, however, operate on private blockchains, lending even greater anonymity to already private dealings. Cryptocurrency is stored on a "wallet," which is a software program that interfaces with blockchains to generate and store public and private keys used to send and receive digital currency.

Cryptocurrency offers a wide variety of benefits. It allows businesses and individuals to operate in a more efficient global marketplace with lower fees, immediate settlement, and with less risk of fraud or identity theft. These benefits have made operating in the digital currency realm attractive for large and small businesses alike without the costs and regulation associated with fiat currencies.

But, the same qualities that attract legitimate business to cryptocurrency also entice criminals who use its anonymous nature to promote schemes to defraud, lure victims, and engage in market manipulation. The popularity of cryptocurrencies to those with good and bad faith alike, and its decentralized nature, have attracted a number of regulators.

Here are six takeaways for companies dealing with cryptocurrency to keep in mind in this swiftly shifting regulatory landscape:

  • The Department of the Treasury's Financial Crimes Enforcement Network, or FinCEN, administers the Bank Secrecy Act and regulates individuals or entities that deal in virtual currency. This means that money services businesses that deal in cryptocurrency must register with FinCEN, establish an acceptable anti-money laundering program, and comply with specific federal statutory recordkeeping and reporting obligations.

  • The Securities and Exchange Commission ("SEC") stated in 2017 that offers and sales of digital assets by "virtual" organizations are subject to the requirements of federal securities laws. Depending on specific facts and circumstances, cryptocurrency exchange offerings like, "Initial Coin Offerings" or "Token Sales," may constitute securities offerings and require registration with the SEC.

  • The Commodity Future Trading Commission ("CFTC") has oversight over futures, options, and derivative contracts pursuant to the Commodity Exchange Act. According to the CFTC, virtual currencies can be "commodities" subject to oversight under its authority. Bitcoin, the most ubiquitous cryptocurrency, is used widely and Bitcoin futures are now traded on the CME in Chicago. The CFTC has also taken enforcement actions against unregistered Bitcoin futures exchanges.

  • The Office of Foreign Assets Control ("OFAC") of the U.S. Treasury Department administers and enforces economic and trade sanctions against designated individuals and countries. An OFAC designation will prohibit engaging in unauthorized transactions, including trade and investment and compliance obligations are the same for individuals and companies dealing in digital currency. Venezuela, an OFAC-designated country, has attempted to deal in its own cryptocurrency, "Petro," to bypass U.S. sanctions.

  • The Internal Revenue Service has stated that virtual currency transactions are like any other property and taxable as income. Therefore, a payment in cryptocurrency is subject to income reporting like any other payment form. State laws may also apply. In New York, for example, cryptocurrencies may be subject to sales tax depending on the transaction type.

  • A company dealing in cryptocurrencies should have methods for dealing with associated risks integrated into its compliance program. Cryptocurrencies, because of their ephemeral, anonymous nature, can form the basis for various types of money laundering under 18 U.S.C. § 1956, or qualify as a monetary transaction involving proceeds of illegal activity under 18 U.S.C. § 1957 when bad actors are involved. Moreover, cryptocurrency money transfers may be subject to state and federal registration as well as recordkeeping and reporting requirements punishable under 18 U.S.C. § 1960.

Cryptocurrencies are a valuable and ingenious innovation that can help fledgling or existing businesses grow in new markets at lower costs. However, companies and individuals should be mindful that there are bad actors seeking to exploit the anonymous nature of this valuable tool to operate, profit, and launder the proceeds of their criminal enterprises.

For more information on digital currencies and compliance issues, please contact your Quarles & Brady attorney, or