Today the Bitcoin Foundation filed comments with FinCEN regarding the regulator’s Notice of Finding in the Liberty Reserve case. Though Liberty Reserve was not a bitcoin company, FinCEN’s reasoning in the filing makes implications that could be applied to digital currencies in general. Accordingly, the Bitcoin Foundation seized the opportunity to remind FinCEN of a number of important points.
In May, the operators of Liberty Reserve were arrested on money laundering charges. The company, operating out of Costa Rica, used a centrally-issued digital currency mechanism to facilitate monetary transfers globally – often with little or no background checks into the identity of their users. The site was allegedly used to facilitate the laundering of up to $6 billion. More info on the company and arrests available via The Guardian.
The Notice of Finding issued by FinCEN outlines the activity at Liberty Reserve that led to the arrests. The Bitcoin Foundation’s concern was that the line of thinking was overly broad in a way that could apply to legitimate activities – specifically those related to bitcoin.
Overview of Bitcoin Foundation’s response
First and foremost, the Foundation established that they are not defending Liberty Reserve. The intention of the comments was simply to make FinCEN aware of the view that some of their reasoning in the filing may unjustly apply beyond the scope of illicit activity to a much broader range of virtual currency acitivity.
Consistency of terms
The Foundation opens by addressing what could be seeen as inconsistencies between the Liberty Reserve filing and guidance around virtual currencies issued in March. For example, the recent filing refers to Liberty Reserve as a “web-based money transfer system, or ‘virtual currency.’” This is at odds with FinCENs definition from the guidance, which defined virtual currency as “a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.”
The comments go on to discuss irrevocable payments. The Notice from FinCEN states, “The fact that the transactions are irrevocable… makes it a highly desirable system for criminal use and a highly problematic one for any legitimate purpose. Revocability… is a common feature of legitimate payment systems.”
The Foundation used this opportunity to explain that cash payments are typically irrevoacable and that there has been a push outside of bitcoin for the U.S. to adopt a widely-available system for immediate and final payment settlement, as is available in other countries. They also note that wire payments and common checks also rely on irrevocability.
Finally, the notion of anonymity in a payment network is addressed as well, noting that the term may not be appropriately applied in the FinCEN finding. In particular, the Foundation addresses the fact that because Liberty Reserve transactions were done between counterparties who did not know the identity of the other does not make them anonymous: it makes them private.
It was, in fact, Liberty Reserve’s lack of adequate identification of its own customers that made it anonymous. As such, Liberty Reserve should be prosecuted for inadequate identification procedures, rather than the outcome of the failure to do so.
In addition to the points made by the Foundation in their letter to FinCEN, further portions of the Notice warrant discussion. In particular, FinCEN explains that “Transfers made through Liberty Reserve currency cost considerably more than transactions made through comparable services, providing a significant disincentive for legitimate users.” They then go on to offer examples of how transferring $10,000 via Liberty Reserve costs up to $2,000, compared with registered MSBs at $200 or a bank wire at $40, apparently indicating increased likelihood of criminal activity.
By that same logic, anyone paying $200 to Western Union to transfer $10,000 should be suspected of criminal activity when they could easily transfer the same value via bitcoin for almost no cost at all. Once again, their stated indicators of illicit activity fall apart when extended beyond the single use case.
It is also worth noting some of the crimes Liberty Reserve users allegedly tried to facilitate through their system. Two individuals in India, for instance, kidnapped and ultimately killed someone, demanding ransom be paid to their Liberty Reserve account. There is another example offered of a person with access to a number of top websites who was selling personally identifiable information from those sites for money payable via Liberty Reserve.
There is certainly a discussion to be had around the balance of trading privacy for security and whether or not the burdens of extensive regulation are justified. That said, it is also easy to understand why lawmakers and constituents of a civilized society would want to heavily regulate entities that could facilitate murder ransoms and identity theft. Though any of the crimes listed could potentially have been facilitated with cash, in a digital world it comes as little surprise that stakeholders may push for increased transparency simply because it is possible.
Takeaways for bitcoin companies
This ruling, while not about a bitcoin company, can still serve as an important lesson for the many young bitcoin companies arising recently. Most notably, US financial regulators will prosecute poor implementation of anti-money laundering practices; shielding a company from awareness of what its users are doing is not a valid defense insofar as FinCEN is concerned.
Bitcoin companies have already begun taking regulatory compliance quite seriously. BitInstant has money transmitter licenses in nearly 40 states and Tradehill partnered with MiiCard, an online identity service that aids in anti-money laundering (AML) and know your customer (KYC) data collection – core components of regulatory compliance. It looks like the chances of major bitcoin companies sharing the fate of Liberty Reserve is getting smaller by the day.