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Global Regulatory Moves

2018 saw lawmakers around the world add more teeth and broader scope to AML and CTF regimes, such as the adoption the European Union’s Fifth Anti-Money Laundering Directive (AMLD5), which increased the scope of the EU’s regulatory perimeter to include cryptocurrency exchanges as well as those that provide custodian wallet services. However, regulatory moves in Q1 2019 were not dominated by such massive legislative actions. Instead, we saw such wide-ranging actions as the French government recommending a ban on anonymous altcoins or the California State Assembly introducing a bill that would allow cannabis-related businesses to pay their taxes and fees in stable coins. The UK and Mexico also drafted new regulations in Q1, which are waiting for comments and approval.

The State of Cryptocurrency Anti-Money Laundering
This quarter saw jurisdictions compete for crypto business based upon regulatory vision and completeness of implementation. The charts below show the widely varying levels of maturity and sophistication in AML/CTF regimes around the globe. The gaps in these regulations present risky avenues that can be exploited by money launderers and terrorist organizations. Specifically, the money laundering potential of crypto-to-crypto exchanges and privacy coins are not well understood by lawmakers attempting to regulate digital assets based on the physics of fiat currency.

FATF – Published New Draft Interpretive Note Further Clarifying Guidance for Crypto Regulations
The Financial Action Task Force (FATF) was founded to address concerns about money laundering and the threat it poses to the world financial system. The inter-governmental body advises 36 member countries and two regional organizations and is one of the most influential voices globally on combating financial crimes. The FATF’s mandate was expanded in 2001 to include efforts to combat terrorist financing (CFT). Its influence also extends beyond its member countries, as a number of regional Financial Action Task Forces around the world provide guidance to regulators in the Caribbean Latin America, the Middle East, and North Africa. Its MoneyVal associate provides guidance to countries of Europe outside the EU, including Malta.

In February 2019, the FATF published a draft of an Interpretive Note to Recommendation 15, further clarifying how its regulation recommendations apply to virtual assets. These changes will guide regulatory authorities in a member country when identifying risk, sharing information, and monitoring virtual asset service providers. Additionally, virtual asset service providers will need to be registered or licensed, agree to monitoring by competent authorities, and comply with FATF Recommendations 10-21 (which include policies regarding customer due diligence, record-keeping, politically exposed persons, higher-risk countries, suspicious activity reports, ad confidentiality). The note will be adopted as a part of FATF Standards in June 2019.

Read CipherTrace’s Response to FATF Regarding Regulation and Monitoring of Virtual Asset Service Providers here

Canada – New Regulations for Canadian Exchanges Considered After QuadrigaCX Collapse
In March, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) released a consultation paper. It aims to gather input from Fintech companies, market participants, investors, and other crypto stakeholders on how to best develop a regulatory framework for Canadian cryptocurrency exchanges. The development of this framework is largely motivated by investor protection concerns following the QuadrigaCX collapse. The paper, titled Proposed Framework for Crypto-asset trading Platform, poses 22 consultation questions and asks that all comments be submitted in writing by May 15, 2019.

Additionally, the paper proposes several solutions to issues of keen interest to regulators. The most notable recommends cryptocurrency exchanges cease short selling and margin trading—two extremely popular methods of trading. According to the paper, “To reduce the risks of potentially manipulative or deceptive activities, in the near term, we propose that Platforms not permit dark trading or short selling activities or extend margin to their participants.”

Feedback from the paper will be used to “establish a framework that provides regulatory clarity to Platforms, addresses risks to investors and creates greater market integrity.” No cryptocurrency exchanges in Canada are currently recognized as legal exchanges, and therefore are not authorized to operate as a marketplace or dealer. This means any exchanges acting as such in Canada are beyond the CSA’ purview. The CSA continues to urge Canadians to be cautious when considering buying crypto assets. As to whether or not this framework could prevent another QuadrigaCX-type debacle, experts believe that without adequate enforcement resources it is unlikely that any new rules would have any dramatic effect.

SEC Releases “New” Crypto Guidance
The United States Securities and Exchange Commission (SEC) published new guidelines this April 2019 to set standards in determining whether or not an ICO is an investment contract and therefore subject to U.S. federal securities law. According to the guidelines, titled Framework for ‘Investment Contract Analysis of Digital Assets, an investment contract exists “when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” The framework goes on to further define these three elements as it applies to digital assets.

However, it should be noted that the framework clearly states that it “represents the views of the Strategic Hub for Innovation and Financial Technology [FinHub]. It is not a rule, regulation, or statement of the Commission, and the Commission has neither approved nor disapproved its content.” It also does not supersede any case law, legal requirement, or statements or guidance from the Commission or staff. The SEC further explained that the framework was never meant to be an exhaustive explanation of the law but, rather, to give clarity and guidance that makes it easier for token issuers to determine whether or not their ICO would qualify as a security. The Commission says FinHub continues to encourage market participants to seek the advice of securities counsel to follow current securities law.

SEC Publishes First ICO No-action Letter
In what came as somewhat of a surprise decision, a little-known jet-leasing company received unprecedented approval from the SEC to sell a digital token—specifically, one that it does not regulate. The SEC declared that the Division of Corporation Finance would not recommend enforcement action to the Commission if TurnKey Jet decides to sell its ICO token (TKJ) without registering with the SEC. This is the SEC’s first ICO no-action letter, confirming TKJ tokens are not securities as long as they abide by the terms set forth in the letter. Among the conditions people who buy the tokens will not receive any ownership stake in TurnKey Jet, the tokens cannot be traded publicly, and the company will face restrictions on using proceeds from coin sales to invest in its business. However, as a result of the SEC staff giving Turnkey Jet a No-action letter the company will now be able to sell tokens that customers can use to reserve private jets.

Interestingly, TurnKey’s decision to find relief from the SEC results from the limitations it faced with traditional banking institutions. Limited banking hours can stall wires for last-minute private jet flights. According to a CoinDesk interview with James Prescott Curry, a TurnKey lawyer that helped draft the SEC proposal, these things are “spur-of-the-moment… Rich guys have wire money ready to go, but they are subject to banking hours.”

While this letter will not likely have broader implications for ICOs overall, it is one example of how blockchain technology can alleviate friction presented by the traditional banking system. This “no action” further seems to add to the SEC’s recent trend towards softening the correlations between token and security.

SEC Reconsiders Current Rule on the Custody of Digital Assets
This March, the Commission published an open letter to Karen Barr, president and CEO of the Investment Adviser Association, soliciting input on ways to improve the existing Custody Rule as it applies to digital asset trade and custody. This inquiry is a result of the rapid growth of the digital asset market as more and more investment advisers are seeking to invest in digital assets on behalf of their clients. The letter probes how characteristics specific to digital assets impact compliance with the Custody Rule, especially in regard to non-DVP (delivery versus payment) arrangements, where a client’s custodian releases payment or securities before the certainty of settlement. The SEC will use the feedback when considering any regulatory changes.

U.S. States
California Bill Aims to Allow Stablecoins for Tax Payments from Cannabis-Related Businesses

In February, the California State Assembly introduced AB-953, which would allow cannabis-related businesses to pay their taxes and fees in stable coins— cryptocurrency that is designed to minimize volatility by fixing its value to a currency or traded commodity. The bill defines stable coins as digital assets that have “price stable characteristics pegged to United States dollars and United States dollars serve as collateral to that digital asset.” According to the bill, it will be up to the city or county to determine whether to store the stable coins in a digital wallet controlled by that jurisdiction or to convert any payments made by stable coins into United States dollars and deposit them into an account of that jurisdiction.

Under current US legislation, cannabis-related businesses are still illegal under federal law. For this reason, banks have an aversion to onboarding these clients, resulting in cash-only businesses that have no choice but to pay their taxes in cash.

Under current US legislation, cannabis-related businesses are still illegal under federal law. For this reason, banks have an aversion to onboarding these clients, resulting in cash-only businesses that have no choice but to pay their taxes in cash. The US banking industry’s decision to avoid working with cannabis-related businesses opens a gap in a multibillion-dollar industry that digital currency and blockchain technology is ready to fill.

Texas Wants to Ban Privacy Coins
The U.S. state of Texas has also proposed some as yet not clearly defined legislation for mandatory KYC and a ban on privacy coins. The proposed law, Texas House Bill 4371, would require people to verify the identity of senders before receiving cryptocurrency.

New Hampshire Bill Aims to Legalize Bitcoin for State Payments in 2020
Lawmakers in the U.S. state of New Hampshire are currently considering a bill to legalize payment of fees and taxes in Bitcoin (BTC), documents originally published on Jan. 3 reveal.

US State of Wyoming Passes Two New Blockchain, Crypto-Related Bills
The state legislature of Wyoming has reportedly passed two new house bills that aim to foster a regulatory environment conducive to cryptocurrency and blockchain innovation. One bill introduced into the legislature On Jan 18 is bill meant to clarify the classification of cryptocurrencies.

Ireland – Government Amends Anti-Money Laundering Bill to Include Cryptocurrency
In January, the government of Ireland approved a bill to incorporate the European Union Fifth Anti-Money Laundering Directive into their existing legal framework—the Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Bill. These amendments will make it easier for regulators to monitor cryptocurrency exchanges and wallet providers in an attempt to counter the use of virtual currencies for terrorist financing.

France Considers Banning Privacy Coins
The Finance Committee of France’s National Assembly has recommended a complete ban on privacy-focused cryptocurrencies. In the committee’s report (in French), the committee’s president, Éric Woerth, suggests it would be appropriate to propose a ban on activity related to cryptocurrencies built with the goal of providing greater levels of anonymity to users.

Mexico – The Bank of Mexico Proposes Crypto Exchange Transaction regulation
On March 11, 2019, the Bank of Mexico (Banxico) released a public consultation plan that proposed several regulations to help prevent crypto-related money laundering and terrorism financing. Some observers and the press have called some of these regulations “draconian,” essentially having the result of banning financial institutions from transacting with cryptocurrency exchanges; however, CipherTrace has not interpreted Banxico’s position as being that extreme. The proposal (translated from the original Spanish publication) states: “…it is considered convenient to maintain a healthy distance between virtual assets and the financial system. However, despite the foregoing, the Central Bank seeks to promote and take advantage of the use of technologies that could have a benefit from the perspective of efficiency or functionality, as long as these technologies are used in the context of the internal operation of the institutions.”

Although these proposed regulations do not explicitly ban cryptocurrency exchanges in Mexico, in the case of the more extreme interpretation of the proposal any exchange transacting in fiat currency would essentially be strangled without access to the traditional banking system.

These guidelines are still just draft provisions, and Banxico will be collecting responses from the community for the next two months on how to best amend the proposed regulations.

Japan – New Crypto Regulations Cap Leverage for Margin Trading
In March 2019, Japanese regulators approved amendments to their financial instruments and payment services laws, limiting leverage for margin trading at two-to-four times initial deposits. All exchanges that offer margin trading will be required to register with the government and consent to monitoring similar to securities traders in an effort to protect investors. Enforcement of these regulations will begin by April 2020, and exchanges are required to register within 18 months of that date.

These regulations are a result of investor protection concerns stemming from Japan’s recent boom in margin trading. According to the Japan Virtual Currency Exchange Association, margin trading reached about 11 times the scale of cash transactions in Japan by the end of 2018. Therefore, these new regulations will differentiate between cryptocurrency operators that engage in margin trading from those that issue tokens in ICOs. Ideally, this categorization will enable Japan’s Financial Service Agency (FSA) to better monitor and prevent scam investment schemes, protecting investors and promoting the overall health of the crypto economy.

Germany – Finance Ministries Publish Paper on Regulation of ICOs and Utility Tokens
In March 2019, the German Federal Ministry of Finance and the Federal Ministry of Justice and Consumer Protection published a paper addressing key issues regarding the regulation of ICOs and utility tokens. Under current German law, securities must be represented by physical documents kept at a central securities depository, meaning ICOs cannot be classified as securities. Therefore, this paper proposes the possibility of regulating the public offer of ICOs and introduces the prospect of electronic securities.

Furthermore, the paper addresses the risks associated with unregulated utility tokens and proposes that utility token providers adhere to adequate risk-disclosure obligations by publishing an information sheet prior to an initial public offering. The paper further states that the content and the order of information on this sheet should be regulated, and the publication must be authorized by the BaFin—the financial regulatory authority for Germany—prior to its release.

UK – Government Says Will Go Further Than AMLD5 On Regulating Cryptoassets
Amid concerns that MSBs could be putting consumers at risk by offering unauthorized services, the UK’s financial watchdog The Financial Conduct Authority (FCA), has proposed a consultation on existing guidance around crypto assets. The (FCA), the US equivalent to the Securities and Exchange Commission (SEC), launched its consultation after the UK Cryptoasset Taskforce requested additional guidance and clarity on the current regulatory framework. The FCA has set a 10-week consultation period to and will publish feedback and the final text of the guidance this Summer.

Iran – New Regulatory Framework for Cryptocurrencies and Introduction of a State-backed Cryptocurrency
The Central Bank of Iran published on its official website on January 28th, 2019 a “Version 0.0” of its regulatory framework for cryptocurrencies. Among other impacts, it would reverse a previous ban on cryptocurrencies, but still impose restrictions on the use of global digital currencies in the Islamic Republic.

Iranian Banks Launch Gold-Backed Cryptocurrency “PayMon”
In February, four Iranian banks—Bank Mellat, Bank Melli Iran, Bank Pasargad and Parsian Bank—partnered with the blockchain startup Kuknos Company to release the gold-backed national cryptocurrency PayMon (PMN). According to Kuknos advisor Soheil Nikzad, PMN is planned for release in a multi-stage token sale, privately to banks at first with the plan to eventually conduct a public securities offering, pending regulations. Kuknos is currently in talks with regulators to determine how best to make the cryptocurrency available throughout the country.

According to Nikzad, although PMN is compatible with international finance systems, the main goal of the national cryptocurrency is to reduce costs and friction in domestic transactions. As it stands, the Central Bank of Iran only allows the use of cryptocurrencies pegged to the Iranian rial and issued by the central bank itself as a payment method, prohibiting the use of “unapproved” cryptocurrencies domestically.

PayMon is the result of last year’s newly reinstated US sanctions against Iran. These sanctions led to SWIFT (the Society for Worldwide Interbank Financial Communications) baring a number of Iranian banks from using their financial messaging system—a necessity for most banks engaging in cross-border payments. In other words, without SWIFT, Iranian companies cannot pay for imports or receive payments for exports through the traditional banking system. Theoretically, the PayMon will be able to bypass this ban and give Iranian banks access to cross-border markets again.

Russian Duma Approves SWIFT-Alternative for International Use

Similar to Iran, the US has imposed political and economic sanctions on Russia. In March, the Russian State Duma approved the international use of SPFS (System for the Transfer of Financial Messages). Russia began developing SPFS in 2014, after the US government threatened to disconnect Russia from the SWIFT system. Although it this new system has severe limitations, as an alternative to SWIFT, it would greatly reduce the risks associated with Western sanctions such as a SWIFT ban, which would make it extremely difficult for Russian banks to process cross-border payments.

Although SPFS has been widely used throughout Russia since 2014, this marks the first time Russia will begin reaching out to international partners to use their system. According to the Central Bank of Russia, SPFS already complies with international standards and foreign players can easily be integrated into it. Anatoly Aksakov, Chairman of the State Duma Committee on Financial Market, has confirmed that Russia is in talks with Iran, Turkey and India about joint use of SPFS. There reportedly are also plans to integrate SPFS with China’s Cross-Border Interbank Payment System (CIPS) a payment system that offers clearing and settlement services for its participants in cross-border RMB payments.

Crypto-Ruble Delayed as Reading of Bill on Digital Financial Assets is Postponed
The second reading of Russia’s draft law on cryptocurrencies has been postponed to April in order to further define cryptocurrencies, tokens, and smart contracts. Although this bill is mainly focused on the governance of cryptocurrency exchanges and marketplaces, clear cryptocurrency regulations are vital if Russia plans to continue with their proposed Crypto-Ruble. The deadline for the adoption of these regulation has been moved to July, 2019.

Anatoly Aksakov, Chairman of the Russian State Duma’s Financial Markets Committee, told local news outlet RIA Novosti in January that the Crypto-Ruble will not differ from the fiat ruble in any way other than existing on the blockchain. According to his calculations, the crypto-ruble may appear in Russia in as soon as two or three years.

Russians Will Need a Special ‘Visa’ to Fund Crypto Accounts from Russian Banks
If passed by the State Duma, a new law will require crypto owners to obtain a special ‘visa’ to transfer money from Russian bank accounts into digital financial assets, especially digital tokens.

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