Virtual currency, once the exclusive domain of online gamers, has gone mainstream, with everyone from Facebook, American Express, Visa, and Amazon getting into the act.
In May, Amazon will launch Amazon Coins, a virtual currency for purchasing apps and in-app goods for the Kindle Fire. And then there is Bitcoin, a de-centralized digital currency distributed via open-source, peer-to-peer networks. Much like U.S. dollars were once backed by gold, Bitcoins have a limited supply and their underlying value rises and falls.
A recent study by Juniper Research has predicted that the amount of money spent on virtual currency in mobile apps—just a slice of the total marketplace—will hit $4.8 billion by 2016 and has been growing as much as 40 percent a year.
Virtual currency, however, isn't just for buying virtual farm animals on online games like Zynga's Farmville. With a current per-coin value of more than $70, Bitcoins are used to order online goods, real world services, and, for those so-inclined, illegal drugs and weapons from the Internet's underbelly. There is currently more than $770 million of Bitcoins in circulation.
It was just a matter of time before regulators took a hard look at these new instruments and, earlier this month, the Treasury Department did just that. The Treasury's Financial Crimes Enforcement Network (FinCEN), which focuses on money laundering and other monetary crimes, issued new guidance for distributing and using virtual currency. It targets “convertible virtual currencies” that either have an equivalent value in real currency or act as a substitute for it.
New payment systems have expanded the boundaries of "money transmission," and the inherent complexity of these systems opens them to potential misuse by criminals, Jennifer Shasky Calvery, FinCEN's director, said in a March 19 speech before the Association of Certified Anti-Money Laundering Specialists. “FinCEN's analysts [are] continually working to understand the schemes and methods used to exploit emerging payment methods for money laundering and terrorist financing, and to develop related guidance for law enforcement.”
A challenge for regulators is how to define the ever-multiplying array of virtual currency and online payment products hitting the marketplace. There are virtual currencies that can only be used within a game, such as Second Life's Linden Bucks and World of Warcraft Gold. Others, like Bitcoin, can be used to purchase real world items. Zynga's Farmville has Farmville Bucks that can be purchased with real money at real retailers.
Regulations on virtual currency, however, could have a big effect well beyond online apps. FinCEN, when it issued pre-paid access guidance in 2011, suggested that credit card, airline, and retailer rewards programs can also fall under the umbrella of virtual currency.
FinCEN's interpretive guidance, released on March 18, seeks to clarify the applicability of Bank Secrecy Act regulations to virtual currencies, defining certain businesses and individuals as money services businesses (MSBs) depending on the nature of their financial activities. MSBs have registration requirements and a range of anti-money laundering, recordkeeping, and reporting responsibilities under FinCEN's regulations.
Those who use virtual currencies exclusively for common, personal transactions, like receiving payments for services or buying goods online, are not affected by this guidance, FinCEN says. Intermediaries in the transfer of virtual currencies from one person to another person, or to another location, are designated as “money transmitters” that must register with FinCEN as MSBs. The distinction of being a money transmitter—as both Western Union and PayPal are classified—also includes additional state registration and regulatory requirements.
“This framework would wildly expand the reach of FinCEN and the BSA, and would be infeasible for many, if not most, members of the Bitcoin community to comply with.”
—Patrick Murk,
General Counsel,
Bitcoin Foundation
“Many online gaming companies whose platforms generate a virtual currency for use in the game have taken the position historically that the issuance of the virtual currency is essentially a license to use the game,” the FinCEN guidance says. “As such, it does not trigger MSB obligations. This position may still be correct, but the guidance requires that the virtual currency have certain limiting features, including that it not be redeemed for real currency; and not be transferrable to other players or parties or otherwise exchanged, in order for the gaming company to be exempt from Bank Secrecy Act requirements of an MSB.”
While companies parse FinCEN's language to see whether or not this guidance applies to them, one unique product is definitely in the crosshairs. Bitcoin, which a recent
European Central Bank study called “the most successful—and probably most controversial—virtual currency scheme to date,” is not mentioned by name, but clearly falls within FinCEN's definitions of a virtual currency subject to the new regulations.
Patrick Murk, general counsel of the Bitcoin Foundation, an advocacy group for the currency, says the guidance, while unclear, specifies that those transacting Bitcoins on someone else's behalf must register with FinCEN and those who exchange a virtual currency like Bitcoin for real money may have to register with FinCEN as an MSB.
That FinCEN firmly believes that virtual currency in general, and Bitcoins in particular, do not fall under pre-paid access rules was surprising to Murk, who says that always seemed the most likely trigger for regulation. Most companies in the space are registered as MSBs under prepaid access rules, not as a money transmitter.
Murk sees plenty within the guidance that is confusing. It implies, for example, that everyone who has ever exchanged virtual currency for real currency may now be considered a money transmitter under the Bank Secrecy Act. He called this “an untenable position.”
“This framework would wildly expand the reach of FinCEN and the BSA, and would be infeasible for many, if not most, members of the Bitcoin community to comply with,” Murk says. “An individual or micro-business cannot be expected to create a robust anti-money laundering program anytime they sell one Bitcoin on an exchange or in-person. The BSA was never intended to apply this broadly.”
“Under the guidance, a coffee shop that accepts Bitcoins for its beverages, then sells that Bitcoin to buy more coffee beans for dollars becomes a money transmitter. I think that's wrong,” says Peter Vessenes, CEO of Coinlab, an exchange that, this month, consummates a partnership with Mt. Gox, the largest Bitcoin exchange in the world.
Prepping for More Regulation
VIRTUAL CURRENCIES GUIDANCE
The following is a selection from guidance issued by FinCEN for “Persons Administering, Exchanging, or Using Virtual Currencies.”
Users of Virtual Currency
A user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an MSB under FinCEN's regulations. Such activity, in and of itself, does not fit within the definition of “money transmission services” and therefore is not subject to FinCEN's registration, reporting, and recordkeeping regulations for MSBs.
Administrators and Exchangers of Virtual Currency
An administrator or exchanger that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN's regulations, unless a limitation to or exemption from the definition applies to the person. FinCEN's regulations define the term "money transmitter" as a person that provides money transmission services, or any other person engaged in the transfer of funds. The term “money transmission services” means “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.”
The definition of a money transmitter does not differentiate between real currencies and convertible virtual currencies. Accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA.
De-Centralized Virtual Currencies
A type of convertible virtual currency activity involves a de-centralized convertible virtual currency (1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort.
A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter.
In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.
Source: FinCEN.
Other alternative currencies, including those used for in-app purchases and credits used for real-world perks may also find themselves under even greater scrutiny. In its S-1 filing, for example, Facebook acknowledged the regulatory risk behind its “Facebook Credits,” which netted it about $3.7 billion in revenue in 2011.
“We may be subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing money transmission, gift cards, and other prepaid access instruments, electronic funds transfers, anti-money laundering, counter-terrorist financing, gambling, banking and lending, and import and export restrictions,” the company wrote. “In some jurisdictions, the application or interpretation of these laws and regulations is not clear.”
To “mitigate regulatory uncertainty,” the company detailed plans to apply for money transmitter licenses in numerous states.
Vessenes is among those who hopes that the new “money transmitter” distinction doesn't trigger a fresh wave of state regulation. “Just let the feds regulate this,” he says, admitting that may be overly optimistic.
Although virtual currency may seem different from paper gift certificates and plastic gift cards, virtual currency sold on a prepaid basis for later use or redemption by a user may be subject to state and federal gift certificate laws, including gift card provisions of the Credit Card Accountability Responsibility and Disclosure Act of 2009, says Dax Hansen, an attorney with the law firm Perkins Coie.
“This area of virtual currency is already very heavily regulated and very confused,” he says. “There are a multitude of regulations you already have to look at.”
The separate application of the money transmitter prong of the money service business rules imposes a significant burden in terms of compliance, Hansen says. “Regulators are looking for transparency,” he says, “but, on the other hand, why is it a given that you must have transparency with some of these low-risk transactions.”
Keyur Mithawala, founder of CampBX, the first Bitcoin trading platform in the U.S., is more optimistic. The FinCEN guidance, he says, is “an important step toward growth and widespread acceptance of Bitcoin.”
Murk, however, says that while efforts to bolster public confidence are welcomed, FinCEN appears to be creating an entirely new regulatory scheme under the guise of “guidance.” Under the Administrative Procedures Act, FinCEN can't promulgate new rules without going through a notice and comment proceeding, he points out. If it wants to expand its statutory authority over “money transmitters” to include brand new categories such as “administrators” and “exchangers” of digital currency it must do so through a proper rulemaking process.
“This guidance is a bit overreaching in terms of what an agency can do under the guise of guidance,” he said. “It smells a lot like a rulemaking.”
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