FinCEN Classifies Mixers as Primary Money Laundering Concern
On October 19th, the US Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued a proposal that would require US financial institutions to monitor and report transactions involving cryptocurrency “mixers.”
The proposed rule classifies transactions involving cryptocurrency “mixers” as being a “Primary Money Laundering Concern.” This classification allows FinCEN to order financial institutions regulated by the Bank Secrecy Act (BSA) to take “special measures” that go beyond the standard anti-money laundering (AML) requirements. This is the first time FinCen has used section 311 of the USA PATRIOT Act to “target a class of financial transactions” rather than a specific entity or group.
Specifically, the proposed rule would require financial institutions (which include, but are not limited to banks, brokers or dealers in securities, money services businesses, futures commission merchants, commodities brokers and mutual funds) to report, within 30 calendar days of a covered transaction:
Transaction information such as the amount, date, type of transferred cryptocurrency, IP address, and time stamps associated with the transaction, wallet addresses associated with the mixer and the user, as well as the transaction hash coupled with the name of the mixer (if known).
Customer information that is already held by the financial institution such as name, date of birth, address, email, phone number and IRS or foreign tax ID number.
Most importantly, FinCen’s definition of “CVC mixing” is incredibly broad and includes “the facilitation of CVC transactions in a manner that obfuscates the source, destination, or amount involved in one or more transactions, regardless of the type of protocol or service used, such as: (1) pooling or aggregating CVC from multiple persons, wallets, addresses, or accounts; (2) using programmatic or algorithmic code to coordinate, manage, or manipulate the structure of a transaction; (3) splitting CVC for transmittal and transmitting the CVC through a series of independent transactions; (4) creating and using single-use wallets, addresses, or accounts, and sending CVC through such wallets, addresses, or accounts through a series of independent transactions; (5) exchanging between types of CVC or other digital assets; or (6) facilitating user-initiated delays in transactional activity.”
What does this mean?
This proposal is sweeping in the scope of the definition of “CVC mixing” and in the information about customers it would require financial institutions to proactively report to the government. For example, the definition of “mixing” effectively captures any on-chain activity, regardless of whether the on-chain transactions actually obfuscate transactional history at all. The proposal would also violate users’ reasonable expectation of privacy in a manner beyond anything we’ve seen in traditional finance. As we’ve recently argued in our amicus brief for Harper v. IRS, reporting requirements that tie users to blockchain addresses would grant the government surveillance of a user’s every past and future transaction — going well beyond what the government is purportedly attempting to accomplish, the identification of possible money laundering. It is not inherently illicit, and indeed is often sensible, for a person to desire and use tools or techniques—like single-use wallets—that enhance financial privacy because financial transactions display intimate details about a person’s life that they may not want to disclose.
Understandably, we’ll be submitting a comment letter in response to the NPRM and you should too. Comments are due by January 22, 2024.
SEC Commissioner Hester Peirce's Dissent in LBRY
Last week, Securities and Exchange Commission (SEC) Commissioner Hester Peirce published her dissent from the SEC's enforcement action against blockchain company LBRY, Inc. In March 2021, the SEC charged LBRY for issuing unregistered securities in the form of its LBRY Credit (LBC) tokens. After over two years of legal battles with the SEC, on November 7, 2022, the District of New Hampshire judge granted the SEC's motion for summary judgment, holding that LBRY offered and sold LBC as a security in violation of the registration provisions of the federal securities laws, and that LBRY did not have a defense that it lacked fair notice of the application of those laws to its offer and sale. LBRY decided to shut down operations earlier this month citing mounting debt.
In her statement, Peirce argues the SEC wrongly targeted LBRY, which developed a useful product and was never accused of fraud or misconduct, especially considering there were many fraudulent crypto projects more “deserving” of the SEC’s attention. Peirce expresses that the SEC’s “scorched earth” tactics forced LBRY to shut down a valid business, noting that the $44 million penalty sought by the SEC was entirely disproportionate to any investment harm. Peirce also questions the outcome of the action for investors: “Are investors and the market really better off now after the Commission’s litigation contributed to the demise of a company that had built a functioning blockchain with a real-world application running on top of it?...This case illustrates the arbitrariness and real-life consequences of the Commission’s misguided enforcement-driven approach to crypto.”
Rather than targeting LBRY, Peirce suggests the SEC should have focused on building a regulatory framework for the industry and urges constructive suggestions for how the SEC can improve its approach to crypto and innovation.
Congressional Hearings on Cryptocurrency and the Financing of Terrorism
On October 25 and 26, Congress held three hearings focused on the funding schemes used by the Islamic Republic of Iran and its affiliated proxies and allies to evade U.S. sanctions and fund terrorist activities. These hearings were conducted in response to Hamas’s recent attack on Israel, and the recent escalation in the region.
The first two hearings concerning terrorist groups’ sanctions evasions and Iran’s access to money were conducted by the House Financial Services’ Subcommittee of National Security, Illicit Finance, and International Financial Institutions. The discussions focused on the partisan shifts in U.S. policy towards Tehran across different administrations. Additionally, the hearings covered the concerns triggered by a recent article from the Wall Street Journal inaccurately reporting the volume of cryptocurrency donations to Hamas.
Mr. Adam Zarazinski, the CEO of Inca Digital Data analytics, delivered his testimony to the committee on the role of cryptocurrencies in financing terrorist activities. He stated that “the narrative around cryptocurrencies being used for illicit financing is often misconstrued and taken out of context.” Additionally, Mr Zarazinski emphasized the significance of building a healthy crypto regulatory framework, stating “ There is no amount of stringent policies against crypto here at home will stop Iranian or Russian cryptocurrency providers from laundering money; part of the goal with the work of our lawmakers should be to draft bills in such a way that it can and does get there and gets here onshore in a healthy way that balances privacy and law enforcement.”
The third hearing, "Combating the Networks of Illicit Finance and Terrorism," was conducted by the U.S. Senate's Committee on Banking, Housing, and Urban Affairs.
Dr. Shlomit Wagman, Affiliated Scholar and Former Chair of Harvard’s Kennedy School; and former Director-General of the Israel Money Laundering and Terror Financing Prohibition Authority, commented: “let's not lose sight and focus on the big picture. Crypto is currently a very small part of the puzzle… Most of the funds are still being transferred by the traditional channels that we all know from the best banks, money transmitter payment system, Hawala money exchange,charity, cash and shell companies.” Dr. Wagman also commented on the Wall Street Journal Article: “it's important to note that these figures are disputed. And per independent analysis that was released just this week, could be overestimated by as much as 99%.” Dr. Matthew Levitt, the Director of Reinhard Program On Counterterrorism & Intelligence added, "I do think that number is very likely exaggerated. It's happening. They're getting money to crypto there's no question. But the experts who follow this closely, think that number is inflated.” Dr Wagman added, “So actually, they are using bank accounts and credit cards and payment cards. I know that firsthand, because many Israelis are now monitoring.”
What does this mean?
The recent reports on the usage of cryptocurrencies to fund terrorist attacks has fueled the already heated discussion on cryptocurrency regulatory framework. However, there are experts out there explaining that while any terrorist funding is of course extremely concerning, cryptocurrencies represent a smaller portion of the broader landscape of illicit finance.