Liberty Reserve, Bitcoin, and the US Bank Regulatory Dog That Didn’t Bark

By Clive, a bank information technology professional and Japanophile

Perhaps readers are familiar with the Sherlock Homes story The Adventure of Silver Blaze, more particularly the famous plot device of the dog that didn’t bark. What our sleuthing hero was able to deduce from the muted mutt was that the supposed guard dog didn’t alert anyone to wrongdoing because he knew who the wrongdoer was.

After delving in to the most curious case of The United States of America vs. Liberty Reserve, while no match for Sherlock Homes, I was in a similar quandary.

But let’s back up a little. It is possible many readers are, at best, only vaguely familiar with Liberty Reserve and at worse completely unaware of what it was and what it did. Liberty Reserve was, put simply, a huge financial fraud, money launderer, sanctions evader and enabler of pretty much any kind of loathsome criminal activity you can mention. :

… the scope of [Liberty Reserve’s] unlawful conduct is staggering. Estimated to have had more than one million users worldwide, with more than 200,000 users in the United States, Liberty Reserve processed more than 12 million financial transactions annually, with a combined value of more than $1.4bn. Overall, from 2006 to May 2013, Liberty Reserve processed an estimated 55 million separate financial transactions and it believed to have laundered more than $6bn in criminal proceeds.

Way back in 2013, when Liberty Reserve was shut down and the owners arrested, . This was after the U.S. Department of the Treasury discovered (I’m tempted to prefix this with the word “finally”, but I’ll resist the temptation) all the shady dealings going on at Liberty Reserve and promptly (well, not that promptly, it did take 7 years or more) .

A trial ensued, followed by convictions and sentencing. Bitcoin promoters leapt in to say that even though Bitcoin looked like a duck (it used a digital /virtual currency), it walked like a duck () it quacked like a duck ( ) . That’s despite the fact that Bitcoin is .

Even a quick trawl through the Bitcoin wiki shows 170 digital currency exchanges, and one in particular brands itself as a “Dark Exchange”, the darkness emanating from the fact that it is entirely P2P-based and as such (or so the participants would like to believe) is stateless and does not fall under any jurisdiction. Others .

In some ways, and being as sympathetic to Bitcoin and the other digital currency proponents as I can be, the regulators are being hoist by their own petards. By taking the line that digital currencies aren’t currencies, they can hardly then complain about Bitcoin exchanges being honey pots to money launderers. Bitcoins are, if you accept the regulators’ and digital currency boosters’ arguments, no different to fine art, sport sponsorship, London apartments or even, being facetious, baseball cards in terms of being a vehicle to facilitate money laundering and hiding the sources of funds.

But of course, digital currencies are not at all like fine art, sport sponsorship, London apartments or baseball cards. Using these asset classes there is either a physical object which needs to be transferred and associated with an owner or else some other contractual provision which a court belonging to a nominated jurisdiction recognises and is, if necessary, willing to enforce. These inherent features of conventional asset classes are bad news for a criminal intent on laundering the proceeds of crime or trying to hide a source of funds.

Digital currencies, on the other hand, make a virtue out of their necessity to do without any of these things. It was almost like they were designed as the perfect asset class to launder ill-gotten gains.
Why, then, is the regulatory dog (or dogs) not barking?

Under Secretary of Terrorism and Financial Intelligence David Cohen about how regulation would be balanced with innovation (does this sound at all familiar?) and that the Department of the Treasury’s FinCEN (Financial Crime Enforcement Network) had “…issued interpretive guidance to bring clarity and certainty to one aspect of the regulation of virtual currencies”. Reaching for his pom-poms, Cohen espoused:

Since FinCEN issued this guidance, dozens of virtual currency exchangers and administrators have registered with FinCEN, and FinCEN is receiving an increasing number of Suspicious Activity Reports (SARs) from these entities. It is encouraging to see players in the virtual currency industry taking their responsibilities seriously and modifying their businesses to comply with these transparency requirements.

He then slightly rowed back:

But we know there are many virtual currency exchangers and administrators that have not registered with FinCEN and are not fulfilling their recordkeeping and reporting requirements. Those that do not comply with these rules should understand that their actions will have consequences. Not only are they subject to FinCEN civil monetary penalties, but the knowing failure to register a money transmitting business with FinCEN – or to fail to register with state authorities when required – can be a federal criminal offense.

Only U.S. regulators seem to have this happy knack of combining an ultra-libertarian free-for-all with the wagging finger of the nanny state in the same policy statement. If it sounds like wishy-washy nonsense, that’s because it is.

Unbelievably, well, actually, all-too-believably, FinCEN has only ever, it its entire history, and no digital exchange apart from Liberty Reserve has ever been shut down. Now, more recently, FinCEN has been a bit tougher and because, in exchanging its digital currency for fiat currency types (primarily U.S. dollars) it had acted as a money services business (MSB) and was thus obliged to register with FinCEN and comply with know-your-customer and anti-money-laundering regulations, which Ripple Labs failed to do.

But of course, the glaring hole in the U.S. Treasury’s and FinCEN’s regulatory regime is that, within certain parameters, so long as a digital currency exchange operating in the U.S. does not facilitate exchange with fiat issued currencies, it does not need to register with FinCEN or comply with the regulatory requirements. And FinCEN when it comes to digital currency exchanges operating outside of U.S. jurisdiction as if it has no powers at all to ensure they operate their businesses cleanly (emphasis mine):

Bank Secrecy Act Regulations – Definitions and Other Regulations Relating to Money Services Businesses, 76 FR 43585 (July 21, 2011) (the “MSB Rule”). This defines an MSB as “a person wherever located doing business, whether or not on a regular basis or as an organized or licensed business concern, wholly or in substantial part within the United States, … This includes but is not limited to maintenance of any agent, agency, branch, or office within the United States.

But the U.S. Treasury is not powerless. There are specific policy changes it could make which would put the digital currency exchanges on notice that the U.S. government was no longer willing to let the U.S. dollar be used as the default choice for murky, untraceable money transmission.

All digital currency exchanges which offer U.S. dollar conversion trades should be registered with FinCEN and FinCEN should impose strict – and by strict I mean to the same standards that ACH clearing banks are expected to adhere to – reporting requirements on the digital currency exchanges. If digital currency exchanges are not FinCEN registered, no U.S. (or EU, the ECB should do likewise) bank or any other bank of a country which considers itself to have any sort of reputation for banking-industry probity should accept any transaction which had originated at or passed through an unregistered digital currency exchange.

It is hard to not be astounded by the U.S. government, via its regulators such as the Treasury, their equally useless poodle FinCEN and the world-class haplessness that is the OCC, and watch it benignly neglect its responsibilities to manage its own currency. Viewed at from outside the U.S., the U.S. government seems to view the dollar and its place in the world financial system as a pile of vomit left on the sidewalk – a bit of a mess, but somehow caused by someone else and it’s someone else’s responsibility to keep the place clean so it doesn’t really need to bother getting its hands too dirty.

When Liberty Reserve was laundering the proceeds of crime and sanctions busting on an industrial scale for 7 long years or more, the U.S. dollars it was exchanging into and out of didn’t just come from nowhere. As the indictment read:

… on or about November 18 2011… FinCEN issued a notice to financial institutions within its network of the risks associated with providing financial services to Liberty Reserve…

Those dollars, then, most certainly were not left by Santa Claus in a stocking by the fireplace. When the indictment said “financial services” this meant, of most significance, access, via the money centre banks, to U.S. dollar clearing. So between c. 2006 and late 2011 (5 years!) Liberty Reserve had been operating in a spectacularly criminal fashion and not even being particularly subtle about it (again, from the indictment, Liberty Reserve opened accounts in the name of “Russia Hackers” and “Hacker Account”). And banks with access to U.S. dollar clearings were more than happy to supply it with whatever dollars it needed.

Banks are not charities. When a bank trades on its banking licence to provide banking services to commercial clients, as Liberty Global was, it charges a fee. The banks’ Commercial Relationship Managers are paid – and receive bonuses based on, in most cases – they ability to attract fee paying customers. I will cover the subject of why the “conventional” banks are so keen to get embroiled in digital currencies, why they are quite happy to turn a blind eye to their potentially dubious business models and what they get in return, in a follow-up article.

The U.S. Treasury should also, without delay, instigate a policy that any fiat issued currency which came through an unregistered exchange, either electronically or as physical banknotes, should be treated by the regulated deposit takers (i.e. mainstream U.S. banks) as an unknown / unverified source of funds. Because that is exactly what it is.

And U.S. based banks (including non-U.S. owned banks such as HSBC) with access to dollar clearing should be prohibited from providing U.S. dollar money transmission – or any other money services business activity for that matter – to any digital currency exchange which isn’t registered with FinCEN. Furthermore, any financial institution which provides U.S. dollar or other fiat currency clearing to an unregistered digital currency exchange anywhere in the world should be put in Special Measures under the Patriot Act. And this policy should be rigorously enforced by FinCEN.

Unless the U.S. regulators takes these steps, they are making a mockery of their own anti money laundering and endeavours to identify and recover the proceeds of crime.

Cfdtrade readers have reported when, following their attempts to manage their personal finances on a “cash only” basis, they have been not only viewed with suspicion by, but in some instances, had their banking facilities withdrawn from them. Well, what’s sauce for the goose is sauce for the gander. Digital currency exchanges are just as prone, if not significantly more so, than physical cash to being used to hide illicit activity and conceal the sources of funds. If the digital exchanges won’t clean up their acts and submit to registration and regulation – and those who use them accept this and the reasons for it – why should they expect more favourable treatment?

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22 comments

  1. OpenThePodBayDoorsHAL

    Yves has said buying a Bitcoin is like buying litigation futures.
    It probably meets the four corners of the “Howey test” that determines whether something is a security under the ’40 Act. The Dao (a so-called “smart contract” issued on the similar Ethereum network) almost certainly is. So maybe the SEC goes after them and not FinCEN?
    But I like your proposed “travel rule” where a Bitcoin transferred to a US resident that was originally bought overseas with funds of unknown origin be tagged as unverified. Right now 95% of the flow of bank money into Bitcoin is in Chinese yuan so that would be a great place to start looking.
    But I’d also ask a more fundamental question. The Bitcoin ledger is validated every 10 minutes (on average) by “miners” who solve ridiculous, very processor-intensive math problems. But there is no way to know the actual identity of a miner, I know of one whose screename is “friedcat” who is based in a cave in China and uses pirated electricity. So the validity of a multi-billion $ ledger is, at least for a few minutes, certified by an anonymous guy in a cave on the other side of the world. I guess I would wonder which judge in a real jurisdiction would find that satisfactory?

    1. flora

      yes.
      An aside:
      “But there is no way to know the actual identity of a miner, I know of one whose screename is “friedcat” who is based in a cave in China and uses pirated electricity. So the validity of a multi-billion $ ledger is, at least for a few minutes, certified by an anonymous guy in a cave on the other side of the world.

      If said ‘guy in a cave’ is pirating his electricity by using a b-coin mining bot network created by, say, malware like Sefnit, Microsoft may reach out and automatically erase his botnet. His and possibly many others’ validation/mining ability goes “poof” without warning. Very chancy validation/certification system.

      1. milesc

        Stealing electricity (which may or may not happen, we don’t know) is one thing. Using a bot net to mine bitcoins is quite another; bot nets are hopelessly outpaced by dedicated mining hardware (ASICs). There are far more lucrative uses for bot nets — I doubt any are used to mine bitcoins. Even ignoring this, neither Microsoft nor anyone else can “reach out” and shut down the Bitcoin network (because of its distributed nature, not unlike BitTorrent).

        An interesting aside regarding electricity use in China — I read that China invested heavily in power facilities that are, in some cases, underused. Further, the infrastructure to move excess electricity around the country is immature, hence very cheap electricity in some places. These areas are, understandably, very attractive to Bitcoin mining operations.

        Similarly, we sometimes see (as a result of the proliferation of renewable energy initiatives) excess electricity generated elsewhere in the world, with power companies even going so far as paying people to use it. At the same time, Bitcoin mining hardware has matured; ASIC manufacturing has caught up with the latest in chip fabrication techniques, meaning new ASICs will remain viable for longer. It is not inconceivable power companies that regularly produces excess electricity may themselves maintain Bitcoin mining equipment to turn that excess directly into bitcoins. Time will tell.

    2. milesc

      Geographic concentration of miners is a concern, but probably not for the reason(s) you have in mind.

      In any event, the validation you speak of – mining – is little more than (a) checking transactions are valid (i.e. validly constructed and using bitcoins that have not already been spent) and adding transactions to a candidate block, which may or may not be added to the blockchain. Keep in mind that if a miner tries to add an invalid transaction to a block, the rest of the network will reject that block; not just other miners, but individual nodes too. An expensive lesson for the miner and part of what makes Bitcoin so powerful — every user of Bitcoin (not just miners) effectively validates that multi-billion $ ledger.

      The worst an individual miner (or pool operator) can do is to refuse to process a transaction (or indeed any transactions at all — in which case, all other things being equal, the transaction(s) will remain in the queue and be mined by another miner in a subsequent block).

      > “I guess I would wonder which judge in a real jurisdiction would find that satisfactory?”

      I don’t think it matters. The only thing that matters is that the Bitcoin network achieves consensus.

  2. Ignacio

    What’s sauce for the goose is sauce for the gander: kept that in my vocabulary. Now I am an english ignorant with a funny saying in my breech.

    Well my question is: what’s the point of creating a watchdog that doesn’t bark? I think that the objective of this institution is to act, not by default, but on demand. Just in case it is necessary for…

    1. Synoia

      Becuse the US’ DBLS (Dear Beloved Leaders) would like us to believe they are trying to be honest.

      In the same manner as the US promotes Democracy around the world, until the local voters elect a Government which actually represents them, and enacts polices which are an anathema to the US, such as preventing US Corporation from exploiting the people in the country, or getting its resources not under US business control.

      At which point the US will provide the means for some right wing tools to ferment a revolution, and extract rent, as they are doing to the US’ own citizens.

      For example: The US’ College Loan System, or the US’ Health Care System.

      This both outs a lie to the US wanting democracy around the world and treating its citizens equitably; thus spotlighting the US’ DBLs perennial hypocrisy and deceit.

      1. Ignacio

        Similarly, the objective of EU fine to Apple is designed to look as if the EU is worried with corporations tax evasion. It is just the price that Apple has to pay to keep things equal.

        Amazing to see how worried is Tim Cook about Ireland’s fiscal sovereignity. How sensible of him!

    2. optimader

      Well my question is: what’s the point of creating a watchdog that doesn’t bark?
      Maybe the underlying mission of the watchdog is not so much to bark but rather to be available as a legally codified hammer to drive politically expedient nails when the time seems fit?
      I can envision the likes of Bitcoin being considered as tolerable experiments, allowing private sector entities to develop and run P2P exchanges for study until whatever is deemed to be useful data on operational strengths/weaknesses -practicality is collected and available to be applied for the government(s) own operation of electronic currency.

      What’s sauce for the goose is sauce for the gander A riff off the old idiomatic expression: What is good for the Goose is Good for the Gander


      What’s Sauce for the Goose (1916)
      An Oliver Hardy short (re: Laurel&Hardy –American (and English) vaudeville comedians turned early American cinema icons)

  3. Jim Haygood

    Money laundering is a victimless “crime” created out of whole cloth in 1986, as an adjunct of the Drug War.

    Now it functions as an all-purpose smear, as well as a cudgel to attack those who dare to compete with the government’s monopoly on currency.

    Anonymous currency is a public service. FinCen is a US-led front organization to force the US Drug War onto the rest of the world. Smash FinCen, live free.

    1. Clive

      People make the same argument about taxation / the IRS. They are similarly wrong.

      And by giving tacit approval to denying governments the ability to confiscate the proceeds of crime, you are giving tacit approval to the criminality which generated those proceeds.

      1. cm

        Surely you can admit there are major problems with the Bank Secrecy Act, such as the 10k limit that was defined in the 70’s and hasn’t been adjusted for inflation?

        Or how FINCEN excuses Mexican President’s brother of money laundering?

        Or how the police use money laundering to steal cash from people?

        Finally, I agree w/ Jim – money laundering should not be the problem of the banks. I helped enforce BSA at American Express, and the entire time felt dirty. The “Know Your Customer” program is simply Orwellian.

        1. Clive

          I do agree there’s a fine line between legitimate investigations into the sources of funds and an overbearing and unwarranted intrusion into law-abiding citizens attempts to simply go about their daily life without a lot of unnecessary aggravation. Most of the problems with the implementation of KYC is that the people who are in the front line having to adhere to it have no power to deviate from the overly-prescribed process. Thus if they fail to demand Aunty Mabel’s proof of ID, original (not copied !) documentation and get her to answer a load of intrusive questions, they risk being fired. “I was just using my common sense” isn’t going to wash with their employers. It’s demeaning for the tellers and for the honest customers.

          That said, sometimes Aunty Mabel is really doing the financial laundry for the vicious pimp who beats the underage sex workers who were vulnerable runaways he’s got hooked crack. It does happen.

          The one and only time I ever as a teller (simply eons ago) filled in a suspicious activity referral form was for a bar (technically, we refer to them as “pubs” here!) in the small town where I worked was paying in £5-10k a week in cash, a figure far higher than the other pubs in the area. They didn’t really even make any efforts to be subtle about it — the notes were shoved in over the counter still rolled up from when they’d been handed over from the smack/crack/meth/coke/ketamine or whatever it was being bought and sold. When I ran them through the note counter, I kept expecting to be high for a week. The people who managed the “pub” were loathsome low life and preyed on the community. It was essential that I was able to report what I was seeing and respond to the concerns of my colleagues without any repercussions. The pub eventually got busted and was closed down before reopening under new, hopefully more honest, management.

          It galls me no end that digital currency exchanges make that pub look like a convent by comparison and there’s precious little being done to put a stop to it. And I don’t like the idea of “good” crime and “bad” crime at all. Crime is crime is crime. Everyone should be equal under the law. FinCEN’s ability to be both incompetent, wilfully blind and overzealous at the same time (depending on who or what it’s looking at) is one reason why I’m on the warpath about them.

  4. John Zelnicker

    Clive – You mentioned banks withdrawing services from cash heavy customers. Just yesterday a client of mine told me that heir current bank has notified her that they are closing her account and they won’t explain why. I said it was probably due to her large cash deposits. Her company sells products that run from $3-4k each and a large number of them are paid for in cash. Her new bank is going to charge .25% for cash deposits over a low minimum. The widespread effort to eliminate cash transactions is another move by the financial elites to control our lives in every aspect. Disgusting and scary.

    1. Clive

      Yes, in retail, banks (usually) set a specific figure / allowance for the percentage of cash transactions, especially cash paid in. This is, notionally, so that if an account is used for money laundering it gets picked up and the bank’s fraud team can investigate further. It’s also to alert the banks to the possibility that a retail account isn’t being used as a commercial one. But higher levels of cash handling reduce profitability so there is always the temptation to simply close the account because you know you’re not making or, worse, losing money on the account. That’s bad enough.

      What’s worse is where you have a commercial account which is being used to operate a business which is exactly as declared by the owner of the account, but again (like the retail example) you don’t fit in with the bank’s profitability model because you’re using “too much” cash — either paid in or taken out. The bank can’t reclassify your business’s area (usually referred to as a “SIC Code” internally) as this messes up the other monitoring in place. So, in effect, you again become exactly like the retail customer, you stop fitting the predetermined model and you are no longer profitable enough. There’s no discretion for the bank staff (and no expertise even if there were) so they dump you. Just like that. They don’t even have to do The Walk of Shame as they do the business equivalent of sneaking out the back.

      In the UK there are some protections imposed by the regulator. They’re a classic Tax on Time though for the business to get enforced so it’s easier (I use the word loosely) to just fall into line and move your business’s account. Not sure if there’s any protection in the US against this sort of bad faith dealing but even if there is, it will suffer the same not worth my hassle disincentive for a time-stressed small business owner.

      1. John Zelnicker

        Clive – Thanks for the detail, I find it very interesting given my economics and finance background. It also confirms my thinking. The account was a business or commercial account, but the cash was $10-50k per month. I’m sure she was charged by her current bank for handling, but not enough for them.

        I sincerely doubt there are any protections for small businesses in the US.

        I do intend to talk to a friend of mine who is a top executive at a local bank and see if he has any ideas about how my client can either reduce her costs or her hassles.

  5. Sirr

    This article is worthwhile and reveals a cause for concern. Yet it is important to note that bitcoin, and other so-called cyrptocurrencies, are psuedononymous, and not anonymous–unlike cash. Cash is cumbersome, but it is anonymous and thereby the vehicle par excellence for moving ill-gotten gains in many placement typologies. From the perspective of the launderer, cryptocurrencies have many benefits, and with a few precautions there is virtually nil risk in being identified, but all such transactions are noted on the distributed ledger. Highly troubling if one doesn’t want to leave a trail.

  6. JustAnObserver

    Hi Clive,

    Even if FinCEN – miraculously – did decide to use the dollar clearing route to crack down on this scummy stuff couldn’t the BC exchanges just convert to EuroDollars instead ? I’m a bit ignorant but aren’t these effectively dollars-in-exile & so don’t pass through the US money center banking system ?

    So the laundering route would now go BC -> Euro$ -> Real$, only a bit more complicated.

    1. Clive

      Yes, you’re quite right, EuroDollars or any expatriated USDs could be outside the clutches of FinCEN. But two points, one of which I touched on briefly (for the sake of brevity in the original piece) is that the EU national bank regulators should be similarly dragooned into taking the same sort of action as I’m asking FinCEN to take. It’s unfair if I just singled out FinCEN because EU regularly authorities are being similarly lax. That said, FinCEN has by far the greatest leverage over USDs tand where they end up than the EU regularly bodies do.

      The second point is that FinCEN can put any bank (in any jurisdiction) into special measures which could (and should in my view) result in the U.S. Wall St. banks denying them access to dollar clearing in the U.S. itself.

      While this wouldn’t close down the unregulated exchanges offering USDs that were outside the U.S., it would start to strangle them or at the very least place significant (and so costly) barriers in their way.

  7. flora

    Under Secretary of Terrorism and Financial Intellegence David Cohen has waffled on about how regulation would be balanced with innovation….”

    The innovation being ‘new ways to not regulate’?

    Great post. Thanks.

    (an aside: “Dark Exchange” selling point is that it’s a P2P service? The term ‘P2P’ can be used to imply not only that their are no regulations or govt restrictions, but also imply all actors in the entire P2P chain are both willing participants and reliable actors. I wouldn’t bet money on either being true.)

  8. Shwell Thanksh

    I’m trying to understand how tracking individuals’ cryptocurrency transfers compares as even a drop in the leaky bucket that is the USD.
    provides all the cover needed to buy real estate with cash, then sell it to wash it clean.
    When a substantial fraction of purchases can be made with bitcoin, who will need to convert it to USD? At that point there will at least be a pseudonymous trail, which sounds like quite an improvement over the current AML/KYC system that gives a pass to LLCs and offshore anonymous trusts.

    1. Clive

      I suppose that FinCEN’s dilatory performance in reigning in the worst abuses going on in the digital currency exchanges is symptomatic of a wider — what? lessees-faire management? regulatory capture? neoliberal ideology? I’m not really sure of the underlying cause — issue in the U.S. Treasury and the OCC. Somewhere along the line, it’s like the $ is a monster which has been created but had escaped from the lab. But the creators who should be owning the problem and sorting it out are just shrugging their shoulders and asking everyone else “gee, how did that happen? I wonder what can be done about it?” as if they don’t have the ability to at least start to fix some of the damage.

      I do feel here like, with FinCEN and the digital currency exchanges, I’m the boy putting his finger in the dyke to stop the flood (only it ain’t water that’s lapping in) but all the while the slop is coming over the top and round the sides. But my take on it is that, if you can diagnose and, better yet, treat, a particular symptom, at least it brings attention to the presence of an underlying disease process that’s going on. FinCEN stepping up to tackle unregistered digital currency exchanges offering USD trades (even if they are outside of the U.S.) would be a practical demonstration of a willingness to act. That alone would send a message about the willingness to look at how the USD is managed (or, rather, not managed) in the global financial system.

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