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?