OPINION: Regulatory Considerations as Cryptocurrencies Enter the Mainstream

Blockchain, FinTech, Innovation, Interviews, Investing, Opinion, Regulation | July 21, 2017 By:

Annette Ebright, Sarah Hutchins and Brian Cromwell are partners on Parker Poe Adams & Bernstein LLP’s FinTech team that provide regulatory compliance, litigation and enforcement as well as data security/privacy issues on behalf of their clients.

They each have significant experience representing corporations and individuals in federal and state criminal and regulatory investigations in a broad array of industries with a particular focus in the financial services sector industry. Each partner brings many years of their experience to help clients in the FinTech segment: Ebright prepares compliance plans for corporations in a variety of regulatory areas; Hutchins practices and speaks on data privacy and general litigation matters; Cromwell is a former North Carolina state and Federal prosecutor who litigated computer-related matters and investigations. For more, visit www.parkerpoe.com.

A faceless currency involved in dealing illegal drugs, selling stolen identity data, offshore gambling, human trafficking, material support to terrorist activity – even before Ross Ulbricht’s 2015 conviction for brokering more than $1 billion in illegal transactions through an online darknet market called Silk Road, the anonymity of using cryptocurrencies has long been the alleged allure for users of the “Dark Web.” Detractors, such as Michael Lewis, author of The Big Short, Moneyball and Liar’s Poker, note the lack of regulation, calling bitcoin “at its heart . . . a libertarian enterprise – anti-government, anti-central authority; for money to really work it needs a central authority behind it.”   In 2015, Washington Post columnist Matt O’Brien called bitcoin a millennial “Ponzi scheme.”

But, like mocha chai lattes, gangsta rap, craft beers and sleeve tattoos, cryptocurrencies are moving from being on the societal fringes to part of the mainstream. Hundreds of vendors accept bitcoin, including Overstock.com, Subway, Microsoft, Reddit, OkCupid, the United States Libertarian Party, CheapAir, Expedia, Wikipedia, certain vendors on Etsy.com, WordPress Whole Foods, Bloomberg.com, MLS soccer’s San Jose Earthquakes, Dish Network, Intuit and MovieTickets.com, just to name a few. Many users are embracing the technology – the number of bitcoin holders reached more than 10 million by the end of 2016.


Arguably, most of cryptocurrency’s blockchain technology appeal is threefold: a degree of anonymity, its decentralized control, and its freedom from governmental regulation. These factors allow users to avoid taxation and bank-driven transaction fees. Blockchain transactions are also irreversible and thus immune to a bank’s frequently exercised right to claw back funds even in the face of parties who both agree to a transaction. Further, while all government-backed currency loses a little value to inflation every year, because there are a finite number of bitcoins, this currency should continue to gain value over time. Thus cryptocurrencies are analogous to digital gold: finite and mined but free of geographical boundaries. Their value is completely driven by their users, with no control by political or regulatory entities. Cryptocurrency’s form also holds inherent benefits: It is easily transferable and does not weigh anything.

The popularity of digital currencies is impossible to ignore, and regulators are catching on. The United States Department of Justice has proclaimed that cryptocurrency is a legitimate financial instrument. In a June 2015 speech, then-Assistant Attorney General Leslie Caldwell said: “The department is aware of the many legitimate actual and potential uses of virtual currency. It has the potential to promote a more efficient online marketplace. It also potentially can lower costs for brick-and-mortar businesses by removing the need to pay credit card-related costs. And in theory, it can help speed and reduce the cost of cross-border transactions.”

But “catching on” is not the same thing as regulatory acceptance. In March 10, 2017, the United States Securities and Exchange Commission (“SEC”) disapproved of a rules change that would have paved the way for a bitcoin ETF – the Winklevoss Bitcoin Trust. Specifically, the SEC noted that such an exchange must have surveillance-sharing agreements with significant markets for trading the underlying commodity or derivatives on that commodity. Further, and more importantly, those markets must be regulated. However, on April 24, 2017, the SEC agreed to reconsider the petition for review, with the public comment period closing on May 15, 2017.


From a law enforcement standpoint, the “anonymity” of blockchain technology noted above is a bit of a misnomer.  Cryptocurrency is not invisible – just the opposite – blockchain technology creates a public ledger of every single blockchain currency transaction.  While the government does not have insight into who is using the currency or what they are buying, once they uncover the criminal activity, blockchain can provide a permanent and indisputable record of all cryptocurrency movements for regulators.

Those regulators are making it clear that their rules apply. In 2013, the United States Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) said that cryptocurrency transmitters or exchangers are not exempt from FinCEN’s rules. According to FinCEN, virtual currency exchangers and administrators are money service businesses (“MSBs”) and must register as such with FinCEN. Virtual currency exchangers must also comply with record keeping, reporting and transaction monitoring rules under FinCEN regulations. All MSBs, including cryptocurrency transmitters or exchangers, are required to develop and implement an anti-money laundering compliance program. This includes following the Know Your Customer (KYC) and Customer Identification Procedures (CIP) that banks must follow. As a result, the anonymity of cryptocurrency transactions will be significantly curtailed, at least for those subject to the laws of the United States. Money transmitters must also register at the state level, with each state having its own money transmitter license and application requirements, as well as other requirements that include those relating to bonding, background checks, proof of holding, and regular reports and audits.

FinCEN and other regulators have not hesitated to bring enforcement actions against cryptocurrency transmitters that have not complied with FinCEN’s requirements. Ripple Labs, at the time the second-largest cryptocurrency exchange by market capitalization, was fined $700,000 in 2016 for willfully violating the Bank Secrecy Act by acting as a money services business and selling its virtual currency without registering with FinCEN. Ripple Labs also failed to implement and maintain an adequate anti-money laundering program. Individuals who have conducted cryptocurrency exchanges have been prosecuted criminally for operating an illegal money transmitting business.  Recently, Jason R. Klein was charged with making five unlicensed money exchange transactions ranging from $1,000 to $15,000, including charging a 10 percent fee for the transfers after he posted advertisements on the internet to exchange bitcoin for cash. He plead guilty to one count of conducting an unlicensed and unregistered money transmitting business and faces up to five years in prison plus fines when he is sentenced later in 2017.

Furthermore, the IRS has taken steps to erode anonymity and ensure cryptocurrency investors pay their share of taxes on short-term capital gains realized from buying and selling cryptocurrency. In November of 2016, the IRS sought information from digital wallet company Coinbase for all United States customers who transferred bitcoin from 2013 to 2015 in order to obtain access to otherwise anonymous trades completed by U.S. investors in bitcoin.  After intervention from anonymous users and Congress, the IRS recently scaled back its investigation to cover only those that engaged in transactions of $20,000 or more in one year.


Alternative, digital currencies are here to stay as a mainstream store of value. The cryptocurrency marketplace has shown itself resilient in the face of legal challenges thus far. For example, while many predicted the end of cryptocurrencies following the high-profile conviction of Ulbricht and his Silk Road website, the opposite has occurred with the cryptocurrency market continuing to grow. This growth has been roller-coaster volatile, with bitcoin’s value soaring or plummeting by roughly 30 percent in a period as small as a few days.

While bitcoins value in dollars dropped as low as $1,500 in May 2017, some investors believe that bitcoin could trade as high as $4,000 in the next year and a half. It is worth noting that it is currently up 250 percent in the last year alone. Though it does not seem that regulation will sharply curve cryptocurrency growth, limitations on certain blockchain design may impact bitcoin’s transactional popularity, as the increasingly complicated mathematical algorithms slow the ability to process transactions. Seth Wilfong, a partner with Atlas Principals, a Charlotte-based hedge fund specializing in disruptive technologies, believes that the blockchain technology has the potential to become a new and decentralized protocol (think web 2.0) that could materially change the landscape of multiple industries.

Aiding growth regardless of regulatory involvement is today’s financial consumer’s demand. As the population becomes more technologically savvy, accepting of virtual currencies and P2P transactions, currencies of choice will hold more digital traits such as expedience and ease of use and transfer. The appeal of these currencies will be measured against the degree to which regulations erode these traits. As regulations increase, expect the most accepted currencies to begin to mirror the traits of government-backed currencies. Regulations should help to stabilize the mercurial growth patterns and protect against some of the inherent risks of cryptocurrencies, including the vulnerabilities that exist due its unique, digital form. Though regulation may chill the red-hot growth, don’t expect a deep freeze on cryptocurrencies anytime soon.