US regulator: Bitcoin exchanges must comply with money-laundering laws

Bitcoin miners must also register if they trade in their earnings for dollars.

Timothy B. Lee – Mar 19, 2013 3:54 PM | 147

The federal agency charged with enforcing the nation's laws against money laundering has issued new guidelines suggesting that several parties in the Bitcoin economy qualify as Money Services Businesses under US law. Money Services Businesses (MSBs) must register with the federal government, collect information about their customers, and take steps to combat money laundering by their customers.

The new guidelines do not mention Bitcoin by name, but there's little doubt which "de-centralized virtual currency" the Financial Crimes Enforcement Network (FinCEN) had in mind when it drafted the new guidelines. A FinCEN spokesman told Bank Technology News last year that "we are aware of Bitcoin and other similar operations, and we are studying the mechanism behind Bitcoin."

America's anti-money-laundering laws require financial institutions to collect information on potentially suspicious transactions by their customers and report these to the federal government. Among the institutions subject to these regulatory requirements are "money services businesses," including "money transmitters." Until now, it wasn't clear who in the Bitcoin network qualified as a money transmitter under the law.

For a centralized virtual currency like Facebook credits, the issuer of the currency (in this case, Facebook) must register as an MSB, because the act of buying the virtual currency transfers value from one location (the user's conventional bank account) to another (the user's virtual currency account). The same logic would apply to Bitcoin exchanges such as Mt. Gox. Allowing people to buy and sell bitcoins for dollars constitutes money transmission and therefore makes these businesses subject to federal regulation.

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Of course, the Bitcoin network is fully decentralized. No single party has the power to issue new bitcoins or approve Bitcoin transactions. Rather, the nodes in the Bitcoin network maintain a shared transaction register called the blockchain. Nodes called "miners" race to solve a cryptographic puzzle; the winner of each race is allowed to create the next entry in the blockchain. As a reward for its effort, the winning miner gets to credit itself a standard amount, currently 25 bitcoins. Given that bitcoins are now worth more than $50 and a new block is created every 10 minutes, Bitcoin mining has emerged as a significant business.

So are Bitcoin miners subject to the regulations? "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," FinCEN writes. That means that if you're a lone Bitcoin miner who uses all of your proceeds to buy drugs on the Silk Road, FinCEN will not expect you to register as an MSB.

On the other hand, "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," and is therefore subject to federal regulations.

However, this may only apply to those who perform money transmitting services "as a business." FinCEN says that "a user of virtual currency is not an MSB under FinCEN's regulations and therefore is not subject to MSB registration, reporting, and record keeping regulations." But with a peer-to-peer currency, the line between a "user" and an "administrator or exchanger" is not at all clear. The regulations define an exchanger as someone who "engaged as a business in the exchange of virtual currency for real currency."

Many participants in the Bitcoin economy provide exchange-like services but do not do so "as a business." For example, I obtained my first bitcoins in August 2011 by giving a friend $20 in cash and getting 1.5 bitcoins (the equivalent value at the time) in exchange. My friend likely did not regard this as a business transaction, but rather as a favor to a friend. The guidelines are silent on whether someone who performs the functions of a Bitcoin exchange as a hobby or as a personal favor is required to register as a Money Services Business.

Disclosure: I own some bitcoins.