Eu Crypto Currency Regulation: Creating a Haven for Businesses or for Criminals?

• Jurisdiction: European Union,United States,Federal
• Citation: Vol. 48 No. 3
• Publication year: 2020

EU Crypto Currency Regulation: Creating a Haven for Businesses or for Criminals?

Blake Hamil^*

Table of Contents

I. Introduction................................................................................834

II. Background.................................................................................834

A. What Is a Virtual Currency?.............................................834
B. Blockchain Explained........................................................835
C. Virtual Currency Business Entities...................................836
D. Initial Coin Offerings........................................................836
E. The U.S.'s Stance on Virtual Currency.............................837
F. The EU's Current Stance on Virtual Currency.................839
G. Money Laundering Defined...............................................840

III. Analysis........................................................................................840

A. General Risk Factors of Virtual Currency........................840
B. Illegal Trafficking..............................................................841
C. Hacking and Theft.............................................................841
D. Fraud.................................................................................842
E. Money Laundering ............................................................ 843
F. Criminal Financing ........................................................... 844

IV. How the U.S.'s Regulatory Approach Better Mitigates Virtual Currency Risks Compared to the EU Approach .... 845

V. Conclusion...................................................................................848

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I. Introduction

Crypto currencies, also known as virtual currencies, are revolutionary financial instruments that harness advanced and complicated technology to provide consumers and investors with an alternative value transfer system to fiat currencies. These virtual currencies have the power to significantly alter how the world pays for commodities and services, as well as how it invests in businesses. However, with this great power also comes increased risk, especially as it comes to the use of crypto currencies in money laundering schemes and criminal financing.¹ Across the globe, virtual currencies are used to fund criminal operations.² These risks have led countries like the United States to take a firmer stance on the regulation of virtual currencies, and it is because of these risks that the European Union needs to rethink its recent Anti-Money Laundering Directive.

This Note will discuss how the EU's current legal framework regulates virtual currencies. The discussion will focus on the EU's omission to regulate virtual currency administrators in contrast to the United States' treatment of virtual currency administrators under FinCEN and the Bank Secrecy Act. The discussion will begin with an overview of the background of virtual currencies and give an explanation of important terms and mechanisms within virtual currency use. Then, this Note will provide an overview of the United States' and the EU's current regulatory environment. Finally, this Note will analyze the risks inherent in the EU's current regulation and explain how revising its regulations will help mitigate these risks.

II. Background

A. What Is a Virtual Currency?

The first virtual currency ever created was Bitcoin.³ Satoshi Nakamoto is credited with Bitcoin's creation; however, Nakamoto's identity is unknown, and he has since disappeared from the public eye.⁴ Nakamoto defined Bitcoin as a "decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen."⁵ Simply put, virtual currencies like

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Bitcoin are "limited entries in a database no one can change without fulfilling specific conditions."⁶ To simplify even further, virtual currency can be described as "cash for the Internet."⁷ This raises the question of what exactly differentiates virtual currency from your typical fiat currency. Fiat currency is "legal tender [that] is backed by a central government," and can "take the form of physical dollars, or it can be represented electronically."⁸ Virtual currency, on the other hand, is not generally considered legal tender and is not "backed by a central government or bank."⁹ Outside of these differences, however, fiat currency and virtual currency are not all that different. Both are mediums of exchange, both can be used to purchase goods and services or traded on exchange, and both are governed by economic factors like supply, demand, and scarcity.¹⁰

B. Blockchain Explained

The decentralized nature of virtual currency is what really makes it unique when compared to fiat currency.¹¹ This raises the question of how virtual currencies can be maintained without some sort of central middleman. The answer is virtual currency's utilization of "blockchain" technology.¹² Blockchain is essentially a public ledger that tracks every transaction in a virtual currency.¹³ In the context of Bitcoin, blockchain is described as a "public ledger" containing "every transaction ever processed."¹⁴ This ledger allows Bitcoin to maintain what the creators of Bitcoin call a decentralized platform to validate transactions.¹⁵ Bitcoin utilizes what the company terms "miners" to validate transactions in lieu of a third party intermediary.¹⁶ These miners are actually other Bitcoin users who have special software which allows their computers to validate these transactions, and in exchange, miners are

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compensated with Bitcoin.¹⁷ The validation process consists of miners ensuring that the users on each side of a transaction have the amount of Bitcoin they are transferring.¹⁸

C. Virtual Currency Business Entities

Today, there are thousands of virtual currencies, with Bitcoin commanding the largest market capitalization of all.¹⁹ The proliferation of virtual currencies has led to the development of many businesses that deal with virtual currencies as a part of, or as their entire, business.²⁰

There are several important entities that face potential regulation under anti-money laundering regulations. The first type of entity is the virtual currency "wallet." These wallets are a digital means to "store, send, and receive" virtual currencies.²¹ Next are virtual currency exchanges, which exchange virtual currency for real currency, other funds, or other virtual currency.²² Finally, we have virtual currency administrators, which are engaged in the business of "issuing . . . a virtual currency," and they have the "authority to redeem (to withdraw from circulation) the virtual currency."²³ Administrators will be important in the coming analysis of the EU's virtual currency regulation because entities involved in "initial coin offerings" (ICOs) qualify as administrators.²⁴

D. Initial Coin Offerings

Briefly, an initial coin offering is a "fundraising mechanism in which new projects sell their underlying crypto tokens in exchange for Bitcoin . . . ."²⁵ This process is similar to initial public offerings in which companies sell shares of stock to investors, except for the fact that ICOs do not utilize an

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underwriter to price the offering or locate buyers.²⁶ Most ICOs involve transactions in which investors send virtual currency to the fundraising entity's smart contract, and the smart contract then stores the investors' funds and distributes an equivalent value of the new token later.²⁷ Although this technology is relatively new, it has already been used to raise staggering amounts of money.²⁸ For example, the blockchain startup Block.one recently raised over $4 billion in an ICO that concluded in June 20 1 8.²⁹ ICOs are also becoming increasingly popular, as the number of firms that completed ICOs jumped from forty-six in 2016 to 228 in 2017.³⁰ While there is much excitement surrounding this cutting-edge innovation in fundraising, ICOs are highly risky due to the infancy of most ICO entities and the unregulated nature of ICOs in most jurisdictions.³¹ The proliferation of ICOs, the opportunity to raise such vast amounts of money, and the highly risky nature of these transactions amplifies the risks created by the complicated web of virtual currency administrators, exchangers, and wallet providers that dominate the virtual currency universe.³² Countries across the globe have responded with a myriad of regulations varying in degrees of stringency.

E. The U.S.'s Stance on Virtual Currency

The United States has several regulatory bodies through which virtual currencies can be regulated. First, the Securities and Exchange Commission (SEC) has ruled that it can regulate virtual currencies and other similar tokens on the basis that they are considered securities.³³ Furthermore, the Commodity Futures and Trading Commission (CFTC) has defined virtual currencies as commodities and has determined it may regulate them as such.³⁴ Finally, the Financial Crimes Enforcement Network (FinCEN) has stated that it "regards

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developers as well as exchanges of [virtual currency] as 'money transmitters' for the purposes of the U.S. Bank Secrecy Act."³⁵ Because the European Union has adopted similar stances to the SEC and CFTC in regards to virtual currencies, the approach taken by the FinCEN will be the focus of this Note.

FinCEN's purpose is to "safeguard the financial system from illicit use, combat money laundering, and promote national security through the strategic use of financial authorities and the collection, analysis, and dissemination of financial intelligence."³⁶ It accomplishes this in two ways: (1) through counter-money laundering laws, such as the Bank Secrecy Act, that require reporting and recordkeeping by banks and other financial institutions, and (2) by providing intelligence and analytical support to law enforcement.³⁷ More specifically, FinCEN and the Bank Secrecy Act require money transmitters to do four things: (1) register with...