FinCEN regulations on Crypto Wallets and Transactions : Paranoia or Euphoria ?
Find Out If This Is the Make or Break Moment for Crypto.
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The U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) has proposed a new anti-money laundering (AML) rule aimed at peeling back the anonymity allowed by certain types of cryptocurrency transactions.
This rule, if enforced shall require financial institutions like banks and credit unions, as well as "Money Service Businesses" like FinTechs, Exchanges, Crypto Products & Service offerings “to submit reports, keep records, and verify the identity of customers in relation to transactions” related to virtual currency or digital assets held in digital wallets not hosted by a financial institution, known as ‘unhosted’ or 'self-custody' wallets.
The rule would require them to report certain types of customer information to FinCEN on any transaction of cryptocurrency worth over $10,000 involving an unhosted wallet made on their platforms within 15 days of the transaction.
In addition, the policies as outlined in Financial Action Task Force (FATF)'s "Travel Rule" Recommendations, Virtual Asset Service Providers (VASPs) are required to share the identities of users involved with any virtual asset transfers valuing $1000 USD or more. VASPs will now need to obtain and verify customer identification with one another, which means they should screen customer wallets and potentially share any blacklists with other VASPs and relevant parties. Additionally, VASPs should be licensed and/or registered in their jurisdiction.
Although in theory it seems simple enough, in practical terms this is a very tedious and a mammoth effort consuming task as a user can use multiple addresses, different wallets based on the coins they use/purchase and reporting it all within the stipulated 15 days would require fresh infrastructure and lot of hands on deck to implement.
Also it raises another confusion regarding ‘smart contracts’, as people convert one digital asset to other and use it for example, to generate yield (like BTC used as a pegged/wrapped Ethereum token WBTC). In this case, the recipient addresses doesn't belong to a person and is managed programmatically in a decentralized system, hence creates several possible bottlenecks in reporting and compliance.
Lastly, in case of unfortunate events where users funds are hacked or stolen, it is going to be real hard to report who received the funds as the address of the recipient (attacker) would be unknown to the original user who has now become the sender.
The broader goal of regulators seems to be creating a mega-centralized database of all possible crypto addresses claimed by American citizens mapped & labelled to their identity i.e. Social Security, Passport etc.
Anytime when the regulators find some unreported transactions are present in the said wallets, the holder is held responsible and could be added to 'No-Fly' list so that they would not leave the jurisdiction until they comply to the regulator's whims.
Not only this would eventually lead to the complete suppression of rights & freedom of citizens (More Orwellian than China !!), governments could later come up with different levels of customized taxation on this and further burden users most of who are trying to transfer funds to their relatives abroad, or to get some yield on their investments in a near zero interest rate world we live in.
What’s even worse is that unfortunately any centralized system is vulnerable to hacks and exploits (which is why cryptos are decentralized, duh !) and regulators do not seem to understand and they are back onto going back to do the things they are comfortable with.
Beginning in March, several Federal agencies including the treasury were targeted by a hacker group allegedly from Russia which further proves this point.
A popular crypto exchange Kraken has said that these new regulations are 'about to Wall Off the Poor from Our Financial System Forever' . The reason being these rules now inhibit several charities and people who were so far helping out the underbanked Poor people in the US without using banks & intermediaries (i.e. via direct transfer) are now forced to stop. Kraken, which has received a Bank charter in 2020 for digital assets would be taking this matter to the courts.
In an interview to Real Vision CEO Raoul Pal, one of the big crypto VC investor and former hedge fund manager Mike Novogratz said "The regulators worry that from self custody wallets, anybody could send money to people like Kim Jong-Un".
While this could be true, its hard to ignore the fact that money launderers have often been helped by US banks and in September 2020, a leaked report identified the involvement of multiple major US banks helping to launder billions of USD including sanctioned jurisdictions by bending the rules. Banks have even paid hundreds of millions in fines for these actions, however this is chump change compared to what they might earn in commissions to encourage this and as long as they are incentivised to break the rules and pay a measly fine, we can assume they will continue to do so.
Surprisingly none of the decisions to enforce such regulations on cryptocurrencies were discussed or hinted prior to 2020 US elections held in November, this has led the public to speculate had the Republicans won the election, there could have been much stricter rules given that both Steve Mnuchin and President Donald Trump have been vocally critical on Bitcoin and cryptocurrencies in the past.
Several crypto advocates like Coincenter have alleged 'Midnight Rulemaking' by the Trump administration, as it is currently doing the transition before the new government takes office in Jan 2021. It has reached out for public support to fight against the proposed measures. Basically this term refers to using the Christmas holiday period to suddenly come out with a all new proposal, bill to be enacted as law even at a time when not enough people are available to study the proposal and provide adequate comments and critique.
A perfect example for this was the passing of the 'Federal Reserve Act' by the Woodrow Wilson administration, back in 1913. No explanation is needed about the FED and what it does in 2020 !
Kristin Smith, Exec Director of Blockchain Association in an interview to Laura Shin (of Unchained podcast) which also included Circle (company that issues USDC stable coin) CEO Jeremy Allaire, they claimed that Treasury Secretary Steve Mnuchin had personal motives to come with the said FinCEN proposals, given that he has a Keynesian view of monetary economics and that money could be only created and controlled by the govt, hence decentralized alternatives like Bitcoin and Crypto do not fit his frame of the world view.
It is worth noting that a recently proposed bill called The STABLE Act by Senator Rashida Tlaib, assisted by Professor Rohan Grey would force all stablecoin issuers (Like Tether, Paxos, Circle etc.) to have bank licenses, whereas several other entities issue Dollar pegged stablecoins algorithmically using over-collaterized digital asset loans via smart contracts with no middlemen involved. Some examples include DAI by MakerDAO, USDX by Kava Labs and VAI by Venus Protocol. How this bill impacts them is yet to be seen. The crypto industry has criticized this bill as it curtails new innovation in the DeFi space.
So what are the alternatives & implications if the new regulations are enforced as Law?
Coin swapping service without KYC Norms
While most crypto users trade on a KYC compliant crypto exchange, there are several swapping services where users can simply send and receive one crypto for another without requiring an account/KYC. Though not fully anonymous, they are relatively less burdensome to use and support a variety of coins which may not be available on a single exchange.
Examples include Changenow, Changehero and Swapzone among others.
Increased preference to using Decentralized exchanges (DEX's) & accelerated innovation towards cross-chain DEX
Currently most activity in DEX's (like Uniswap, Bancor network etc.) is focused on trading Ethereum based (ERC-20) tokens however when Cross-chain DEX's become a reality via efforts by interoperable chains like Cosmos & Polkadot, that’s when people are likely to witness further regulatory crackdown.
Mass Flip Over to using Privacy Coins (Anonymity Enhancing Cryptocurrencies)
Privacy coins are cryptos that have in-built features that encrypt information of senders, recipients and transaction amounts. Though they have some auditability features, they have faced ire from many regulators all over the world. The new rules could trigger a shift in user preference to use something like Monero (XMR) as reporting to one regulator is better than letting their funds be visible for the whole world in open view. While several firms are working to enhance AML compliant regulatory frameworks for these coins across geographies to make them more acceptable. This way users could still report their activity and remain compliant while not have prying eyes all the time on their funds, a feature not currently provided by majority of the popular cryptos in the market.
Its no surprise that Monero daily on-chain transactions count has reached an all time high in recent months.
Atomic Swaps
An atomic swap is a smart contract technology that enables the exchange of one cryptocurrency for another without using centralized intermediaries like exchanges. Think of it like a escrow based swap. By taking some necessary precautions, users can remain fully anonymous while making crypto transactions. One example of this is atomic swaps between Bitcoin and a mimblewimble based privacy coin BEAM, which also supports Litecoin and several other pairs in their desktop Wallet, read more here.
Atomic Swaps between Bitcoin & Monero is in progress and likely to be completed in 2021.
Innovator Exodus
Another possibility is that some of the industry players (companies/projects) from the crypto space could move out of US into other nation states with friendlier regulatory policies, yet the probability of this remains low at this point.
Conclusion:
The newly proposed FinCEN rules, despite the regulators intentions to prevent funding to illicit activities is certainly going to create a lot of annoying burdensome extra chores to a LOT of crypto enthusiasts and investors who use it for legitimate purposes.
The cryptocurrency markets overall have not reacted negatively to this yet, however I do see it as a positive sign as the regulators are NOT considering a blanket ban on bitcoin and other digital currencies which seemed to be the narrative several years ago. Now that these are initial set of regulations to begin with, many are hopeful of further negotiations down the road and its quite possible that the Biden administration, set to take office next month might come up with a new set of rules which could have a better foresight into the innovative spirits and the rapid evolution happening in the space.
So in the meantime, Stay Safe, HODL Safe, and think about the impact on your financial privacy in the near future.
Here's wishing you all a Merry Christmas and enjoy the holidays !
You can find us on Twitter : @clarity_focus
Dear reader, I am a huge fan of a secure, fast, practical, scarce and privacy preserving decentralized digital currency called Monero (ticker XMR).
Unlike most coins which are fully transparent, you can store and spend Monero safely on-chain, knowing that no one else can see your balances or track your activity, or create more supply than what is predictably programmed. It is well established with a large number of users, open source code while the network is up & running since 2014. It has no founder, leader or a CEO. Monero has the third most active number of developers working on the protocol among ALL cryptos while dev effort for each new feature is fully crowdfunded by the community.
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Disclaimer: The information in the article is for educational purposes only. None of this content must be considered financial advice, instead as personal opinions of the author.
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Sources & References:
FinCEN proposes BSA reporting rules for cryptocurrency transactions
New KYC & Reporting Rules for Crypto Wallets
Cyber attack on US federal agencies by alleged Russian group
Kraken on the Walling Off the poor from the financial system
Leaked Report on money laundering by Banks
Coincenter on Midnight Rulemaking & Seeks public support to fight back
Unchained Podcast - Why Is the Proposed FinCEN Rule for Unhosted Wallets Being Pushed So Quickly?
Enabling AML Compliant Regulation of Privacy-Enhancing Cryptocurrencies