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ANALYSIS: New U.S. Illicit Finance Strategy Demands Crypto AML

Feb. 27, 2020, 11:45 AM

The Treasury Department has made a series of announcements in recent weeks establishing, beyond question, that anti-money laundering/combating the financing of terrorism (AML/CFT) compliance in the cryptocurrency sector will be a high priority going forward.

Treasury released the 2020 National Strategy for Combating Terrorist and Other Illicit Financing (2020 National Strategy), declaring “digital assets” to be one of the most significant illicit finance vulnerabilities. The Financial Crimes Enforcement Network (FinCEN) announced leadership, organization, and budgetary changes institutionalizing this national policy. These actions send the unequivocal message that U.S. efforts to address illicit finance problems created by the rise of cryptocurrencies have only begun.

The 2020 National Strategy

The 2020 National Strategy, announced on Feb. 6, is an interagency document declaring the whole of government approach at the federal level. It was prepared by the Department of the Treasury, in consultation with the departments of Justice, State, and Homeland Security; the Office of the Director of National Intelligence; the Office of Management and Budget; and the staffs of the federal financial regulators, including the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve System. Its conclusions should apply to all policy decisions on AML/CFT by any federal agency.

The 2020 National Strategy replaces the 2018 National Illicit Finance Strategy (2018 National Strategy), which had assessed “virtual currencies” to be an emerging illicit finance risk. The 2018 National Strategy, announced just over a year ago in December 2018, included an extensive review of virtual currencies that assessed them to be an emerging money laundering vehicle and not yet a significant terrorist financing risk. This treatment was a significant advance compared to that of the 2015 National Money Laundering Risk Assessment, which had briefly mentioned virtual currencies only as a subset of the issues relating to money transmitters, regulated as money services businesses (MSBs).

“Digital assets”—a broader category than virtual currencies, including digital assets that are securities, commodities, and derivatives—are addressed by the 2020 National Strategy. The 2020 National Strategy recognizes that much digital asset activity is considered “money transmission” subject to regulation by FinCEN, while other digital asset activity involves securities regulated by the SEC, commodities regulated by the CFTC, or other financial services falling under other authorities.

“The growing misuse of digital assets and failure of foreign jurisdictions to effectively supervise digital asset activity” are among the most significant U.S. illicit finance vulnerabilities, according to the 2020 National Strategy. It specifies certain uses of digital assets that create higher vulnerabilities, including:

—privacy coins designed to obscure or anonymize transactions;
—person-to-person transfers that increase disintermediation;
—direct marketing of digital securities to consumers, whose pose a higher risk of fraud;
—state-sponsored cyber groups targeting digital assets; and
—central bank digital currencies and other national digital currencies if they are developed without AML/CFT controls (the main example being the Venezuelan Petro, designed explicitly to evade U.S. sanctions).

Terrorist use of digital assets is a development that “U.S. authorities are closely monitoring,” according to the 2020 National Strategy. Most terrorist groups rely on the traditional financial system, but growing use of digital assets is making it likely that terrorist groups will use them as well, the report said.

Regulatory gaps—both domestic and foreign—complicate the task of addressing the illicit finance problems created by digital assets.

U.S. Regulatory Gaps. “The U.S. regulatory framework for money transmission activities (under which digital asset exchangers and administrators are regulated) does not cover the full range of digital asset activities that could be exploited for illicit purposes,” according to the 2020 National Strategy. As mentioned earlier, FinCEN’s regulation of money transmitters as MSBs does not cover digital assets that are securities or commodities subject to regulation by the SEC or the CFTC.

Foreign Regulatory Gaps. “U.S. authorities also cannot address global gaps in supervision,” The report said. It cited U.S. efforts to ensure that the Financial Action Task Force (FATF) adopted international AML/CFT standards for digital assets while the United States held the FATF presidency in 2018–19, and ongoing bilateral and multilateral efforts to ensure effective regulation and supervision of digital assets globally. However, the report said, U.S. authorities cannot be certain that all significant jurisdictions will follow the FATF standards.

FinCEN Implementation of the 2020 National Strategy

FinCEN, which has issued regulatory guidance on virtual currencies since 2013 and has conducted regulatory enforcement actions on virtual currency activities since 2015, rapidly followed Treasury’s Feb. 6 announcement of the 2020 National Strategy with actions addressing digital asset issues.

The FinCEN Fiscal Year 2021 Budget Request, submitted to Congress on Feb. 10 as part of the Treasury Department’s FY 2021 Congressional Justification of Appropriations, included a request for additional funding for FinCEN’s virtual currency and cyber threat mitigation program. An $819,000 appropriation would enable the hiring of three full-time employees to conduct analyses of virtual currency and cyber-enabled financial crimes, and support coordination with other jurisdictions on training and capacity building, analytical development, and information-sharing initiatives.

On Feb. 21, FinCEN announced a more fundamental change than an incrementally increased budget appropriation. FinCEN hired a new Deputy Director, who will also serve in the newly created position of Digital Innovation Officer. The Digital Innovation Officer will “advance FinCEN’s engagement with emerging technology and financial innovation,” in the words of FinCEN Director Kenneth Blanco, by helping FinCEN to “proactively engage with industry and government partners to confront emerging threats and to capitalize on diverse opportunities in the financial and national security spaces.”

Designating a Digital Innovation Officer who will simultaneously serve as Deputy Director sends a clear message that FinCEN regards digital assets to be a key development for it to address. The description of the role sends the further message that FinCEN is emphasizing engagement with private-sector companies and joint actions with government partners. FinCEN’s 2013–19 virtual currency regulatory actions, including its October 2019 Joint Statement on Activities Involving Digital Assets with the SEC and CFTC, already have sent these messages occasionally; the management shakeup institutionalizes them.

Filling the Deputy Director/Digital Innovation Officer role is Michael Mosier, who has an appropriate background for it. He served as FinCEN’s Chief of Strategic Advancement & Tactical Development in 2018–19 prior to joining the cryptocurrency analysis company Chainalysis as Chief Technical Counsel in June 2019. Prior to this period, he served as an Associate Director of the Office of Foreign Assets Control (OFAC) and Deputy Chief of DOJ’s Money Laundering and Asset Recovery Section, with a tour at the National Security Council as Director for Transnational Organized Crime.

These February actions by FinCEN and the wider Treasury Department have been in the making for months, and we should expect that many additional U.S. actions on AML/CFT for cryptocurrencies and other digital assets are in progress. Treasury Secretary Mnuchin’s statement to the Senate Finance Committee on Feb. 12 that FinCEN is preparing rules on transparency for cryptocurrencies indicates that a notice of proposed rulemaking is coming soon, possibly on customer due diligence for digital payment systems. We should be prepared for a busy 2020 in the field of cryptocurrency AML/CFT.

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