What Do I Need To Know About Cryptocurrency Compliance Before Entering the Game

May 14, 2018
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At BitAML, we talk with tons of entrepreneurs thinking about or even taking the first steps to start a new venture in cryptocurrency.

Most are just like you. They are not sure what the risks and regulations are of cryptocurrency compliance and want to avoid fatal mistakes early on in their venture.

There’s a lot to understand if you’re just getting started – and much of it can feel a bit overwhelming. As financial regulators continue to look at the cryptocurrency industry with a skeptical eye, things are changing slowly and for the better.

One of those positive changes is many cryptocurrency Money Service Businesses (MSBs) are accelerating their conformity with traditional compliance requirements, and in many instances striving to exceed regulatory expectations. This helps legitimize the industry in the eyes of financial regulators the world over.

Let’s dive into answer your question: “What do I need to know about cryptocurrency compliance before entering the game?”

Federal Requirements

At the federal level, the Internal Revenue Service (IRS) holds firm that all types of cryptocurrency coins are taxable. Federal regulators view Bitcoin, and all other cryptocurrencies for that matter, as property which is taxed as capital gains.

Even though courts have ruled Bitcoin can be used as a currency, the Security and Exchange Commission (SEC) has issued multiple investor alerts warning millions of Americans against fraudulent cryptocurrency investment schemes.

Because companies that develop Bitcoin and other cryptocurrency exchanges are considered MSBs, The U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a guidance regarding Persons Administering, Exchanging, or Using Virtual Currencies. Additionally, all MSBs are required to adhere to and follow Bank Secrecy Act laws.

No matter where you find yourself in the crypto-world, it is smart to keep up on the latest news and developments from federal regulators regarding cryptocurrency, ICOs, and changing rules and regulations that are placed on cryptocurrencies.

State License Requirements

Beginners can easily research the State-by-State regulations governing cryptocurrency. The clear majority of States in the US have no opinion or ruling on cryptocurrencies, but it’s important to get the most important updated information as these could change at any time.

You can find a 2017 list here.

States labeled as “hostile” to crypto-investors include Connecticut, Georgia, Hawaii, New Mexico, New York, North Carolina, Pennsylvania, and Washington State. (One’s definition of what constitutes hostility is open to interpretation, however.) In these states, at a minimum, a money transmitter license is likely required. Again, it’s always best to check with the state before entering the market, as changes can and do happen anytime.

Other states have murky laws that are not clearly defined. According to Bitcoin Market Journal, California is one of those, and “is seeking to impose a Bitcoin-focused business license that would require any business seeking to sell or transmit fiat currency by Bitcoin to apply for a license and pay a licensure fee.” The rule has yet to be enacted, however, as legislation remains stalled (for a third year in a row).

Other states like Florida are in the process of drafting new legislation and rules around cryptocurrencies. Wisconsin reportedly mandates any company dealing with cryptocurrencies to sign an agreement promising not to use virtual currencies to transmit traditional fiat currency. Companies that do not sign the agreement cannot obtain a money transmission license.

Other states are friendlier to those in the cryptocurrency space. Subject to certain criteria, Texas and Tennessee have already mandated that no money transmission license is needed to sell coins in the state, nor does it require Texas-based Bitcoin companies to obtain a license to set up an exchange.

Cryptocurrency companies are also protected from regulation in Kansas, Montana, and New Hampshire after recent regulation exempts were issued via regulatory guidance in those states. Most states are still in the process of forming rules around trading or establishing exchanges – the clear majority have still not even considered the issue. This is likely to change within the next decade; probably sooner.

Anti-Money Laundering & Knowing Your Customer

Know Your Customer is simply the process of identifying and verifying the identity of cryptocurrency customers, and understanding his/her/their financial dealings. Anti-Money Laundering (AML) compliance is simply all the rules and practices to prevent money laundering toward the government’s effort to stop theft, fraud, corruption, and the funding of terrorism.

The U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) has recently issued compliance guidelines for money transmitters to develop and enforce Anti-Money Laundering (AML) and Know Your Customer (KYC) measures.

The agency released the documentation to provide clarity and regulatory certainty for businesses and individuals engaged in an expanding field of financial activity. The compliance guidance is called the ‘Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies’ (PDF).

The Security Situation

What I need to know - BitAML BlogIt’s important to remember that once a transaction in the cryptocurrency space becomes finalized, it cannot be reversed. For this simple reason, security is of extreme importance to everyone involved – from exchange operators wanting to keep their customers happy, to customers who and making transactions, and to consumer financial protection agencies that, for this very reason, remains rather skeptical of the blockchain in general.

Risk Management company, RSM, notes: “Security in this space is extremely important. Therefore, you must balance the currencies you keep on an exchange, on your local computers, and in cold storage. There are good security options available on the exchanges, but it’s incumbent on the participant to utilize them. They are not required or automatically available.”

This is also true if you keep coins on a computer – they are simply vulnerable to hacking if the precautions are not taken. Risk management companies have advised many in the cryptocurrency space to keep their coins offline or in “cold storage”. Of course, your specific security strategy will depend on how you participate in the crypto-space to begin with.

Customer complaints about theft, hacking issues, and other loss of their coins shed a negative light on the industry when there is very little exchanges or companies can do. This is particularly true for regulators that sometimes receive consumer complaints about specific transactions made with cryptocurrency companies.

What’s the bottom line?

As Bitcoin and other cryptocurrencies become more accepted, regulations will become clearer and much more defined. But the cryptocurrency industry didn’t get to where it is today by accident. Developing and enforcing compliance should be the next big thing for those looking to get started in the industry, and the more this occurs the more likely the industry will be seen as a legitimate one in the eyes of regulators.

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