Dapps and DEXs in FinCEN crosshairs

Following the recent arrest of Eric Powers, a peer-to-peer bitcoin trader, on charges of violating the Bank Secrecy Act, US anti-money laundering agency FinCEN has released new guidance to help individuals and companies using cryptocurrency determine if they are acting as a money transmitter.

While the document doesn’t establish new regulatory expectations or requirements, it does clarify how existing rules and regulations apply to users of cryptocurrency.

The guidance covers several common crypto business models, including peer-to-peer traders, Dapps, DEXs, and certain types of wallets. Depending on the use case, all have the potential to act as money transmitters, and therefore have specific obligations under the Bank Secrecy Act (BSA).

The arrest of Eric Powers is only the third enforcement action by FinCEN involving cryptocurrency since it first issued guidance in 2013. The FinCEN view is that virtual currencies are subject to the same AML requirements as fiat currency.

O’Melveny fintech lawyer Laurel Loomis Rimon points out that the recent FinCEN action highlights the potential risk of criminal or civil enforcement action to any person, regardless of business form or size, who engages in virtual currency exchange or other money transmitting activities without the proper registration, licensing, or AML program.

What makes a money transmitter?

To determine who should be classified as a money transmitter, FinCEN uses the classification of Money Services Business (MSB) — a legal term used by financial regulators to describe businesses that transmit or convert money.

Anyone providing transmission or conversion services to American citizens for profit needs to register as an MSB, says crypto commentator Katherine Wu, who used her legal expertise to annotate the guidance on Twitter saying “If you make any money for exchanging crypto or buying crypto for someone else, you need to register as an MSB, even if it’s all done via messaging apps.”

This guidance applies to both individuals and businesses, regardless of their status:

“Whether a person qualifies as an MSB subject to BSA regulation depends on the person’s activities and not its formal business status. Thus, whether a person is an MSB will not depend on whether the person: (a) is a natural person or legal entity; (b) is licensed as a business by any state; (c) has employees or other natural persons acting as agents; (d) operates at a brick-and-mortar branch, or through mechanical or software agents or agencies; or (e) is a for-profit or nonprofit service.”

But there are a few exceptions — banks are not obligated to register, and neither are entities regulated or examined by the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), or a foreign financial agency.

This creates what Wu calls a “pick and choose your regulator” situation, and one that might change the perspective of those who had hoped to avoid SEC enforcement by claiming their cryptocurrency is not a security:

“Reading the new FinCEN guidance. Mark this prediction in your calendars: The same investors and crypto lawyers who desperately wanted utility tokens to never be securities are going to be begging for them to be securities so that they can avoid being money,” tweeted Gabriel Shapiro, Blockchain Attorney at DLx Law.

Dapps, wallets, and DEXs

Whether or not a Dapp qualifies as a money transmitter depends on whether or not it transmits value: “when Dapps perform money transmission, the definition of money transmitter will apply to the Dapp, the owners/operators of the Dapp, or both.”

This is good news for blockchain developers, as while the operator of the Dapp might need to register as a money transmitter, the developers themselves do not — unless they are using the Dapp for this purpose:

“The developer of a Dapp is not a money transmitter for the mere act of creating the application, even if the purpose of the Dapp is to issue a Convertible Virtual Currency (CVC) or otherwise facilitate financial activities denominated in CVC. However, if the developer of the Dapp uses or deploys it to engage in money transmission, then the developer will qualify as a money transmitter under the BSA.”

The status of cryptocurrency wallets depends on how they handle custody. Hosted wallets, where users surrender private keys to a third-party exchange to safeguard their coins, may be considered money transmitters. But unhosted wallets, where private keys are retained by the owner, are not considered subject to money transmitter regulation.

Multisig wallets may also be considered MSBs depending on if they are hosted or unhosted, and the same custodial classification is applied to DEXs. Those that simply match buyers and sellers without holding cryptocurrency would not be classified as an MSB, but those that take crypto into custody would.

Other categories of crypto businesses — including bitcoin ATMs, tumbling services, and P2P traders operating over platforms like LocalBitcoins — are defined more conclusively as money transmitters, and invited to register with FinCEN by filling out Form 107, or contacting FinCEN’s Resource Center.