Virtual Currency and Electronic Money Movers: AML Red Flags John A. Beccia, Circle Internet Financial
Discussion Topics Background on Digital Currency and Emerging Payments Regulatory Update Assessing Risks and Red Flags Banking MSBs Digital Currency Compliance Programs
Payments Past, Present, Future Cash Money Order Check Credit and Debit Cards ACH Wire Prepaid cards Mobile payments P2P and B2B Bill Pay Digital wallets, PayPal, Apple Pay, etc. Open question: Where does digital currency fit in?
Rise of Mobile and Digital Age 90% of US households have 3 or more Internetconnected mobile devices In 2014, global smartphone subscriptions will reach 2.7 billion (up from 1.9 billion in 2013) By 2020, 90% of individuals over the age of six will have a mobile device Consumers will interact with their banks via Internetconnected mobile devices more than any other means
Millennials Changing the Landscape 2.5 billion Millennials worldwide (84 million in the US alone) $1.3 trillion annual purchasing power; 75% of global workforce 83% of Millennials have a smartphone and spend nearly 15 hours per week (two hours per day) using it 20% access the Internet exclusively on their smartphones 33% believe they won t need a bank in the future 70% believe payments will be totally different within next five years
Identity Theft Nearly 50% of American households were victims of credit card theft from data breaches in 2014 In the US, 11.5 million are victims of identity theft each year Financial losses from identity theft approaching $25 billion annually Consumers demanding payments platforms that are more resilient
Legacy Payments Credit Cards
Digital Currency Consumer Attitudes Source: TheStreet
Consumer Concerns Source: CSBS 2014
What is Bitcoin? Alternative payment system that allows consumers to transfer value Open source software Peer-to-peer financial transaction network and protocol Form of digital money that is held electronically (not legal tender, but similar attributes to currency) Movement of value from one user of the network to another via a chain of digitally signed transactions Independent of any central authority Transactions are recorded on a public ledger (block chain) and are anonymous
Blockchain Peer-to-peer transaction protocol; open source that anyone can use to send transactions to the network Public ledger viewable by anyone Public/private keys used to digitally sign transactions and identify users
Why is it Secure? Each Bitcoin address has a corresponding private key Bitcoin wallets protect and store the private key (and generate addresses) Only a person with a private key can send $ from the bitcoin address Source: preshing.com
Mining (Transaction Processors)
How to Get Bitcoin Mining Block reward is halved every 210,000 blocks or every four years Block reward started at 50 bitcoin in 2009 and is now 25 bitcoin in 2014 Use Bitcoin exchanges to exchange fiat currency (dollars, Euro, etc.) into bitcoin Purchased at the current exchange rate Subject to volatility Held in a digital wallet
Bitcoin Ecosystem Exchanges Merchant Services Payment Processors Wallet Services Miners Investment Vehicles ATMs
Digital Currency Key Metrics Bitcoin is primarily seen as a currency used for payments Only 21 million bitcoins will exist (but divisible into units) Currently 13 million bitcoin; market cap is around $3b Blockhain technology has unlimited potential $433m in venture capital invested to date ($335m in 2014)
Why Use Bitcoin? Method for payments (P2P, remittance, merchant transactions) Consumers Lower costs and fees Faster payments Improves privacy and security (no loss of PII) Merchants Avoid interchange No chargebacks (instant payments) Don t have to hold personal information
Digital Currency Merchant Transactions 90,000 merchants now accept Bitcoin Represents $85 billion in annual revenue Merchants include Dell, Expedia, Microsoft, Overstock In 2015, major digital payments providers Stripe, Square, PayPal and others launching commercial support for Bitcoin VC funded startups offering 0% fees, utility pricing, touchless POS integration and other innovations
Merchant Transactions
Consumer Adoption
Risks Recent regulatory guidance and reports from European Banking Authority, GAO, CFPB and state authorities address potential risks to users, market participants and financial system Risks include: o o o o o o Price volatility (no FDIC insurance) and lack of liquidity (exchange risk) Digital asset security (bitcoins can be lost or stolen) Transactions can t be canceled or reversed Lack of government control; regulation Mining and control of network (51% attack) Regulatory risks use of bitcoin for financial crimes
Price Volatility
Risks and Regulatory Considerations Financial crimes Security Consumer protection Tax issues
Risks Enforcement Actions Liberty Reserve Mt. Gox Silk Road U.S. v. Faiella and Shrem SEC v. Shavers (E.D. Tex.2013)
Regulatory Update FEDERAL FinCEN guidance March 2013 CFPB guidance and complaint protocol Potential rules from SEC and CFTC IRS guidelines Congressional hearings, but no significant legislation STATE CSBS Emerging Payments Task Force Some progress in key states (CA, TX) BitLicense proposal introduced by NY INTERNATIONAL EU reticent to take action (See recent EBA Report) Have seen government warnings and limited tax guidance Some recent progress (Canada, Luxembourg, FATF, FCA)
AML Regulations Focus of regulators are on and off ramps for Bitcoin to fiat exchange Concern over anonymity and counterparty risks FinCEN guidance (March 2013) Relates to convertible decentralized virtual currency Defined administrators and exchangers ( users are exempt) that must register as MSBs January 2014 guidance relating to miners and investors Special highlight discussion in July 2014 SAR update Open Issues Travel rule, OFAC
State Requirements Money transmitter statutes do not contemplate digital currency Licensing varies by state (may be considered money transmitter, payment instrument, stored value or none of the above) Barrier to entry capital requirements, bond, financial statements, background information, permissible investments Examinations/enforcement NYDFS BitLicense Proposal AML provisions over and above FinCEN rules Differ from other money transmitters Wide discretion over businesses
What to Consider When Banking MSBs Joint Guidance on Providing Banking Services to Money Services Businesses Operating in the United States (2005) Minimum due diligence requirements Risk assessment FinCEN Statement on Providing Banking Services to MSBs (11/10/14) Avoid De-Risking 2008 MSN exam manual; 2010 FFIEC BSA/AML manual FDIC FIL-5-2-15 (1/28/15) Statement on Banking Services
Assessing Digital Currency Clients Comprehensive due diligence and risk-based review Risk/benefit analysis Costs to monitor/staff; reputational risks; potential fees for compliance Review the business activities of the digital currency firm Analyze types of accounts desired (operational, settlement, etc.) and anticipated activity Complete risk assessment of products, clients, and geo locations Are they a registered Money Service Business and licensed in states? Assess management, board, investors and culture of compliance Review entire AML program (4 pillars) and OFAC program Review beyond AML compliance (consumer protection, financials, security, etc.)
Banks - Ongoing Monitoring Risk Assessment - ongoing Information requests (quarterly reports and risk dashboards) Periodic reviews of account activity Site visits and requests for audit/compliance testing Special monitoring procedures and staffing (high risk division) Updates for material changes Changes in activity patterns Insight into firm s KYC/monitoring systems Utilize 314(b) for clients (and non-clients)
AML Program Digital Currency
AML Program Digital Currency
Onboarding Clients Customer fund accounts via ACH, debit/credit card or existing BTC wallet Risk-based approach to gathering KYC information Verification of information provided Utilize technology IP addresses, geo location, document validation, facial recognition Conduct OFAC and sanctions screening Determine high-risk countries based on factors (country, PEP, etc.) EDD (source of funds, validation questions, etc.) Use of transaction limits to mitigate risk
Red Flags Customer provides insufficient, incomplete or suspicious information that can t be verified Use of proxies, unverifiable IP address or geo location, disposable email address Customers or transactions in high risk locations Unusual patterns of transaction activity (volumes, velocity, structure, etc.) Attempts for single user to purchase/sell digital currency from numerous different bank or card accounts Transactions involving known blacklisted addresses Attempts to conceal identity