Blockchain and Money Transmission: A New Horizon for Token-Driven Startups?**

Sam Miller

While the security-not-a-security debate has raged for months, one can be forgiven for forgetting that securities compliance is just one pillar of the regulatory space that affects token-driven blockchain businesses.

Just recently, chat platform, Kik Interactive Inc.’s Well’s Submission received considerable public attention in Kik’s challenge to the Securities and Exchange Commission’s (SEC) preliminary finding that Kik issued unregistered securities in its 2017 public token offering. Kik insists that its token is currency and not within the purview of the strict letter of the Securities Act nor an investment contract ala Howey.

However this, and the ongoing debate plays out, one other pillar of compliance, that, although equally relevant, hasn’t been as hotly debated, is money transmission.

Tokens, security tokens, cryptocurrency, or however you wish to define the digital asset which distributed ledger technology has now allowed us to pull from ether puts issuers and exchangers of this value within the cross-hairs of both Federal and State money transmitter regulation.

As with securities regulation, de rigueur, the approach is to fit virtual currency within the exiting regulatory framework. This may soon change.

There are a number of bills making their way through Congress, including the Token Taxonomy Bill, seeking somewhat ambitiously to exclude digital tokens from ‘security’ treatment, and now, most recently the new Blockchain Regulatory Certainty Bill, introduced by Representative Tom Emmer (Minnesota). This is in addition to numerous initiatives, and legislation in various States, with Wyoming being particularly notable in its ambitions.

What is notable about Rep. Emmer’s proposed Blockchain Regulatory Certainty Act (BRCA), is that it addresses a vexing question which, if left within the existing regulatory framework, may be problematic for token-driven blockchain startups, even those that have no intention of engaging in Initial Coin Offerings or wholesale token sales.

To understand the potential impact of the BRCA, it is worthwhile taking a look at the existing money transmitter regulatory framework, starting with the Federal view on ‘virtual currency’ and money transmitters.

The Federal Position

The part of the Code of Federal Regulations (CFR) implementing the federal Bank Secrecy Act (BSA) defines “money transmission services” as “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.” (31 CFR § 1010.100 (ff)(5)(i)(A)) (my emphasis).

In its March 18, 2013 interpretive guidance (The Guidance), the Financial Crimes Enforcement Network (FinCEN), the bureau of the Department of the Treasury responsible for enforcing the BSA, moved to clarify the inclusion of ‘convertible virtual currency’, which would include tokens, into the money transmitter regulatory scope .

FinCEN clarified that ‘administrators’ and ‘exchangers’ of convertible currency would be money transmitters, with the former defined as the person or entity “…engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency”, and the latter, “… engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.” In The Guidance, FinCEN went on to state that, “…[a]ccepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA…” (my emphasis).

So, in essence, it seems that the acceptance of ‘value’ from one person, and the transmission of ‘value’ to another person or to another location makes one a ‘money transmitter’ under the BSA.

Nevertheless, the CFR recognizes an exemption to what otherwise would be money-transmission where a person “[a]ccepts and transmits funds only integral to the sale of goods or the provision of services, other than money transmission services, by the person who is accepting and transmitting the funds…”(31 CFR § 1010.100 (ff)(5)(ii)(F)) (The Goods and Services Exemption)(my emphasis). This appears to make sense in the context of the very person selling goods and services ‘accepting’ and ‘transmitting’ value, for example currency or virtual currency, to another ‘person’ or ‘location’, for example that person’s bank or another third party.

But what about a token-driven blockchain startup that accepts and transmits currency or virtual currency, not directly in relation, perhaps, to goods and services which its users buy and sell on its platform, but in relation to the service which the startup itself provides, i.e. the very platform on which those goods and services are sold?

In the Guidance, FinCEN, appears to dispel the notion that that an administrator of a virtual currency could avail itself of the Goods and Services Exemption in all of its activities. It did so in analyzing “…different activities involving virtual currency…” including, what it termed “Centralized Virtual Currencies” and “De-Centralized Virtual Currencies”.

In relation to Centralized Virtual Currency, that is one, as FinCEN describes, which has a centralized repository, it states that an administrator is a money-transmitter where “… to the extent…it allows transfers of value between persons or from one location to another…” (my emphasis). In the case of De-Centralized Virtual Currencies, which FinCEN delineates as having no central repository, an administrator would be a money-transmitter where it “…creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent…[being so] engaged in transmission to another location” (again, my emphasis). The transmission here to “another location” could be, it seems, the transfer, for example, of currency from a user’s bank account, and crediting the user’s wallet or a repository centrally held by the blockchain token-driven startup.

In The Guidance, FinCEN goes on to exclude the Goods and Services Exemption for exchangers of virtual currencies in stating that, “…[i]t might be argued that the exchanger is entitled to the exemption from the definition of “money transmitter” for persons involved in the sale of goods or the provision of services. Under such an argument, one might assert that the exchanger is merely providing the service of connecting the user to the administrator and that the transmission of value is integral to this service. However, this exemption does not apply when the only services being provided are money transmission services…”.

By analogy, this could suggest that the Goods and Services Exemption would not be available to an administrator (here the startup that issues the convertible token) who engages in the transfer of value to another location or to another person in relation to the goods or services the platform offers, but which transfer is not directly related to the receipt of payment for the goods or services themselves. Although The Guidance does not, at least expressly, appear to deal with this point in the context of an administrator (as opposed to an exchanger), this transfer of value could conceivably take place where an administrator sells tokens for cash or other convertible currency for use on its platform, whether or not in the context of an ICO or general placement or sale of its tokens.

Accordingly, it would appear that a token driven blockchain startup that mints a fungible token for use as a utility token on its platform, and which ultimately would be used by the recipient for the purchase of goods or services on the platform, may be a money-transmitter and be required to register as one with the Department of the Treasury (DOT).

Or is it conversely, that, in distinguishing in The Guidance between an exchanger and an administrator in applying the Goods and Services Exemption, FinCEN may be alluding to the argument that an administrator’s sale or acceptance of tokens purely for use on the platform would be sufficiently integral to the platform, i.e. the very service which the administrator provides, and so exempt the administrator from registration as a money transmitter? However, it is not clear when an administrator would start to be an exchanger, and in different applications on different platforms the distinction may be blurred.

Nevertheless, that an administrator of this type is a money transmitter seems to be supported by the letter of February 13, 2018, addressed by the DOT to Senator Wyden where Drew Maloney, DOT Assistant Secretary for Legislative Affairs states, “…“[g]enerally, under existing regulations and interpretations, a developer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply with AML/CFT requirements that apply to this type of MSB. An exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat currency, or other value that substitutes for currency, would typically also be a money transmitter.” (My emphasis).

A requirement for token-driven blockchain startups to register with the DOT as money transmitters, does not end with simple registration. It requires adherence to the BSA’s strict reporting requirements, including submitting currency transaction, suspicious activity, and other reports, implementing written anti-money laundering compliance programs and doing KYC to combat money laundering and financing of terrorism.

One begins to see the existing potential burden for startups and why clarification is sorely needed. And when exactly would this burden start? In general, any person who owns or controls a money transmitting business must register the business not later than 180 days after the business is started. If a startup launches a platform, mints a fungible token for users to buy goods or services on its platform, it has to disperse the token in some way. Is the registration requirement look-back activated as soon as it mints a pure utility token? Or does it need to allocate it to a user in some way, perhaps even simply by crediting a user’s account on the platform?

The Federal penalties for getting this wrong could possibly be steep. With per-violation civil penalties (assessed on a continuing daily basis) (31 U.S. Code § 5330), and criminal penalties for carrying on an unlicensed money transmitting business (18 U.S. Code § 1960), the stakes could potentially be high.

The State Position

The concern for confusion and innovation stifling doesn’t end with the Federal requirements.

State level money transmitter licensing requirements, differing, and processed, generally, separately from State to State, can have long-arm, out-of-state application and make for very daunting, paper-chasing and potentially inconsistent compliance requirements for startups which, by nature, operate across multiple States and jurisdictions.

In California, for example, one cannot engage, or hold oneself out as being engaged in ‘money transmission’ in the State without being licensed or exempt (Financial Code §2030). ‘In the State’ appears to mean either being located in California or transmitting “…with, to, or from persons located in California…” (Financial Code §2003(k)). One gets the picture of this compliance headache where other States applies this type of long-arm reach too.

The California license regime is overseen by the California Department of Business Oversight, Money Transmitter Division , and requires application for licensure, including a non-refundable $5,000 application fee. The regime includes extensive reporting, filing and disclosure requirements, the assessment of hefty civil fines, and potentially criminal sanction, for non-compliance.

The California Financial Code defines ‘Money Transmission’ to include “…[r]eceiving money for transmission.” (Financial Code §2003(q)), which is, in turn, defined as “…receiving money or monetary value in the United States for transmission within or outside the United States by electronic or other means…” (Financial Code §2003(u)). “Money” means “…a medium of exchange that is authorized or adopted by the United States or a foreign government…” (Financial Code §2003(p))and “Monetary Value”, “…a medium of exchange, whether or not redeemable in money.” (Financial Code §2003(o)).

This appears to bring virtual currency, and perhaps, tokens, within the ambit of the California licensure regime.

A limited ‘Goods and Services’ exception does appear to apply, which seems to exempt from licensure transmissions in transactions in which the recipient of the money or other monetary value is an agent of a provider of goods or services under a preexisting written contract and takes the monetary value in satisfaction of the consumer of the goods or services’s obligations to the payee ((Financial Code §2010(l)). Whether or not an administrator of a blockchain platform could be construed as an agent for the provider of the goods or services does not seem to be clear, particularly in circumstances where the administrator simply credits the provider with the tokens used to purchase the goods or services under a centrally controlled payment system.

A quick search of the Department of Business Oversight’s money transmitter directory, appears only to reveal traditional-type money transmitter licensees, rather than token-driven blockchain startups, with the latter appearing to take a ‘watch-and-see’ approach for clarification from State regulators as to the reach, and enforcement potential for not seeking licenses. Potentially, a delicate position to be in.

The Pressing Need for Clarification and the Blockchain Regulatory Certainty Bill

It is clear that there is a pressing need for certainty in the money transmission arena, at both the Federal and State levels.

The application of existing frameworks does not augur well for innovation and freedom of development in the blockchain space. While the underlying KYC and reporting rationale for registration of token-driven blockchain startups as money transmitters, particularly on the Federal level, seems clear, the existing framework appears to leave to many questions unanswered to be productive.

That is where potential legislation like the aptly titled Blockchain Regulatory Certainty Bill can be very useful.

The BRCA, as introduced by Representative Emmer, proposes to exclude from the definition of ‘money transmitter’, as defined under State licensing laws, Federal law, “… or any other State or Federal legal designation requiring licensing or registration as a condition to acting as a blockchain developer or provider of a blockchain service, unless the developer or provider has, in the regular course of business, control over digital currency to which a user is entitled under the blockchain service or the software created, maintained, or disseminated by the blockchain developer…”. (My emphasis)

The BRCA goes on to define ‘blockchain developer’ as “ any person or business that creates, maintains, or disseminates software facilitating the creation or maintenance of a blockchain network or a blockchain service…”, and ‘blockchain service’ as “ any information, transaction, or computing service or system that provides or enables access to a blockchain network by multiple users, including specifically a service or system that enables users to send, receive, exchange, or store digital currencies described by blockchain networks.”

The BRCA’s potential exclusion from State and Federal licensure or registration of blockchain services or developers would create a space in which to innovate without doubt or penalty. Token-driven blockchain startups could conceivably then be able to mint tokens safe in the knowledge that they would not be administrators or exchangers of virtual currency or money transmitters under State or Federal law.

Nevertheless, the BRCA’s inclusion in its current form of the requirement that the developer or provider not have ‘control’ over the digital currency creates a measure of uncertainty.

Control’ is defined in the bill as “… the legal right, authority, or ability to obtain upon demand data sufficient to initiate transactions spending an amount of digital currency.”

But, as is becoming apparent with evolving blockchain businesses, ‘decentralization’ is a matter of degree. Where would ‘control’ exist, and where not? A startup may not want to give control of its tokens to users for a number of reasons, including lack of sophistication in keeping wallets or handling private keys, or the nature of the market the platform serves. For example, requiring fine art collectors to manage wallets and private keys for a fine art title registry may not be conducive to platform aggregation.

Wouldn’t there be more reason to regulate platforms which have little or no control over tokens to ensure that users are known and suspicious transactions reported? Wouldn’t selling tokens for currency or other virtual currency be initiations of “…transactions spending an amount of digital currency…” to which a user of the service is entitled? Would alternative structures, such as creating a foundation to sell the tokens, solve this ‘control’ issue, perhaps leading down a path similar to that which providers have (evidently, mistakenly) taken to emulate pure Ethereum-type cryptocurrency structures and escape security token scrutiny?

Conclusion

The BRCA appears to have a number of unanswered questions, which hopefully will resolve as it makes its way through Congress.

Perhaps the very framework for its attempts to alleviate the apparent regulatory burden for token-driven blockchain startups needs to be reconsidered in favor of, for example, a uniform ‘registration lite’ for State and Federal purposes, in which context startups could mint and transmit tokens safely while concurrently complying with KYC, anti-money laundering and financing of terrorism requirements?

Whatever the case, the BRCA is definitely a step in the right direction. As in a lot of blockchain start up regulation, applying legacy frameworks, de rigueur, may not be the answer indeed.

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**Competent, specific legal advice from a suitable, licensed attorney, should always first be obtained before taking any action, and the information in this article should not be relied upon independently of that advice. Sam Miller is Founder: theFineArtLedger.com, the blockchain powered fine art title and authentication platform, art collector, and Rimon P.C. corporate finance attorney.

Sam Miller

Written by

Founder:the FineArtLedger.com, blockchain powered fine art title and authentication platform, art collector, Rimon P.C. corporate finance attorney. Venice, CA

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