The new U.S. proposal for the "Digital Asset Anti-Money Laundering Act": VASP may be regarded as a financial institution

Author: Mitch Eiven Nowadays, true bipartisan legislative cooperation is rare in Washington, D.C., but Democratic Senators Elizabeth Warren, Joe Manchin, and Republican Senators Lindsey Graham and Roger Marshall successfully co-sponsored a proposal targeting cryptocurrency crime. The senators stated that the proposal for the 2023 Digital Asset Anti-Money Laundering Act aims to fill gaps in the national anti-money laundering rules. The proposal would amend the Bank Secrecy Act and classify certain digital asset providers as financial institutions. The Bank Secrecy Act outlines the procedures, record-keeping, and reporting requirements for national banks, federal savings associations, federal branches, and foreign bank agencies. Under the proposed legislation, digital asset providers would be required to comply with many of the same regulations as traditional banks. Warren submitted the proposal to the U.S. Senate on July 27, 2023, on behalf of herself and Senators Joe Manchin, Roger Marshall, and Lindsey Graham. The proposal was subsequently referred to the Senate Committee on Banking, Housing, and Urban Affairs. The proposal has not yet been voted on by the full Senate or sent to the U.S. House of Representatives for consideration. President Biden has not signed it, and the proposal has not yet become law. The proposal would add several types of cryptocurrency providers to the list of financial institutions regulated by U.S. authorities. These include non-custodial wallet providers, digital asset miners and validators (or other nodes that validate transactions for third parties), extractable value searchers, other validators, or network participants with control over network protocols, as well as those who facilitate or provide services related to the trading, sale, custody, or lending of digital assets. All these organizations and individuals would be subject to the same regulations currently applicable to U.S. financial institutions. The proposal also includes exceptions for those using distributed ledger, blockchain technology, or similar technologies for internal business purposes.

Cryptocurrency Under Federal Scrutiny

If the proposal becomes law, the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of the Treasury will announce within 18 months of its enactment that any U.S. person owning $10,000 in digital assets or one or more digital assets overseas must file a report. At the same time, the Treasury will establish controls to mitigate illegal financial risks associated with digital asset mixers and privacy-enhanced cryptocurrencies. Within two years of the proposal's enactment, the Treasury will consult with banking regulators to create a risk-based examination and review process for those newly designated as financial institutions in the digital asset space. They will determine whether efforts to prevent money laundering and combat the financing of terrorism through cryptocurrencies are adequate and whether cryptocurrency providers and service providers comply with the new rules. Meanwhile, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) will consult with the Treasury on the same matters.

Regulation of Digital Asset Kiosks

The next part of the proposal focuses on digital asset kiosks. Within 18 months of the proposal's passage, FinCEN will require owners and operators of digital asset self-service terminals (ATMs) to submit and update the actual addresses of their kiosks every 90 days. Kiosk owners will also need to verify each customer's identity using government-issued valid identification and must collect the name and actual address of each counterparty for every transaction. FinCEN will publish a report within 180 days regarding any unregistered digital asset kiosks. This report will include estimates of the number and locations of unregistered kiosks, as well as an assessment of the additional resources FinCEN may need to investigate these information kiosks. Within one year of the legislation's enactment, the Drug Enforcement Administration (DEA) will issue a report with recommendations to reduce drug trafficking and money laundering activities associated with digital asset kiosks.

Impact on the Cryptocurrency Industry

Grant Fondo, co-chair of Goodwin's digital currency and blockchain practice and former U.S. Assistant Attorney, told the magazine, "The proposal attempts to bring more participants in the digital asset industry under regulatory control to fill what some in Congress believe are gaps in the current regulatory framework." Fondo believes that if the proposal passes, it will impose unworkable regulations on DeFi protocols, effectively stifling decentralized finance in the U.S. He argues that the legislation burdens validators and miners and questions whether it is realistic to impose bank-like requirements on software companies that validate blockchain transactions. Hadas Jacobi, a lawyer with Reed Smith's financial services group who previously worked at New York's financial enforcement agency, agrees. According to Jacobi, the proposal will apply the Bank Secrecy Act's requirements to non-financial cryptocurrency participants on a case-by-case basis. "The bill could be interpreted as applying to programmers and other tech providers who create frameworks for financial services operations rather than providing services themselves," Jacobi said. Although Jacobi believes the field needs legislative regulation, she questions whether the primary intent of the legislation (the threat of the cryptocurrency industry to national security) is relevant. She states that targeted regulation of cryptocurrency and digital asset service providers is necessary, but digital assets do not pose a threat to national security. "The blanket statement that digital assets pose a threat to U.S. national security is both inaccurate and shortsighted. From the perspective of national security and financial stability, bad actors in the digital asset space pose a threat globally, but the digital asset industry and its underlying technology do not."

What Politicians Are Saying

Senator Marshall stated in a written statement that the proposal addresses U.S. concerns about national security. "This legislation is about national security. Hackers from hostile nations like Iran, Russia, and North Korea are committing cyber crimes against the U.S., causing losses in the billions, and they must be held accountable. The reforms outlined in our legislation will help us fight back, and we will protect our digital assets by using proven methods that domestic financial institutions have adhered to for years." Marshall stated that the legislation would expand the scope of the Bank Secrecy Act's responsibilities, including "know your customer" requirements for affected parties; address the "significant gaps" associated with non-custodial digital wallets; guide FinCEN to issue guidelines for financial institutions to mitigate digital asset risks; strengthen enforcement of BSA compliance; extend BSA foreign bank account rules to include digital assets; and mitigate illegal financing risks associated with digital asset ATMs. Warren believes that U.S. authorities are warning that cryptocurrencies are being used for various types of crime and are being utilized by hostile nations to evade U.S. sanctions. "Countries like Iran, Russia, and North Korea are using digital assets to launder money, evade U.S. and international sanctions, and fund illegal weapons programs." Warren hinted that the proposal would help eliminate these threats, focusing her remarks on North Korea's missile program. "For example, it is estimated that nearly half of North Korea's missile program is funded by cybercrime and digital assets. In 2022, the total volume of illegal digital asset transactions reached at least $20 billion, a record high." Manchin called for Democrats and Republicans to come together to vote in support of the proposal. "Our bipartisan legislation will reduce these security risks and require cryptocurrency platforms to comply with the anti-money laundering rules that banks must follow. I urge my colleagues on both sides of the aisle to support this legislation to protect Americans by preventing bad actors from using cryptocurrencies to fund their criminal activities." Fondo does not believe that the Anti-Money Laundering Act can minimize national security risks but does recognize that the proposal may address issues related to privacy-enhancing cryptocurrencies. Nevertheless, he hopes to see the legislative work thoughtfully considered before the proposal is passed. "No one wants terrorists and criminals to obscure their financial transactions. But conversely, privacy is a rare commodity, so it is crucial to strike the right balance between privacy and national security," Jacobi worries that overregulation could lead to redundancy and excessive costs, draining the entire industry. She states that the proposal will instruct FinCEN to regulate digital service providers as money transmission businesses, although she believes they have been doing so since 2013. Additionally, she notes that most state regulators have been reviewing and registering them for nearly as long. "The proposal has the potential to disrupt the balance of the existing dual regulatory system at both the state and federal levels in the U.S., as it would create redundancy in the regulation and review of money transmission businesses, not to mention the issues of resource depletion and duplicate enforcement actions facing the digital asset industry."

Will the Proposal Become Law?

No one can say for sure. In Congress, the House has just begun to recover after struggling for weeks to elect a new Speaker. The U.S. Senate still requires an absolute majority vote to approve nearly all legislation, and lawmakers and President Biden have been highly focused on geopolitical issues such as the Israel/Hamas conflict and the war in Ukraine. Furthermore, most U.S. federal politicians are about to enter the 2024 election season, with fierce competition for control of the Senate, House, and presidency. Controversial legislation will certainly be delayed until after the elections, but a potentially popular cryptocurrency proposal may be welcomed by bipartisan candidates and ultimately make its way to the President's desk. If the Digital Asset Anti-Money Laundering Act becomes law, many cryptocurrency providers will have to learn how to comply with the same regulations that apply to traditional financial institutions.