May 2018 JD Supra
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Who monitors digital currency wallets? was published by JD Supra on 5/8/18.

Investors in Virtual Currency (VC) utilize the services of on-line “secure” platforms for buying, selling, transferring, and storing VC.  The providers of these services are known as web-wallets (Coinbase is an example).  They are required to register and operate as Money Service Businesses (MSB) by the Financial Crimes Enforcement Network (FinCEN).   MSB’s that operate in the U.S. are regulated by the state.  This means that while web-wallets are not subjected to the direct oversight of the Securities Exchange Commission (SEC), the MSB’s are required to keep records and file reports on certain transactions to FinCEN by Bank Secrecy Act (BSA) regulations.       

What is a MSB?

According to FinCEN and the IRS, a MSB is “any person doing business, whether or not on a regular basis or as an organized business concern, in one or more of the following capacities:

(1) Currency dealer or exchanger.

(2) Check casher.

(3) Issuer of traveler’s checks, money orders or stored value.

(4) Seller or redeemer of traveler’s checks, money orders or stored value.

(5) Money transmitter.

(6) U.S. Postal Service”

MSB’s have to register with the Federal Government via FinCEN Form 107 (Registration of Money Services Business).  They also have to report Cash Transactions (FinCEN FORM 112) and report Suspicious Activity (FinCEN Form 111). All MSBs are required to develop and implement an anti-money laundering (AML) compliance program. The program should reasonably prevent individuals from using the MSB to facilitate money laundering or to finance terrorist activities. Each program must be reduced to writing and take into account inherent risks.  FinCEN states that MSB’s do not include:

  • A bank,  or
  • A person registered with, and regulated or examined by, the SEC or the Commodity Futures Trading Commission (CFTC)

What do the on-line wallets do?

They facilitate the buying of VC with credit card, PayPal, cash, or bank transfers, and provide merchant services so that Businesses are able to accept VC as a form of payment.

Security related to Storage

On-line wallets store their Customer’s VC holdings on-line or off-line.  On-line wallets keep a portion of their VC holding on-line in order to meet their customer’s liquidity needs.   On-line storage is riskier and the reason why these on-line wallets keep only a minute portion of their entire customer holdings on-line.  By storing VC holdings off-line, the risk of hacking is practically eliminated.  Off-line storage also known as cold storage is the safest kind of storage. 

Off-line storage means that on-line wallet servers are disconnected from the internet.  The information is stored in separate drives and hard paper copy and then sent to vaults and safe deposit boxes for storage. 

Is there any Insurance?

VC is not legal tender (not fiat currency).  It is NOT backed by the full faith and credit of the Government.  VC accounts and value balances in on-line wallets are not covered by FDIC insurance or SIPIC (Securities Investor Protection Corporation) protection. 

To the extent that a Customer at an on-line wallet has a “Cash Position” in actual USD or Euros (as an example), the on-line wallet might pool all the customer cash accounts with the balances of other customers and hold those funds in custodial accounts at U.S. banks and/or invests those funds in liquid U.S. Treasuries in accordance with state money transmitter laws.  The “pooled custodial accounts” could potentially be placed at a bank with FDIC insurance. 

VC Account Holders have responsibilities and ought to educate themselves

VC investors are ultimately responsible for their VC holdings.  They ought to have strong passwords and full control of their login credentials.  On-line web wallets that keep information on their servers expose VC investors to potential losses as the VC holdings could be “available” to hacking or theft.  Off-line storage (cold storage) via a USB drive, hardware wallet, paper wallet or in physical form is a safer way to go.

Don’t be a victim of your own making.  If you are a VC investor, learn the VC business and the responsibilities associated with investing in VC.  Consult with a tax specialist that has experience in the tax reporting that is associated with VC transactions.