Virtual Currency Companies Grapple with Role as Crime Watchdogs for Feds

When Chris Morton and his partners co-founded BlockScore in June 2013, they initially planned to get into the business of Bitcoin remittances. That’s a new way to send money via the Web to someone in another country, with the virtual currency Bitcoin as a medium of exchange. Such services—often available through a mobile phone—can be faster and cheaper than going through traditional companies such as Western Union.

But within a few months, Morton and his co-founders concluded that the regulatory hurdles for such virtual currency businesses were so great that it wasn’t worth building the product they’d envisioned.

“It was a hundred times the amount of regulation we were prepared to deal with,” Morton (pictured above) says. Instead, the BlockScore team identified a new mission and a new market—helping other young companies grapple with the complex regulatory requirements surrounding virtual currencies that were emerging from federal, state, and foreign authorities.

Digital currency creators, like other innovative tech companies, have often operated outside established regulatory schemes until governments figure out what slot to put them in. Should Uber be regulated as the employer of its drivers? Is Skype a telecom operator? Such questions are always pending. But a key uncertainty hovering over virtual currencies was addressed a few months before Mountain View, CA-based BlockScore was founded, in a U.S. government decision that imposed some weighty obligations.

Companies engaged in the administration or exchange of digital currencies would have to help the government detect crooked financial transactions, the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) decreed in March 2013. These companies were directed to take on the same watchdog obligations held by banks, Western Union, Moneygram and other traditional entities that move money around the globe.

Like banks, virtual currency traders would have to demand the true identities of their customers, and alert the government to any suspicious transactions that might be part of money laundering schemes, terrorist plots, or other criminal violations.

Until that FinCEN announcement, libertarians and other Bitcoin advocates could still hold on to a vision of novel digital currencies existing in a sort of alternate universe where the government had less power to examine currency exchanges or payments made by private individuals and organizations. FinCEN’s 2013 decision stripped away much of that hope of anonymity.

FinCEN underscored its intentions early this month, announcing its first enforcement action against a virtual currency exchanger. The agency assessed civil penalties totaling $700,000 against San Francisco-based Ripple Labs, which administers XRP, the second-largest digital currency after Bitcoin.

After a lengthy investigation in which Ripple cooperated, FinCEN found that Ripple entities had sold and exchanged XRP in 2013 before they registered with the agency as a money services business as required; had been late to set up a complete company anti-money laundering program; and had failed to notify the government of three questionable customer interactions it should have flagged.

As part of a settlement agreement with the U.S. Attorney’s Office for the Northern District of California, Ripple avoided civil and criminal prosecution, accepted responsibility for the alleged violations, and pledged to adopt a set of policies and procedures to fully comply with the Bank Secrecy Act, a cornerstone of the U.S. anti-money laundering regime.

In a written statement, U.S. Attorney Melinda Haag said Ripple’s pledge of compliance should set “an industry standard in the important new space of digital currency.” There was also a bit of saber-rattling among the federal agencies involved in the Ripple probe.

“Unregulated, virtual currency opens the door for criminals to anonymously conduct illegal activities online, eroding our financial systems and creating a Wild West environment where following the law is a choice rather than a requirement,” IRS chief of criminal investigation Richard Weber said in a statement.

A spokeswoman for Ripple, a venture-backed financial technology company that now partners with banks to speed the settlement of transactions, said Ripple was … Next Page »

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