Today's Trends in Credit Regulation

Virtual Currency Provider Liberty Reserve Sanctioned by Feds
By Thomas P. Quinn, Jr.

In our April issue we discussed the background of Bitcoin, currently the leading form of virtual currency. Virtual currencies have been in the news a great deal in recent months as the use of digitally based value provides the promise of a truly universal means of payment in an increasingly global economy. This promise has fueled growth in the value of and interest in virtual currencies from the general public and regulators alike.

With this promise comes a rather daunting challenge: how to ensure that virtual currencies, which are generally more anonymous than more traditional payment mechanisms, are not used for illegal purposes or to launder the proceeds of illegal activities. The first steps toward greater regulation of virtual currencies came in March when the Financial Crimes Enforcement Network (or “FinCEN”) issued guidance that would treat parties that administer virtual currencies or exchange virtual currencies for real currency, other funds or even in exchange for other virtual currencies as money transmitters and thus subject to registration, reporting and recordkeeping regulations applicable to “money service businesses.”

On May 28th FinCEN upped the ante – significantly – by deeming Liberty Reserve, S.A. (“Liberty Reserve”) a financial institution operating out of Costa Rica as a primary money laundering concern. FinCEN has the authority to make such determinations by delegation from the Secretary of the Treasury. The allegations against Liberty Reserve read like something out of a spy novel.

According to the FinCEN allegations, Liberty Reserve took affirmative steps to facilitate money laundering, including:

  • Basing their activities off-shore, and specifically in a country without a mutual legal assistance treaty with the United States;
  • Requesting a minimum amount of identifying information (name, email address, date of birth), without any follow-up validation;
  • Requiring deposits and withdrawals to be made through “exchangers” – many of whom do not disclose contact names and obscure information regarding their country of business registration or where they are physically located;
  • Offering the ability (for a fee) to obscure the originating party’s account number in transactions; and
  • Once deposited through an exchanger, accounts were established in Liberty Reserve’s virtual currency denominations (e.g.: “Liberty Reserve Dollars” or “Liberty Reserve Euros”) and then could be moved between accounts and account holders without additional records or identification.

Because of these multiple layers of anonymity, FinCEN alleged that it was essentially impossible to track the flow of funds in the manner required to limit the possibility of money laundering. With diminished controls in place, Liberty Reserve allegedly became a haven for fraudsters who regularly used its services to store, transfer and launder the proceeds of their illegal activity. Worse still, Liberty Reserve allegedly took a “piece of the action” by charging fees far in excess of what a legitimate financial services company would assess for similar transactions.

Hopefully, no one reading this article is in the same situation as Liberty Reserve. So why is this development important for you? We think there are two reasons why it deserves your attention.

The first is that while virtual currencies remain in their infancy, they are being actively used in small corners of the payment systems world. Whether the use of such currencies will spread to the mainstream and grow in proportion to the segment of the population who were raised as “digital natives” remains to be seen. The pace and degree of this growth may well depend on the scope of governmental regulation.

Which brings us to our second reason to keep an eye on this issue: the possibility of indirect regulation through parties that accept funds (either for deposit or in payment of a credit obligation) held, at one point in their life-cycle, as a virtual currency. Will such parties be required to conduct some degree of due diligence to determine the legitimacy of these funds? There is precedent for similar forms of due diligence “deep dives.”

In 2008 the Office of the Comptroller of the Currency (the “OCC”) entered into a settlement with Wachovia Bank over allegedly unsafe and unsound practices involving parties who were depositors of “remotely created checks.” A “remotely created check” is a form of check that is drawn on a depositor’s account by a third party, pursuant to the authorization of the account holder.

Coupled with this settlement the OCC also published a Bulletin (Bulletin OCC 2008-12) outlining a series of risk management controls for parties that accept remotely created checks for deposit. For certain depositors the recommended level of due diligence involved not only the customer of the bank, but also that customer’s clients (usually merchants) to determine that both had legitimate businesses, were creditworthy and had appropriate business practice controls in place.

Whether the regulators will require similar scrutiny by parties accepting funds that may have passed through a phase in virtual format remains to be seen. Even if they do not, the use of virtual currency should prompt some review of your risk management and anti-money laundering controls.

Thomas P. Quinn, Jr. is a partner in the Fall River, MA office of Hudson Cook, LLP. Tom can be reached at 774-365-4758 or by email at

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