[Senate Hearing 113-210]
[From the U.S. Government Publishing Office]






                                                        S. Hrg. 113-210


           THE PRESENT AND FUTURE IMPACT OF VIRTUAL CURRENCY

=======================================================================

                             JOINT HEARING

                               before the

 SUBCOMMITTEE ON NATIONAL SECURITY AND INTERNATIONAL TRADE AND FINANCE

                                and the

                    SUBCOMMITTEE ON ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                                   ON

  EXPLORING THE DEVELOPMENT OF VIRTUAL CURRENCIES, THEIR CURRENT AND 
POTENTIAL FUTURE USE, AND THE REGULATORY, MONETARY, NATIONAL SECURITY, 
           AND OTHER IMPACTS AND ISSUES ASSOCIATED WITH THEM

                               __________

                           NOVEMBER 19, 2013

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


                 Available at: http: //www.fdsys.gov /
                                   ______

                         U.S. GOVERNMENT PRINTING OFFICE 

87-095 PDF                     WASHINGTON : 2014 
-----------------------------------------------------------------------
  For sale by the Superintendent of Documents, U.S. Government Printing 
  Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; 
         DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, 
                          Washington, DC 20402-0001














            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                      Kelly Wismer, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

 Subcommittee on National Security and International Trade and Finance

                   MARK R. WARNER, Virginia, Chairman

             MARK KIRK, Illinois, Ranking Republican Member

SHERROD BROWN, Ohio                  JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia

                Milan Dilal, Subcommittee Staff Director

        Lindsey Johnson, Republican Subcommittee Staff Director

                                 ______

                    Subcommittee on Economic Policy

                     JEFF MERKLEY, Oregon, Chairman

             DEAN HELLER, Nevada, Ranking Republican Member

JOHN TESTER, Montana                 TOM COBURN, Oklahoma
MARK R. WARNER, Virginia             DAVID VITTER, Louisiana
KAY HAGAN, North Carolina            MIKE JOHANNS, Nebraska
JOE MANCHIN III, West Virginia       MIKE CRAPO, Idaho
HEIDI HEITKAMP, North Dakota

               Andrew Green, Subcommittee Staff Director

        Scott Riplinger, Republican Subcommittee Staff Director

                                  (ii)

















                            C O N T E N T S

                              ----------                              

                       TUESDAY, NOVEMBER 19, 2013

                                                                   Page

Opening statement of Chairman Warner.............................     1
Opening statement of Chairman Merkley............................     3

Opening statements, comments, or prepared statements of:
    Senator Heller...............................................     2
    Senator Kirk.................................................     4
        Prepared statement.......................................    31

                               WITNESSES

Jennifer Shasky Calvery, Director, Financial Crimes Enforcement 
  Network, Department of the Treasury............................     4
    Prepared statement...........................................    32
    Response to written questions of:
        Senator Kirk.............................................    71
David J. Cotney, Commissioner of Banks, Massachusetts Division of 
  Banks, on behalf of the Conference of State Bank Supervisors...     6
    Prepared statement...........................................    38
Paul Smocer, BITS President, on behalf of the Financial Services 
  Roundtable.....................................................    16
    Prepared statement...........................................    46
    Response to written questions of:
        Senator Kirk.............................................    73
Sarah Jane Hughes, University Scholar and Fellow in Commercial 
  Law, Indiana University Maurer School of Law,..................    18
    Prepared statement...........................................    51
    Response to written questions of:
        Senator Kirk.............................................    74
Mercedes Kelley Tunstall, Partner and Practice Leader, Privacy 
  and Data Security Group, Ballard Spahr LLP.....................    19
    Prepared statement...........................................    58
Anthony Gallippi, Cofounder and CEO, Bitpay......................    21
    Prepared statement...........................................    60
    Response to written questions of:
        Senator Kirk.............................................    77

              Additional Material Supplied for the Record

Prepared statement of Aaron J. Greenspan.........................    81

                                 (iii)

 
           THE PRESENT AND FUTURE IMPACT OF VIRTUAL CURRENCY

                              ----------                              


                       TUESDAY, NOVEMBER 19, 2013

U.S. Senate, Subcommittee on National Security and 
  International Trade and Finance, Subcommittee on 
                                   Economic Policy,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittees met at 3:34 p.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Mark R. Warner and Hon. Jeff 
Merkley, Chairmen of the Subcommittees, presiding.

          OPENING STATEMENT OF SENATOR MARK R. WARNER

    Senator Warner. I am pleased to co-chair this joint 
Subcommittee hearing on ``The Present and Future Impact of 
Virtual Currency.'' My friend Senator Merkley and I also 
appreciate the work that Senator Heller has done, and I know 
Senator Kirk is going to be joining us as well.
    We are going to do this a little different. Because this is 
a joint Subcommittee hearing, I will chair the first panel, and 
Senator Merkley will chair the second panel.
    The uses of virtual currencies have proliferated in recent 
years. My hope for this hearing is to educate the Senate 
Members and others and start the education of the public about 
virtual currencies, including the potential and drawbacks. I 
also hope to explore how regulators are keeping up with this 
technological innovation to protect consumers.
    I have got a full statement here, but I actually have to 
acknowledge that, you know, I have been following this 
development of bitcoins for the last few months, and I think I 
am only starting to wrap my head around the potential upside, 
downside, regulatory issues, monetary policy issues, taxation 
issues, consumer protection issues that this innovation 
represents. And rather than going through my whole statement, I 
just will point out to the witnesses that back in 1982 I had 
the opportunity to get engaged in a new industry at that point 
that was on the cutting edge of innovation called cellular 
telephones. And all of the experts at that point thought it 
would take the world 30 years to develop out a wireless network 
and at the end of that 30 years about 5 percent of Americans 
would use them. Luckily for me, the experts were wrong, and now 
these devices transform our lives.
    Getting it right from all of the regulatory, financial, 
consumer points around virtual currencies, and Bitcoin in 
particular, could pose as great, if not greater challenge and 
opportunity. And what my hope is is that this will be the 
beginnings of an effort to come in with open minds, to hear 
about the potential, but to also hear about the important 
ramifications around monetary policy, around taxation. Think 
about the notion with this 21 million bitcoins that could be 
created, and as we see acceptance--I understand already the FEC 
has allowed political contributions to be made in bitcoins, so 
this is a development that is already in process. But if this 
becomes a standard currency or tool, it could radically and 
dramatically transform the role of central banks, monetary 
policy. It could transform--it has enormous security concerns.
    So I am very, very interested about this hearing as a 
member of the Intelligence Committee. I am concerned as well 
about the potential abuse of this development. But I think as 
we see now about somewhere between 10 to 12 million bitcoins 
that have been mined and just the reactions yesterday from 
Senator Carper's hearing where I believe bitcoins spiked at 
over $700 per unit, we are talking about a currency that has 
already been monetized, and we as policymakers in ways will 
have to catch up.
    So I am very much looking forward to this and really 
appreciate my colleagues and, in particular, Senator Merkley's 
interest in this, and with that I will turn to Senator Heller, 
and we will go back and forth with just a couple quick opening 
statements, and then I want to get to introducing the 
witnesses.

                STATEMENT OF SENATOR DEAN HELLER

    Senator Heller. Very good. Thank you, Mr. Chairman. I want 
to thank you and Chairman Merkley for holding this 
Subcommittee. I want to thank Ranking Member Kirk, and I am 
happy that we are having this joint Committee. I think we need 
to have more of these, and with that, I will keep my statement 
relatively brief.
    Today we are here to learn about virtual currencies and 
cryptocurrencies, the most popular, of course, which is 
Bitcoin. While generations in Nevada have mined for gold and 
silver and copper, today Nevadans can now mine for new virtual 
currencies on their computer.
    While these virtual currencies are not yet widely accepted, 
the number of users continue to grow, and we must recognize 
that these innovations decentralize digital payment systems.
    Today I look forward to learning about the long-term 
viability and practicality of virtual currencies. I also want 
to learn how various Government regulators interact with 
virtual currencies and which by their design are meant to be 
independent, of course, of any government.
    I will end with this note: The Internet is a new frontier 
of innovation. With every new Internet-based technology, I 
believe that Members of Congress should recognize that we often 
do not know what these new advancements will development into. 
While we must ensure proper safeguards, it is my hope that 
through hearings like this we can help maintain an environment 
that continues to promote new financial technologies and 
innovative growth.
    So thank you again to my colleagues. I look forward to 
hearing all the testimonies from our witnesses. Thank you.
    Senator Warner. Thank you, Senator.
    Senator Merkley.

           OPENING STATEMENT OF SENATOR JEFF MERKLEY

    Senator Merkley. Thank you, and it is a pleasure to co-
chair this gathering. I can see by the full room the level of 
interest and enthusiasm in this topic. Certainly this is a new 
technological strategy that has a tremendous number of 
implications. The wave of innovation is reaching into the world 
of currency payments and money transmission. We have all heard 
about exciting developments such as mobile payments and 
companies like Square, which rely on classic banking system 
payments.
    This latest generation of technology which we are talking 
about today takes things to a whole new level. With the 
creation of virtual currencies like Bitcoin and more recently 
Ripple, we are actually seeing payments transacted entirely 
with peer-to-peer trust driving the stores of value. Combined 
with open-source code and a public transaction ledger listing 
every transaction, virtual currencies are truly a completely 
different animal.
    Similar to the ways that the last decade's innovations out 
of the Silicon Valley and Silicon Forest have improved people's 
lives--I had to throw ``Silicon Forest'' in there because that 
is in Oregon.
    [Laughter.]
    Senator Merkley. Developments in virtual currency have real 
potential to provide value to American consumers and 
businesses. More transaction costs, more secure money 
transmission--these are significant qualities. At the same 
time, leaving this space unwatched and unregulated will all but 
ensure it is full of pitfalls for users and law enforcement 
alike. We have had recent news about illicit activities, 
narcotics money laundering; we have had rapid fluctuations in 
the value of the market for the bitcoins. We have questions 
about consumer protections, and there is certainly, therefore, 
a lot of issues about whether virtual currencies are ready for 
prime time.
    Today's hearing will explore the current and future state 
of virtual currency, especially how it affects core financial 
services that families and businesses rely on to move money and 
make payments, where is the potential for innovation and 
opportunity, and where are the gaps and weaknesses along the 
way.
    I wanted to note I have a recent article here called 
``Portland Businesses Enter the World of Digital Currency.'' 
Back in 2009, Gregg Abbott, the owner of Whiffies Fried Pies, 
was hanging out with a bunch of tech enthusiasts along his food 
cart, and he was discussing the potential of the then-new 
online currency known as Bitcoin. And one of the folks hanging 
out, an early investor, offered Abbott 1,000 bitcoins for one 
of his ham pies. He says, ``I did not say no. I just got 
distracted, and the individual wandered off.'' And then he 
says, ``That was a $250,000 mistake. Silly me.'' Well, based on 
yesterday's value, that is a $700,000 mistake. That certainly 
would have been the most expensive pie in the history of 
humankind.
    This is absolutely fascinating. By the way, he did proceed 
to start accepting bitcoins, as a number of Portland facilities 
have done, using a mobile app that converts from dollar, 
bitcoin to dollar, and back and forth based on the most recent 
exchange rate. So this is actually a functional, viable 
technology at this very moment.
    So, with that, Senator Kirk.
    Senator Warner. Senator Kirk.

                 STATEMENT OF SENATOR MARK KIRK

    Senator Kirk. Thank you, Mr. Chairman. I just thank you for 
gathering us together on this Bitcoin effort. I would say that 
I have been worried about Bitcoin, that because it is so 
complicated it could facilitate illegal activities or terrorist 
activities.
    Senator Warner. Thank you, Senator Kirk, and I think that 
is obviously one of the focuses we will have on this first 
panel.
    Let us get to the witnesses. Let us get to the real 
experts. The first panel, as I mentioned, will focus from the 
governmental side; the second panel will focus more from some 
of the advocates, and I think it will be an interesting 
afternoon.
    We have Ms. Jennifer Shasky Calvery, the Director of 
Financial Crimes Enforcement Network, FinCEN, a bureau of the 
Treasury Department. Prior to joining Treasury, she was Chief 
of the Asset Forfeiture and Money Laundering Section at the 
U.S. Department of Justice. As Chief, Ms. Shasky Calvery 
managed a Justice Department program responsible for the annual 
forfeiture of more than 1.5 billion in criminal assets and 
related programs to ensure that those assets were returned to 
victims and reinvested in law enforcement. She has also 
testified before Congress on a wide range of issues, including 
transnational organized crime, financial crime, State business 
incorporation practices, and this one will probably break some 
new boundaries as well. Welcome, Ms. Shasky Calvery.
    Mr. David Cotney is Commissioner of Banks for the 
Commonwealth of Massachusetts. He has served in that position 
since November 2010 overseeing the supervision of over 200 
banks and credit unions without assets in excess of $325 
billion. Mr. Cotney is an active contributor to consumer 
protection efforts, both in Massachusetts and nationally. In 
2013, he was elected as Vice Chairman of the Board of Directors 
of the Conference of State Bank Supervisors, on whose behalf he 
testifies here today. Welcome, Mr. Cotney.
    Ms. Shasky Calvery, if you could start.

   STATEMENT OF JENNIFER SHASKY CALVERY, DIRECTOR, FINANCIAL 
     CRIMES ENFORCEMENT NETWORK, DEPARTMENT OF THE TREASURY

    Ms. Shasky Calvery. Chairmen Warner and Merkley, Ranking 
Members Kirk and Heller, and Members of the Subcommittees, I am 
Jennifer Shasky Calvery, the Director of Treasury's Financial 
Crimes Enforcement Network, or FinCEN. I am pleased to be here 
today to discuss the important regulatory, enforcement, and 
analytical work we are doing at FinCEN to prevent illicit 
actors from exploiting the U.S. financial system as 
technological advances, such as virtual currency, create new 
ways to move money.
    Recognizing the potential for abuse of emerging new payment 
methods and understanding that anti-money-laundering 
protections must keep pace with these advancements, FinCEN 
began working with our partners several years ago to study the 
issue. Here is what we learned.
    Illicit actors might decide to use virtual currency for 
many of the same reasons as legitimate users, but also for some 
more nefarious ones. Specifically an illicit actor may choose 
to use a virtual currency because it provides anonymity, is 
easy to navigate, may have low fees, is accessible globally 
with a simple Internet connection, does not typically have 
transaction limits, is generally secure, and provides a 
loophole from the AML/CFT regulatory safeguards in most 
countries around the world.
    Indeed, the idea that illicit actors might exploit the 
vulnerabilities of virtual currency to launder money is not 
theoretical. Liberty Reserve engaged in a $6 billion major 
money-laundering operation, and just recently, the Department 
of Justice alleged that customers of Silk Road, the largest 
contraband marketplace on the Internet, were required to pay in 
bitcoins to evade detection and facilitate laundering hundreds 
of millions of dollars.
    That being said, it is also important to put virtual 
currency in perspective. It has been publicly reported that 
Bitcoin processed transactions worth approximately $8 billion 
over the last year. But by way of comparison, in 2012 Bank of 
America alone made $245 trillion in wire transfers. Thus, while 
of growing concern, to date virtual currencies have yet to 
overtake more traditional methods to move funds, whether for 
legitimate or criminal purposes.
    Nonetheless, to address growing concerns, in July 2011, 
after a public comment period, FinCEN released two regulations 
which update several definitions and provide flexibility to 
accommodate payment systems innovation, including virtual 
currencies, under our pre-existing regulatory framework. Then 
last March, FinCEN issued additional guidance to further 
clarify the compliance obligations for virtual currency actors 
covered by our regulations. In short, they are required to 
register with FinCEN, put AML controls in place, and provide 
certain reports to FinCEN.
    It is in the best interests of virtual currency providers 
to comply with these regulations. Any financial institution 
could be exploited for money-laundering purposes. What is 
important is for institutions to put controls in place to deal 
with those money-laundering threats.
    At the same time, being a good corporation citizen and 
complying with regulatory responsibilities is good for a 
company's bottom line. Every financial institution needs to be 
concerned about its reputation and show that it is operating 
with transparency and integrity within the bounds of the law. 
Legitimate customers will be drawn to a virtual currency or 
administrator or exchanger where they know their money is safe 
and where they know the company has a reputation for integrity. 
And banks will want to provide services to administrators or 
exchangers that show not only great innovation but also great 
integrity and transparency.
    The decision to bring virtual currency within the scope of 
our regulatory framework should be viewed as a positive 
development for the sector. It recognizes the innovation 
virtual currencies provide and the benefits they might offer 
society. Several new payment methods in the financial sector 
have proven their capacity to empower customers and expand 
access to financial services. We want such advances to 
continue. However, those institutions that choose to act 
outside of the law will be held accountable. FinCEN will do 
everything in its regulatory power to stop abuses of the U.S. 
financial system.
    We have proven our willingness to do just that by using our 
targeted financial measures under Section 311 of the PATRIOT 
Act to name Liberty Reserve as a primary money--laundering 
concern and take steps to terminate its access to the U.S. 
financial system. We stand ready to take additional regulatory 
actions as necessary to stop other abuses.
    As the financial intelligence unit for the United States, 
FinCEN must stay current on how money is being laundered in the 
United States so that we can share this expertise with our 
domestic and foreign partners and serve as the cornerstone of 
this country's AML/CFT regime. We are meeting this obligation 
in the virtual currency space as we continue to deliver 
cutting-edge analytical products to inform the actions of our 
many partners. The Administration has made appropriate 
oversight of the virtual currency industry a priority, and 
FinCEN is very encouraged by the progress we have made thus 
far.
    Thank you for inviting me to testify before you today. I 
would be happy to answer any questions you may have.
    Senator Warner. Thank you so much.
    Mr. Cotney.

     STATEMENT OF DAVID J. COTNEY, COMMISSIONER OF BANKS, 
MASSACHUSETTS DIVISION OF BANKS, ON BEHALF OF THE CONFERENCE OF 
                     STATE BANK SUPERVISORS

    Mr. Cotney. Thank you. Good afternoon, Chairmen Warner and 
Merkley, Ranking Members Kirk and Heller, and Members of the 
Subcommittees. My name is David Cotney, and I serve as the 
Commissioner of Banks for the Commonwealth of Massachusetts.
    It is my pleasure to testify before you today on behalf of 
the Conference of State Bank Supervisors. I thank you for 
holding this hearing today to address the risks and benefits of 
virtual currency.
    The risks of virtual currency include consumer protection, 
payment systems, national security, money laundering, and other 
illicit activities. The potential benefits are also diverse: 
speed and efficiency, lower transaction costs, and providing an 
outlet for the unbanked and underbanked.
    With these evolving payment technologies, States are 
exploring the connection between existing money transmitter 
regulation and virtual currencies. State regulators have long 
supervised money transmitters to protect consumers and preserve 
national security and law enforcement interests.
    State regulators are talking with industry and other 
regulators about evolving methods of moving funds. This 
includes virtual currencies, prepaid cards, mobile services, 
and peer-to-peer transactions. State regulators believe that an 
open dialogue among regulatory, industry, and other 
stakeholders is key to accomplishing the goal of determining 
the appropriate level of oversight and supervision.
    Emerging payment technologies and alternative currencies 
are, at their core, about the electronic movement of other 
people's money. This is not unlike the activities of money 
transmitters for which the States have an established structure 
for regulation and oversight.
    Licensing is the foundation of supervision, ensuring that 
businesses in a position of trust are legitimate and 
accountable. And entities seeking a State license must submit 
information to verify their credentials, typically including 
criminal background and credit checks, business plans, 
financial statements, and surety bonds.
    State regulators examine money transmitters on an ongoing 
basis, ensuring that a company does not lose its customer's 
money and complies with consumer protection laws. Further, 
States actively examine for Bank Secrecy Act and anti-money-
laundering requirements, coordinating with FinCEN and the IRS.
    In addition to licensing and examinations, enforcement is a 
key part of State supervision. After working with the Brazilian 
Central Bank and two private banks in Brazil, my division 
earlier this year found evidence of forgery and ongoing illegal 
conduct by a licensed money transmitter. Relying on existing 
State-to-State coordination processes, 37 States were able to 
ensure that all customers were made whole after we shut down 
the company.
    Cooperation has been a hallmark of State supervision, 
manifested in a uniform licensing system for all States. 
Originally developed by the States as a mortgage licensing 
platform and codified into Federal law by the SAFE Act of 2008, 
the Nationwide Multi-State Licensing System has become an 
integral part of State supervision for a variety of nonbank 
financial services providers. Massachusetts and 14 other States 
currently use NMLS as the licensing platform for money 
transmitters, and 14 more will start using the system in the 
next year.
    To improve the States' ability to use the NMLS for other 
licenses like money transmitters, I want to note CSBS' support 
for S. 947, which enhances the SAFE Act's protections for 
confidential or privileged information.
    To address the rapidly changing technology and payments 
landscape, CSBS continues to explore policy options for digital 
issues facing regulators. We look forward to working with 
Congress and policymakers to continue a collaborative approach 
to all innovative financial products and services, ensuring 
individuals and economies are well served.
    Thank you, and I look forward to answering any questions 
you may have.
    Senator Warner. Thank you both for your testimony.
    We will put 5 minutes on the clock and go back and forth.
    I want to pick up on something Senator Heller said in his 
opening statement as I try to, again, wrap my head around this. 
We have to strike the right balance since we are talking about 
here no governmental entity, and we are talking about here the 
anonymity that is allowed to take place, the ability to set up 
these exchanges with very little oversight. If we lay too much 
a regulatory burden, we could simply chase these exchanges 
offshore and still leave Americans unprotected.
    So I guess my first question for both of the witnesses is: 
We are talking about this as a currency, but have we really 
determined even that? I mean, there are some who said this may 
simply be an Internet protocol. Or is this a security? Have we 
thought through--or is it a currency? And from FinCEN, and 
also, David, if you want to make a comment as well, you know, 
has FinCEN consulted at all with the SEC or the CFTC as you 
have started to develop your guidance? And then, Mr. Cotney, if 
you would answer the question as well, you know, is there any 
kind of beginnings of an international regime, as you talked 
about with the Brazilians, how they are categorizing this 
development?
    Ms. Shasky Calvery. Thank you, Senator. I will attempt to 
take those questions in turn.
    So first on the issue of is it a currency, FinCEN is the 
regulator for anti-money-laundering and counterterrorist 
finance purposes, and so we have never opined and still are not 
opining as to whether virtual currency is a real currency, or a 
commodity, as those questions are really outside our purview.
    What we do recognize is that it exists and that it is 
operating and value is being transferred through the U.S. 
financial system, and as such, we need to protect that 
financial system from illicit actors.
    And so we were able to cover it under our pre-existing 
definitions and regulations, which include the concept of other 
value that substitutes for currency. So we did not need to take 
a position. But in terms of have we consulted with other 
regulatory bodies here, at least federally, the answer is we 
have. Again, as a part of our rulemaking and our guidance on 
our narrow lane and issue, we spoke with the FBI, the Secret 
Service, DEA, ICE, FDIC, OCC, IRS, the Federal Reserve, NCUA--
--
    Senator Warner. And they all have sophisticated opinions on 
Bitcoin?
    [Laughter.]
    Ms. Shasky Calvery. Yes. Now that I will let them answer. 
But we did consult with--including CFPB from the consumer fraud 
perspective. But, you know, we have consulted with all of them 
as we can. This is a developing and innovative arena. We were 
lucky to be able to cover it under pre-existing regulations. As 
we talked to our counterparts abroad, which I think was kind of 
the last portion of your question, there is great interest by 
fellow regulators abroad, as they are trying to get their heads 
around what is this and what does it mean. Our German 
counterparts, like us, had fairly flexible regulations in place 
that they could fit this within pre-existing regulations, and 
so they have done so. And other countries thus far have been 
asking us to see what we are doing and why.
    And, finally, I understand the Financial Action Task Force, 
which is the AML standard-setting body for the international 
community, plans to take up this topic.
    Senator Warner. Mr. Cotney?
    Mr. Cotney. In answer to your first question about the 
level of regulation, that is exactly what the States are trying 
to do by working with our colleagues, both State and Federal 
regulators, law enforcement, working with industry, to make 
sure that we have the appropriate level of oversight and 
supervision, and that we have the tools to detect and prevent 
illegal activity.
    In terms of your second question on international regimes, 
I think it is important to note that many of these evolving 
alternative payment systems are in response to consumer demand. 
And as we have seen in Europe and as we have seen in Canada and 
elsewhere, there is a big demand for more real-time payments at 
lower transaction costs, including the transmission of money 
from one country to the next.
    There are many members of Europe and Canada that have 
embarked on efforts to speed the payment systems. Ours has not 
really evolved substantially in the last 40 years. So I think 
now is the time to be talking about this subject.
    Senator Warner. Well, I am going to turn to Senator Kirk, 
who I know will press on some of the potential for abuse, but, 
you know, I may want to get back some of the folks from 
Treasury at some point, because I do think there could at least 
be the potential of serious implications about monetary policy. 
We have taken--even though with Congress' recent actions 
sometimes we seem to be jeopardizing America's status as the 
reserve currency, with some of our, I think, mistakes we have 
made, but, you know, if you think a little broadly, this could, 
again, have huge, huge implications. So I am looking forward to 
further pursuing this.
    Senator Kirk?
    Senator Kirk. Thank you, Mr. Chairman. I would just ask 
Jennifer one quick question. Have we seen any recognized 
terrorist group ever express interest or actually use Bitcoin 
for its operations?
    Ms. Shasky Calvery. So we have certainly recognized the 
possibility and the vulnerability there. There is nothing in 
terms of information in the public domain about a terrorist 
organization expressing such interest or using it, but we would 
always be more than happy to have any outside briefings to 
discuss that topic further.
    Senator Kirk. Thank you.
    Thank you, Mr. Chairman.
    Senator Warner. Senator Merkley.
    Senator Merkley. Thank you very much.
    I wanted to ask a couple things related to different forms 
of crimes that have occurred with bitcoins. The first thing I 
want to ask is: There is a centralized public ledger that is 
encrypted, and so the anonymity is only in terms of--you are 
not truly anonymous. There is an encrypted version of who owns 
what. And so one concern about, if you will, the reliability of 
a currency is whether that encryption can actually be broken. 
So I want to ask that question. There are some very powerful 
code breakers in the world, and we certainly have discussions 
about our own U.S. capability to break codes quite often up 
here.
    But the second is we have had this series of reported 
crimes. One was a Bitcoin savings and trust which ran a pyramid 
scheme in bitcoins. We also had the hacking of a Bitcoin 
exchange called BitFloor, and as it was reported, 24,000 
bitcoins were stolen. And we had Instawallet, a wallet provider 
that was hacked, and they lost 35,000 bitcoins. These are not 
small-dollar items given the value of the individual coins. But 
maybe to paint a little bit of a picture for us, how does this 
all work? If there is a public ledger that is keeping track of 
who owns what, then how does one actually steal a bitcoin?
    Ms. Shasky Calvery. All right. So in terms of breaking the 
code and the really powerful cryptologists that are out there, 
I just do not know the answer to that. I do not know if there 
is anyone out there that can break the code. It has certainly 
been represented to us at FinCEN that it is as strong an 
encryption as exists out there, and so it seems quite safe from 
that standpoint.
    Senator Merkley. This is prime number trapdoor cryptology?
    Ms. Shasky Calvery. To tell you the truth, I do not know 
the type of cryptology that is used, but I would be happy to 
take that back and get you an answer.
    In terms of some of the types of schemes you mentioned, 
whether it is a pyramid scheme or hacking, probably the most 
relevant concept that comes up there is the irrevocability of 
the transactions of bitcoins. So the idea that when I take a 
bitcoin and pay you with that bitcoin, there is no way for me 
to get that money, so to speak, or that bitcoin back unless you 
choose to give it to me and choose to tell me who you are. And 
so that can be a great tool for fraudsters in the pyramid 
scheme sense or hackers who hack into your computer and are 
able to get your code that is your half of the bitcoin, so to 
speak.
    So as I understand it, there is a public key and a private 
key to Bitcoin. I think of the public key myself almost like 
the routing number on my bank account, and I do give that to 
others who might want to send me money, and I am happy to give 
that public information. What I am not going to give you is the 
PIN that I use to access the ATM in my account, and the private 
key is like that PIN. And so typically the person holds onto 
the PIN, as it is--or the private key. It is only when you put 
the public and private key together that you now have some 
bitcoin that you can actually do something with. And so if a 
hacker gets your private key, they are able to take your 
bitcoin, and you cannot get it back.
    Senator Merkley. They can modify essentially the public 
ledger, and the public ledger becomes de facto record of 
ownership.
    Ms. Shasky Calvery. That is exactly right.
    Senator Merkley. OK. So in these--well, OK. Let me see if 
Mr. Cotney has any comments on this.
    Mr. Cotney. Well, you bring up an interesting case 
regarding consumer protections, because as the Director noted, 
these transactions are irreversible. And as a regulator charged 
with consumer protection, that is what we are interested in 
every day: the interests of consumers to make sure that their 
money gets from Point A to Point B and that there is someone 
reliable standing behind that transaction. And that is what we 
are interested in.
    Senator Merkley. Well, in the few seconds I have left, I 
will just say it is fascinating that this system, which is not, 
if you will, continuously tended but is in this public space, 
has been robust enough to hold up for this long without a major 
flaw that brought the entire thing down, it certainly has 
attracted the attention of innumerable other programmers around 
the world asking, well, can we create a similar system, and so 
thus we are here today.
    Thank you.
    Senator Warner. And I would just echo, based upon other 
commodities where there is a physical presence, you can somehow 
trace it back. The fact that we are talking about something in 
the virtual world really has, again, remarkable ramifications.
    Senator Heller?
    Senator Heller. Thank you, Chairman. I want to thank our 
witnesses for being here today. We are trying to grapple with 
this, trying to figure this out, and we have more questions 
than answers, and hopefully you can answer some of these 
questions.
    Ms. Calvery, I just want to know when the first time--when 
did FinCEN first start to take notice of these bitcoins and 
other virtual currencies?
    Ms. Shasky Calvery. Back in probably 2007 with the e-gold 
case. It was back then that we put out, I believe it was, an 
administrative ruling talking about e-gold, which was a 
commodity-backed virtual currency, and even back then put out 
our view that it fell under the money-transmitting regulations 
issued by FinCEN. And so we have been keeping up with it since 
that time.
    Senator Heller. Do you have any idea what percentage of the 
current virtual currency users and perhaps businesses are 
participating in illegal activities?
    Ms. Shasky Calvery. We would have no way to know that. What 
we do know is if you take a currency, a virtual currency like 
Liberty Reserve, that was an instance where we believe it was 
set up for the purpose of laundering money, and the vast 
majority of transactions using Liberty Reserve were to 
facilitate criminal activity of all types. It is what the 
Department of Justice alleged; that is what we alleged in our 
311 action.
    With regard to Bitcoin, I think we may have a bit of a 
different situation. It seems that there is a lot of legitimate 
users out there, and like any type of payment system, it can be 
exploited by illicit actors, and we have seen it exploited by 
illicit actors, at least with regard to the allegations made by 
the Department of Justice in the Silk Road matter alleging that 
it was used--Bitcoin was used to facilitate hundreds of 
millions of dollars of money laundering.
    Senator Heller. On that Silk Road issue, the FBI seized 
about 144,000 bitcoins. What does the Federal Government do 
with those?
    [Laughter.]
    Ms. Shasky Calvery. So luckily that is not an issue that we 
will have to deal with at FinCEN, but I can tell you from my 
past job as the head of the forfeiture program that they will 
be thinking about whether they can sell those assets.
    Senator Heller. Do they still have them?
    Ms. Shasky Calvery. I would have to defer to my colleagues 
at the Department of Justice.
    Senator Heller. I want to talk, Mr. Cotney, a little bit 
about volatility. As we know, last week it was trading 
somewhere around $400. It went up to as high as, I think, $900 
yesterday, and it finally settled at $600. Why the volatility?
    Mr. Cotney. Well, I think that there is a great interest in 
this particular space. There is, as I mentioned, a demand for 
real-time payments and lower transaction costs. And one of the 
means today now that we are looking at is through virtual 
currency.
    Certainly at the State level, we have a regulatory regime 
in place. As I mentioned, we are consumer protection regulator. 
We are not an investor protection regulator like the SEC, like 
the States. So we want to make sure that those consumers are 
protected, and just like any investment, someone who is looking 
at making an investment, whether it is in virtual currency or 
in a stock or a bond investment, they need to do their due 
diligence.
    Senator Heller. Do you follow anything that goes on in 
China and Europe? It is my understanding that they are 
increasing in volume in other countries. Is there any reason 
for this? Would you have any knowledge?
    Mr. Cotney. I do not have any direct knowledge, sir, no.
    Senator Heller. Jennifer?
    Ms. Shasky Calvery. My understanding is in some countries 
there may be an interest in Bitcoin because it can--where you 
have a home currency that might be considered extremely 
volatile itself, Bitcoin might be considered a better place in 
which to store value. And in other places, it is also 
considered a good medium for transacting--or transferring 
value. And so if there is not a good internal system for 
transferring value efficiently, it might be used for that 
purpose as well.
    Senator Heller. Thank you.
    Thank you, Mr. Chairman.
    Senator Warner. Senator Heitkamp.
    Senator Heitkamp. In the category of shameless plugs, 
congratulations on holding a hearing on something that could be 
a problem later on and is not a crisis right now. It is such a 
rare moment.
    [Laughter.]
    Senator Heitkamp. Seriously the Homeland Security Committee 
is starting to weigh in on this, and I am going to take this 
conversation away from the illegal to the practical realities 
of what we are dealing with here. As this becomes, as Senator 
Merkley suggested, a common method of transmitting goods and 
services, payment of goods and services, replacing a dollar 
bill or replacing a credit card, which we know are longstanding 
methods, there are a tremendous number of challenges by not 
categorizing this.
    Now, I noticed both of you, especially you, Jennifer, have 
deferred that, saying thank goodness we did not have to 
achieve, you know, that result because we had enough broad 
authority that allowed us to pursue this.
    But let us take, for example, a bitcoin being used to buy a 
pie. How do you ring that up on the cash register? What is the 
sales tax on that? How do you record it for income tax 
purposes? How do you transmit it for purposes of payroll taxes? 
How do you deal with this when it becomes a more commonly 
accepted method of transmission?
    And so what I am saying is that it is not just nefarious 
groups, you know, terrorists and illegal operations that have a 
potential of really skirting on the edges. It is, in fact--the 
more commonly accepted it is and the more available it becomes, 
the more difficult it is for regular kind of regulatory 
activities to be carried out, especially tax activities.
    I would like maybe your thinking on whether categorizing a 
bitcoin achieves a result so that we then can think about the 
regulatory regime or whether we need to create a whole new 
category and think about this differently. Either one of you 
can answer that question.
    Ms. Shasky Calvery. Sure. From an anti-money-laundering/
counterterrorist financing perspective--and I will go broader 
in a moment, but from that limited perspective, it is not as 
important. We have similar regulations across different parts 
of the industry, the idea that they are going to have anti-
money-laundering controls in place, that they are going to 
provide certain reports on suspicious activity to FinCEN, 
regardless of whether it is a commodity or a currency or a 
security, those basic protections will follow however we define 
it. So from our perspective it is not as important.
    But I take your point. Look, this country and all countries 
are going to have an interest in protecting consumers and 
protecting investors and thinking about monetary policy and 
thinking about taxing. All those things and reasons why we have 
regulatory and statutory schemes in every country around the 
world covering these issues, if Bitcoin truly takes off and 
becomes a serious part of the financial system, then those 
issues will need to be brought to the forefront.
    I think there is still a question and that we cannot assume 
that Bitcoin is going to become the major player that many 
enthusiasts think it will. It very well might, and far be it 
for me to know which way this is going to go. I did hear some 
venture capitalists speak recently, though, and say that they 
saw this as a binary investment. This is either going to take 
off and be the next great thing. It is going to be the cell 
phone of 20 years ago. Or it is going to be a nice experiment 
that completely fails. And so I think we are waiting to see, 
and in the meantime, at least at FinCEN, we are trying to make 
sure that we protect our U.S. financial system from illicit 
actors.
    Mr. Cotney. Senator, I think you rightly pointed out the 
differences between legal activity and illegal activity. 
Illegal activity--and we cannot be distracted by this--is 
illegal no matter what the means, whether it is paid for by 
cash, paid for by ACH, or----
    Ms. Shasky Calvery. Guns.
    Mr. Cotney. Exactly, or through now virtual currency.
    On the legal side, those actors who want to play by the 
rules will work through, you know, agencies like mine, will 
play by the rules set by FinCEN, and that is really the 
importance of a comprehensive set of regulations, both on the 
State and the Federal level.
    Senator Heitkamp. Just to follow up on a comprehensive set 
of regulations, you tell me--I am now the State tax 
commissioner, and someone paid in a bitcoin, and I call you up 
because I find out you have expertise, and I say, OK, I just 
heard that this thing is trading for $700, is that what the pie 
is worth? Do you think you could come down and be my expert 
witness when I collect sales tax on $700?
    Mr. Cotney. Well, fortunately I am not the tax 
commissioner.
    [Laughter.]
    Senator Heitkamp. I used to be. And so, I mean, this is 
going to be a big challenge. And my point is that we can focus 
on the illegal part of this, but to the extent that it becomes 
recognized as a valid method in the perfectly legitimate 
commercial world of transferring goods and services, this is 
going to become an increasing problem. And the more the 
opportunity presents itself to evade, not illegally but to 
avoid taxation, to say that actually was speculation, you know, 
so are you going to pay capital gains on it--I mean, it is a 
really interesting challenge. And I think we need to be 
thinking about these issues if, in fact, we see this becoming a 
way to transmit goods and services that is more generally and 
regularly accepted.
    Senator Warner. I think you raised a great point, and since 
many--you know, we point here to today's focus on nefarious 
schemes, but since it seems from, as I learn about this, a lot 
of folks who are interested lack trust in central banks, you 
know, want to be, in fact, kind of off the grid, a huge, huge 
number of questions.
    Senator Moran?
    Senator Moran. Mr. Chairman, thank you. Thank you both for 
being here.
    Earlier this afternoon I posted on Reddit this hearing 
topic and asked Kansans in particular to comment on what I 
should know, what would be some suggestions for questions that 
they might have. And, interesting, in just the last few hours 
125 responses, most of them very long and thoughtful.
    Let me explore one of the topics that was raised, and in a 
sense it is regulatory arbitrage. Is there an effort to make 
certain that the regulations are uniform globally? And in the 
absence of that, is there not a risk that the activity is 
simply taken offshore if we are the country that is the 
regulator? And is there an economic consequence to that 
happening? What is the downside to our country and its economy 
and the opportunities for innovation if the United States is 
the heavy regulator and other countries are not?
    Ms. Shasky Calvery. Sure. Maybe I can take that from both 
the domestic perspective and then the international, because 
here, of course, in the United States we have the States and we 
have the Federal regulation.
    We do, I think, a fairly good job, as Mr. Cotney mentioned 
in his testimony, of the States working together to try to find 
common approaches whenever possible, and then with FinCEN to 
work with the States on the Federal approach and try to get as 
much common ground there as we can so that we have as much 
consistency as we can at least within the United States. Then 
we go externally.
    Externally, at least from the money-laundering and 
counterterrorist finance perspective, the Financial Action Task 
Force is the international standard-setting body that attempts 
to keep a consistency in standards across the globe, and it is 
a body that has both carrots and sticks, and it has been fairly 
effective in getting countries to put regulations in place.
    But all that being said, I think if businesses are going to 
leave the United States based on perceived or real regulatory 
burden, I think they are going to find the gain short-lived 
because, as mentioned, countries are going to have an interest 
in figuring out the tax implications and monetary policy. It is 
not just the United States that has an interest in these things 
and in protecting consumers and investors and so forth. So the 
regulation is going to catch up, and I think there are plenty 
of good reasons to bring innovative business and keep 
innovative business in the United States.
    Mr. Cotney. I think it is very important to leverage the 
strengths of each of us, the State regulators and the Federal 
agencies. At the local level, as a State regulator, I know, for 
example, that there is a large Cambodian population in Lowell. 
I know Lowell, Massachusetts. I know that there is a large 
Brazilian population in Framingham. I send examiners out every 
day to conduct examinations, to do transaction testing, testing 
actual transactions of money going abroad. So we have the boots 
on the ground and a local understanding of these companies.
    And then we pair that with the national perspective and 
knowledge of Federal agencies who also interact on an 
international level. By leveraging these strengths, I think we 
do a much better job at detecting and preventing this illegal 
activity.
    Senator Moran. I appreciate both those answers. Do you have 
a sense about the importance of this activity being centered in 
the United States? What is it that--this is a broader question 
than a regulatory one, but what benefits does our economy and 
our innovative environment gain by encouraging or at least not 
discouraging the bitcoin from being centered here?
    Ms. Shasky Calvery. So I think what we gain is our 
continued reputation and economic advantages as being a country 
where innovators come to start new businesses, and that gives 
us great economic value, and it is something we would want to 
continue. So I think the great challenge for the regulators is 
to encourage innovation wherever we can and put smart 
regulation in place that tries to deal with risks, very real 
risks about which we need to be concerned, but minimizes burden 
on innovation.
    Mr. Cotney. Clearly the United States, the mother of 
invention, we want to take advantage of innovation, and to the 
extent that we see innovation in this space, that could have 
spillover effects into other payments or other financial 
industries or even beyond the financial services industry. So 
we want to be able to encourage innovation and have it 
developed here locally.
    Senator Moran. I appreciate that.
    Mr. Chairman, thank you.
    Senator Warner. I think we have all got a lot more 
questions for you, but we understand a vote will be held around 
5, so we want to make sure we get to the second panel. I want 
to thank you both for your testimony, and I look forward to 
continuing the dialogue.
    Ms. Shasky Calvery. Thank you for the opportunity.
    Mr. Cotney. Thank you.
    Senator Warner. Now I will turn the chair over to Senator 
Merkley at this point, and he can go ahead and maybe start 
introducing the next panel.
    Senator Merkley. [Presiding.] Because of the time, I am 
going to start introducing you as you come up, so feel free to 
take your seats quickly.
    I will start with Paul Smocer, the President of BITS. BITS 
in this case I do not believe has any relation to the term 
``bitcoin.'' BITS is the technology policy division of the 
Financial Services Roundtable. Mr. Smocer joined the Roundtable 
in February 2008 as Vice President of Security. In this role, 
he led BITS work in promoting the safety and soundness of 
financial institutions through best practices and successful 
strategies for developing secure infrastructures, products, and 
services.
    Second, we have Professor Sarah Jane Hughes. She is a 
University Scholar and Fellow in Commercial Law at Indiana 
University's Maurer School of Law. For the past 25 years, 
Professor Hughes has regularly taught payments law, commercial 
law, and banking regulation at the Maurer School of Law. She is 
a nationally recognized expert on payment systems, public and 
private methods to detect, deter, and prosecute domestic and 
international money laundering, and consumer protection and 
financial privacy.
    Next we have Mercedes Kelley Tunstall. She is a partner at 
Ballard Spahr and the practice leader of their Privacy and Data 
Security Group. She has substantial experience working with 
clients to develop new financial products and services, 
including virtual currencies. She also works with clients from 
a spectrum of industries on mobile and other e-commerce 
initiatives, privacy and cybersecurity issues, and the use of 
social networking sites for marketing, consumer service, and 
crowdsourcing purposes.
    And we have Anthony Gallippi. Anthony is the cofounder and 
CEO of BitPay, an electronic payment processing system for 
Bitcoin. Mr. Gallippi founded BitPay in 2011. He has 15 years 
of experience in sales and marketing working in the robotics 
industry. Before founding BitPay, Mr. Gallippi was district 
sales manager at Aerotek and regional sales manager at 
Industrial Devices Corporation.
    So, Paul, we will start with you. Thank you to all of you 
for bringing your expertise to bear on this topic.

 STATEMENT OF PAUL SMOCER, BITS PRESIDENT, FINANCIAL SERVICES 
                           ROUNDTABLE

    Mr. Smocer. Thank you, Chairman Merkley and Chairman 
Warner, Ranking Members Kirk and Heller, and Members of the 
Subcommittees for the opportunity to testify today. My name is 
Paul Smocer, and I am the President of BITS, the technology 
policy division of the Financial Services Roundtable.
    Attempts to develop digital currencies have existed for 
decades. As consumers have become more comfortable with 
Internet financial activity and computer systems have become 
more powerful and less expensive, we are witnessing the 
viability of digital currencies increase. However, we need to 
recognize that digital currency usage exists outside of 
traditional currency, financial accounting, and payment 
systems. In my testimony today, I will address both 
opportunities and risks in the environment.
    One measure of a currency's success is its acceptability. 
We are beginning to see select retailers accepting digital 
currencies for goods and services. For example, the Web 
publishing service WordPress accepts bitcoin as a form of 
payment. Just last week, the Federal Election Commission 
indicated it is considering allowing Bitcoin's use as in-kind 
contributions. Merchant and Government agency acceptance will 
establish these currencies' legitimacy and increase the trust 
parties have in them and their stability.
    Digital currencies also allow merchants access to new 
consumers in countries where traditional payment systems do not 
permit access. The lack of interchange fees and chargebacks 
also appeal to merchants.
    Digital currencies may also have the ability to provide 
access to the underbanked and unbanked. For example, a mobile 
phone-based money transfer and microfinancing service in Kenya 
called M Pesa recently added a bitcoin payment option for its 
customers.
    Digital currencies can also help individuals in countries 
with repressive regimes to support causes they might otherwise 
not be able to support through their country's traditional 
payment providers. They can also serve as a potentially stable 
currency in countries whose own currencies are in distress. For 
example, during the recent Cyprus financial crisis, citizens 
transferred funds to digital currencies.
    Another interesting aspect related to certain digital 
currencies is cryptographic protections, which some providers 
claim prevent counterfeiting and duplication.
    Digital currencies and the supporting infrastructures do 
present opportunities to watch, including facilitating real-
time payments, particularly those involving international 
parties and those involving micro payments; possibly deeper 
cryptographic options for Internet-based transactions; and 
opportunities to serve the underbanked and politically 
repressed more effectively.
    While there are opportunities, we also have to recognize 
the potential risks. First, as noted, digital currencies pose 
significant market risk. Without Government funding or support, 
digital currencies are often subject to significant market 
volatility, creating risks to both holders of the currency and 
to merchants and others who accept the currency as payment.
    Beyond the March 2013 guidance issued by FinCEN, the 
digital currency environment incorporates virtually no existing 
regulatory protections, particularly consumer protections. For 
example, and also as noted, within the last 2 months there have 
been multiple reports of currency disappearances from various 
bitcoin trading platforms. In none of these cases is it likely 
that the owners will recover anything.
    The lack of consumer protections extends to other areas, 
such as liability limits for fraudulent or unauthorized 
payments. Currently none of the digital currency operators or 
infrastructure providers is subject to regulatory oversight 
applied to regulated financial providers, such as the Gramm-
Leach-Bliley Act's cybersecurity and data breach notification 
requirements, the Federal Financial Institutions Examination 
Council's regulatory guidance, or often to independent 
regulatory examinations.
    Given the anonymity of the digital currency world and the 
lack of Know Your Customer requirements that apply to 
traditional financial institutions, using digital currencies 
individuals may also be able to donate to illegal organizations 
that would otherwise be legitimately banned, such as those 
engaged in terrorist financing.
    Some recent studies, as we have been discussing, suggests 
the anonymous nature of digital currencies has made them a 
haven for illegal activity. We talked about Silk Road, and we 
talked about Liberty Reserve, but those I think are probably 
just the prime examples of the point that criminals are using 
digital currencies to assist in a broad array of criminal 
activities.
    So as we look at the lack of regulatory oversight, the 
risks to consumers, and the market risks associated with 
digital currency, there is a continuing challenge to their 
overall legitimacy, usage, and endorsement.
    In conclusion, clearly the use of digital currencies will 
continue to evolve, and there are opportunities to explore, but 
we will need to address both the concerns to consumers, to 
society, the need for appropriate regulation, and the 
effectiveness of risk mitigations.
    Thank you for your invitation to testify to the 
Subcommittees, and we look forward to continuing to work with 
you.
    Senator Merkley. Thank you.
    Professor Hughes.

 STATEMENT OF SARAH JANE HUGHES, UNIVERSITY SCHOLAR AND FELLOW 
   IN COMMERCIAL LAW, INDIANA UNIVERSITY MAURER SCHOOL OF LAW

    Ms. Hughes. Thank you, Mr. Chairman, Chairman Warner, 
Ranking Members Heller and Kirk, and honorable Members of both 
Subcommittees, I am honored to be here with you today.
    Monitoring the developments in digital currencies and 
taking a responsible approach to their regulation reflects 
their growing presence in domestic and international 
transactions. Recent negative publicity associated with law 
enforcement actions against Silk Road and reports of the 
disappearance of bitcoin exchange values in China and the Czech 
Republic raises important policy concerns.
    I have, as the Chairman said, worked in areas that are like 
this for a long time, not as a provider but as a watcher. And I 
also wish that my late father could be here today because he 
served in World War II as a cryptographer for the United States 
and was early involved in the computing industry in the United 
States. I remember being a teenager when he brought home two 
big briefcases, and he said, ``It is a computer.'' And it was.
    So one of the things is that we are seeing in a relatively 
short period of time important, path-breaking changes in 
technology of the character that Senator Warner suggested 
earlier, and we need to be very cautious not to chill those 
innovations, but we still need to have appropriate legal 
regimes around them. And I think it is important that we take 
some time and craft those legal regimes with great care and in 
as flexible a way as possible, particularly with regard to the 
remarks of Director Calvery and Commissioner Cotney.
    So I had a number of recommendations that responded to the 
questions that the invitation to appear put forward, and taking 
them slightly out of order from my prepared testimony, 
obviously there has already been some support for the idea of 
retaining the current division between the States and the 
Federal Government for portions of the role that each do very 
well. And I share those views.
    Second, I think it is incredibly important that we enforce 
our anti-money-laundering, anti-terrorism, and economic 
sanctions laws. And as a corollary, I also believe that 
customers of programs such as Bitcoin and other virtual 
currencies that may develop should get the same Federal 
protections that people get under Gramm-Leach-Bliley, under the 
Right to Financial Privacy Act of 1978, et cetera.
    I think FinCEN has taken important steps toward clarifying 
the application of their existing authority, and I think we 
need to continue to clarify particularly so that banks and 
investors do not get cold feet, because we have no way of 
knowing today what second-stage innovations that may have 
completely different roles in our economy these new 
technologies may offer us, and we want to be certain we do not 
do anything to take them offline.
    I would encourage on an interim basis payment systems 
operators, assuming that we all agree that this is a payment 
system and not something else like commodities or securities, 
to adopt and publicize their own transparent standards of how 
they will behave. As you suggested, legal liability limits, 
dispute resolution possibilities, guarantees for redemption 
opportunities, and clear rules about when redemption can happen 
are all important user protections. Notice I said ``user'' and 
not ``consumer,'' because businesses who use have many of the 
same needs as consumers, and we tend to be focused on 
regulating for consumers. I spent lots of my life looking at 
consumer issues, but I am equally interested in businesses 
being protected.
    I think we need to leave room for depository and 
nondepository providers to innovate in the virtual currency 
space. And so we want a regulatory climate--we do not want a 
regulatory climate, rather, in which early entrants can freeze 
out later ones. We would like to have a lot of innovation in 
all of this space.
    I worked at the Federal Trade Commission many years ago, 
and one of the projects I worked on was the rescission of a 
number of 1940s and 1950s trade regulation rules that had 
essentially been written by industries for themselves. We would 
like not to see that again because they can be very anti-
competitive, and if they are anti-competitive, they are very 
anti-consumer. So we need an open set of rules.
    I am going to run out of time, but I would say that the 
other thing is do not buy the Wild West argument. Just because 
something is new does not mean it should not be regulated on 
the same basis as the types of activity with which it competes.
    Thank you so much for this invitation. I would be delighted 
to answer your questions.
    Senator Merkley. Thank you very much, Professor.
    And now Ms. Tunstall.

  STATEMENT OF MERCEDES KELLEY TUNSTALL, PARTNER AND PRACTICE 
   LEADER, PRIVACY AND DATA SECURITY GROUP, BALLARD SPAHR LLP

    Ms. Tunstall. Chairman Merkley, Ranking Member Heller, and 
Members of the Subcommittee, I am Mercedes Kelley Tunstall, a 
partner at Ballard Spahr here in DC, and I am the head of our 
Privacy and Data Security Group. My testimony today reflects my 
personal experience with the virtual currency industry and 
represents my own opinion. It does not necessarily reflect the 
opinions of Ballard Spahr or our clients.
    Thank you for this opportunity to testify about the present 
and future impact of virtual currency. I currently work 
directly with a number of clients in financial innovation 
issues, and one of the things, as I have been listening to the 
testimony today, that I feel like is worth saying is that one 
of the things that I often say with financial innovation is 
there is a tendency to say, ``Well, it is completely new. It is 
so new, we have never seen anything like it before.''
    But the fact is that it is like a lot of things that have 
happened in the past, so I am going to go through some of the 
statements that I have in my testimony, but let us start with 
the discussion of currency generally in the United States.
    The United States actually has a long history of having 
concerns around currency. It finally settled down in the 1870s 
when the Supreme Court had a series of opinions called the 
``legal tender cases,'' and basically what they said at that 
time is we are going to stop all this different stuff with the 
currencies, happening, we are going to say there is a U.S. 
currency, and the rule is everyone in the United States has to 
accept that currency. So there could be other currencies, you 
can accept other currencies, but you have to accept U.S. 
currency. It is the currency of the land, et cetera.
    So that is the basis that we are working from, and we do 
actually have a long history, long legal precedent that talks 
about how to handle different types of currency in our 
financial ecosystem.
    Having said that, when we take a look at Bitcoin and the 
lessons that we can learn from Bitcoin--and I want to point to 
you where we can talk about a bit of their failures.
    The first point is that Bitcoin was really designed to not 
integrate with our existing financial ecosystem. It was 
designed to be its own thing and try to, you know, break apart 
the world without working within the practical realities that 
we have today. And as a result, financial institutions, 
especially in the United States, view Bitcoin and other types 
of virtual currencies as being unreliable, getting involved 
into them affects their safety and soundness concerns, and so 
it really is something that right now, not much interest in.
    The next point that Bitcoin really focused on is that the 
transactions need to be anonymous. There is the sense that 
because it is virtual currency and we are trying to remake a 
cash transaction, it has to be anonymous. But if I am going to 
take a dollar bill and hand it to you, I have to see you and I 
know the personal information about you, at least some personal 
information, what you look like. So in the virtual currency 
world, there is no need for the currency transactions to be 
anonymous. It can be.
    The other two elements that Bitcoin addressed besides 
anonymity is taking out the middleman, so the bank involvement, 
and not having a record that has personally identifiable 
information in it. So I would say that in order to address the 
excesses that we are seeing with virtual currencies, where it 
is being used by criminals and terrorists and money launderers 
today--we do know that that is occurring--that the anonymity 
part of it, let us let that go. The whole point should be keep 
that middleman out of it, if that is what the virtual 
currency--and there are lots of reasons--we have had lots of 
people talk about the value that a virtual currency could have. 
Keep the middleman out of it, and we do have the technology 
today to make it possible that there is no a record with 
personally identifiable information for others to see, but it 
is something that is retained by the two parties involved in 
the transaction.
    Finally, Bitcoin has caused some of its own problems 
because it has this commodity aspect to it, and you could 
design--and some of the other virtual currencies out there have 
specifically been designed to avoid the boom-and-bust cycle 
that we have heard about today.
    So those are the three points really that we can learn from 
Bitcoin to allow virtual currency innovation to continue.
    In terms of looking at what has to happen from a legal 
perspective, I am just going to mention we do need to come to 
what a definition of virtual currency is. Is it a commodity? Is 
it not--is it a commodity or a security or not? We do need 
stronger FinCEN guidance as virtual currency develops.
    And then, finally, on the consumer protection side, we 
touched briefly on the unauthorized transactions issue. That 
issue also needs to be addressed and considered.
    Thank you very much for the opportunity today, and I am 
happy to take any questions.
    Senator Merkley. Thank you very much.
    Now we are going to turn to Anthony Gallippi, cofounder and 
CEO of BitPay.

   STATEMENT OF ANTHONY GALLIPPI, COFOUNDER AND CEO, BITPAY, 
                          INCORPORATED

    Mr. Gallippi. Thank you, Chairmen Merkley and Warner, 
Ranking Members Heller and Kirk, and distinguished Members of 
the Committee, for the opportunity to speak today.
    My name is Tony Gallippi, and I am the cofounder and CEO of 
BitPay. I appreciate the Members for their interest in the 
commercial and international trade aspects of digital 
currencies and, more importantly, the opportunities for digital 
currencies to create jobs in America and to increase America's 
exports.
    Our company, BitPay, was started in May 2011. We have been 
operating for over 2 years now, which makes us pretty old in 
the Bitcoin space. During this time we have acquired over 
12,000 merchants to accept bitcoin using our service. Our 
merchants include many small and medium-sized businesses in 
every State, who accept bitcoin side by side with credit cards 
and other forms of payment.
    Most online payments today are made with credit cards, but 
credit cards were never designed for the Internet. Credit cards 
were designed in the 1950s, and last year, over 12 million 
people became victims of identity theft, mostly from shopping 
online. Businesses lose over $20 billion a year due to payment 
fraud. The banks do not take responsibility for the fraud. If 
you are a business, it is your fault that you took a stolen 
credit card, even if the bank approved it. And credit card fees 
are discriminatory. The highest fees are paid by the smallest 
Mom-and-Pop businesses and the lowest-income consumers. Bitcoin 
is a cheaper, faster, and more secure payment system with no 
discrimination against smaller businesses.
    At BitPay, our role in the Bitcoin ecosystem is very close 
to that of the traditional merchant acquirers in the credit 
card space. Our software helps merchants clear and settle 
transactions over the Bitcoin network. BitPay has a strict Know 
Your Customer policy to verify all of our merchant 
applications. We need to know who our merchants are and what 
they are selling. We only want the good actors using our 
service.
    BitPay also follows all Bank Secrecy Act guidelines to 
prevent, detect, and report suspicious activity. Our strict 
policies to comply with laws and protect our brand have earned 
BitPay the reputation as a leader and well-respected company in 
the payments space.
    Bitcoin does have some limitations that will keep it a 
small player in the payments space for quite some time. 
Compared to credit cards, for example, Visa's payment network 
can handle 20,000 transactions per second worldwide. Bitcoin 
can handle seven--not 7,000, but seven transactions per second. 
So even though it is very small, Bitcoin has invented something 
pretty amazing. With Bitcoin, it is now possible to transfer an 
asset remotely and immediately settle the transaction, with no 
counterparty risk. That type of instrument has never existed 
before. And the possibilities of this instant worldwide 
settlement are very interesting. The Bitcoin block chain, which 
is the public accounting ledger of Bitcoin, is a large property 
rights database. It can handle quadrillions of individual asset 
accounts, with a full chain of custody every time an asset is 
transferred from one party to another.
    If you want to energize the housing market, think of 
Bitcoin. The biggest up-front costs for consumers trying to buy 
a home today are the closing costs, high fees for deeds, 
titles, stamps, insurance, and other redundant tasks to record 
the sale in different record books. Bitcoin can replace 
thousands of dollars in closing costs with a single transaction 
that costs 5 cents.
    Bitcoin does have risks. Criminals use cell phones, 
criminals use email, criminals use dollars, and criminals use 
banks. Many businesses like BitPay, offering innovative 
services on top of Bitcoin, share the Committee's goals to 
protect consumers from fraud and keep the criminals away from 
our businesses.
    Guidance from the IRS, Treasury, Justice, and SEC have all 
established that bitcoins are legal and that those dealing with 
them must follow the existing tax laws and anti-money-
laundering regulations.
    In the early 1990s, when the Internet was in its infancy, 
Congress took a wait-and-see attitude to let the Internet 
develop. So where would social media and other free 
applications of the Internet be today if in the 1990s we 
required licenses for the Internet and we taxed Internet access 
as if it was a telecom?
    In 1995, the National Science Foundation lifted its strict 
prohibition of e-commerce, and immediately companies like 
Amazon, eBay, and Dell were born. Americans will benefit from a 
similar openness and wait-and-see approach to Bitcoin.
    Bitcoin is a technology with tremendous cost savings for 
businesses and consumers. Bitcoin is a more secure, faster, and 
more affordable option for transferring funds. If America is 
the leader in Bitcoin technology, America will create more jobs 
and more exports.
    In conclusion, today Bitcoin is in its infancy. It is much 
like the Internet in the early 1990s. If we look 10 to 20 years 
in the future, we will see many companies built upon Bitcoin-
related technology, and we want those companies to be based in 
America, creating jobs in America, and building a revenue base 
and a tax base in America.
    I commend the Committee for recognizing the real, practical 
uses of virtual currencies, and thank you for the opportunity 
to speak today.
    Senator Merkley. Thank you very much.
    We are going to jump right into questions, and given we 
have 16 minutes and four of us, I am going to ask for 4 minutes 
to be on the clock. I am going to take my 4 minutes now, and I 
have three questions, so I am going to try to move them quickly 
and see if I can get through all of them.
    First, Mr. Gallippi, what is your transaction fee?
    Mr. Gallippi. So our transaction fee, when we first 
started, was 1 percent. So compared to credit cards that are 
around 3 percent, we are 1 percent. But we realized very 
quickly that our marginal cost to do a transaction is low, so 
we have actually switched over to a software as a service 
pricing model. Different features and different levels of 
service, merchants pay 1 monthly fee. Then they can transact 
all they want with no transaction fees.
    Senator Merkley. So I have got Whiffies out in Oregon that 
says it likes to accept bitcoins because it has a one-tenth of 
1 percent transaction fee. Do any of your transaction fees go 
that low?
    Mr. Gallippi. Possibly. If you take our monthly service and 
divide it by the volume that you put through, you could get 
something that low. That is correct.
    Senator Merkley. OK. That is fascinating. Thank you.
    Professor Hughes, I recently read the book ``The Wolf of 
Wall Street,'' and I think this is coming out as a movie soon, 
but this broker makes a lot of money, and at one point--this is 
a true story--he has his wife's aunt strapping money and taking 
it to Switzerland to put into Swiss bank accounts.
    Are Bitcoin wallets, like Instawallet, going to replace 
Swiss bank accounts?
    Ms. Hughes. Mr. Chairman, I do not know the answer to that 
question, but I would be delighted to speculate about it for a 
second.
    So there are two ways that you can currently--you could 
store anything you want, including bitcoins, right now on a 
private wallet. The trick is that it would be harder to 
transact business that way, so most people who do it use 
exchanges.
    But there are so many ways in which one can store value, 
which could and have included in the past putting it on stored 
value cards and loading them and taking them to Switzerland and 
not even needing to do that.
    So the answer is, yes, technically you can, and, yes, 
technically they could be. And I think that that is one of the 
reasons why rigorous and clear guidelines for how our anti-
money-laundering, anti-terrorist, and economic sanction regimes 
are applied to virtual currencies, not just bitcoins but those 
that may come in the future, are very important to us. We 
really do not want to facilitate hiding money, and we do want 
to be very careful that we protect people who are using 
currencies of this kind in war-torn areas or areas in which the 
governments are not reliable or the banking system is not like 
ours.
    Senator Merkley. Thank you. And I will follow up with some 
questions about the Electronic Funds Transfer Act and issues 
that may arise there. But I want to use my last minute to get 
to this question.
    Mr. Gallippi is talking about these very low transaction 
fees, which will make many of my merchants in Oregon, their 
eyes light up. And as we think about this, this actually--not 
Bitcoin by itself because we have a limited number of bitcoins 
under the structure it has created. It has security issues. But 
the concept in general poses some interesting models that could 
significantly change our credit card system, our bank deposit 
system, our debit card system. And, Mr. Smocer, in your role 
with the financial services world, can you give us a little 
insight on kind of the current thinking of those challenges?
    Mr. Smocer. Sure. And I actually like the way you 
characterized it because when I think about Bitcoin, we kind of 
tend to use it as a generic term, but in reality, at least for 
me, it really is three things: it is a currency, potentially, 
or a security; it is secondarily the way we use it a depository 
system, so the wallets and what-not; and, third, it is a 
payment system. So we are talking about kind of three different 
realms that I think we need to think about individually.
    I do think that, as I mentioned in the testimony, it has 
value in showing us that there are ways that we can make the 
payment system more rapid; we can perhaps make it less 
expensive. We can make it more available to the unbanked and in 
some cases to people who might not otherwise be able to use a 
payment system. But I think, having said that, I think without 
the consumer protections that we think about in traditional 
systems, there are a lot of risks to those users as well.
    And, you know, if I could go back actually to answer your 
question that you posed to Ms. Hughes as well, I am not sure 
you even have to move money to Switzerland in this case 
because, to me, the anonymity that is associated with users and 
their wallets would suggest I really do not need to try and 
cover who owns the money.
    Senator Merkley. Thank you. I am out of time, so we are 
going to pass this on to our Ranking Member.
    Senator Heller. Thank you.
    Mr. Gallippi, I have a couple questions for you. I would 
love to be at your home as you are explaining to your wife how 
your virtual company gave you a virtual paycheck using virtual 
money.
    [Laughter.]
    Senator Heller. But that being the case, I assume your 
business wants more consumers than investors.
    Mr. Gallippi. Well, actually, our business model--and I 
have detailed it more in my written testimony--we are just a 
merchant acquirer, so we only facilitate the payments for 
merchants. We do not have a consumer wallet. We do not offer an 
exchange for consumers. So we are strictly focusing on State 
acceptance and business adoption of Bitcoin, and the rules and 
regulations around that are fairly well defined, you know, in 
the credit card space, and our business model is very similar 
to them.
    Senator Heller. I am just wondering what would happen if 
someone like Senator Warner cornered the market of virtual 
coins. How would that impact the consumer marketplace?
    Mr. Gallippi. Well, it is interesting. You know, we look at 
Bitcoin being traded in open markets today, and China is 
getting very aggressive in the open market. And if we want 
America to remain a leader in technology and in Bitcoin, you 
have to look at the exchanges, because that is where all the 
liquidity is. And right now the number one exchange in the 
world for Bitcoin is in China. The number two exchange is in 
Japan. Numbers three, four, and five are in Europe. Number six 
is in Canada. America is not a leader right now in the 
liquidity and the exchange of bitcoins.
    Senator Heller. You talked a little bit earlier in your 
testimony about vetting these businesses. What is that? What do 
you have to do?
    Mr. Gallippi. Well, it is modeled really around the credit 
card system. You know, what does it take to get a merchant 
account with a credit card processor? We have modeled our 
system after that. So we need to know that, A, you are a 
legitimate business; we need to know who you are; and we need 
to know what you are selling. And then depending on the 
different levels of volume that you want to process, we will go 
even deeper into getting background checks and that kind of 
thing.
    Senator Heller. Ms. Tunstall, if virtual currencies become 
more and more popular, what keeps a bank from starting their 
own virtual currency?
    Ms. Tunstall. Absolutely nothing, except that, like I said, 
they do have to maintain their safety and soundness concerns, 
and a U.S. bank needs to be very focused on U.S. money. But 
there is nothing to stop a financial institution from getting 
into virtual currency themselves.
    Senator Heller. Are you familiar with other virtual 
currencies?
    Ms. Tunstall. I am sorry?
    Senator Heller. Are you familiar with other virtual 
currencies besides bitcoins?
    Ms. Tunstall. I am, yes.
    Senator Heller. Can you share some knowledge?
    Ms. Tunstall. Sure. So there are a number of virtual 
currencies that are designed for very kind of niche purposes 
that are designed for online video gaming-type situations, so 
you can play with your partners across in China and Japan and 
wherever, so there are a number of those types of virtual 
currencies.
    There are also a number of virtual currencies that are 
based on Bitcoin and try to basically fix some of the issues 
that I detailed in my testimony here today.
    And then there is also a virtual currency called Ripple 
that has started very differently from Bitcoin and started with 
the premise we are operating in an existing financial 
ecosystem, and we need to, you know, be able to comply with the 
criminal laws and anti-money-laundering laws that are in place.
    Senator Heller. Thank you.
    Thank you, Mr. Chairman.
    Senator Warner. I am going to try to go through the 
lightning round as well. First of all, I do not want to overuse 
my telecom analogy, but just as we saw in developing countries 
in many ways as they developed telecom networks, to skip the 
wired system and immediately go to wireless, wouldn't those 
regimes that have either huge currency restrictions or are 
enormously underbanked, couldn't you actually see initially the 
development of these virtual currencies actually quicker and 
faster in the underdeveloped world than in the developed world? 
Could we get quick responses? Because I have got two or three 
more questions.
    Ms. Tunstall. So my quick response on that is one of the 
reasons that virtual currencies in the United States have 
actually proliferated and succeeded is because of the strength 
of our financial system's security, and so for these other 
countries where there is not that kind of infrastructure, it is 
unlikely to be able to support the growth of a virtual currency 
as you are discussing.
    Senator Warner. Other views? Similar?
    Ms. Hughes. I agree.
    Mr. Gallippi. Yes, I think the example of Kenya is a great 
one. Kenya is a country where more people have access to 
smartphones than to running water. And, you know, the telecom 
companies stepped up and saw that there was a need, that the 
existing banking infrastructure was not meeting the needs of 
the people, and so the telecoms built a mobile payment system 
in Kenya that today represents 30 percent of the GDP of Kenya. 
It is done by people sending text messages on their cell phone.
    Senator Warner. And I guess, Mr. Gallippi, I want to just 
make an editorial comment. I agree with you. We have got to get 
this balance right. We want to keep this innovation in America. 
But as a former Governor, the revenue leakage from Internet-
based transactions for States that depend upon a sales tax is 
an enormous challenge. So we have got to get this balance 
right, and that is one of our challenges going forward.
    I guess I would want to press as well Senator Heller's 
comments. We have thought about and, Ms. Tunstall, you have 
commented about some of these other competing virtual 
currencies. I think about a few years back when Second Life was 
going to be all the rage and everybody was going to have an 
avatar and we were going to trade.
    You know, it seems, though, that the Bitcoin currency--that 
my understanding is--now has about 90 percent of the folks who 
are not users but actually investors rather than users, you 
know, at some point do you think one of these currencies will 
emerge and does Bitcoin seem to be going down that path? Or do 
you think there will always be that threat that other 
currencies--and, again, I think particularly your comments 
about one that tries to fit within the legal regime?
    Ms. Tunstall. So I think it is more--unless Bitcoin makes 
some big changes that allow the Silk Road-type situation to 
stop from happening, I do not see how it will become 
commercially viable in the United States. And I would like to--
you mentioned Second Life. I would like to mention that. 
Actually in Second Life, I looked at for a client--they wanted 
to brand the banks in Second Life and be the bank in Second 
Life. And as I looked at it, the way that the law works, even 
if it is in a virtual world, if the bank is doing the 
transactions, the U.S. banking laws apply.
    And so that was a very interesting result, and what is 
fascinating about virtual currency actually is that it has 
found a way to fall through what our infrastructure is right 
now for financial regulation, which is why we do need to have 
some kind of framework put around it.
    Senator Warner. My time is going to run out, but I would 
simply say, though, that because of some of the illicit 
activities and because of perhaps the interest of some of the 
folks who want to do this off the grid or not be controlled by 
a central banking system, you know, we have got to get this--
you know, we have got to sort through this right.
    I would also make mention, Mr. Chairman, that as a 
politician who had a Second Life avatar, that got me attention 
for a nanosecond.
    [Laughter.]
    Senator Heitkamp. Mr. Chairman, thank you. Just take this a 
different direction and just use my little time to tell a 
little story about when I used to regulate truth in 
advertising, and I could not get my advertisers to tell the 
truth, and so I told them they could tell whatever they wanted 
in an ad, but I was going to take out a full-page ad right next 
to theirs saying I do not regulate them. I do not regulate 
them; buyer beware. And we are really at that point because the 
more we legitimize this in regulation, the more we 
commercialize it.
    And so how do we strike that balance? And I am interested 
in the academic point of view and maybe the legal point of 
view. How do we strike that balance? Because to me, if we get 
involved in regulation, we legitimize it as a true opportunity.
    Ms. Hughes. Well, I think that there is a lot to what you 
say, Senator, that if we regulate, we do legitimize. And some 
of today's witnesses have talked about trust, and trust is a 
very important factor, particularly with financial products and 
services. So there is that risk.
    There is a bone in my body that says I think that is a risk 
worth taking. And I think it is particularly worth taking as we 
think of these virtual currencies as having functions that are 
a lot like credit cards or debit cards in some respects.
    Senator Heitkamp. But wouldn't you agree that right now, 
without any form of intervention, without legitimizing it, 
every buyer out there has to be careful, and that has 
restricted or limited or tapped down the willingness of people 
to participate? And you really are--you know, it is kind of 
ironic because we want all the free enterprise system, but the 
regulatory scheme and saying I have adapted to the regulatory 
scheme buys you the opportunity to participate in the market in 
a way that other financial institutions participate.
    Ms. Hughes. I could not agree more. And I think that there 
is--in my prepared statement, I make the observation that right 
now it looks like all the risks fall on the users, and that----
    Senator Heitkamp. And what is wrong with that?
    Ms. Hughes. Well, that is why maybe we are not seeing the 
growth that we would see if there was a bigger structure around 
it and greater clarity in that structure. But if people want to 
do their business that way, they----
    Senator Heitkamp. Well, we would just tell them, you go 
ahead, do your business that way, but----
    Ms. Hughes. Right, and we are not going to help you.
    Senator Heitkamp.----you are not responsible, and we will 
deal with the sales tax consequences, we will work through 
those issues in terms of value-for-value transfer, because you 
can deal barter to barter. I mean, people can barter, and you 
still can do an analysis. You can do an analysis on what, in 
fact, is the capital gains or the short-term or long-term 
capital gains and just let--try and adapt on a case-by-case 
basis the existing regulation without legitimizing. I am 
interested in your point of view, Ms. Tunstall.
    Ms. Tunstall. So my perspective on that is it is an analogy 
to social media, where a number of companies have decided to 
kind of stick their head in the sand and say we are not going 
to engage in social media, and then, you know, 
thecompanysucks.com gets founded and then somebody sets up a 
fake Facebook page and pretends to be that company, and that 
company loses significant reputation when they choose to stick 
their head in the sand and not engage and not pay attention to 
what is happening.
    And so my concern with not getting into regulating this 
area and being interested in what happens here is that it will 
be--it could eventually affect our financial system's 
reputation.
    Senator Heitkamp. And I understand that, but my point is 
frequently in these situations we think about how we are going 
to fix it or facilitate it when maybe we should just leave it 
alone, and maybe that is the approach that we need to think 
about and warn people, you are on your own.
    Ms. Tunstall. And I think from a consumer perspective and 
from a user perspective, I think that was a very good comment, 
that that is where we are. And I think that that is a very fair 
point.
    Senator Merkley. Well, we are all left with a lot of 
questions. We are going to turn to Senator Schumer, but first I 
just want to note that we will follow up on some of those 
questions, the separation of the payment system from the 
banking system, Professor Hughes, your thoughts about how you 
avoid the boom-and-bust cycle that is inherent in Bitcoin where 
it is both a speculatory instrument as well as a payment 
system. And, of course, we are all absolutely enthralled to 
find out exactly what Senator Warner's avatar looked like.
    [Laughter.]
    Senator Merkley. And with that, we are going to turn to 
Senator Schumer. Welcome.
    Senator Schumer. I for one do not want to see what Senator 
Warner's avatar looked like.
    Anyway, I want to thank Chairmen Merkley and Warner for 
letting us have this hearing and allowing me to participate. I 
have been very interested in this issue. I have a somewhat 
different approach than Senator Heitkamp.
    A while back, as you know, I called on Federal authorities 
to shut down the Web site Silk Road, which they recently did. 
Many people interpreted my action at the time as directed at 
Bitcoin because Bitcoin was the sole method of payment on Silk 
Road, and assumed that I also wanted to shut down or stamp out 
Bitcoin. That is not the case. I do not want to shut down or 
stamp out Bitcoin.
    New York sits in many ways at the nexus of all the issues 
being discussed today. As financial capital, the potential for 
creation of a new payment platform and the rise of alternative 
currencies could have profound and exciting implications for 
the way we conduct financial transactions. As a rapidly growing 
hub for technology and VC, venture capital, New York has every 
interest in building on the promise that technologies like 
Bitcoin have to revolutionize payment systems or even form the 
building blocks for whole new technology platforms.
    But all of that promise is threatened by the association of 
virtual currencies with criminal activities, from purchasing 
illicit goods and services to money laundering. If Bitcoin 
continues to attract attention, mostly as a way to finance 
purchases on Web sites like Silk Road, it is going to find 
itself in the digital wasteland.
    So in order for the legitimate uses of technology like 
Bitcoin to flourish, it is imperative that its susceptibility 
to illicit uses be addressed. There must be a way to separate 
the wheat from the chaff.
    So bottom line is very simple. I would ask Mr. Gallippi, do 
you have any specific suggestions of how we would separate the 
wheat from the chaff? What would you suggest to the witnesses 
on panel one to ensure that we address legitimate law 
enforcement concerns without duly inhibiting the development of 
these promising new technologies?
    Mr. Gallippi. Yes, thank you, Senator Schumer. So I think 
you have to first understand that there are multiple parts of 
Bitcoin. There is the low-level protocol, which are the bits 
and bytes that make it work, and then there is the application 
and service layer that businesses and consumers can engage in. 
And this is typically where you find businesses like mine 
operating.
    So when you want to try to separate the legitimate uses 
from the illegitimate ones, clearly the point to do that are by 
the visible service providers like ourselves, like BitPay. We 
have over 12,000 businesses using our service to accept 
bitcoin, and we have a very strict Know Your Customer policy to 
make sure that we know every merchant, you know, who they are 
and what they are selling, because we only want the legitimate 
and good actors using our service.
    The bad guys are going to try to figure out how to do it on 
their own, but it shows you with the recent arrest of the guy 
from Silk Road that just because you use Bitcoin does not mean 
that you can evade law enforcement, right? They caught the guy. 
He is in jail. So----
    Senator Schumer. It took long enough.
    Mr. Gallippi. Yeah. So I think there is a lot of effort, 
and services like ours and others are willing to work with 
regulators to make sure that what we do complies with the 
rules, because we all share in the same common goal: to protect 
consumers from fraud and to prevent the bad actors from using 
the system.
    Senator Schumer. Right. And I am sure you have thought 
about this, because you realize the danger Silk Road-type 
actors have to this appropriate new way of payment.
    Do you have any specific suggestions? And if you do not, if 
you would like to try to spend a little time thinking them up 
and sending them to us--I know the record probably, Mr. 
Chairman, will remain open for a week--that would be helpful.
    Mr. Gallippi. Yes, I would be happy to do that.
    Senator Schumer. OK.
    Senator Schumer. Other witnesses in answer to my specific 
question? Anyone have any thoughts? Ms. Tunstall?
    Ms. Tunstall. Yes, so I think that a very good point was 
made by Mr. Gallippi, and that is that the face to the user is 
the point to catch the transaction. So very similar to the 
Internet gambling restrictions that are in place, and I would 
actually be curious. Do you screen against merchant codes for 
Internet gambling as a credit card processor would do?
    Mr. Gallippi. Yes, correct--we do not allow that.
    Ms. Tunstall. OK. So that type of approach, you know, for 
tagging the transactions and knowing what the parties are, you 
can still be anonymous as long as it is a transaction between 
an individual and, you know, this company for a purchase. So we 
do have some existing controls and examples that can help on 
this side.
    Senator Schumer. Good. Well, I would, again, be interested 
in your submitting the specifics in writing.
    Senator Schumer. Any of the other witnesses? My time is up, 
so you do not----
    Mr. Smocer. I would just say that while I think Mr. 
Gallippi deserves a lot of credit for creating the company that 
he created with the kinds of controls he created, I would 
question if that is applicable across the industry and whether 
there are things we could do to make sure that the kinds of 
mitigations and controls that he has put in place are 
applicable to all in that business.
    Senator Schumer. OK. Well, thank you all very much, and I 
hope you will submit some specific suggestions and, Mr. 
Gallippi, in detail about what you have been able to do so we 
might be able to parlay that to other companies, although as 
Mr. Smocer says, we may not be able to do it in certain places.
    Thank you, Mr. Chairmen.
    Senator Merkley. Thank you very much, Senator Schumer, and 
thank you to all of our witnesses, and thank you, Co-Chair 
Warner. We will, in fact, keep the record open for additional 
questions for 7 days, and this concludes the hearing of the 
Subcommittee on National Security and International Trade and 
Finance and the Subcommittee on Economic Policy.
    [Whereupon, at 5:10 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                PREPARED STATEMENT OF SENATOR MARK KIRK
    I am very pleased to be having this hearing today. I think virtual 
currencies have for too long been something that we were content to let 
occur and develop without fully understanding. Yet the headlines 
covering virtual currencies are more and more each day--many related to 
the enormous challenges and threats that exist in this currency space. 
What is often overlooked however is the massive innovation in the 
virtual currency space that provides incredible opportunities--a 
technology space where the United State can and should be the global 
leader. As we seek to understand and hopefully curtail many of the 
nefarious practices that seem to be drawn to the virtual currency 
space, we must also make sure that we do not stifle innovation--
especially innovation that could be used to help so many people around 
the world.
    As eloquently stated in Jerry McGuire, ``Show me the money''. The 
directive within this statement has become both more significant and 
more challenging than ever before as financial transactions have 
evolved from simple people to people transactions to social networks 
and complex systems and software--using not only traditional State-
backed currencies, but also purely digital ones.
    The movement and transfer of currency in exchange for goods and 
services have been contemplated since the beginning of time. To a great 
extent, the value and legitimacy of a currency depend on individuals' 
confidence and willingness to accept it for any particular item.
    One major rationale cited by promoters of virtual currencies is 
that there is no Central Bank and therefore, digital currency is far 
less susceptible to currency manipulation. This notion is largely 
correct--the U.S. dollar and other widely accepted government 
currencies are proof. The dollar, which was originally pegged to gold 
reserves, now essentially derives its value from the confidence that 
the people using it place in it. As we have witnessed during the latest 
financial crisis, Central Banks, including the U.S. Federal Reserve, 
the Central Bank of Japan and several European Central Banks' 
willingness to engage in monetary policies that often resemble currency 
manipulation--which have significant impacts on the value of currency. 
Therefore, I tend to agree that it is appropriate to question if a 
centralized institution that is susceptible to political and public 
pressure can be truly ``independent'' and free from currency depression 
or manipulation.
    Another key justification given by some virtual currency promoters 
is that there is some anonymity to an individual or group's financial 
transactions. Parties of financial transactions can have reasons--some 
legitimate and some not--for desiring anonymity. While many of us 
understand the negative that can come from this anonymity, it is also 
critical to understand that this anonymity has helped finance 
revolutions against tyrannical governments and has helped NGO's and 
others get money to individuals and groups without having to pay a 
middleman or losing it to illegitimate forces.
    Further, traditional currencies often fail in reaching the nearly 
2.5 billion people who are unbanked across the globe--those ``credit 
invisible'' persons without bank accounts, credit lines, or credit 
histories. This is what makes the prospect of virtual currencies so 
amazing--that it can and already has helped revolutionize access to 
financial services for millions of individuals across the globe.
    Virtual currencies, however, are not without significant problems 
and complex issues that not only users and investors, but also Central 
Banks and law enforcement agencies, must grapple with. Media headlines 
surrounding the use of virtual currencies for financing the Silk Road, 
drug and human trafficking and terrorist financing make us aware of the 
most notorious problems with these currencies that can make the user in 
the transactions and even the transactions themselves anonymous and 
obscure.
    In addition to these headline stories, other problems exist for 
virtual currencies including massive fluctuations in value, the lack of 
security in the exchanges, and hackers stealing money from Bitcoin 
users. Other macro concerns include potential challenges these 
currencies create for the U.S. dollar, how governments will choose to 
recognize virtual currencies, and how law enforcement and financial 
regulators can effectively monitor, report, and control illicit 
activities conducted through the use of virtual currencies. Just over a 
week ago, there was a report of an Australian man that had 4,100 
bitcoins, worth more than $1.1 million, stolen from him. This alleged 
theft is one of the largest since Bitcoin was created 4 years ago.\1\ 
Bitcoin hit an all-time high yesterday closing over 600--a fluctuation 
of over 5000 percent over its 52-week low--which compares to a 7 
percent 52-week change for the dollar. Further, there have been a 
number of hacks into Mt. Gox, the largest exchange for BitCoin, which 
in a hacking event in 2011 resulted in an estimated $8.75 million USD 
worth of bitcoins lost to individuals.
---------------------------------------------------------------------------
    \1\ http://www.dailymail.co.uk/news/article-2492813/Bitcoin-site-
hacked-1million-virtual-currency-stolen.html.
---------------------------------------------------------------------------
    Many of the more significant problems arise from the anonymity that 
can be achieved through the use of virtual currencies. These headlines 
warn us that virtual currencies, like most other currencies in the 
developed world, need parameters and some visibility. While many 
developers and others in the virtual currency space suggest that 
anonymity is critical to the currencies' success, I question whether it 
is privacy, not anonymity that is most critical and if there is 
anonymity, whether complete anonymity is necessary. I don't think that 
there is anyone that would argue that governments should not be able to 
track activities such as terrorism, drug and human trafficking and 
other illicit activities conducted through the use of virtual 
currencies. Yet the many questions related to how, why and where 
governments can and should have access and the ability to track this 
type of data is debatable. Some virtual currencies and exchanges thrive 
on anonymity, while others try to be more transparent, stressing 
privacy and a lack of a central bank rather than anonymity as the 
selling point.
    Bitcoin, for example, one of the most well known virtual 
currencies, stresses anonymity as a feature that could be achieved if 
the user wants it. However it really underscores the value of having a 
decentralized currency as the selling point. Bitcoin is a peer-to-peer 
network, math-based currency. The network is decentralized, which makes 
it more attractive because it is less susceptible to human judgment 
errors and manipulation. While Bitcoin touts this decentralization, 
this lack of centralization also makes Bitcoin more susceptible to use 
of illicit money transfers and manipulation including through the use 
of malware and botnets. Further, this decentralization makes Bitcoin 
incapable of conducting due diligence, monitoring, and reporting of 
suspicious activity and conducting anti-money laundering compliance 
programs.
    While it appeared that many virtual currencies, such as Bitcoin, 
allowed financial transactions to become completely anonymous, we are 
learning through cases such as the Silk Road scandal that virtual 
transactions are not entirely anonymous, largely dependent on the 
actions of the user. We also know that not all virtual or algorithmic 
currencies seek or promote anonymity. Other virtual and math-based 
currencies, such as Ripple, seem to be less focused on anonymity and 
more focused on a decentralized currency that has little-to-no 
counterparty risk. Ripple and others appear to also be on the cusp of 
bringing virtual currencies into mainstream financial services.
    The ability for law enforcement to understand and trace illicit 
activities being financed through virtual and digital currencies is 
critical to ensuring the national and financial security of the United 
States. However, it seems imperative that we don't rush to over-
regulate this system, pushing it offshore and truly into the shadows.
    Given the rate of change in the virtual and technology-based money 
transfer systems, it will be nearly impossible for a single government 
agency to codify a set of rules and regulations that will not quickly 
become obsolete. It appears that the only way for governments to 
address some of the formidable technical and organizational challenges 
associated with detecting and monitoring illicit activities done using 
digital currencies will come through a combination of self-regulation, 
government and industry collaboration, and large-scale government 
technological upgrades.
    I look forward to hearing from our first panel to better understand 
how the U.S. Government, including our financial regulators and 
enforcement agencies are looking at, studying and preparing for the 
challenges and opportunities presented by virtual currencies.
    I also look forward to hearing from our second panel to understand 
their views on possible regulations or standards that might improve the 
industry, the new innovations, technology developments, and what if any 
safeguards are being considered and developed to better protect the 
system. I would also like to understand ways that the private sector 
might be able to help self-regulate itself through best practices and 
standards to make the illicit actors even that much more obvious.
                                 ______
                                 
             PREPARED STATEMENT OF JENNIFER SHASKY CALVERY
             Director, Financial Crimes Enforcement Network
                       Department of the Treasury
                           November 19, 2013
    Chairmen Warner and Merkley, Ranking Members Kirk and Heller, and 
distinguished Members of the Subcommittees, I am Jennifer Shasky 
Calvery, Director of the Financial Crimes Enforcement Network (FinCEN), 
and I appreciate the opportunity to appear before you today to discuss 
FinCEN's ongoing role in the Administration's efforts to establish a 
meaningful regulatory framework for virtual currencies that intersect 
with the U.S. financial system. We appreciate the Committee's interest 
in this important issue, and your continued support of our efforts to 
prevent illicit financial activity from exploiting potential gaps in 
our regulatory structure as technological advances create new and 
innovative ways to move money.
    FinCEN's mission is to safeguard the financial system from illicit 
use, combat money laundering and promote national security through the 
collection, analysis, and dissemination of financial intelligence and 
strategic use of financial authorities. FinCEN works to achieve its 
mission through a broad range of interrelated strategies, including:

    Administering the Bank Secrecy Act (BSA)--the United 
        States' primary anti-money laundering (AML)/counter-terrorist 
        financing (CFT) regulatory regime;

    Sharing the rich financial intelligence we collect, as well 
        as our analysis and expertise, with law enforcement, 
        intelligence, and regulatory partners; and

    Building global cooperation and technical expertise among 
        financial intelligence units throughout the world.

    To accomplish these activities, FinCEN employs a team comprised of 
approximately 340 dedicated employees with a broad range of expertise 
in illicit finance, financial intelligence, the financial industry, the 
AML/CFT regulatory regime, technology, and enforcement. We also 
leverage our close relationships with regulatory, law enforcement, 
international, and industry partners to increase our collective insight 
and better protect the U.S. financial system.
What is Virtual Currency?
    Before moving into a discussion of FinCEN's role in ensuring we 
have smart regulation for virtual currency that is not too burdensome 
but also protects the U.S. financial system from illicit use, let me 
set the stage with some of the definitions we are using at FinCEN to 
understand virtual currency and the various types present in the market 
today. Virtual currency is a medium of exchange that operates like a 
currency in some environments but does not have all the attributes of 
real currency. In particular, virtual currency does not have legal 
tender status in any jurisdiction. A convertible virtual currency 
either has an equivalent value in real currency, or acts as a 
substitute for real currency. In other words, it is a virtual currency 
that can be exchanged for real currency. At FinCEN, we have focused on 
two types of convertible virtual currencies: centralized and 
decentralized.
    Centralized virtual currencies have a centralized repository and a 
single administrator. Liberty Reserve, which FinCEN identified earlier 
this year as being of primary money laundering concern pursuant to 
Section 311 of the USA PATRIOT Act, is an example of a centralized 
virtual currency. Decentralized virtual currencies, on the other hand, 
and as the name suggests, have no central repository and no single 
administrator. Instead, value is electronically transmitted between 
parties without an intermediary. Bitcoin is an example of a 
decentralized virtual currency. Bitcoin is also known as 
cryptocurrency, meaning that it relies on cryptographic software 
protocols to generate the currency and validate transactions
    There are a variety of methods an individual user might employ to 
obtain, spend, and then ``cash out'' either a centralized or 
decentralized virtual currency. The following illustration shows a 
typical series of transactions in a centralized virtual currency, such 
as Liberty Reserve:


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    By way of comparison, the next illustration shows a very similar 
series of transactions in a decentralized virtual currency such as 
Bitcoin:


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    From a ``follow the money'' standpoint, the main difference between 
these two series of transactions is the absence of an ``administrator'' 
serving as intermediary in the case of Bitcoin. This difference does 
have significance in FinCEN's regulatory approach to virtual currency, 
and that approach will be addressed further during the course of my 
testimony today.
Money Laundering Vulnerabilities in Virtual Currencies
    Any financial institution, payment system, or medium of exchange 
has the potential to be exploited for money laundering or terrorist 
financing. Virtual currency is not different in this regard. As with 
all parts of the financial system, though, FinCEN seeks to understand 
the specific attributes that make virtual currency vulnerable to 
illicit use, so that we can both employ a smart regulatory approach and 
encourage industry to develop mitigating features in its products.
    Some of the following reasons an illicit actor might decide to use 
a virtual currency to store and transfer value are the same reasons 
that legitimate users have, while other reasons are more nefarious. 
Specifically, an illicit actor may choose to use virtually currency 
because it:

    Enables the user to remain relatively anonymous;

    Is relatively simple for the user to navigate;

    May have low fees;

    Is accessible across the globe with a simple Internet 
        connection;

    Can be used both to store value and make international 
        transfers of value;

    Does not typically have transaction limits;

    Is generally secure;

    Features irrevocable transactions;

    Depending on the system, may have been created with the 
        intent (and added features) to facilitate money laundering;

    If it is decentralized, has no administrator to maintain 
        information on users and report suspicious activity to 
        governmental authorities;

    Can exploit weaknesses in the anti-money laundering/counter 
        terrorist financing (AML/CFT) regimes of various jurisdictions, 
        including international disparities in, and a general lack of, 
        regulations needed to effectively support the prevention and 
        detection of money laundering and terrorist financing.

    Because any financial institution, payment system, or medium of 
exchange has the potential to be exploited for money laundering, 
fighting such illicit use requires consistent regulation across the 
financial system. Virtual currency is not different from other 
financial products and services in this regard. What is important is 
that financial institutions that deal in virtual currency put effective 
AML/CFT controls in place to harden themselves from becoming the 
targets of illicit actors that would exploit any identified 
vulnerabilities.
    Indeed, the idea that illicit actors might exploit the 
vulnerabilities of virtual currency to launder money is not merely 
theoretical. We have seen both centralized and decentralized virtual 
currencies exploited by illicit actors. Liberty Reserve used its 
centralized virtual currency as part of an alleged $6 billion money 
laundering operation purportedly used by criminal organizations engaged 
in credit card fraud, identity theft, investment fraud, computer 
hacking, narcotics trafficking, and child pornography. One Liberty 
Reserve cofounder has already pleaded guilty to money laundering in the 
scheme. And just recently, the Department of Justice has alleged that 
customers of Silk Road, the largest narcotic and contraband marketplace 
on the Internet to date, were required to pay in bitcoins to enable 
both the operator of Silk Road and its sellers to evade detection and 
launder hundreds of millions of dollars. With money laundering activity 
already valued in the billions of dollars, virtual currency is 
certainly worthy of FinCEN's attention.
    That being said, it is also important to put virtual currency in 
perspective as a payment system. The U.S. Government indictment and 
proposed special measures against Liberty Reserve allege it was 
involved in laundering more than $6 billion. Administrators of other 
major centralized virtual currencies report processing similar 
transaction volumes to what Liberty Reserve did. In the case of 
Bitcoin, it has been publicly reported that its users processed 
transactions worth approximately $8 billion over the twelve-month 
period preceding October 2013; however, this measure may be 
artificially high due to the extensive use of automated layering in 
many Bitcoin transactions. By way of comparison, according to 
information reported publicly, in 2012 Bank of America processed $244.4 
trillion in wire transfers, PayPal processed approximately $145 billion 
in online payments, Western Union made remittances totaling 
approximately $81 billion, the Automated Clearing House (ACH) Network 
processed more than 21 billion transactions with a total dollar value 
of $36.9 trillion, and Fedwire, which handles large-scale wholesale 
transfers, processed 132 million transactions for a total of $599 
trillion. This relative volume of transactions becomes important when 
you consider that, according to the United Nations Office on Drugs and 
Crime (UNODC), the best estimate for the amount of all global criminal 
proceeds available for laundering through the financial system in 2009 
was $1.6 trillion. While of growing concern, to date, virtual 
currencies have yet to overtake more traditional methods to move funds 
internationally, whether for legitimate or criminal purposes.
Mitigating Money Laundering Vulnerabilities in Virtual Currencies
    FinCEN's main goal in administering the BSA is to ensure the 
integrity and transparency of the U.S. financial system so that money 
laundering and terrorist financing can be prevented and, where it does 
occur, be detected for follow on action. One of our biggest challenges 
is striking the right balance between the costs and benefits of 
regulation. One strategy we use to address this challenge is to promote 
consistency, where possible, in our regulatory framework across 
different parts of the financial services industry. It ensures a level 
playing field for industry and minimizes gaps in our AML/CFT coverage.
    Recognizing the emergence of new payment methods and the potential 
for abuse by illicit actors, FinCEN began working with our law 
enforcement and regulatory partners several years ago to study the 
issue. We understood that AML protections must keep pace with the 
emergence of new payment systems, such as virtual currency and prepaid 
cards, lest those innovations become a favored tool of illicit actors. 
In July 2011, after a public comment period designed to receive 
feedback from industry, FinCEN released two rules that update several 
definitions and provide the needed flexibility to accommodate 
innovation in the payment systems space under our preexisting 
regulatory framework. Those rules are: (1) Definitions and Other 
Regulations Relating to Money Services Businesses; and (2) Definitions 
and Other Regulations Relating to Prepaid Access.
    The updated definitions reflect FinCEN's earlier guidance and 
rulings, as well as current business operations in the industry. As 
such, they have been able to accommodate the development of new payment 
systems, including virtual currency. Specifically, the new rule on 
money services businesses added the phrase ``other value that 
substitutes for currency'' to the definition of ``money transmission 
services.'' And since a convertible virtual currency either has an 
equivalent value in real currency, or acts a substitute for real 
currency, it qualifies as ``other value that substitutes for currency'' 
under the definition of ``money transmission services.'' A person that 
provides money transmission services is a ``money transmitter,'' a type 
of money services business already covered by the AML/CFT protections 
in the BSA.
    As a follow-up to the regulations and in an effort to provide 
additional clarity on the compliance expectations for those actors 
involved in virtual currency transactions subject to FinCEN oversight, 
on March 18, 2013, FinCEN supplemented its money services business 
regulations with interpretive guidance designed to clarify the 
applicability of the regulations implementing the BSA to persons 
creating, obtaining, distributing, exchanging, accepting, or 
transmitting virtual currencies. In the simplest of terms, FinCEN's 
guidance explains that administrators or exchangers of virtual 
currencies must register with FinCEN, and institute certain 
recordkeeping, reporting and AML program control measures, unless an 
exception to these requirements applies. The guidance also explains 
that those who use virtual currencies exclusively for common personal 
transactions like buying goods or services online are users, not 
subject to regulatory requirements under the BSA. In all cases, FinCEN 
employs an activity-based test to determine when someone dealing with 
virtual currency qualifies as a money transmitter. The guidance 
clarifies definitions and expectations to ensure that businesses 
engaged in such activities are aware of their regulatory 
responsibilities, including registering appropriately. Furthermore, 
FinCEN closely coordinates with its State regulatory counterparts to 
encourage appropriate application of FinCEN guidance as part of the 
States' separate AML compliance oversight of financial institutions.
    It is in the best interest of virtual currency providers to comply 
with these regulations for a number of reasons. First is the idea of 
corporate responsibility. Legitimate financial institutions, including 
virtual currency providers, do not go into business with the aim of 
laundering money on behalf of criminals. Virtual currencies are a 
financial service, and virtual currency administrators and exchangers 
are financial institutions. As I stated earlier, any financial 
institution could be exploited for money laundering purposes. What is 
important is for institutions to put controls in place to deal with 
those money laundering threats, and to meet their AML reporting 
obligations.
    At the same time, being a good corporate citizen and complying with 
regulatory responsibilities is good for a company's bottom line. Every 
financial institution needs to be concerned about its reputation and 
show that it is operating with transparency and integrity within the 
bounds of the law. Legitimate customers will be drawn to a virtual 
currency or administrator or exchanger where they know their money is 
safe and where they know the company has a reputation for integrity. 
And banks will want to provide services to administrators or exchangers 
that show not only great innovation, but also great integrity and 
transparency.
    The decision to bring virtual currency within the scope of our 
regulatory framework should be viewed by those who respect and obey the 
basic rule of law as a positive development for this sector. It 
recognizes the innovation virtual currencies provide, and the benefits 
they might offer society. Several new payment methods in the financial 
sector have proven their capacity to empower customers, encourage the 
development of innovative financial products, and expand access to 
financial services. We want these advances to continue. However, those 
institutions that choose to act outside of their AML obligations and 
outside of the law have and will continue to be held accountable. 
FinCEN will do everything in its regulatory power to stop such abuses 
of the U.S. financial system.
    As previously mentioned, earlier this year, FinCEN identified 
Liberty Reserve as a financial institution of primary money laundering 
concern under Section 311 of the USA PATRIOT Act. Liberty Reserve 
operated as an online, virtual currency, money transfer system 
conceived and operated specifically to allow--and encourage--illicit 
use because of the anonymity it offered. It was deliberately designed 
to avoid regulatory scrutiny and tailored its services to illicit 
actors looking to launder their ill-gotten gains. According to the 
allegations contained in a related criminal action brought by the U.S. 
Department of Justice, those illicit actors included criminal 
organizations engaged in credit card fraud, identity theft, investment 
fraud, computer hacking, narcotics trafficking, and child pornography, 
just to name a few. The 311 action taken by FinCEN was designed to 
restrict the ability of Liberty Reserve to access the U.S. financial 
system, publicly notify the international financial community of the 
risks posed by Liberty Reserve, and to send a resounding message to 
other offshore money launderers that such abuse of the U.S. financial 
system will not be tolerated and their activity can be reached through 
our targeted financial measures.
Sharing Our Knowledge and Expertise on Virtual Currency
    As the financial intelligence unit for the United States, FinCEN 
must stay current on how money is being laundered in the United States, 
including through new and emerging payment systems, so that we can 
share this expertise with our many law enforcement, regulatory, 
industry, and foreign financial intelligence unit partners, and 
effectively serve as the cornerstone of this country's AML/CFT regime. 
FinCEN has certainly sought to meet this responsibility with regard to 
virtual currency and its exploitation by illicit actors. In doing so, 
we have drawn and continue to draw from the knowledge we have gained 
through our regulatory efforts, use of targeted financial measures, 
analysis of the financial intelligence we collect, independent study of 
virtual currency, outreach to industry, and collaboration with our many 
partners in law enforcement.
    In the same month we issued our guidance on virtual currency, March 
2013, FinCEN also issued a Networking Bulletin on crypto-currencies to 
provide a more granular explanation of this highly complex industry to 
law enforcement and assist it in following the money as it funnels 
between virtual currency channels and the U.S. financial system. Among 
other things, the bulletin addresses the role of traditional banks, 
money transmitters, and exchangers that come into play as 
intermediaries by enabling users to fund the purchase of virtual 
currencies and exchange virtual currencies for other types of currency. 
It also highlights known records processes associated with virtual 
currencies and the potential value these records may offer to 
investigative officials. The bulletin has been in high demand since its 
publication and the feedback regarding its tremendous value has come 
from the entire spectrum of our law enforcement partners. In fact, 
demand for more detailed information on crypto-currencies has been so 
high that we have also shared it with several of our regulatory and 
foreign financial intelligence unit partners.
    One feature of a FinCEN Networking Bulletin is that it asks the 
readers to provide ongoing feedback on what they are learning through 
their investigations so that we can create a forum to quickly learn of 
new developments, something particularly important with a new payment 
method. Based on what we are learning through this forum and other 
means, FinCEN has issued several analytical products of a tactical 
nature to inform law enforcement operations.
    Equally important to our ongoing efforts to deliver expertise to 
our law enforcement partners is FinCEN's engagement with our regulatory 
counterparts to ensure they are kept apprised of the latest trends in 
virtual currencies and the potential vulnerabilities they pose to 
traditional financial institutions under their supervision. FinCEN uses 
its collaboration with the Federal Financial Institutions Examination 
Council (FFIEC) BSA Working Group as a platform to review and discuss 
FinCEN's regulations and guidance, and the most recent and relevant 
trends in virtual currencies. One such example occurred just recently, 
when several FinCEN virtual currency experts gave a comprehensive 
presentation on the topic to an audience of Federal and State bank 
examiners at an FFIEC Payment Systems Risk Conference. The presentation 
covered an overview of virtual currency operations, FinCEN's guidance 
on the application of FinCEN regulations to virtual currency, 
enforcement actions, and ongoing industry outreach efforts.
    FinCEN also participates in the FBI-led Virtual Currency Emerging 
Threats Working Group, the FDIC-led Cyber Fraud Working Group, the 
Terrorist Financing & Financial Crimes-led Treasury Cyber Working 
Group, and with a community of other financial intelligence units. We 
host speakers, discuss current trends, and provide information on 
FinCEN resources and authorities as we work with our partners in an 
effort to foster an open line of communication across the Government 
regarding bad actors involved in virtual currency and cyber-related 
crime.
    Finally, FinCEN has shared its strategic analysis on money 
laundering through virtual currency with executives at many of our 
partner law enforcement and regulatory agencies, and foreign financial 
intelligence units, as well as with U.S. Government policymakers.
Outreach to the Virtual Currency Industry
    Recognizing that the new, expanded definition of money transmission 
would bring new financial entities under the purview of FinCEN's 
regulatory framework, shortly after the publication of the interpretive 
guidance and as part of FinCEN's ongoing commitment to engage in 
dialogue with the financial industry and continually learn more about 
the industries that we regulate, FinCEN announced its interest in 
holding outreach meetings with representatives from the virtual 
currency industry. The meetings are designed to hear feedback on the 
implications of recent regulatory responsibilities imposed on this 
industry, and to receive industry's input on where additional guidance 
would be helpful to facilitate compliance.
    We held the first such meeting with representatives of the Bitcoin 
Foundation on August 26, 2013 at FinCEN's Washington, DC, offices and 
included attendees from a cross-section of the law enforcement and 
regulatory communities. This outreach was part of FinCEN's overall 
efforts to increase knowledge and understanding of the regulated 
industry and how its members are impacted by regulations, and thereby 
help FinCEN most efficiently and effectively work with regulated 
entities to further the common goals of the detection and deterrence of 
financial crime. To further capitalize on this important dialogue and 
exchange of ideas, FinCEN has invited the Bitcoin Foundation to provide 
a similar presentation at the next plenary of the Bank Secrecy Act 
Advisory Group (BSAAG) scheduled for mid-December. The BSAAG is a 
Congressionally chartered forum that brings together representatives 
from the financial industry, law enforcement, and the regulatory 
community to advise FinCEN on the functioning of our AML/CFT regime.
Conclusion
    The Administration has made appropriate oversight of the virtual 
currency industry a priority, and as a result, FinCEN's efforts in this 
regard have increased significantly over recent years through targeted 
regulatory measures, outreach to regulatory and law enforcement 
counterparts and our partners in the private sector, and the 
development of expertise. We are very encouraged by the progress we 
have made thus far. We are dedicated to continuing to build on these 
accomplishments by remaining focused on future trends in the virtual 
currency industry and how they may inform potential changes to our 
regulatory framework for the future. Thank you for inviting me to 
testify before you today. I would be happy to answer any questions you 
may have.
                                 ______
                                 
                 PREPARED STATEMENT OF DAVID J. COTNEY
         Commissioner of Banks, Massachusetts Division of Banks
         on behalf of the Conference of State Bank Supervisors
                           November 19, 2013
INTRODUCTION
    Good afternoon Chairmen Warner and Merkley, Ranking Members Kirk 
and Heller. My name is David Cotney and I serve as the Commissioner of 
Banks for the Commonwealth of Massachusetts. The Massachusetts Division 
of Banks is responsible for the overseeing all State-chartered banks 
and credit unions as well as regulating a range of nonbank financial 
service providers including money transmitters. I also serve as the 
Vice Chairman of the Board of Directors of the Conference of State Bank 
Supervisors (CSBS), and as the Chairman of the State Liaison Committee 
of the Federal Financial Institutions Examination Council (FFIEC).\1\
---------------------------------------------------------------------------
    \1\ Since 2006, State depository regulators have had a voting seat 
on the FFIEC, an interagency body empowered to prescribe uniform 
principles, standards, and report forms for financial institution 
examinations. The State Liaison Committee is made up of representatives 
of State bank, credit union and savings bank regulators and serves as 
the formal means for State input and representation on the FFIEC.
---------------------------------------------------------------------------
    It is my pleasure to testify before you today on behalf of CSBS. 
CSBS is the nationwide organization of banking regulators from all 50 
States, the District of Columbia, Guam, Puerto Rico, and the U.S. 
Virgin Islands. For more than a century, CSBS has given State 
supervisors a national forum to coordinate supervision and to develop 
regulatory policy. CSBS also provides training to State banking and 
financial regulators and represents its members before Congress and the 
Federal financial regulatory agencies.
    State banking regulators supervise over 5,200 State-chartered 
banks.\2\ The majority of State banking departments also regulates a 
variety of nonbank financial services providers, including money 
services businesses (MSBs) as well as mortgage lenders, check cashers, 
and payday lenders. This broad supervisory portfolio provides State 
regulators with a unique perspective in the payments landscape. Unlike 
any single Federal prudential regulator, most States regulate all of 
the financial intermediaries in the payments system: banks, credit 
unions, and money transmitters.
---------------------------------------------------------------------------
    \2\ Federal Deposit Insurance Corporation Statistics on Depository 
Institutions, Report Date June 30, 2013.
---------------------------------------------------------------------------
    I thank you for holding this hearing on virtual currency. The risks 
virtual currency presents impact consumer protection, payment systems 
stability, money laundering, national security, and tax evasion. The 
potential benefits are similarly multi-faceted: speed and efficiency, 
lower transaction costs, and providing an outlet for the unbanked and 
underbanked around the world. To address these areas, State regulators 
view our responsibility as supervising in a manner that mitigates risks 
while not impeding industry innovation and flexibility.
    States and State regulation have served as a forum for market 
experimentation as well as an early warning system of troublesome 
consumer and market trends. As the laboratories of innovation, the 
States welcome technology developments in the payments system that can 
lead to greater choice, security, and lower costs for consumers. 
Whether it's the Cambodian community in Lowell, the Somali community in 
Minneapolis, or the unbanked in Portland, Oregon, the States have a 
responsibility to ensure their citizens have the best possible options 
for transmitting value in a manner that does not put people, 
businesses, the payments system, or national security at risk.
    My testimony today discusses existing State regulatory regimes and 
processes that offer the ability to supervise payment systems 
participants in a manner that promotes trust, confidence, and 
regulatory collaboration. I will also set out State regulators' efforts 
to further define priorities and approaches moving forward.
PAYMENT SYSTEMS AND STATE SUPERVISION
    Payments systems are increasingly dynamic, signaling a shift in the 
way consumers and businesses pay for goods and services as well as the 
manner in which funds are remitted domestically and globally. Whether 
point of sale technologies, payment system intermediaries, or virtual 
currencies, development is ongoing and the possibilities are promising. 
However, while the opportunity for economic and consumer benefit is 
significant, so is the opportunity for real time losses and other 
destabilizing effects.
    Nowhere are opportunities and challenges more starkly visible than 
in the emerging field of virtual currencies. Virtual currencies are 
decentralized digital mediums of exchange that, depending on the 
structure, serve as a hybrid of types of value. Today's virtual 
currencies are mostly math based, finite, verifiable, and open source, 
factors that present an opportunity to enhance the basic manner in 
which we conceive the exchange of value. In addition to virtual 
currencies, the business of transmitting value continues to evolve 
through mobile and Web-based technologies that allow for instant and 
mobile payments on a secure basis.
    To understand the opportunities and the risks presented in this 
sector, State agencies are actively monitoring new entrants into the 
digital market, including recent high-profile law enforcement actions 
related to virtual currency. State regulators are engaged in open 
discussions with a broad range of industry participants, joint State 
and Federal working groups, and State-to-State coordination and 
strategic planning. States are also using their regulatory and 
legislative tools to learn more about the industry and increase 
transparency. For example, the New York Department of Financial 
Services launched an inquiry in August \3\ and recently announced it 
will hold public hearings on virtual currency with an eye toward 
identifying possible licensing regimes.\4\ New York's goal is one all 
States share, to determine appropriate regulatory guidelines that 
``allow new technologies and industries to flourish, while also working 
to ensure that consumers and our national security remain 
protected.''\5\ The California legislature has also worked to give 
regulators more tools to make the licensing process more transparent, 
authorizing the Department of Business Oversight to make written 
guidance public and offer guidance to prospective licensees.\6\
---------------------------------------------------------------------------
    \3\ Notice of Inquiry on Virtual Currencies, NYDFS (12 August 2013) 
available at http://www.dfs.ny.gov/about/press2013/memo1308121.pdf. 
Superintendent Lawsky explains: ``The emergence of Bitcoin and other 
virtual currencies has presented a number of unique opportunities and 
challenges. Building innovative platforms for conducted commerce can 
help improve the depth and breadth of our Nation's financial system. 
However, we have also seen instances where the cloak of anonymity 
provided by virtual currencies has helped support dangerous criminal 
activity, such as drug smuggling, money laundering, gun running, and 
child pornography.''
    \4\ Notice of Intent to Hold Hearing on Virtual Currencies, 
Including Potential NYDFS Issuance of a `BitLicense,' NYDFS (14 
November 2013) available at http://www.dfs.ny.gov/about/press2013/
virtual-currency-131114.pdf.
    \5\ Notice of Inquiry on Virtual Currencies, supra.
    \6\ California Assembly Bill No. 786, Money Transmissions (2013-
2014). Effective January 1, 2014. Available at http://
leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=2013
20140AB786.
---------------------------------------------------------------------------
    The States have a legal and regulatory structure that encompasses a 
broad range of financial services offered by a variety of bank and 
nonbank providers. For emerging payment technologies and alternative 
currencies, the threshold issue is the electronic movement of value 
owned by others--conduct over which the States have an existing 
structure for regulation and oversight. Money services businesses are 
entities that provide money transmission, currency exchange, prepaid 
access, monetary instruments as well as check cashing products and 
services. These companies provide a variety of financial products and 
services to a diverse customer base ranging from sophisticated 
financial customers to the underbanked and unbanked. One type of MSB, 
money transmitters, conducts remittance transfer services, domestically 
and internationally.
    State MSB regulation recognizes the reality that money transmitters 
are local in touch, global in scale, and include a broad range of 
business models. A money transmitter's business platform may include 
telephone, online, authorized agent locations, or a combination thereof 
to reach its customer base. Additionally, a money transmitter may offer 
several different types of MSB activities simultaneously. For example, 
Moneygram Payment Systems--a company licensed in 48 States, the 
District of Columbia, and Puerto Rico--offers money transmission, bill 
payment, prepaid cards, and money orders through their online platform 
and authorized agents nationwide. As technology has evolved to include 
mobile payments and digital commerce, State money transmitter 
regulation has demonstrated the flexibility to supervise these products 
and services to consumers.
    At the most basic level, many of the new products and services 
receive, hold, and send funds domestically or internationally. As such, 
these activities could fit into State money transmission definitions: 
the accepting or delivering of currency, funds, or other value, to 
another location or person by electronic means.\7\
---------------------------------------------------------------------------
    \7\ `` `Money transmission' means . . . receiving money or monetary 
value for transmission . . .'' Alaska Stat.  06.55.990; Arkansas 
A.C.A.  23-55-102 (12) (A); Hawaii HRS  489D-4; Iowa Code  533C.102; 
Kansas K.S.A.  9-508; La. R.S. 6:1032; Michigan MCLS  487.1003; Miss. 
Code Ann.  75-15-3; N.C. Gen. Stat.  53-208.2; N.D. Cent. Code,  13-
09-02; S.D. Codified Laws  51A-17-1; New Hampshire RSA 399-G:1; Tex. 
Finance Code  151.301; Vermont 8 V.S.A.  2500; Va. Code Ann.  6.2-
1900.
---------------------------------------------------------------------------
CREDENTIALING OF FINANCIAL SERVICES PROVIDERS
    Given the position of trust and confidence held by money 
transmitters and their critical function within local economies,\8\ 
State law generally requires the licensing of companies and individuals 
that transmit other people's funds. By credentialing those who take and 
send monetary value on behalf of others, the States limit potential 
consumer harm and add stability to financial markets. In turn, licensed 
companies increase consumer and commercial confidence, which encourages 
the economic stability needed to support successful innovation.
---------------------------------------------------------------------------
    \8\ See, e.g., The California Money Transmitter Act, Cal Fin Code  
2000 et seq. (``The [California] Legislature finds and declares all of 
the following: * * * (c) The failure of money transmission businesses 
to fulfill their obligations would cause loss to consumers, disrupt the 
payments mechanism in this State, undermine public confidence in 
financial institutions doing business in this State, and adversely 
affect the health, safety, and general welfare of persons in this 
State.'').
---------------------------------------------------------------------------
    Licensing communicates to the public that a licensee is viable, 
secure, and able to protect funds. State regulatory agencies license 
and regulate money transmitters to ensure compliance with State and 
Federal regulatory requirements, to help prevent the use of money 
transmitters to finance illicit activities such as narcotics 
trafficking and terrorism, while also providing consumer protection for 
residents. Oversight includes ensuring the proper policies, procedures, 
and safeguards are in place to protect the company and its customers 
from operational, monetary, and fraud risk. Many States have utilized 
the Uniform Money Services Act, adopted by the National Commission on 
Uniform State Laws as the outline for their statutory provisions, which 
includes licensing standards, financial stability requirements, and 
regulatory principles.
    Prospective licensees must file an application that typically 
includes the submission of credit reports, fingerprints, a business 
plan, financial statements, and a surety bond. The prospective licensee 
may provide evidence of policies, procedures, and internal controls 
that will facilitate the organization's compliance with State and 
Federal regulations, including required Financial Crimes Enforcement 
Network (FinCEN) registration and documentation of a Bank Secrecy Act 
(BSA) compliance program.\9\ Once a license is granted, management is 
required to maintain requisite permissible investments,\10\ surety 
bonds, and submit periodic reports that often include financial 
statements, permissible investments calculations, branch and agent 
reporting, and transmission volume activity.
---------------------------------------------------------------------------
    \9\ BSA compliance programs include policies, procedures, and 
internal controls to detect and deter money laundering and other 
illegal activity.
    \10\ Permissible investments are low risk, liquid assets such as 
cash and high rated investments required to be maintained in case an 
institution is unable to meet its commitments or fails. Permissible 
investments must be equal to the outstanding transmissions, payment 
instruments, or prepaid access values in the State or in all States.
---------------------------------------------------------------------------
    One of the main purposes of licensing is credentialing the entities 
and individuals seeking to engage in money transmission. Prospective 
licensees may be required to undergo rigorous requirements with the 
State agencies that include dialogue with the applicant regarding their 
business plan. The application may also include a background check on 
all owners, a requirement common in the MSB, banking, mortgage, 
securities, and other financial industries to ensure persons in a 
position of trust meet established standards to protect consumers and 
businesses alike. While some have complained that the process is 
cumbersome, most licensees recognize the value of identifying and 
validating market participants.
    Credentialing requirements are vital and elementary to consumer 
protection. Some comments to date suggest this process is invasive and/
or unnecessary, a view that reflects inexperience with time-validated 
requirements and unfamiliarity with the public policy goals served by 
licensing and regulatory oversight. We have seen this type of initial 
reaction as the States have enhanced their regulatory responsibilities, 
such as with the licensing of mortgage brokers and payday lenders. 
State legislatures have been very deliberate in crafting a 
credentialing process designed around the core objectives of consumer 
protection and promoting safety and soundness. State agencies would be 
negligent in their responsibilities if they simply allowed the push of 
technological innovation to preempt the need to apply the law in a 
thorough and deliberate manner.
SUPERVISION OF FINANCIAL SERVICES PROVIDERS
    State agencies examine licensed money transmitters on a 12-to-24 
month cycle to ensure licensees operate in a safe, sound, and legal 
manner. Between exams, State regulators monitor their licensees on an 
ongoing basis by reviewing the information submitted pursuant to 
reporting requirements. Licensees have periodic reporting requirements 
covering financial statements, permissible investments adequacy, branch 
and agent listings, and transmission volume activity. Consumer 
complaints provide another input into the supervisory process.
    During the course of an examination, State examiners review 
complaints, capital, asset quality, management, earnings, operations, 
and compliance with the Bank Secrecy Act and the institution's anti-
money laundering program. All these areas of review provide State 
agencies with data and other information to assess if a licensee is 
complying with applicable laws and conducting business in a safe and 
sound manner. If a licensee is found operating in an unsafe manner or 
out of compliance with State and Federal requirements, the licensee may 
face State enforcement actions.
    State enforcement actions vary depending on the entity, 
substantiated behavior, and violation. Importantly, enforcement is 
subject to appeal to an administrative hearing, ensuring licensees are 
afforded due process. For less serious findings warranting redress, the 
regulator and the regulated entity might agree to a letter of 
understanding or consent order, acknowledging the violation and setting 
forth a corrective plan. For more serious violations, temporary or 
permanent cease and desist orders will be issued, potentially limiting 
or even halting an entity's ability to operate. In more egregious 
circumstances, civil money penalties will be imposed in addition to any 
consumer restitution. Additionally, an entity's license could be 
revoked and the regulator's findings may necessitate referral to State 
and/or Federal law enforcement.
STREAMLINED AND COORDINATED OVERSIGHT
    Many State MSB licensees hold licenses in more than one State. 
Consequently, State agencies have proactively built a foundation for 
multi-State coordination and examinations. The Money Transmitters 
Regulators Association (MTRA)\11\ formed the foundation for multi-State 
MSB efforts by executing the Money Transmitter Regulators Cooperative 
Agreement (MTRA Agreement) in 2002 \12\ and the MTRA Examination 
Protocol (MTRA Protocol) in 2010. These documents established the 
initial framework for States to coordinate MSB examinations and share 
information.
---------------------------------------------------------------------------
    \11\ MTRA is a national nonprofit organization dedicated to the 
efficient and effective regulation of the money transmission industry 
in the United States of America. The MTRA membership consists of State 
regulatory authorities in charge of regulating money transmitters and 
sellers of traveler's checks, money orders, drafts, and other money 
instruments.
    \12\ The MTRA Cooperative Agreement can be found at http://
www.mtraweb.org/about/cooperative-agreement/.
---------------------------------------------------------------------------
    The MTRA Agreement started the States on the path to coordinated 
regulatory oversight by promoting concurrent and joint examinations 
among States. The MTRA Protocol provided a process for examinations, 
including multi-State examination schedules, work programs, and reports 
designed to increase effectiveness and reduce regulatory burden. Since 
the MTRA Agreement and Protocol were implemented, State agencies have 
conducted over 300 multi-State MSB examinations. Through coordination, 
regulatory oversight is applied in a uniform manner, a benefit that has 
been publicly noted by industry.\13\
---------------------------------------------------------------------------
    \13\ ''Recent developments in money transmitter regulation have 
been positive for regulated entities, as examinations by multi-State 
regulator teams have blossomed.'' Ezra C. Levine, Counsel, The Money 
Services Roundtable. Hearing before the Subcommittee on Financial 
Institutions and Consumer Credit of the Committee on Financial 
Services, U.S. House of Representatives, 112th Congress, Second 
Session, Serial No. 112-139, 9 (June 21, 2012). See also, Timothy P. 
Daly, Senior Vice President, Global Public Policy, The Western Union 
Company. Id. at 49. (``Recent developments in money transmitter 
regulation have been positive for both consumers and regulated 
entities, as examinations of multi-State organizations have grown more 
efficient, effective and consistent.'').
---------------------------------------------------------------------------
    To foster consistency, coordination, and communication, the States 
have collaborated on the enhanced CSBS/MTRA Nationwide Cooperative 
Agreement for MSB Supervision \14\ and the Protocol for Performing 
Multi-State Examinations. The CSBS/MTRA Agreement and Protocol will 
supplement an effective and efficient regulatory framework for 
licensees by establishing the Multi-State MSB Examination Taskforce 
(MMET) to oversee joint examinations. Representing all States, the MMET 
has 10 members, currently comprised of State regulators from 
California, Florida, New York, North Carolina, Ohio, Pennsylvania, 
Texas, Virginia, Washington, and Wyoming. The MMET is working on 
developing an enhanced supervisory program tailored to multi-State 
licensees that fosters a process of consistency and coordination among 
State agencies. In its first year, the MMET has improved the MSB 
examination work program and identified MSBs that meet the criteria for 
multi-State examinations.
---------------------------------------------------------------------------
    \14\ The Enhanced CSBS/MTRA Nationwide Cooperative Agreement for 
MSB Supervision, available at http://www.csbs.org/regulatory/
Cooperative-Agreements/Documents/MSB/MSB
-CooperativeAgreement010512clean.pdf.
---------------------------------------------------------------------------
    As a result of established processes and lines of communication, 
State agencies promptly communicate to one another to reduce the 
possibility of consumer harm when enforcement is necessary across State 
lines. Over the last several years, the Massachusetts Division of Banks 
and our sister States have been active in ensuring that the monies that 
consumers transmit are received by the intended recipients. When 
companies fail to deliver, we are the only regulators out there to help 
consumers who may have lost their hard earned money. When we learn that 
someone has lost their funds, either through fraud or the financial 
instability of the company, the Division can act swiftly and in 
collaboration with our State regulatory counterparts. State 
collaboration and coordination was evident earlier this year when it 
became clear to the Division that a money transmitter was possibly 
misappropriating customer funds. The money transmitter in question 
primarily remitted funds to Brazil with transfers in excess of $122 
million originating from Massachusetts in 2012 alone. During an 
examination that involved coordination with the Brazilian Central Bank 
and two private Brazilian banks, it was determined that transaction 
records were falsified, evidencing an even broader pattern of illegal 
activity.
    As a result, we promptly issued a Cease and Desist order \15\ to 
stop this company from accepting and transmitting money from 
Massachusetts consumers and initiated a coordinated response across 37 
States.\16\ My agency communicated the enforcement action to our sister 
States, held multi-State calls, and worked with other State regulators 
to ensure remittance transfers were received and customers were 
assisted in a timely manner. All consumers who lost money have been 
made whole. This investigation is ongoing, but demonstrates that State 
regulators are prepared and capable of promptly acting on a national 
and international basis.
---------------------------------------------------------------------------
    \15\ Braz Transfers Cease and Desist Order, available at http://
www.mass.gov/ocabr/business/banking-services/banking-legal-resources/
enforcement-actions/2013-dob-enforcement-actions/braz04012013.html.
    \16\ Braz Transfers was licensed in 7 of the 14 States currently 
using NMLS to license MSBs. According to NMLS Consumer Access, the 
company is no longer authorized to do business in any of these States. 
See http://www.nmlsconsumeraccess.org/EntityDetails.aspx/COMPANY/
907744.
---------------------------------------------------------------------------
STATE-FEDERAL COORDINATION
    Equally important as inter-State action is meaningful coordination 
with Federal regulatory agencies. States recognize the importance of a 
larger regulatory fabric and integrated oversight for consumer 
protection and national security. In many areas of bank and nonbank 
regulation and supervision, the States have found that a more 
coordinated approach better serves both consumers and regulated 
entities.
    The FFIEC has proved a valuable venue for coordination on processes 
between State regulators and Federal financial regulators across a wide 
range of supervisory issues and processes. Through the State Liaison 
Committee to the FFIEC, the States collaborate with the FFIEC on the 
Bank Secrecy Act/Anti-Money Laundering Examination Manual, and 
participate as voting members of the FFIEC BSA/AML Working Group, an 
interagency effort to enhance coordination of BSA/AML training, 
guidance, and policy. The responsibilities of the working group include 
ensuring consistent agency approaches and collaborating on emerging 
issues.
    The States have also entered into memorandums of understanding with 
FinCEN and the Internal Revenue Service (IRS) to coordinate BSA/AML 
supervision in the nonbank sector.\17\ As such, State agencies provide 
information to FinCEN and the IRS on a quarterly and annual basis. This 
information may include the number of BSA examinations conducted, 
referrals of BSA violations, and State enforcement actions. 
Additionally, State agencies worked collaboratively with FinCEN and the 
IRS on the FinCEN/IRS Bank Secrecy Act/Anti-Money Laundering 
Examination Manual for MSBs that was issued in 2008. State agencies 
also have provided resources to develop and conduct training for State 
and IRS examiners nationwide on BSA compliance for MSBs.
---------------------------------------------------------------------------
    \17\ Memorandum of Understanding between the Internal Revenue 
Service and the States concerning Money Services Businesses and Certain 
Other Nonbank Financial Institutions. Available at http://www.csbs.org/
regulatory/Cooperative-Agreements/Documents/IRS-States
BSA_MOU_4-22-2005.pdf.
---------------------------------------------------------------------------
    The Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Dodd-Frank) recognized the importance of a holistic approach to 
supervision. States bring a local point of view and a hands-on approach 
that complements the national priorities and perspective of Federal 
regulators. In addition to existing State/Federal cooperative 
frameworks, Dodd-Frank established new expectations for coordination, 
collaboration, and information sharing between the States and Federal 
regulators, including with the Consumer Financial Protection Bureau 
(CFPB).\18\ In 2011, the States entered into an Information Sharing 
Memorandum of Understanding with the CFPB (Information-Sharing 
MOU).\19\ This was the first such MOU that the CFPB signed. Sixty-one 
State agencies and the six State regulatory associations \20\ have 
signed the Information-Sharing MOU, which lays the foundation for 
information-sharing and supervision and enforcement cooperation between 
the CFPB and State regulators. Additionally, the State system is 
coordinating with the CFPB through CSBS on examiner training, 
examination technology and procedures, and complaint sharing.
---------------------------------------------------------------------------
    \18\ ``The Bureau shall coordinate with . . . State regulators, as 
appropriate, to promote consistent regulatory treatment of consumer 
financial and investment products and services.'' Dodd-Frank Act  
1015, codified at 12 U.S.C. 5495.
    \19\ Memorandum of Understanding Between the Consumer Financial 
Protection Bureau, the Conference of State Bank Supervisors, and the 
Other Signatories Hereto On the Sharing of Information for Consumer 
Protection and Other Purposes. Available at http://www.csbs.org/
regulatory/Cooperative-Agreements/Documents/CFPB %20CSBS%20MOU.pdf.
    \20\ The six State regulatory associations are the American 
Association of Residential Mortgage Regulators, Conference of State 
Bank Supervisors, Money Transmitter Regulators Association, National 
Association of Consumer Credit Administrators, North American 
Collection Agency Regulatory Association, and National Association of 
Credit Union Supervisors.
---------------------------------------------------------------------------
    Building on the foundation of the Information-Sharing MOU, on May 
20, 2013, CSBS on behalf of the State regulators entered into the 2013 
CFPB-State Supervisory Coordination Framework (Framework)\21\ for the 
purposes of implementing a State-Federal process for coordinated 
supervision. Under the Framework, the State Coordinating Committee 
(SCC)\22\--representing nearly 100 State regulatory agencies covering 
mortgage, MSBs, payday lending, consumer finance, student lending, debt 
collection, and others--is charged with coordinating examination and 
enforcement efforts directly with the CFPB. Through the SCC, the State 
system has the opportunity to influence and direct supervisory policy 
on a nationwide basis for nondepository industries including emerging 
and innovative players in the mobile, payments systems, and virtual 
currency markets.
---------------------------------------------------------------------------
    \21\ 2013 CFPB-State Supervisory Coordination Framework. Available 
at http://www.csbs.org/regulatory/Cooperative-Agreements/Documents/
2013-CFPB.pdf.
    \22\ The SCC is comprised of representatives of the six State 
Regulatory Associations and is responsible for representing the State 
system as a single body to the CFPB.
---------------------------------------------------------------------------
NATIONWIDE MULTI-STATE LICENSING SYSTEM
    State regulators have long understood that regulation needs to 
adapt alongside marketplace changes in order to capture the benefits 
and mitigate the risks of innovation. State regulators also understand 
that, in the modern economy, businesses and markets grow irrespective 
of geographic boundaries. Accordingly, the States recognized a need to 
be able to effectively and efficiently license mortgage companies and 
mortgage loan originators, to keep track of bad actors, and to provide 
responsible actors with greater efficiency and consistency in the 
licensing process. To achieve these goals, the States collectively 
developed and currently operate through CSBS the Nationwide Multi-State 
Licensing System and Registry (NMLS or System). After success in the 
mortgage licensing arena, States are currently using the System to 
license other regulated businesses, including all 12 license types 
issued by the Massachusetts Division of Banks.
    Originally developed as a voluntary State system for mortgage 
licensing and then codified in the Secure and Fair Enforcement for 
Mortgage Licensing Act of 2008 (SAFE Act),\23\ NMLS is a Web-based 
system that allows State-licensed nondepository companies, branches, 
and individuals in the mortgage, consumer lending, money services 
businesses, and debt collection industries to apply for, amend, update, 
or renew a license online for all participating State agencies using a 
single set of uniform applications.
---------------------------------------------------------------------------
    \23\ P.L. 110-289. Codified at 12 U.S.C. 5101 et seq.
---------------------------------------------------------------------------
    Last year, NMLS expanded functionality to include MSBs. 
Massachusetts is among 15 States currently using NMLS for MSB 
licensing, and 14 more are scheduled to come onto the system in the 
next year. The System enables licensees to manage their licenses in one 
location for multiple States, while States are able to track the number 
of unique companies and individuals, as well as the number of licenses 
they hold in each State. As a system of record for State regulatory 
authorities and a central point of access for licensing, NMLS brings 
greater uniformity and transparency to these nondepository financial 
services industries while maintaining and strengthening the ability of 
State regulators to monitor these industries.
    Both industry and regulators see great advantages to NMLS. During 
last year's House hearing on money services businesses, industry 
representatives testified that widespread adoption of the system 
``would eliminate duplication of effort and opportunities for error'' 
and ``urge[d] any changes at the Federal level to accommodate and 
encourage its further development.''\24\ To that end, I want to thank 
Senators Hagan and Toomey for taking the lead in sponsoring S. 947, 
which enhances the confidentiality and privilege already built into the 
NMLS. I also want to thank the other Members of the Committee--Senators 
Merkley, Manchin, Heitkamp, and Johanns--who have signed on as co-
sponsors of S. 947. With the passage of S. 947, State regulators will 
have full confidence in the expanded use of NMLS, bringing greater 
efficiency to the regulatory process.
---------------------------------------------------------------------------
    \24\ Timothy P. Daly, Senior Vice President, Global Public Policy, 
The Western Union Company. Hearing before the Subcommittee on Financial 
Institutions and Consumer Credit of the Committee on Financial 
Services, U.S. House of Representatives, 112th Congress, Second 
Session, Serial No. 112-139, 49-50 (June 21, 2012).
---------------------------------------------------------------------------
    In addition to shared functionality between regulators and 
industry, NMLS provides transparency to consumers seeking information 
on regulated companies and individuals. NMLS Consumer Access 
(www.nmlsconsumeraccess.org) is a fully searchable public Web site that 
allows consumers to view information concerning companies, branches, 
and individuals holding State licenses in the NMLS. In 2012, the 
information available on the Web site was upgraded to include public 
State regulatory actions for State licensees. The Web site also enables 
consumers to connect directly to State agencies for the purpose of 
submitting a consumer complaint against a State licensed company.
    As we continue to expand NMLS into other license types, regulators 
and industry alike will have the benefit of streamlined licensing 
requirements at a single source, and NMLS will be an important tool to 
provide understanding and responsiveness to companies that are local in 
touch but global in scale. Considering this, we continue to recommend 
to our colleagues at FinCEN and the CFPB that they use NMLS for any 
Federal registration requirements.\25\ State regulators and CSBS are 
ready to work with our Federal counterparts to bring registration and 
licensing requirements under one shared structure, and NMLS already has 
the proven capabilities and widespread support for such a streamlined 
process.\26\
---------------------------------------------------------------------------
    \25\ Section 1022(c) of the Dodd-Frank Act directs the CFPB to 
``consult with State agencies regarding requirements or systems 
(including coordinated or combined systems for registration), where 
appropriate.''
    \26\ NMLS complies with the moderate baseline security controls 
contained in National Institute of Standards and Technology (NIST) 
Special Publication 800-53, and is fully accredited (FISMA 
Certification and Accreditation) by the Consumer Financial Protection 
Bureau. Technical Details and Data Security Protocols for NMLS are 
available at http://mortgage.nationwidelicensingsystem.org/about/
Documents/NMLS%20Data%20Security%20Overview
.pdf.
---------------------------------------------------------------------------
LOOKING FORWARD
    State regulators are keenly aware that constantly emerging 
technologies have brought exciting and innovative products to the 
financial marketplace that consumers are utilizing on a daily basis. I 
and my fellow State banking commissioners recognize the need to 
understand these innovations. We also understand that there is a desire 
by many in the payments and technology industries for greater clarity 
for both State and Federal regulatory requirements.
    State regulators have structures, processes, and systems in place 
to bring clarity and consistency, while promoting consumer protection, 
safety and soundness, and national security goals. The States stand 
ready to work with our Federal counterparts, as well as with 
representatives from industry and consumer groups, to seek 
opportunities for greater clarity and consistency, allow for innovation 
in the payments systems, and both exploit the benefits and minimize the 
risks of such innovations.
    To address this changing landscape, CSBS is currently exploring 
policy processes for framing and considering issues facing regulators. 
These threshold issues include establishing the right characterization 
of virtual currency,\27\ the consumer protection needs raised by 
instantly settled payments,\28\ the resolution of conflicts between 
commercial entities in an instantaneous transfer system, and whether--
and in what manner--States should license entities involved with 
digital currency.\29\ Our consideration of these and other issues will 
inform our efforts to preserve marketplace stability while supporting 
constructive innovation. The States will continue to work with this 
goal in mind, expanding on a framework that ensures safety and 
soundness, minimizes the use of digital currencies to fund illicit 
activities, and protects consumers and across a diverse landscape of 
companies and business models.
---------------------------------------------------------------------------
    \27\ Whether virtual currency is ``money'' is a critical question. 
Congress has the sole power to ``coin money'' and ``regulate the value 
thereof'' under Article I, Section 8 of the Constitution. Conversely, 
Article I, Section 10 prohibits States from coining money and from 
``mak[ing] any Thing but gold and silver Coin a Tender in Payment of 
Debts.'' If virtual currency is not money, the States must determine 
whether it holds monetary value for the purposes of money transmission 
laws, or whether it is an instrument securing an interest in another 
currency.
    \28\ The Electronic Funds Transfer Act requires disclosure and 
other consumer protections for the transfer of funds. As technology 
accelerates payment clearing, disclosures and liability standards will 
be of the utmost importance. For example, if a virtual currency wallet 
is hacked, who is responsible for the lost funds?
    \29\ Article 4A of the Uniform Commercial Code currently governs 
commercial fund transfers. Though ``funds transfer'' is broadly defined 
under the law, the process is reliant on relationships through the 
banking system.
---------------------------------------------------------------------------
    Local understanding, coordination between regulators, and 
collaboration with policymakers has provided the States a unique 
ability to actively regulate a broad range of financial products and 
services in an effective and timely manner. We look forward to working 
with Congress and our Federal regulatory partners toward an integrated 
and collaborative approach to all innovative financial products and 
services, ensuring individuals and economies are well served.
                                 ______
                                 
              PREPARED STATEMENT OF PRESIDENT PAUL SMOCER
    President, BITS, on behalf of the Financial Services Roundtable
                           November 19, 2013
    Thank you Chairmen Warner and Merkley, Ranking Members Kirk and 
Heller and Members of the Committee for the opportunity to testify 
before you today.
    My name is Paul Smocer and I am the President of BITS, the 
technology policy division of The Financial Services Roundtable. BITS 
addresses issues at the intersection of financial services, technology 
and public policy, on behalf of its one hundred member institutions, 
their millions of customers, and all of the stakeholders in the U.S. 
financial system.
    The financial services market constantly evolves and matures to 
reflect the explosive growth of technological capacity, entrepreneurial 
innovation and consumer needs and preferences. The topic of today's 
hearing, ``Virtual Currency,'' has been and continues to be an area of 
focus for our member companies and within the industry. As virtual or 
digital currencies have evolved, our members discuss the potential 
benefits as well as potential drawbacks--particularly drawbacks related 
to security, fraud and consumer impact. My testimony today will cover 
the evolution of digital currency, as well as opportunities and risks.
Digital Currency Evolution
    Since the commercialization of the Internet, the concept of digital 
money has held intrigue. The terms ``virtual currencies'' and ``digital 
currencies'' are the generally accepted vernacular terminology used to 
identify forms of electronic currency that can be used to effect 
transactions involving true goods and services.
    Attempts to develop digital currencies, and the methodologies used 
to exchange them for value, have existed for several decades. For 
example, in the 1990s, we saw attempts such as NatWest's Mondex card, 
which was an attempt at creating an electronic cash card that acted as 
alternative to coins and banknotes, and DigiCash Inc., which was an 
electronic money corporation founded by David Chaum. The regulatory 
community has also been thinking about this subject for some time. For 
example, in September 1996, the United States Department of the 
Treasury held a conference entitled ``Toward Electronic Money and 
Banking: The Role of Government'' that explored this issue. Until 
recently, however, attempts to launch digital currencies have been 
unsuccessful. What makes today's environment different and enhances the 
probability of success in launching digital currencies? The answers to 
that question include:

    Consumers are much more comfortable in transacting online 
        through traditional financial systems as well as other vehicles 
        such as online games that leads consumers to an increasing 
        overall comfort with the online world.

    Computer systems are more powerful and less expensive thus 
        facilitating some of the processing intensive techniques 
        associated with emergent digital currencies.

    A growing interest in having an international currency free 
        of some of the factors such as exchange rate considerations, 
        inter-currency transactional fees, etc.

    The increasing desire for privacy.

    The general cache that some attach to the concept and to 
        innovative developments on the Internet.

    And sadly, but realistically, a desire to facilitate 
        illegal activities such as money laundering, fraud, and 
        terrorism financing.

    This has allowed a market for, though still on a limited basis, 
digital currency and the development of some infrastructures to support 
the exchange of digital currency.
    Bitcoin is often the focus of digital currency discussions as it is 
the largest independent digital currency. Bitcoins are created through 
a digital process, ``mining'', which involves computer programs working 
on the same set of data to solve a puzzle. Across the Internet, a 
bitcoin is mined every 10 minutes through this process with allegedly a 
maximum of 21 million allowed in circulation. Once mined, the owner is 
able to use his or her bitcoins at any participating merchant and the 
transactions are tracked through a public ledger known as a block 
chain, which identifies users by a unique code. Bitcoin users review 
these ledgers to validate transactions and to ensure that users are 
spending existing bitcoins. These transactions operate outside of the 
traditional payments system. Thus, they would not intersect with credit 
card, ACH or other trusted financial services networks. The system is 
not run by any one entity or company, but rather is supported by 
participants in the Bitcoin environment.
    Unlike depository accounts held in traditional financial 
institutions, bitcoin ownership is not associated with any named 
individuals. Owners of individual accounts are recognized by unique 
codes intended to assure their anonymity. Even the creator of Bitcoin 
is considered anonymous. Its creation is often attributed to a Satoshi 
Nakamoto, though it is speculated that this is actually a pseudonym for 
an anonymous individual or group of anonymous Web developers. In 
general, Bitcoin provides a decentralized system, using peer-to-peer 
networking, digital signatures and cryptographic proofing to enable 
funds transfers between participants.
    Other entities in the digital marketplace, such as Ripple, rely on 
the efficiencies of the Internet by developing an open source digital 
transaction protocol. Ripple uses existing currencies or valuable items 
(e.g., airline miles), which are converted into its internal currency 
called XRP. Users can then quickly transact within XRP. Individuals can 
convert funds back to a monetary value by selling the XRP. Similar to 
Bitcoin, Ripple includes an open ledger to allow all participants to 
see the activity of the system and validate transactions, again with 
individual accounts recognized by a unique code. These transactions 
also would not cross the traditional payments, but could leverage the 
existing funds in a financial institution consumer's account as an 
individual could directly transfer dollars into their Ripple account. A 
unique feature of Ripple is to allow individuals to provide loans to 
others within the network. Individuals establish their own ability to 
trust different users and decide how much they would like to loan the 
individual. In addition, a trust score can be assessed to different 
users.
Opportunities
    As we think about the opportunities associated with digital 
currencies, I believe we need to think of them in two distinct areas--
the concept of the currency itself and the infrastructure mechanisms 
being created to exchange them.
    We have witnessed the concepts of new, emerging currencies before. 
Some have noted that even within our country, the creation of new 
currencies was an early part of our history as the States, regions, and 
even merchant exchanges established currencies. What makes digital 
currencies different is that they allow the concept of cash or a cash 
equivalent to be used over the Internet. That fact, in turn, 
essentially makes them a global form of currency.
    One measure of a currency's success is its acceptability. An 
emergent trend is that institutions such as international and large 
retailers are beginning to accept select digital currencies as payment 
for goods and services. For example, in November 2012, the Web 
publishing service WordPress announced they would accept Bitcoin as a 
form of payment for WordPress upgrades. Interestingly too, just last 
week, we all became aware that the Federal Election Commission is 
seriously considering letting candidates and committees accept bitcoins 
as in-kind contributions. Given digital currencies today rely neither 
on Government-Sponsored central banks nor have the backing of any 
national currency, merchant acceptance and certainly acceptance by 
government agencies tends to help these currencies establish their 
legitimacy and increase the trust parties have in them and their 
stability in the marketplace. At this point, however, the established 
financial services industry still does not generally recognize these 
currencies as broadly accepted.
    One important aspect to recognize is that, as digital currencies 
become more internationally accepted, there is a growing recognition of 
their ability to increase international sales opportunities and their 
ability to facilitate simpler international funds transfers. Returning 
to the WordPress example of retailer acceptance, WordPress found the 
acceptance of digital currencies allowed it access to new consumers in 
countries where traditional payment systems do not permit access for 
financial, security or international sanction reasons.
    Because of the ability to work internationally and outside of 
existing markets, some suggest digital currencies also have the ability 
to provide affordable access to the unbanked on a global scale. For 
example, a mobile phone based money transfer and microfinancing service 
in Kenya backed by Kenya's largest two mobile network operators called 
M-Pesa, recently added a bitcoin payment option for customers in Kenya.
    In addition, digital currencies can assist individuals in countries 
with repressive regimes to support causes or efforts that they might 
otherwise not be able to support. For example, in certain countries 
where citizens fall under strict government control, individuals can 
often not donate to or purchase from sites that are banned by their 
country's traditional payments providers. These transactions are made 
easier using decentralized, unaffiliated, anonymous currencies with 
their own payment infrastructures. Because of this, often times digital 
currencies are referred to as a ``censorship-resistant'' currency.
    If digital currencies reach a state where their economic stability 
is more assured, they can also function as an outside currency that can 
provide additional economic security for individuals living in a 
country whose own currency is under financial distress. For example, 
during the recent Cyprus and Argentina financial crises, citizens 
transferred funds to digital currencies, mostly Bitcoin, to provide a 
more steady assurance for the security of their funds.
    The infrastructure supporting digital currency payments has some 
appealing quality to merchants also due to the lack of interchange 
fees. For many, digital currencies can provide a lower transaction cost 
to the benefit of both merchants and consumers. Digital currencies may 
be more attractive to merchants as many do not allow the payments to be 
reversed, so there is no opportunity for chargebacks.
    Another interesting aspect related to certain digital currencies is 
their cryptographic protections. Ostensibly, the cryptography is 
intended to provide a level of security that both helps limit the 
amount of a currency in circulation and to bolster their providers' 
claims that their currencies cannot be duplicated or counterfeited. The 
currency providers also claim that the financial information about any 
particular user's wallet (e.g., their identity, their balance) is 
anonymous and, therefore, more secure than in other Internet-based 
financial transaction environments. If these claims hold true, which is 
questionable, this could be very significant for the future of monetary 
security.
    In summary then, digital currencies and their supporting 
infrastructure do indeed present opportunities that we are closely 
watching. They could provide a model for how to facilitate real-time 
payments--particularly those involving international parties and those 
involving micropayments. They offer some opportunity to explore deeper 
cryptographic options for Internet-based transactions and they may 
offer opportunities to serve more effectively the under-banked and 
those who are truly politically repressed.
Risks
    While the opportunities noted above have piqued the interest of the 
financial services industry in digital currencies, we also have to 
recognize a plethora of potential risks.
    First, digital currencies pose significant market risk. Without 
government funding or support, digital currencies may be subject to 
extreme market volatility. The participants in the market itself have 
to decide the worth of each currency. Given the immaturity of the 
market, slight changes in the market can produce significant swings in 
value. In addition, the value of items purchased could change 
drastically and there would not be a single arbitrator to provide final 
decisions as to the value of the currency. Bitcoin is the best example 
of market volatility. Since its creation 4 years ago, the market has 
gone through several significant swings in value, including in 2011 
when the value fell 90 percent from $30 to $3. Recently, its value took 
a steep dive again when the use of bitcoins was associated with the 
alleged operations of the drug ring known as ``Silk Road.'' While its 
value has bounced back, broad swings in value create significant risk 
to both holders of the currency and to merchants and others who accept 
the currency as payment. With an established currency, merchants can 
generally be assured that the payment they receive will be of equal 
value to the service or merchandise purchased. With a currency that can 
fluctuate wildly, there is significantly more risk and little to no 
recourse for the merchant if the payment currency's value falls 
significantly. If the transaction happens to be international, the 
payment settlement methods used with established currencies do not 
apply. If, for example, one makes a purchase with a credit card issued 
in the United States from a UK-based merchant, the payment 
infrastructure will convert the purchase price from British pounds to 
U.S. dollars at a market rate and post that amount to the purchaser's 
account. The infrastructure to support this type of conversion is only 
in its infancy with the digital currency world. As well, we simply do 
not yet have enough experience to know if these currencies will even 
continue to exist. Many factors including broader acceptability will 
influence whether we see an increase or collapse in value of these 
currencies.
    On the consumer side, the use of these currencies and the 
infrastructure exchange mechanisms they utilize are currently subject 
to few of the consumer protections we have come to expect in the 
traditional world of currency and payments. In addition, since these 
currencies do not carry clear and effective disclosures, even the most 
sophisticated consumers are unlikely to be aware of and understand the 
risks associated with them.
    At this point, in the United States, the Financial Crimes 
Enforcement Network (FinCEN) has taken the regulatory lead by creating 
its formal statement on digital currencies. This March 2013 guidance 
clarified the responsibilities of participants in the digital currency 
marketplace to register as money services businesses and money 
transmitters. Given the decentralized approach of the currencies, this 
requires registration by many individuals who previously did not 
consider themselves part of this network. Beyond this March guidance of 
FinCEN, digital currency providers have virtually no existing 
regulatory oversight. This is even more meaningful for currency 
providers and users operating outside regulated countries. Without 
regulations, these digital currencies are not providing appropriate 
consumer protections to ensure individuals understand the risks much 
less are protected in ways we now take for granted. As examples:

    If the value in an individual's digital currency account is 
        fraudulently stolen, the victim has no recourse to recover the 
        funds. In fact, within the last 2 months there have been 
        multiple reports of Bitcoin currency disappearances from 
        various Bitcoin trading platforms. Some allegedly involved 
        hacks into Bitcoin repositories. At least one allegedly 
        involved the creation of an ``unlicensed'' repository into 
        which Bitcoin owners deposited their funds only to have the 
        repository suddenly disappear. In none of these cases is it 
        expected that the owners will recover a single bitcoin. 
        Contrast that to the recourse available to a consumer who is a 
        bank customer. If funds are fraudulently taken from the 
        consumer's deposit account, the bank will make that customer 
        whole. If an entire institution that is an FDIC-insured 
        depository institution were to fail due to a major cyber-
        attack, consumers would generally be afforded protections that 
        would allow them to recover a significant balance of their 
        deposit accounts.

    If a consumer's digital currency account were used to make 
        an unauthorized payment, laws that limit the amount of consumer 
        financial responsibility and require investigation by the 
        financial institution holding the consumer's transaction or 
        credit card would not apply. The consumer would simply lose the 
        value of the fraudulent payment.

    While there is an emerging trend in the regulatory 
        community, led by FinCEN at the Federal level, to consider the 
        classification of certain parties in the digital currency world 
        as money transmitters, laws and regulations that apply to funds 
        transfers occurring through traditional financial institutions 
        currently have little relevance in the digital currency world. 
        There is no method for attrition or preemptively stopping the 
        transfer of digital currency funds.

    These types of fraud protections provided by the financial services 
industry have developed into an essential part of overall consumer 
protection. Without some level of parity, today's digital currency 
consumers are essentially unprotected.
    It is important to note however, that while the digital currency 
market seems ripe for further oversight and regulation, the act of 
regulating it, in and of itself, adds legitimacy to the market.
    Another risk related to digital currencies involves the fact that 
most digital currencies are stored in digital wallets that are 
associated with personal computers or devices. Once these devices are 
compromised, there are no additional ways for the consumer to access 
their funds. In addition to the fraud risks noted above, there have 
been several recent cases of hacks on digital wallets that hold digital 
currencies. These hacks use similar techniques to traditional hacking 
efforts we have seen in the financial services industry. For example, 
phishing techniques are used to gain access to a user's information 
needed for authentication.
    It is important to recognize too that while FinCEN has taken some 
action and others at the Federal and State levels are considering 
regulatory actions, currently none of the digital currency operators or 
infrastructure providers are subject to the intense level of regulatory 
oversight applied to regulated and chartered financial providers. They 
are not subject to any required regulatory standards regarding, for 
example, cyber security and data breach notification requirements that 
grew out of the Gramm-Leach-Bliley Act. They are not subject to the 
regulatory and best practices guidance issued by the Federal Financial 
Institutions Examination Council and its member agencies that they have 
developed over the last 20 years. Likewise, they are not subject to 
independent examination of their controls environments by any 
regulatory authority. Because digital currency transactions typically 
occur within privately operated, unregulated networks, financial and 
security risk determination and mitigation is left up to the currency 
or infrastructure provider.
    In addition, while many digital currencies tout that they are 
anonymous, they rely on a unique identifier for each account. Through 
analysis of transactions or confirmation by an individual, these 
identifiers could be connected with an individual. Given that digital 
currencies rely on a public ledger, the individual's transaction could 
become knowledgeable to individuals who have been identified.
    Earlier I noted in the ``Opportunities'' section the ability for 
individuals to provide funds to legitimate organizations that their 
native country might inappropriately ban. This can also work in the 
reverse. Using digital currencies, individuals may also be able to 
donate to illegal organizations that would otherwise be legitimately 
banned by one or more governments. The ability for governments to ban 
payments to sites, for example, is a useful technique in thwarting 
illegal activity and terrorist funding.
    Allowing digital currencies, particularly ones that by design are 
intended to provide full anonymity to the currency holders, has also 
invited their use for illicit activities. In fact, some recent studies 
suggest that the anonymous nature of digital currencies has made them a 
haven for illegal activity. The most notable recent example is the FBI 
case that resulted in the take down of Silk Road--an operation that 
allegedly was used to anonymously buy or sell illegal drugs, offer guns 
and assassins for sale, and provide tutorials on hacking ATM machines. 
The operation was completely reliant on digital currency for 
transactions. When this site was taken down, law enforcement had 
numerous challenges in seizing the funds of the site and those of Silk 
Road's alleged operators and customers.
    The digital currency environment is also being used as a new way to 
launder money. A recent major example would be the situation involving 
the May 2013 indictment of Liberty Reserve. Liberty Reserve was a 
global currency exchange that allegedly ran a $6 billion money-
laundering operation online ostensibly serving as an exchange for 
criminals engaged in various illegal activities. According to the 
prosecutors who presented the charges, Liberty Reserve was responsible 
for laundering billions of dollars, conducting 55 million transactions 
that involved millions of customers around the world, including about 
200,000 in the United States. It is also important to note that all a 
user need to do to use the system was to provide a name, address and 
date of birth. However, unlike the Know Your Customer requirements that 
apply to traditional financial institutions, Liberty Reserve, being 
unregulated and incorporated outside the United States, was not 
required to validate customers' identities. As the indictment stated, 
``Accounts could therefore be opened easily using fictitious or 
anonymous identities.''
    While the Silk Road and Liberty Reserve situations serve as 
examples, the point here is that digital currencies are being used to 
assist a broad array of criminal activities including illegal drug 
sales, stolen identities, child pornography, prostitution, human 
trafficking, and illegal weapons sales. It is also being used as a 
favorite of cyber criminals to pay for services such as developing and 
distributing malicious software to the movement of stolen funds 
resulting from account take overs.
    One additional consideration is the level of clarity that currently 
exists regarding how virtual currencies will be treated within the tax 
code and whether virtual currencies offer an ability to evade taxes. In 
May 2013, the U.S. Government Accountability Office issued a report to 
the U.S. Senate's Committee on Finance entitled, ``Virtual Economies 
and Currencies, Additional IRS Guidance Could Reduce Tax Compliance 
Risks.'' The report suggests that the IRS should determine and 
subsequently address the need for additional tax guidance and 
additional taxpayer education. The lack of regulatory oversight, the 
risks to consumers and the market risks associated with digital 
currency provide a continuing challenge to its overall legitimacy, 
usage and endorsement by the financial services industry.
Conclusion
    In conclusion, there is no denying that the use of digital 
currencies will continue to evolve. Consequently, we will continue to 
discuss that growth and the associated opportunities and risks. As with 
the Internet and electronic commerce in general, we have seen 
innovations grow from early concepts where the risks outweighed the 
advantages to, over time, becoming an accepted norm. For now, I would 
opine we are not yet there with digital currencies. They do provide 
opportunities--or more accurately perhaps suggest areas of opportunity, 
but we will need to address the threats to consumers and society, the 
need for appropriate regulation and the effectiveness of risk 
mitigations. As the discussion continues, we would be happy to continue 
to participate, particularly where it would be advantaged by public-
private collaborations such as through the Federal Reserve Banks study 
of the future of the payments system.
    Thank you for your invitation to testify to the Subcommittees this 
afternoon. We look forward to continuing to work with you relative to 
this emerging technology.
                                 ______
                                 
                PREPARED STATEMENT OF SARAH JANE HUGHES
            University Scholar and Fellow in Commercial Law
                Indiana University Maurer School of Law
                           November 19, 2013
    Chairman Merkley and Chairman Warner, Ranking Members Heller and 
Kirk, and Honorable Members of the Subcommittees on Economic Policy and 
National Security and International Trade and Finance, I am honored to 
be here with you today to discuss virtual currencies.
    Monitoring the developments in virtual currencies and taking a 
responsible approach to their regulation reflects their growing 
presence in domestic and international transactions. Recent negative 
publicity associated with law enforcement action against Silk Road and 
reports of the disappearance of bitcoin exchanges in China and the 
Czech Republic raises important public policy concerns.
Part I: Recommendations and a Roadmap to the Balance of This Testimony
    The Committee has invited testimony on a variety of subjects that I 
have addressed in this prepared statement. I have a number of 
recommendations that pertain to the Committee's question.
    My recommendations include:

  1.  Retain the current division of regulation between the States and 
        Federal Government--with prudential regulation of the 
        nondepository providers of new payments systems with the States 
        and retaining the anti-money-laundering, anti-terrorism and 
        economic sanctions regulations with the Federal Government.

  2.  Make providers of virtual currencies comply with the customer-
        identification program and AML compliance program requirements 
        of Sections 326 and 352 of the USA PATRIOT Act, and with the 
        economic sanctions regulations enforced by OFAC, just as other 
        payments systems providers do. Virtual currency customers will 
        have to reveal their identities to issuers of the currencies 
        they use. As a corollary, customers should get the same Federal 
        financial privacy rights that users of other payments products 
        have under the Right to Financial Privacy Act of 1978 and Title 
        V of the Gramm-Leach-Bliley Act.

  3.  Encourage FinCEN to clarify the manner in which customer-
        identification and AML compliance requirements apply to virtual 
        currencies. This is needed to help banks ensure that they can 
        do business with providers and users of virtual currencies and 
        other payments innovators. Second-stage innovations from 
        distributed computing and database technologies could offer 
        benefits to payments and commerce far beyond those that virtual 
        currencies now offer. If banks cannot determine how to comply 
        with FinCEN regulations, for example, they may continue to 
        terminate their relationships with payments innovators before 
        the innovators can attract investors and users to make it to 
        the second-stage technologies their current work may generate.

  4.  Encourage payments systems innovators to adopt and publicize 
        transparent payment systems rules for their own systems and 
        even to compete for customers on the basis of the system rules 
        they adopt. It is too early to enact user protections for 
        virtual currencies.

  5.  Ignore the claims that

    a.  additional regulation of virtual currencies will halt 
        innovations,

    b.  innovators deserve freedom from regulations that apply to other 
        payments systems and their providers, and

    c.  virtual currencies deserve a single Federal licensure system 
        that preempts State prudential regulation and licensure.

  6.  Monitor the development of virtual currency providers in case 
        they transform their products into commodities or securities 
        and, if this happens, then decide whether regulating their 
        products under the applicable regulations makes more sense.

  7.  Leave room for nondepository and depository providers of payments 
        products to innovate in the virtual currency space.

  8.  Authorize and fund a study of virtual currencies to be carried 
        out by the Federal Reserve Board or pursuant to the Federal 
        Advisory Committees Act by an inter-agency task force and 
        industry participants.

    The balance of this statement begins in Part II with a brief 
history of ``legal tender'' and the regulation of payments products in 
the United States. Part III discusses my recommendations in some 
greater detail. Part IV responds to questions posed in the Committee's 
invitation to testify.
Part II: A Short History of ``Legal Tender'' and Governments' Roles in 
        Establishing it and its Value
    The emergence of a large digital ``currency'' unconnected to a 
sovereign threatens a sovereign right recognized back to Renaissance 
times. In one of the earliest court decisions involving ``legal 
tender''--the 1605 decision in Britain of The Case of Mixed Money \1\ 
in which the House of Lords observed that the regulation of currency 
was a sovereign right and declaring the sovereign's right to declare 
``legal tender'' by decree, the affixing of the sovereign's stamp, and 
to decision of the value of increments of currency--and later to change 
its mind about valuation. ``The prince, the stamp, and the value'' 
became from that point forward hallmarks of what could pass as ``legal 
tender'' that participants in trade transactions were required by the 
sovereign to take from others in satisfaction of obligations (trade or 
debt) they undertook. Proponents of virtual currencies often seek to 
end sovereign ``monopolies'' over legal tender, fiat currencies.
---------------------------------------------------------------------------
    \1\ The Case of Mixed Money in Ireland, Trin. 2 James I. AD 1605 
[Davies' Reports]. A key sentence from the opinion in that case 
proclaimed: ``that it appertaineth only to the King of England, to make 
or coin money within his dominions. [2 Ro. ab. 166. 1 Co. 146, 5 Co. 
114. 1 H.H.P.C. 188.]'' The court also announced its conviction that 
there were three attributes of ``money'' and ``legal tender'' that 
distinguished them: the price, the stamp, and the value. Id.
---------------------------------------------------------------------------
    Contributing to the history of sovereign, stamps, and values was 
the rambunctious, highly problematic period in the United States in the 
pre-Civil War 19th Century in which ``wild cat'' banks operated. Banks 
issued paper notes--a form of what economists call fiat currencies-- As 
opposed to coins or other ``specie.'' Persons who took paper ``bank 
notes'' encountered significant problems with redeeming the value that 
the notes were supposed to represent.\2\ They either encountered long 
waits while the notes moved for collection from banks near them to 
distant issuers of these notes, additional long periods while the 
issuing bank assembled enough funds to pay them off, or were forced to 
take huge discounts from local depositary banks against the prospect of 
these long waits or insolvency when the notes were eventually presented 
for payment to their issuing banks. ``Wild cat banking'' was cited as a 
cause of regional recessions and of decades of financial instability on 
the parts of businesses and individuals who had no other providers of 
financial intermediation services close enough to their homes.
---------------------------------------------------------------------------
    \2\ See Marine Bank v. Fulton Bank, 69 U.S. (2 Wall.) 252 (1864) 
(upholding the depositor's right to the sum owed on bank notes by its 
bank, rather than the lower value prevailing for Illinois notes of the 
time, which had decreased by 50 percent in value during the year that 
collection took). ``Wildcat banks'' did not have reserves sufficient to 
back their issues. Lissa L. Broome & Jerry W. Markham, Regulation of 
Bank Financial Service Activities 17 (Thomson Reuters, 2011).
---------------------------------------------------------------------------
    The problems associated with wild cat banks and the pressures of 
sustaining the Federal effort during the Civil War led Congress to 
create a national paper currency and national banks in the 1860s.\3\ 
Eventually, the need for financial stability, including stable prices, 
and sound monetary policy was so great as to cause Congress to 
establish the Federal Reserve System. Federal authority in this arena 
has remained in place since that time--through various ``gold 
standard'' debates, the creation of the Bretton Woods' Agreement that 
established the current international monetary systems in the 1940s, 
and to the present. The Federal Government has the sole power to issue 
``legal tender.''\4\
---------------------------------------------------------------------------
    \3\ The Stamp Payments Act of 1862, 12 Stat. 592; Rev. Stat. 711, 
sect. 3583 (prohibiting circulation of bank notes worth less than one 
dollar); National Currency Act of 1863, ch. 58, 12 Stat. 665 (Feb. 25, 
1863) (authorizing the chartering of national banks); and the National 
Bank Act of 1864, act June 3, 1864, ch. 106, 13 Stat. 99, as amended 
(superceding the National Currency Act). The goal of these collective 
National Banking Acts

         . . . was to create a uniform national currency. Rather than 
have several hundred, or several thousand, forms of currency 
circulating in the States, conducting transactions could be greatly 
simplified if there were a uniform currency. To achieve this all 
national banks were required to accept at par the banknotes of other 
national banks. This insured that national banknotes would not suffer 
from the same discounting problem with which State banknotes were 
afflicted. In addition, all national banknotes were printed by the 
Comptroller of the Currency on behalf of the national banks to 
guarantee standardization in appearance and quality. This reduced the 
possibility of counterfeiting, an understandable wartime concern.
    American History from Revolution to Reconstruction and Beyond, 
http://www.let.rug.nl/usa/essays/general/a-brief-history-of-central-
banking/national-banking-acts-of-1863-and-1864.php (last visited Nov. 
17, 2013). Problems of counterfeit or altered notes caused the creation 
of John Thompson's Bank Note Detector, a precursor of the listing of 
counterfeit and altered notes issued routinely by the Office of the 
Comptroller of the Currency and Federal Deposit Insurance Corporation 
today. The national currency was commodity currency backed by specie 
(e.g., gold certificates) in place of ``greenbacks.'' Eventually, as 
the Members know, the United States replaced commodity currency with 
fiat currency in the form of Federal Reserve Notes. Proponents of 
virtual currencies and other followers of the Austrian School of 
Economics distrust fiat currencies for their roles in business cycles 
and consequences of monetary interventions reasons as explained well in 
the European Central Bank's 2012 report on Virtual Currency Schemes, 
virtualcurrencyschemes201210en.pdf, at 21. The Austrian School 
economists also prefer the ``de-nationalization'' of currency, 
effectively an end to governments' monopoly on the issuance of money. 
Id. These economists criticize fractional-reserve banking systems like 
ours, and urge the re-adoption of the gold standard. Id. Broome & 
Markham also note that as ``electronic money'' came into the market in 
the 1990s, commentators considered The Stamp Payments Act to bar its 
issuance in the Nation. Supra, note 1 at 19.
    \4\ Congress' authority was upheld in a series of decisions 
including United States v. Van Auken, 96 U.S. (6 Otto) 366 (1977); 
Legal Tender Cases, Know v. Lee & Parker v. Davis, 79 U.S. (12 Wall.) 
457 (1870); Veazie Bank v. Fenno, 75 U.S. (8 Wall.) 533 (1869). The 
Federal Government's authority thus preempts the issuance by States 
such as Virginia of competing currencies, as the Virginia Legislature 
proposed to do in the past year.
---------------------------------------------------------------------------
    All of our principal trading partners also operate in national 
systems in which a single, State-specified currency constitutes ``legal 
tender'' for all transactions. There is little literature on the 
attitudes of our principal trading partners about ``virtual 
currencies''--with the exception of coverage of Canada's development 
and plan to issue as ``legal tender'' forms of ``digital currencies 
known as ``MintChips,''\5\ and the European Central Bank's 2012 report 
on Virtual Currency Schemes.\6\ Canada's ``Mint Chip'' experiment 
reveals no intention of abandoning the principles set forth in The Case 
of Mixed Money in 1605: the prince, the stamp, and the value will 
continue to be the province of the sovereign. The ECB's report, as one 
would expect, also favors a continuing role for central banks and 
sovereign currencies.
---------------------------------------------------------------------------
    \5\ Canada's plans have revolved around a State-created digital 
``currency'' that they call ``Mint Chips.'' For more information on the 
status of this development, see John Greenwood, Canadian Mint ready to 
test its own digital money project, Fin. Post (Canada) (Sept. 19. 
2013).
    \6\ Available at virtualcurrencyschemes201210en.pdf (last visited 
Nov. 17, 2013). (The ISBN for this report is 9778-92-899-0862-7 
(online).)
---------------------------------------------------------------------------
    But, just because ``legal tender'' exists as a fact in most 
developed nations, it does not follow that individuals or businesses 
cannot agree to take barter or nonlegal tender in exchange for goods 
and services. It just dramatically increases some, primarily legal 
risks in those transactions, much as we saw with ``wild cat'' banking 
in the pre-Civil War period here, and in the disappearance of bitcoin 
exchanges in China and also the Czech Republic. In these cases, the 
risk of engaging in virtual currency transactions currently falls 
entirely on users.
    We must recognize that some individuals and, apparently, an 
increasing number of businesses, see value in using forms of ``virtual 
currencies'' to complete their own transactions.\7\ Can we prevent them 
from doing so? Probably not. Should the United States step up their 
regulatory efforts in this arena? My answer is not yet, and not until 
such time as stronger evidence suggests problems exist with these 
currencies that contribute to financial instabilities, or otherwise 
enable issuers or intermediaries to commit fraud on users or complicate 
monetary or other important public policies.
---------------------------------------------------------------------------
    \7\ Media reports cite reasons such as avoiding the expense of 
exchange of currencies and other transaction costs associated with use 
of debit or credit cards, or even checks.
---------------------------------------------------------------------------
Part III: Discussion of Recommendations
        Recommendation 1: Retain the current division of regulation 
between the States and Federal Government--with prudential regulation 
of the nondepository providers of new payments systems with the States 
and retaining the anti-money-laundering, anti-terrorism and economic 
sanctions regulations with the Federal Government.
    The current balance between State and Federal regulation affords 
more opportunities to follow developments in this area with lots of 
eyes on these innovations, ensure AML and economic sanctions goals are 
met, and allow room for innovation of these intriguing technologies 
that a comprehensive Federal licensure and supervision scheme might not 
allow as well. Furthermore, having prudential regulation should 
contribute to the confidence among users--whether consumers or 
businesses--that their stored value is safe and that their transactions 
will be executed as expected.
    The split between prudential money transmission regulation by the 
States, and anti-money laundering and economic sanctions/ anti-
terrorism regulations by the Department of the Treasury reflects a 
robust regulatory, supervision and examination scheme for virtual 
currency transactions with much room on the prudential side of State 
regulation to promote product innovation without sacrificing important 
protections for users or, on the Federal side, anti-money laundering 
(AML) or economic sanctions goals.
    Some advocate for a single, Federal scheme of licensure and 
regulation of virtual currencies and their providers. The proponents of 
this view should be careful what they wish for: they could find 
themselves unable to qualify for a Federal license as the efforts of 
certain retailers to obtain approval from the Federal Deposit Insurance 
Corporation for their industrial loan operations (even after they had 
obtained a State ILC charter) or national bank or Federal savings and 
loan charters. These Federal approvals are also expensive and time-
consuming processes with considerable discretion left to regulators to 
reject applicants. It is not clear to me that early applicants will 
enjoy the relief from 50-State regulation that they seem to expect.
    Some individuals will not adopt payment methods they do not 
understand and whose rules of the road are not transparent. Thus, we 
should appreciate the longstanding role the States have played in 
innovating regulations that have encouraged users to adopt new payments 
methods. The work of the Uniform Law Commissioners and American Law 
Institute, begun more than 65 years ago, created the uniform and 
predictable provisions of the Uniform Commercial Code (UCC) that State 
Legislatures enacted. The UCC's predominance in payments regulation is 
now complemented by payments systems rules and bilateral agreements, 
including those that govern transactions that the UCC does not address, 
as well as limited Federal laws and regulations. Federal regulations 
also may prompt faster user adoptions of new technologies, as many 
believe the Fair Credit Billing Act (FCBA) and the Electronic Fund 
Transfers Act (EFTA) did in the late 1960s and 1970s, respectively, 
even though the EFTA has been criticized for chilling certain ATM 
developments.
        Recommendation 2: Make providers of virtual currencies comply 
with the customer-identification program and AML compliance program 
requirements of Sections 326 and 352 of the USA PATRIOT Act, and with 
the economic sanctions regulations enforced by OFAC, just as other 
payments systems providers do. Virtual currency customers will have to 
reveal their identities to issuers or transaction intermediaries of the 
currencies they use. They should get the same Federal financial privacy 
rights that users of other payments products have under the Right to 
Financial Privacy Act of 1978 and Title V of the Gramm-Leach-Bliley 
Act.
    My concern is that disintermediation of payments--the separation of 
payment flows from the comprehensive recordkeeping and retention 
requirements applicable to payments that eventually flow through the 
banking system--makes it more difficult to determine the identities of 
senders and recipients of payments. This may contribute to the efficacy 
of the ``layering'' stage of money laundering, the passage of the funds 
or credits through so many hands that the identities of payments 
participants is obscured. This is an important concern for anti-money-
laundering, anti-terrorism, anti-proliferation, and anti-tax-avoidance 
purposes.
        Recommendation 3: Encourage FinCEN to clarify the manner in 
which customer-identification and AML compliance requirements apply to 
virtual currencies to a greater degree if that is needed to stop banks 
from discontinuing their business relationships with virtual currency 
providers and other payments innovators. If banks cannot determine how 
to comply with FinCEN regulations, for example, they will cutoff 
payments innovators before the innovators can attract investors and 
users to make it to the second-stage distributed computing and database 
technologies their current work may generate.
    Depository institutions deserve the clearest guidance on how 
customer-identification and AML compliance requirements apply to 
virtual currencies. This is one of the few ways in which we can stop 
the recent spate of terminations of banking relationships with 
providers of virtual currencies--colloquially called ``bank 
discontinuance.''
    Without the clearest possible guidance available for banks and 
investors, we are likely to experience a domestic decline in 
innovations and the potential loss of development of future associated 
uses of the distributed computing and database technologies such as for 
tracking tangible goods transactions or even in tracking and trading 
intangibles such as electronic mortgages and other evidences of equity 
or debt. Moreover, if bitcoins or other virtual currencies prove to 
garner even more widespread international adoptions, the United States 
will want to have a share of the productive research and applications 
capacity in the United States and may regret actions that send it 
offshore.\8\ This would be even more important if distributed 
technologies developing in the next 5 years that would not suffer the 
perceived disadvantages of bitcoins today were to emerge.
---------------------------------------------------------------------------
    \8\ For a valuable discussion of the regulation of virtual 
currencies from the perspective of the European Central Bank, see 
Virtual Currency Schemes, supra note 6. This study does not accurately 
reflect current state of regulation of virtual currencies in the United 
States in two respects. First, it ignores the presence of State 
prudential regulation of ``money transmitters.'' Also, it fails to 
reflect the fact that widely used payments systems here have already 
moved away from reliance on ``payments laws'' and toward system rules 
and bilateral agreements for processing payments. These system rules 
and bilateral agreements often augment laws that otherwise apply to the 
underlying form of payment being used, but in other cases they provide 
uniformity and certainty to forms of payments that neither Federal or 
State laws comprehensively govern (credit cards, electronic fund 
transfers, and certain aspects of payroll cards, for example).
    The Bank's report mentions a case in which French ``banks shut down 
the currency exchange facility for accounts handling [bitcoins], on the 
presumption that Bitcoin should conform to electronic money 
regulations. Id. at 43, citing Finextra: http://
www.finextra.comnews.fullstory.aspx?newscemid=22921.
---------------------------------------------------------------------------
    On the other hand, we should not condone the virtual currency 
systems that market the anonymity of their users or claim immunity from 
otherwise applicable compliance responsibilities in the name of 
``innovation.'' If proponents of virtual currencies want access to 
profits for transactions in the United States, they should be prepared 
to comply with applicable laws, and, in specific, they should obtain 
sufficient information from customers to enable them to respond to 
properly authorized requests for access from Federal or State 
regulators and law enforcement agencies.
    A corollary of this recommendation involves providing financial 
privacy rights to users of virtual payments systems equal to those 
provided to users of more traditional payment systems. In the United 
States, two functionally different, Federal financial privacy statutes 
should govern virtual currency transactions--the Right to Financial 
Privacy Act of 1978, which governs access to account and transaction 
information of individuals and businesses by the Federal Government, 
and Title V (Privacy) of the Gramm-Leach-Bliley Financial Services Act 
of 1999, which governs how providers of consumer financial products and 
services may use and share the nonpublic, personally identifiable 
information they hold, including with their functional or prudential 
regulators and with Federal, State, and local law enforcement agencies. 
It is unclear that participants in virtual currency systems are 
enjoying these rights today. As banks increasingly buy providers of 
digital currencies to develop their own products, it is even clearer 
that customers should enjoy the same financial privacy protections, 
including due process rights, however limited they may be with border 
seizures and other Title 18 forfeiture provisions.
        Recommendation 4: Encourage payments systems innovators to 
adopt and publicize payment systems rules for their own systems and 
even to compete for customers on the basis of the system rules they 
adopt.
    Whenever a consumer or business prepares to make or receive a 
payment it will want to have certainty that:

    the payment is authorized by the person from whose funds or 
        credits the payment will be made,

    the person has sufficient funds or credits for the payment 
        processor to deliver those funds on time to the payee/ 
        recipient so that the payee/ recipient will receive ``goods 
        funds'' instantly or in a reasonable period of time,

    the payment is made to the proper payee and in the 
        timeframe specified or expected by the person whose funds or 
        credits are being used or consistently with any applicable 
        contract between the obligor and payee,

    the payment, from the obligee's perspective, will become 
        final at a specified time or after a specified interval and, 
        from the obligor's perspective, that it will discharge the 
        underlying obligation to pay for goods or services or to retire 
        a debt, and

    the payment has integrity--that is, the named payee/ 
        recipient has not been altered, the amount has not been lowered 
        or raised, or the funds will not be held up unreasonably in 
        transit.

These are ``regulatory'' or system rule qualities that will allow the 
provider to maintain users' trust.
    Additionally, every person or business that stores funds or other 
value with a bank or broker--or in this case with the issuer, exchange 
or other provider/ participant in a virtual currency transaction--wants 
suitable assurances that they can redeem/ retrieve their funds or value 
when they want to do so. This issue surfaced with bitcoins when the 
Federal Government froze some bank accounts belonging to the Mt. Gox 
Exchange and the Exchange was unable to pay holders of bitcoins when 
they sought to redeem value stored in bitcoins. Other issues related to 
value storage include whether any form of insurance against the 
insolvency of the issuer or exchange is available to protect those who 
deposit value or otherwise hold accounts that they have reasonable 
expectations to redeem on little or no notice, or even on predictable 
terms.
    Some virtual currencies have attracted negative publicity, 
including recent publicity about the disappearance of a Bitcoin 
exchange based in China with $4.1 million of value that belonged to 
others. This type of negative publicity stands in the way of broader 
adoption of virtual currencies.
    Prudential regulation and transparent system operating rules should 
help legitimate businesses offering virtual currencies attract more 
customers--assuming we have no reason today to fear competition for 
legal tender from current-day virtual currencies.
    I encourage virtual currency issuers to create payment systems 
rules for their own systems and harbor some hope that issuers will 
compete to offer system rules that match the needs of the individuals 
and businesses who participate. Payment systems rules often precede 
full government regulations by long periods of time. Examples include 
traveler's cheques and bank wire transfers, and more recently automated 
clearing house transactions governed by the National Automated Clearing 
House Association and electronic checking processing systems that use 
ECCHO Operating Rules. New payments methodologies regulated too soon 
often do not receive the same levels of innovations. The primary 
example I can cite was based on a report by the Board of Governors of 
the Federal Reserve System following the enactment and implementation 
of the Electronic Fund Transfers Act in the late 1970s. The alternative 
to provider-created system rules may be more government regulation. 
This gives providers a choice between self-regulation for these 
specific customer protection purposes or more government regulation. I 
imagine they will give self-regulation careful consideration.
    Payments systems that have not established transparent and uniform 
system rules normally suffer a worse fate: so few individuals or 
businesses will use them that they wither for lack of investors and of 
income. This happened to some extent in the United States to early 
offerors of ``electronic money,'' including Mondex and Digicash, 
despite talented senior management and significant investments. 
Consumers did not adopt them so merchants did not adopt them--in part 
because neither group was certain of their rights if they adopted them.
        Recommendation 5: Ignore the claims that any regulation of 
virtual currencies will halt innovations or that innovators deserve 
freedom from regulations that apply to other payments systems and their 
providers, and their wishes for a single Federal licensure system.
    I urge Members to resist the ``we're new so don't regulate us at 
all'' arguments that you've heard since the advent of electronic 
commerce. Payments are payments and stored value is value storage. The 
``don't regulate us or you will stifle innovation'' arguments did not 
persuade many as digital money, prepaid cards, payroll cards and other 
new products appeared in markets and they offer no reason to abandon 
existing prudential regulation now.
    There also is no reason to reward ``innovators'' with freedom from 
regulations with which their ``real world'' competitors must comply. 
That would provide anti-competitive advantages to certain new entrants 
for which no justification appears.
        Recommendation 6: Monitor the development of virtual currency 
providers in case they transform their products into commodities or 
securities and, if this happens, then decide whether regulating their 
products under the applicable regulations makes more sense.
    Bitcoins' values have been highly volatile over the past year. This 
volatility looks like price volatility associated with commodities and 
securities; bitcoin prices seemingly move separately from the values of 
the world's major currencies. If other virtual currencies demonstrate 
this market freedom from legal tender currencies, this may be the 
signal that a reconsideration of type of regulation to be applied from 
regulation as payment systems to regulation as commodities or 
securities.
        Recommendation 7: Leave room for nondepository and depository 
providers of payments products to innovate in the virtual currency 
space.
    It is important not to rush new laws or regulations following 
negative publicity from a new technology when existing laws regulate 
issuers prudentially and clarity in enforcement of AML regulations can 
allow some space for innovators in the virtual currency space. I was 
delighted to read last week that the New York State Department of 
Financial Services was considering offering a BitLicense. Careful 
development of licensure standards will help develop stable payments 
products. As I have mentioned, virtual currency technologies can 
produce secondary, distributed computing and database applications that 
could yield enormous benefits to domestic and cross-border commerce.
        Recommendation 8: Ask for a study of virtual currencies to be 
carried out by the Federal Reserve Board or the Department of the 
Treasury or fund a study pursuant to the Federal Advisory Committees 
Act by an inter-agency task force and industry participants.
    The Subcommittees sponsoring today's hearing should ask for a study 
by the Board of Governors of the Federal Reserve System or the 
Department of the Treasury of virtual currencies, the potential for 
innovations and efficiencies they may offer more broadly, and the kinds 
of risks--to price stability, financial stability, payment system 
stability, reputational risks and for users--identified in an October 
2012 report by the European Central Bank entitled ``Virtual Currency 
Schemes.''\9\
---------------------------------------------------------------------------
    \9\ Supra, note 6. For more information about this report, see 
supra, note 8.
---------------------------------------------------------------------------
    Another option is for Congress to authorize and separately fund an 
inter-agency working group to produce a study of how the various 
Federal agencies involved in payments, regulating of banking, 
commodities, securities and law enforcement.
    Regardless of which agency leads the study, the work should be 
organized under the Federal Advisory Committees Act so that all 
industry segments can be included.
Part IV: Responses to Other Questions Posed by the Committee
A. Issues implicated in cross-border payments and cross-border trade 
        and finance
    Monetary policy is one of the concerns cited by the European 
Central Bank in its 2012 report on Virtual Currency Schemes. But that 
report did not discuss enforcement of collateralized debt obligations.
    Virtual currency transactions could render finance transactions 
nontransparent so that current and potential providers of financing 
might not be able to ascertain their relative priorities to assets that 
underlie those trade transactions. The United States will want to 
follow closely developments that frustrate creditors' claims to 
inventory or other assets if the obligor fails to complete payments for 
goods that it has purchased here or abroad.
    The trend away from bank-issued letters of credit to supply chain 
financing not involving banks--indeed including financing provided by 
logistics suppliers--has not yet degraded the ability of sellers, 
buyers or their financers to monitor cross-border trade transactions. 
This may be because logistics suppliers of supply chain finance enjoy 
hard-earned reputations as honest participants delivering the goods 
they carry and collecting payments if required on behalf of senders. 
But the potential for trade finance disruption still exists.
B. Possible regulatory models for providers of payments products and 
        systems
    In addition to the current State prudential regulation of virtual 
currency providers and to Treasury's comprehensive registration, AML 
and economic sanctions regulations applicable to money services 
businesses, we have a number of potential models for regulating, 
requiring registration or supervising and examining providers of 
virtual currencies. I mention these more for future purposes than for 
any need I perceive at this point, but the eventual use of alternative 
regulatory models depends in large measure on how the products offered 
as ``virtual currencies'' work in fact.
    For example, State prudential regulation of money transmitters is 
framed to ensure that competent transaction execution. Those who take 
funds from one person with a promise to deliver them to a second person 
need to have the capacity to do just what they promise--to pay in the 
manner, in the time, and to the person that the first person instructed 
them to pay.
    Prudential regulation by States establishes qualifications for 
providers--depository and nondepository providers they license to do 
business with their own residents, and establishes a system of reserves 
or bonds or both so that funds will be available to complete 
transactions on those persons' parts.\10\ State licensing and bonding 
requirements are cited by many entrepreneurs as a reason why virtual 
currencies are not attracting the widespread uses and investor funding 
that entrepreneurs seek. However, without these State requirements, the 
prospect of value disappearing--as it apparently has with the 
disappearance of the bitcoin exchange in China--likely would rise and 
injure users of these products.
---------------------------------------------------------------------------
    \10\ This system has features of fractional reserves that our 
banking system depends on, as well as of bonding or comparable 
requirements to ensure completion of transactions in the event of 
provider failure. The Board of Governors of the Federal Reserve System 
also establishes reserve requirements for depository institutions on an 
annual basis, in Regulation D.
---------------------------------------------------------------------------
    State prudential regulation began in the late 18th Century when 
Massachusetts and New Hampshire prohibited unincorporated banks from 
operating.\11\ New York State followed them with its prohibition in 
1804. Some States banned banking--period. These included Texas until 
1904, and Iowa, Arkansas, Oregon and California before the Civil War. 
State laws also established ``safety deposit'' systems and have 
regulated them. Items in safety deposit boxes are not immune from asset 
freeze orders issued by courts, or seizure by the IRS. States have been 
regulating money transmitters since the advent of the telegraph.
---------------------------------------------------------------------------
    \11\ For a brief discussion of this period in bank and payments 
regulation in the United States, see Broome & Markham, supra, note 2 at 
1-28.
---------------------------------------------------------------------------
    The regulation of safe-storage systems is even more ancient, 
beginning with the Knights Templar and Vatican as lenders in the pre- 
and early-Renaissance periods, and with the Silver Vaults in London and 
lenders in Belgium, the Netherlands, and Florence whose services 
contributed to the early Renaissance flows of commerce and modern 
trade. I mention safety deposit systems because of the similarities 
they have, and that their predecessors had, to products such as e-Gold, 
and even bitcoins. Some of these contemporary products are more like 
commodities to be bartered than they are true ``currencies.''\12\
---------------------------------------------------------------------------
    \12\ Francois R. Velde, Bitcoin: A primer, Chic. Fed Letter No. 317 
(Dec. 2013) (copy on file with the witness) (describes the operations 
of bitcoins and, particularly, its unique methods for controlling two 
challenges of digital money--controlling the creation and avoiding 
duplication of units).
---------------------------------------------------------------------------
    Alternative regulatory schemes for virtual currencies include 
commodities and securities regulation. The securities model offers 
advantages such as registration and requirements for disclosing 
material events that may affect the value of the security or the health 
of its issuer.
    One reason to consider commodities or securities regulatory schemes 
for virtual currencies that do not track the movements of legal tender 
currencies is evidence that investors are speculating in these 
currencies. To the extent that virtual currencies seem to be used more 
for speculative purposes and less for transaction execution, the 
nonpayments models of regulations present feasible alternatives.
V. Conclusion
    I applaud the Subcommittees for holding this important hearing and 
urge them to continue to watch developments in virtual currencies. 
Thank you again, Chairman Merkley and Chairman Warner, and Ranking 
Members Heller and Kirk, for this opportunity to share my views with 
your Subcommittees. I will be pleased to take questions.
                                 ______
                                 
             PREPARED STATEMENT OF MERCEDES KELLEY TUNSTALL
       Partner, Practice Leader, Privacy and Data Security Group
                           Ballard Spahr LLP
                           November 19, 2013
INTRODUCTION
    Chairman Merkley, Ranking Member Heller, and the Members of the 
Subcommittee, I am Mercedes Kelley Tunstall, a Partner at Ballard Spahr 
LLP and the Practice Leader of our firm's Privacy and Data Security 
Group. My testimony today reflects my personal experience with the 
virtual currency industry and represents my own opinion. My testimony 
does not necessarily reflect the opinions of Ballard Spahr LLP or our 
clients.
    Thank you for this opportunity to testify about the present and 
future impact of virtual currency. I work directly with multiple 
clients that offer their own forms of virtual currency. I also advise 
large banking clients on how to interact with virtual currencies as 
well as how to structure their programs and services as to avoid being 
treated as virtual currency. I have spoken extensively on this topic 
during Webinars and other public forums, and I have been quoted 
frequently by the press. I will focus my remarks today on the important 
steps that the virtual currency industry and Federal regulators should 
take in order for virtual currency to have a commercially viable 
future.
THE NEXT GENERATION OF VIRTUAL CURRENCY
    In only a few short years, Bitcoin may have become the most well-
known virtual currency today, but Bitcoin has also demonstrated a 
number of weaknesses that the next generation of virtual currency 
should be careful to address.
I. Bitcoin % Integration
    Bitcoin has built its reputation and structured its virtual 
currency around being both antigovernment and anti-establishment. 
Although this reputation may be attractive to a certain type of 
consumer, the structure has limited, and will continue to limit, 
Bitcoin's adoption by a wider population. Due to Bitcoin's reputation, 
large financial institutions view the currency as being unreliable and 
therefore not able to meet their safety and soundness requirements. If 
a virtual currency could be reliable, then financial institutions may 
very well incorporate the currency as a solution to certain problems 
faced. For example, virtual currency could be attractive to large 
financial institutions if the fees associated virtual currency 
transactions, including the exchange fees, are lower than the fees 
accompanying other payments methods (e.g., interchange fees). The next 
generation of virtual currency should figure out a way to better align 
with existing payment methods, or virtual currency will never be able 
to move from a ``niche'' into the mainstream.
II. Virtual Currency % Anonymity
    One of the most frequently cited advantages of virtual currency is 
the increased privacy and anonymity associated with using bitcoins. 
However, even Bitcoin is not completely anonymous as a public record of 
each Bitcoin transaction is electronically recorded. In order for the 
industry to continue maturing, the next generation of virtual 
currencies should dispel the perception that an important element of 
using virtual currency is the ability for an individual to engage in 
online transactions with complete anonymity.
    In a transaction involving hard currency, the two parties to the 
transaction may not know each other, but in order for the currency to 
be handed from one person to the next, the two people must see each 
other and be in each other's presence (or have a proxy to do the same 
for them).
    This transaction is hardly anonymous, and yet many have compared 
Bitcoin transactions to cash exchanges between strangers and referred 
to such exchanges as being anonymous. Instead, the distinction is that 
such cash transactions can occur without being recorded by any 
financial system or government and without the involvement of middlemen 
such as banks. As such, bitcoins, like cash, have been used in 
transactions to perpetrate fraud, money laundering, and other illegal 
activities. Unlike hard currency, however, technological solutions 
could be developed to track the digital exchange of virtual currency so 
that the transaction is not conducted through a middleman. Bitcoin and 
other virtual currency providers have a responsibility to prevent 
criminal activity and to comply with anti-money laundering and other 
laws. The next generation of virtual currencies must address the 
ability of individuals to use virtual currency to engage in illegal 
activities anonymously or the Congress, the Federal agencies, or the 
courts may take action, which could result in harmful consequences to 
the industry's overall growth.
III. Bitcoin = Commodity or Bitcoin % Commodity
    Bitcoin displays some features that allow Bitcoin to function like 
a commodity, such as the self-imposed limit of 21 million bitcoins and 
the volatility of the value of bitcoins. However, Bitcoin does not 
presently comply with current securities or commodities laws and 
regulations. In order for banks to work with virtual currencies, those 
virtual currencies either need to comply with or protect against 
commoditization. Unless the next generation of virtual currencies can 
resolve the question as to whether virtual currency should be 
considered a commodity, the industry will remain characterized by 
volatility. Without further stabilization, mainstream adoption of 
virtual currency remains unlikely.
REGULATORY CERTAINTY
    As the virtual currency industry matures, regulatory certainty will 
also be needed to ensure a future for this industry.
I. Legal Definition of Virtual Currency
    The virtual currency industry would benefit greatly from guidance 
from the Federal Government as to the legal definition of virtual 
currency. Although it is clear from the Legal Tender Cases of the 1870s 
and 1880s that virtual currencies can legally operate in the United 
States of America, it is unclear as to what regulations could and 
should apply to virtual currency.
    The Commodity Futures Trading Commission and the Securities 
Exchange Commission have both examined Bitcoin-related issues and 
determined that there are times when the currency operates as a 
commodity/security, but beyond that, there is no existing legal 
framework that addresses the unique features and functionality of 
virtual currency.
II. Financial Crimes Enforcement Network
    Existing FinCEN guidance has offered much-appreciated guidance for 
the industry and related players, but as the industry continues to 
mature, additional guidance will be needed on how to integrate virtual 
currency into the existing financial ecosystem, especially with regard 
to compliance with anti-money laundering requirements.
III. Electronic Fund Transfer Act / Federal Reserve Board Regulation E
    Currently, consumer protections contained in financial regulations 
such as the Electronic Funds Transfer Act and its implementing 
regulation, Regulation E, do not apply to virtual currencies. 
Therefore, unauthorized transactions involving virtual currency have no 
recourse--once the currency is gone, it is gone, just as surely as when 
someone swipes bills from a wallet. Due to the electronic nature of 
virtual currencies, consumers may not understand the reasons for the 
disparate protections conferred on the use of these disparate payment 
forms. If consumers are unable to embrace virtual currency as a safe, 
effective means to conduct online (and even offline) transactions, 
industry growth will be stalled.
CONCLUSION
    Thank you again for the opportunity to testify on these important 
issues. I would also like to express my appreciation to your staff for 
all their assistance in preparing for this hearing.
    I would be happy to address any specific questions that the Members 
of the Subcommittee may have for me.

Mercedes Tunstall
Biography
    Mercedes Kelley Tunstall is the Practice Leader of Ballard Spahr's 
Privacy and Data Security Group. She is also a member of the software 
and business methods practice team in the firm's Patents Group.
    Ms. Tunstall counsels clients on compliance with consumer financial 
services laws, including unfair, deceptive, and abusive acts or 
practices, as well as the investigations, rulemakings, and proceedings 
of the Consumer Financial Protection Bureau and the Federal Trade 
Commission.
    Ms. Tunstall has substantial experience working with clients to 
develop new financial products and services, including mobile wallets, 
virtual currencies, and prepaid cards. These engagements typically 
include negotiating agreements with technology vendors, reviewing 
technical designs, drafting customer communications and agreements, and 
advising on potential regulatory and privacy and data security 
concerns.
    She also works with clients from a spectrum of industries on mobile 
and other ecommerce initiatives, privacy and cybersecurity issues, and 
the use of social networking sites for marketing, customer service, and 
crowdsourcing purposes.
    Before joining Ballard Spahr, Ms. Tunstall was lead counsel for 
Global Marketing and Deposits at Ally Financial. She also worked in-
house for Bank of America, where she managed all legal aspects of e-
commerce, and at HSBC, where she managed consumer financial services 
litigation.
    Ms. Tunstall was a Staff Attorney at the Federal Trade Commission, 
where she investigated and litigated the Commission's first Internet 
hijacking case, among other Internet fraud matters.
                                 ______
                                 
                 PREPARED STATEMENT OF ANTHONY GALLIPPI
                       Cofounder and CEO, Bitpay
                           November 19, 2013
    Thank you Chairmen Merkley and Warner, and Ranking Members Heller 
and Kirk, and Distinguished Members of the Committees for the 
opportunity to speak with you today.
    My name is Tony Gallippi and I am the Cofounder and CEO of BitPay. 
I graduated magna cum laude from Georgia Tech with a degree in 
Mechanical Engineering. BitPay is a startup company with 16 fulltime 
employees, based in Atlanta.
    I appreciate the Members for their interest in the commercial and 
international trade uses of digital currencies, and more importantly, 
the opportunities for digital currencies to create jobs in America and 
to increase America's exports. Since Bitcoin represents the dominant 
market share of virtual currencies, my testimony will focus on Bitcoin 
specifically and not on any of the alternative virtual currencies.
    Our company, BitPay, was started in May 2011 and we have been 
operating for over 2 years now, which makes us pretty old in the 
Bitcoin space. During this time we have acquired over 12,000 merchants 
to accept bitcoin with our service. Our merchants include many small 
and medium-sized businesses in every State, who accept bitcoin side-by-
side with credit cards and other forms of payment.
    Most online payments today are made with credit cards, but credit 
cards were never designed for the Internet. Credit cards were designed 
in the 1950s, and they still function the pre-Internet age. Last year, 
over 12 million people became victims of identity theft, mostly from 
shopping online (source: https://www.javelinstrategy.com/news/1387/92/
1). Businesses lose over $20 billion per year due to payment fraud 
(source: http://www.lexisnexis.com/risk/downloads/assets/
truecostfraud2013.pdf). The banks don't take responsibility for the 
fraud. If you are a business owner, it is your fault that you took a 
stolen credit card, even if the bank approved it. Credit Card fees are 
discriminatory the highest fees are paid by the smallest mom-and-pop 
businesses and the lowest income consumers. Bitcoin is a cheaper, 
faster, and more secure payment system.
Background on Merchant Acquiring
    Even though we deal with bitcoin, our business model of merchant 
acquiring is fairly traditional. Merchant Acquiring began in the 1950s 
with credit cards, and the big marketing push to get businesses to 
accept credit cards as payment. Over the years, companies such as First 
Data, TSYS, Fiserv, and others would emerge with new tools for 
merchants. These companies are typically not household names. They 
operate behind the scenes, facilitating merchant payment acceptance as 
a business-to-business service. Most consumers, even when making a 
payment through one of these service providers, don't even know that 
these companies exist.
    Fast forward 40 years to the 1990s with the launch of the worldwide 
Web and the first Web browser. Businesses could build a Web site to 
reach customers, but how could they take a payment from a Web page? It 
was the mail-order companies who figured it out first. If they could 
accept a credit card over the phone, then perhaps they could also 
accept a credit card over the Internet. Companies like Cybersource and 
Authorize.net built payment gateways for processing credit cards over 
the Internet, and today, 20 years later, credit cards are still the 
most widely used form of payment over the Internet.
Differences between Credit Cards and Bitcoin
    Credit cards are ``pull'' transactions. The shopper provides their 
account number, and secret credentials that the business can use to 
pull money from their account. The problem is that the same credentials 
to pull money one time can be used to pull money many more times by 
that same business, or by anyone who has these credentials. This is the 
fundamental design problem with credit cards, and it is the root cause 
of the identity theft and fraud that we see today.
    Think about that for a minute. Why would you ever give someone full 
access to your $20,000 line of credit to pay them $20?
    Because of this design flaw, security around credit cards is 
massively expensive. Apple has iTunes, with over 500 million credit 
card numbers stored on file. The cost and risk of securing this data is 
enormous. Visa alone spends $200 million a year on fraud prevention. 
They are throwing big money at the problem and it is not working, 
because every year fraud remains very high.
    In 2009, Bitcoin was invented. Bitcoin takes everything we know 
about the Internet, Security, and Cryptography, and builds a payment 
system designed for the Internet.
    Bitcoin is an open standard, an open protocol, and an open source 
payment network. Nobody owns the network, and nobody controls the 
network. All of the users collectively own the network, its rules, and 
its ledger.
    Anyone can use bitcoin or build an application on top of bitcoin. 
Bitcoin is much like the Internet itself, where anyone can use the 
Internet and build an application on top of the Internet. And because 
Bitcoin is borderless, a business can receive a payment from China just 
as easily as they can receive it from someone in the same room.
    Bitcoin payments are ``push'' transactions, which are very 
different than credit cards. If I want to pay someone, I push them the 
exact amount I want to give them. The recipient does not get my account 
number, they do not get my secret credentials, and they do not get any 
permission to ever pull money from my account. Only I can push out a 
payment. Bitcoin works similar to email, and text messages. Text 
messages are a push transaction. You cannot pull an email from me or a 
text message from me, only I can push the message to you. Bitcoin works 
the same way, for payments.
BitPay is a Bitcoin Merchant Acquirer
    At BitPay, our role in the bitcoin ecosystem is very close to that 
of the traditional merchant acquirers in the credit card space. We act 
as an agent of the payee, to help merchants clear and settle 
transactions over the bitcoin network. Merchants could accept bitcoin 
directly, but automating this is very difficult, and most merchants 
choose to use our software and service rather than try to figure it out 
themselves.
    BitPay has a strict Know Your Customer (KYC) policy to verify all 
of our merchant applications. We need to know who our merchants are and 
what they are selling. We only want the good actors using our service. 
We routinely audit our merchants, and we suspend and terminate those 
who violate our Terms of Use. A copy of BitPay's Merchant Terms of Use 
is attached in Exhibit A.
    BitPay also follows all Bank Secrecy Act (BSA) guidelines to 
prevent, detect, and report suspicious activity. Our strict policies to 
comply with laws and protect our brand have earned BitPay the 
reputation as a leader and well respected company in the payments 
space.
    BitPay is not a bitcoin exchange, but we use nearly all of the 
bitcoin exchanges around the world to manage our own asset allocation. 
We do not act as a broker dealer to facilitate trades, and we also do 
not offer any bitcoin services for consumers. Consumers do not need to 
store funds with BitPay, they can simply pay the merchant invoice from 
whichever bitcoin wallet they choose to push the payment from. In the 
near future, our service will be more integrated into the merchants 
branding and checkout experience.
Bitcoin protects Consumers from Identity Theft
    For consumers, Bitcoin is another choice of payment which is 
voluntary to use. One of the main reasons why a consumer would choose 
to pay with Bitcoin is that Bitcoin can reduce, if not completely 
eliminate, the risk of the consumer becoming a victim of identity 
theft. Identity theft happens when a criminal gets access to the 
victim's account number and credit card credentials, and uses those 
credentials to make unauthorized purchases. When using Bitcoin, the 
consumer never needs to provide their identity to make a payment, so 
there is no identity information to steal, and no risk of identity 
theft. Bitcoin is a massive win for consumers, saving 12 million people 
per year the expense and hassle of dealing with the fallout of identity 
theft.
    Consumers will be educated of the different ways in which they 
store their bitcoin. It functions more like cash, where if you lose it, 
it's gone. The funds are locked in the private key, which defines the 
ownership of the asset. Consumers can create many wallets with varying 
levels of convenience and security. The technology is being developed, 
and consumers will be educated on data security and proper data backups 
to ensure proper use of the technology. If consumers understand how 
bitcoin works, they should be allowed to use it.
Bitcoin protects Businesses from Payment Fraud
    For businesses, Bitcoin can also stop the $20 billion/year fraud 
problem. When your business receives a bitcoin payment, it's confirmed, 
and it's yours. It cannot be reversed or taken away from you. 
Businesses can now reach customers in emerging markets, where they 
could not collect payments from before. Credit cards for online 
businesses don't really work beyond 8 or 10 countries, so most 
businesses simply choose not to sell internationally not because their 
Web site can't reach, or their shipping company can't reach, but only 
because they can't take the payment.
    It is the small mom-and-pop businesses that are most excited about 
Bitcoin, and represent most of the adoption today. The businesses who 
accept Bitcoin are now opening up new markets, and creating more 
exports, and more jobs in America. If the United States doesn't allow 
our businesses to accept bitcoin and create more jobs and exports, then 
countries like Germany and China certainly will.
Bitcoin's limitations
    Bitcoin does have limitations that will keep it a small player in 
the payments space for quite some time. Compared to credit cards, 
Visa's payment network can handle 20,000 transactions per second, 
worldwide. Bitcoin can handle seven. Not seven thousand, but seven 
transactions per second. Today, the average rate on the bitcoin network 
is one transaction per second. So compared to the collective networks 
of credit cards, debit cards, payment cards, ACH, and wires, there are 
50,000 times more transactions taking place on traditional networks 
than on the bitcoin network.
    Bitcoin also has some limitations on its usability. The global 
money supply of Bitcoin is worth around $5 billion. Compare this with 
the global M2 money supply of around $70 trillion, there is 15,000 
times more money in the world in traditional currencies than in 
bitcoin.
Bitcoin's potential for nonmonetary use
    Even though it's small, Bitcoin has invented something previously 
thought to be impossible. Many times when parties transfer assets to 
each other, they are trading a digital representation of an asset. The 
asset itself settles 13 days later. With Bitcoin, it is now possible to 
transfer an asset remotely, and immediately settle the transaction, 
with no counterparty risk. That type of instrument has never existed 
before.
    The possibilities of this instant worldwide settlement are very 
interesting. And this is where the real potential for Bitcoin exists. 
The Bitcoin blockchain, which is the public accounting ledger of 
bitcoin, is a large property rights database. It can handle 
quadrillions of individual asset accounts, with a full chain of custody 
every time an asset is transferred from one party to another party.
    If you want to energize the housing market, think of Bitcoin. The 
biggest upfront costs for consumers trying to buy a home are the 
closing costs, which include fees for deeds, titles, stamps, title 
insurance, and other redundant tasks to record the sale in different 
record books. Bitcoin can replace thousands of dollars in closing costs 
with a single transaction that costs 5 cents. By reporting deeds and 
titles on the blockchain, the information would be public record 
forever, for pennies, and eliminate the need for title insurance.
    The property rights aspect of Bitcoin can go one step further, to 
create smart property. This can be used for purchases like cars, where 
if a loan is attached to the car, the ownership of the car can be 
transferred back to the lender in case of default, or if the loan is 
paid off the owner would have full ownership of the car, and then they 
can transfer it to whomever they want.
Bitcoin Risks
    Bitcoin does have risks. Criminals use cell phones, criminals use 
email, and criminals use dollars and banks. Many businesses like 
BitPay, offering innovative services on top of bitcoin, share the 
Committee's goals to protect consumers from fraud, and keep the 
criminals away from our businesses.
    The Board of Governors of the Federal Reserve System acknowledged 
that virtual currencies ``may pose risks related to law enforcement and 
supervisory matters,'' but ``there are also areas in which they may 
hold long-term promise, particularly if the innovations promote a 
faster, more secure and more efficient payment system.''
Bitcoin Regulation
    Guidance from the IRS, Department of Treasury, Department of 
Justice, and SEC has all established that bitcoins are legal, and that 
those dealing with them must simply follow existing tax laws and 
antimoney-laundering regulations.
    In the 1990s when the Internet was in its infancy, Congress took a 
wait-and-see attitude to let the Internet develop. Where would Social 
Media and other free apps be today if in the 1990s we required licenses 
for the Internet, and taxed Internet access as if it was a Telecom?
    In 1995, the National Science Foundation lifted its strict 
prohibition of commercial enterprise on the Internet, and immediately 
companies like Amazon, Ebay, and Dell were born. Americans will benefit 
from a similar openness and wait-and-see approach to Bitcoin.
Bitcoin Regulation outside the United States
    Bitcoin by design is borderless, like the Internet itself. 
Businesses using bitcoin are forming every day, at a pace not seen 
since the expansion of the worldwide Web in the 1990s. There is a 
tremendous amount of capital, resources and effort being spent to 
create innovation in finance.
    We don't believe that new legislation or regulation around bitcoin 
is needed. The rules for consumer protection and antimoney laundering 
already exist today.
    Germany has declared Bitcoin to be ``private money'' and other 
countries are working to categorize Bitcoin and Bitcoin-related 
services into regulatory frameworks that exist today. Bitcoin is a 
technology with tremendous cost savings for businesses and consumers. 
Bitcoin is a more secure, faster, and more affordable option for 
transferring funds. If America is the leader in Bitcoin technology, 
America will create more jobs and more exports.
Bitcoin is Disruptive
    Bitcoin is a disruptive technology. Bitcoin will not replace the 
dollar, or the euro, or gold, but it will certainly disrupt existing 
financial services and their fee structures. Today banks charge many 
fees to consumers: overdraft fees, overlimit fees, interest fees, 
application fees, monthly fees, authorization fees, processing fees, 
ATM fees, maintenance fees, minimum balance fees, late fees, and even 
fees to send your paper statement in the mail. With bitcoin, users can 
handle many of their daily payments needs themselves and avoid the bank 
fees, so banks relying on fee revenue could be impacted the most by 
virtual currencies.
    Most IT systems used by banks and financial services today were 
built in the 1970s. They were designed well before the Internet and 
they lack many of the technical innovations that other industries use 
today. Bitcoin could offer immediate cost reductions and technical 
advancements to our financial institutions, particularly in the areas 
of interbank settlement, international transfers, and foreign exchange. 
The current 13-day settlement times on many types of transactions can 
be reduced to 13 seconds.
    Bitcoin is a technology with tremendous cost savings for businesses 
and consumers. Bitcoin is a more secure, faster, and more affordable 
option for transferring funds. If America is the leader in Bitcoin 
technology, America will create more jobs and more exports.
Conclusion
    In conclusion, today Bitcoin is in its infancy. It is much like the 
Internet in the early 1990s. Thanks to Congress's protection, the 
Internet was allowed to evolve and develop, and today it has greatly 
improved our lives.
    If we look 10-20 years in the future, we will see many companies 
built upon bitcoin-related technology. We want those companies to be 
based in America, creating jobs in America, and building a revenue base 
and tax base in America.
    The original application of the Internet was commerce, with 
companies like Amazon and Ebay. Over time, the killer apps for the 
Internet emerged, and these apps were not the original application. 
Search, Social Media, and Big Data are all powerful industries built on 
the Internet, and where would all of the free applications like Social 
Media be today if the early Internet was pigeonholed, overly regulated 
and required expensive telecom licenses?
    I commend the Committee for recognizing the real, practical uses of 
virtual currencies and the potential future applications of this 
technology. Thank you for the opportunity to speak today.

Appendix A BitPay Merchant Terms of Use
    These Merchant Terms of Use (the Terms) govern your use of the 
products, services or any other features, technologies or 
functionalities (the Services) provided by BitPay, Inc. (BitPay, we, 
our, or us) through BitPay's Web site, API or through any other means. 
You and your mean the merchant to which we will be providing the 
Services and the person signing below or otherwise agreeing to the 
Terms on behalf of the merchant. Please read the Terms carefully; by 
using the Services, you agree to the Terms and confirm that you accept 
them.
    The Services. We are a Bitcoin payment processor--we enable you to 
accept bitcoins as payment for goods or services, and process Bitcoin 
payments that you receive from your customers. We are not a Bitcoin 
exchange, Bitcoin wallet, or a place to purchase Bitcoin. By using the 
Services, you authorize us to receive, hold and disburse funds on your 
behalf and to take any and all actions that we think are necessary or 
desirable to provide the Services and to comply with applicable law.
Registration
        Generally. In order to use the Services, you must open a BitPay 
        account. When you open an account, we will ask you for contact 
        information such as, for instance, your name, mailing address, 
        phone number, email address, and Web site. The information that 
        you provide at the time of account opening must be accurate and 
        complete, and you must inform us in a timely fashion of any 
        changes to such information. We may require additional 
        information about you (including any person signing below or 
        otherwise agreeing to the Terms on behalf of the merchant) such 
        as, for instance, your date of birth, tax identification number 
        or Government-issued identification, and we may also obtain 
        information about you from third parties, such as credit 
        bureaus and identity verification services. We have the right 
        to reject your account registration, or to later close your 
        BitPay account, if you do not provide us with accurate, 
        complete and satisfactory information.

        Merchant Tiers. BitPay imposes daily transaction processing 
        limits on merchants. When you register for a BitPay account, 
        you will be required to select the limit (the Tier) that will 
        apply to your BitPay account, and to provide us with the 
        documentation necessary to qualify for that Tier. A description 
        of the Tiers, as well as a list of the documentation required 
        to qualify for each, is available on our Web site. If your 
        business is a High Risk category, as determined by BitPay, you 
        will be required to qualify for the ``Trusted'' Tier in order 
        to use the Services. We will not begin to process payments on 
        your behalf until we have reviewed the documentation that you 
        provide, in accordance with applicable law. If you wish to 
        change to a Tier with a higher limit, you must provide us with 
        the additional required documentation. We will not approve your 
        request to change Tiers and permit you a greater processing 
        volume unless and until we have reviewed your documentation to 
        our satisfaction. Please also refer to Section 3.1, ``Daily 
        Transaction Volume; Tiers.''

        Guarding your Password. You will choose a password when 
        registering. You are responsible for maintaining the 
        confidentiality of your password and account. You are fully 
        responsible for all activities that occur using your password 
        or account. Please notify us immediately of any unauthorized 
        use of your password or account or any other breach of 
        security. We will not be liable for any loss that you may incur 
        as a result of someone else using your password or account, 
        either with or without your knowledge. You may not use anyone 
        else's password at any time.

        Prohibited Accounts. Use of the Services is subject to the laws 
        and regulations of the United States regarding the prevention 
        of terrorist financing and antimoney laundering. You agree and 
        acknowledge that your use of the Services would and will 
        comport with such laws and regulations, including, without 
        limitation, the sanctions programs administered by the Office 
        of Foreign Assets Control of the United States Department of 
        the Treasury.
Your Sales.

        Daily Transaction Volume; Tiers. You agree to adhere to the 
        transaction processing limits applicable to your Tier. You 
        agree that, if you exceed that limit, BitPay has the right to 
        hold the over-the-limit funds until you have provided us with 
        the additional documentation required to qualify for the next 
        Tier, and until we have had the opportunity to review such 
        documents. We will take additional measures if you exceed your 
        limit. If you are a ``Trusted'' merchant, you may create an 
        unlimited value of invoices (see Section 8.1), although you 
        will only receive payments from us up to the specified limit. 
        If you are not a ``Trusted'' merchant, you may not create a 
        value of invoices that exceeds your specified limit.

        Invoices and Records. You must keep all records needed for 
        fulfilling the merchandise to the purchaser and providing any 
        post-sale support to the purchaser. If the sale of the item 
        requires any government registration of the sale, you are 
        responsible for such registration.

        Customer Verification. You are solely responsible for obtaining 
        any information required of those who purchase your goods or 
        services. For instance, if applicable law prohibits a sale to 
        persons under the age of 18 years, you must ensure that a 
        purchaser is at least 18 years of age. Similarly, if applicable 
        law requires that a purchaser's identity be verified, you must 
        verify the purchaser's identity. We will not be responsible for 
        your failure to adequately verify your purchasers' identities 
        or qualifications.

        Representation and Warranties. Your use of the Services is 
        subject to several important restrictions. Specifically, you 
        represent and warrant to us that:

        (a)  Your use of the Services will not contravene any 
        applicable international, Federal, State or local law or 
        regulation, including applicable tax laws and regulations, and 
        that your use of the Services will not violate the laws of the 
        United States of America.

        (b)  Your use of the Services will not relate to sales of (i) 
        narcotics, research chemicals or any controlled substances, 
        (ii) cash or cash equivalents, including derivatives, (iii) 
        items that infringe or violate any copyright or trademark, (iv) 
        ammunition, firearms, explosives, weapons or knives regulated 
        under applicable law, or (v) any services which compete with 
        BitPay.

        (c)  Your use of the Services will not relate to transactions 
        that (i) show the personal information of third parties in 
        violation of applicable law, (ii) support pyramid or Ponzi 
        schemes, matrix programs or other ``get rich quick'' schemes, 
        (iii) are associated with purchases of annuities or lottery 
        contracts, layaway systems, offshore banking or transactions to 
        finance or refinance debts funded by a credit card, (iv) are 
        associated with Money Service Business activities, as defined 
        by the Financial Crimes Enforcement Network of the United 
        States Department of the Treasury, or (v) provide credit repair 
        or debt settlement services.

        (d)  Your use of the Services will not involve gambling or any 
        other activity with an entry fee and a prize, including, but 
        not limited to casino games, sports betting, horse or greyhound 
        racing, lottery tickets, other ventures that facilitate 
        gambling, and sweepstakes, unless you have obtained our prior 
        approval and you and your customers are located exclusively in 
        jurisdictions where such activities are permitted by law.

        (f)  You have the right, power and ability to enter into and 
        perform under these Terms.

        Our Right to Reject. We reserve the right to decline to process 
        a sale if we believe that it violates these Terms or would 
        expose you, other merchants, purchasers, or other parties to 
        harm. If we reasonably suspect that your BitPay account has 
        been used for an illegal purpose, you authorize us to share 
        information about you, your BitPay account, and your account 
        activity with law enforcement.

        Our Right to Inspect. We may ask for permission to inspect your 
        business location, in connection with your use of the Services 
        or specific transactions. If you refuse our request, we may 
        suspend or terminate your BitPay account.
Third Parties.
        Your Use of Third-Party Services. In using the BitPay Web site 
        or the Services, you may be offered services, products and 
        promotions provided by third parties. If you decide to use 
        these third-party services, you do so at your own risk and are 
        solely responsible for reviewing, understanding and complying 
        with the associated terms and conditions. We expressly disclaim 
        any liability for the third-party services and are not 
        responsible for the performance of the third-party services or 
        servicers.

        Security. We have implemented security measures designed to 
        secure your information from accidental loss and from 
        unauthorized access, use, alteration or disclosure. However, we 
        cannot guarantee that unauthorized persons will never gain 
        access to your information, and you acknowledge that you 
        provide your information at your own risk, except as otherwise 
        provided by applicable law.

        How we Collect, Use and Share Information. In order to provide 
        the Services, we may share information about you and your 
        BitPay account with third parties, including but not limited to 
        your bank and purchasers.

        Our Ownership of the Services and the BitPay Website. You agree 
        and acknowledge that we own all right, title and interest to 
        and in the Services, the associated software, technology tools 
        and content, the BitPay Web site, the content displayed on the 
        Web site, and other materials produced by and related to BitPay 
        (collectively, the BitPay IP). You are only permitted to use 
        the Services and the BitPay IP to accept and receive payments, 
        according to these Terms. When you accept the Terms, we grant 
        you a personal, limited, revocable and nontransferable license 
        to use the BitPay IP, without the right to sublicense. You 
        shall not rent, lease, sublicense, distribute, transfer, copy, 
        reproduce, download, display, modify or timeshare the BitPay IP 
        or any portion thereof, or use the BitPay IP as a component of 
        or a base for products or services prepared for commercial 
        sale, sublicense, lease, access or distribution. You shall not 
        prepare any derivative work based on the Company IP, nor shall 
        you translate, reverse engineer, decompile or disassemble the 
        Company IP.

        Advertising. By mutual consent, we may publish your corporate 
        name, artwork, text and logo (Merchant Content) on the BitPay 
        Web site and promotional materials to acknowledge you as our 
        customer. You represent and warrant to us that you have the 
        right to provide the Merchant Content to us, and that the use, 
        copying, modification and publication of the Merchant Content 
        by us: (a) will not infringe, violate or misappropriate any 
        third party copyright, patent, trade secret or other 
        proprietary rights, (b) will not infringe any rights of 
        publicity or privacy, and (c) will not be defamatory or obscene 
        or otherwise violate any law.
Fees & Settlement.
        Invoice Generation and Exchange Rate Guarantee. To create an 
        invoice, you may post a request to BitPay to collect a specific 
        amount in your local currency, such as dollars or euros, or in 
        Bitcoin. BitPay will pull the exchange rate and provide the 
        Bitcoin payment instructions to the purchaser. We guarantee the 
        exchange rate to you as long as the purchaser pays within the 
        proper time window after the invoice is created. Invoice 
        timeout information is clearly displayed on each BitPay 
        invoice. While we guarantee the exchange rate as long as the 
        purchaser pays within such time window, you agree that you 
        assume the volatility risk of your local currency or Bitcoin, 
        as applicable. For instance, if you ask us to collect USD $150, 
        and the purchaser sends the payment within the time window, we 
        guarantee you will receive exactly USD $150, minus our fee, but 
        do not guarantee the value of the U.S. dollar.

        Fees. We charge a processing fee on all transactions. The 
        proceeds payable to you will equal the amount of the invoice 
        (assuming that we have received the full amount of the invoice 
        from the purchaser), unless you agree to accept less than the 
        amount of the invoice, minus the processing fee. We reserve the 
        right to change our fees and will give you 30 calendar days' 
        prior notice of any fee increase. Your continued use of the 
        Services after we notify you of any increase in our fees 
        constitutes your acceptance of such change. Current pricing 
        information is provided on the BitPay Web site at https://
        bitpay.com/pricing.

        Methods of Settlement. We will clear the payments over the 
        Bitcoin peer-to-peer payment network and post the balance to 
        your accounting ledger, according to your preference settings.

        The debits and credits to your accounting ledger are funds 
        temporarily held by BitPay until settlement to your bank 
        account can take place. You can receive a settlement in your 
        local currency, in bitcoins, or in a mixture of both. You 
        assume volatility risks of the currency in which you choose to 
        be settled. If you choose to keep bitcoins, then you assume the 
        volatility risk of the Bitcoin value.

        Settlements in Local Currencies. Direct deposit to a bank 
        account in a local currency is available to merchants located 
        in certain countries. Please refer to Please refer to https://
        bitpay.com/bitcoindirectdeposit for a list of those countries. 
        If you wish to receive direct deposit, you must provide us with 
        valid bank account information and keep such information 
        current. We will send a direct deposit to your bank account to 
        clear out your accumulated balance. Minimum settlement amounts 
        apply; please refer to https://bitpay.com/bitcoindirectdeposit 
        for information related to minimum settlement amounts and 
        deposit frequency.

        Your Bank Account. You must provide us with written notice at 
        least 1 business day prior to closing your bank account. If you 
        wish to continue to receive direct deposits, you must provide 
        us with information for a substitute bank account. You are 
        solely liable for all fees and costs associated with your bank 
        account and for all overdrafts. You authorize us to initiate 
        electronic credits to your bank account at any time, as 
        necessary to process your transactions. We will not be liable 
        for any delays in receipt of funds or errors in bank account 
        entries caused by third parties.

        Settlements in bitcoins. Payments in bitcoins are sent to the 
        Bitcoin address of your choice, at least once per calendar day. 
        BitPay does not operate a Bitcoin wallet and funds must be 
        moved to your wallet address.

        Certain Deferrals. If we need to conduct an investigation or 
        resolve any pending dispute related to your BitPay account, we 
        may delay settlement or restrict access to your funds while we 
        do so. Additionally, we may delay settlement or restrict access 
        to your funds if required to do so by law, court order or at 
        the request of law enforcement.

        Account Statements. On demand, we will provide you with a 
        statement detailing your account transaction and settlement 
        history. Should you identify an error in the statement, you 
        must notify us of such error within 30 calendar days.
Refunds and Adjustments.
        Refund Procedures. In the event that you wish to issue a refund 
        to a purchaser, BitPay can handle this. You can decide to issue 
        a partial refund or the full amount of the initial purchase.

        You can also decide whether to issue the original amount of the 
        invoice in your local currency or in the number of bitcoins 
        paid. If you do not have enough funds in your BitPay account to 
        cover the refund, BitPay may require you to deposit bitcoins 
        into your BitPay account to cover the refund to the purchaser. 
        Any required currency conversion during the refund process will 
        be calculated at a spot rate determined by BitPay, following 
        the guidelines found here: https://bitpay.com/bitcoin-exchange-
        rates.

        Disclosure of Your Refund Policy. Merchants are required to 
        have a clear refund policy for their customers. We recommend 
        you refund the amount of the initial purchase in the currency 
        in which the item was priced.

        Purchaser Complaints. Purchasers filing complaints about a 
        purchase will be forwarded to you for resolution. BitPay 
        reserves the right to terminate accounts which receive 
        excessive complaints.
Account Termination.
        Your Right to Close Your Account. You may close your BitPay 
        account at any time. You will still be obligated to us for any 
        fees incurred before the closure and we will remit to you funds 
        not yet paid to you and associated with preclosure sales. If 
        your account balance is below our documented minimum transfer 
        amount, you may be responsible for any transactions fees that 
        may be incurred in the funds transfer.

        Our Right to Close or Suspend Your Account. We may terminate 
        these Terms and close your account, at our discretion, upon 
        notice to you via email or phone communication. We may also 
        suspend your access to the Services if we suspect that you have 
        failed to comply with these Terms, pose an unacceptable fraud 
        risk to us, or if you provide any false, incomplete, inaccurate 
        or misleading information. We will not be liable to you for any 
        losses that you incur in connection with our closure or 
        suspension of your account.

        Effect of Account Closure. If your BitPay account is closed, 
        you agree: (a) to continue to be bound by these Terms, (b) to 
        immediately stop using the Services, (c) that the license 
        provided under these Terms shall end, (d) that we reserve the 
        right (but have no obligation) to delete all of your 
        information and account data stored on our servers, and (e) 
        that we shall not be liable to you or any third party for 
        termination of access to the Services or for deletion of your 
        information or account data.

        Indemnification. You agree to indemnify BitPay, its affiliated 
        and related entities, and any of its officers, directors, 
        employees and agents from and against any claims, costs, 
        losses, liabilities, damages, expenses and judgments of any and 
        every kind (including, without limitation, costs, expenses, and 
        reasonable attorneys' fees) arising out of, relating to, or 
        incurred in connection with any claim, complaint, action, 
        audit, investigation, inquiry, or other proceeding instituted 
        by a person or entity that arises or relates to: (a) any actual 
        or alleged breach of your representations, warranties, or 
        obligations set forth in these Terms; (b) your wrongful or 
        improper use of the Services; (c) the products or services sold 
        by you through the Services, including but not limited to any 
        claims for false advertising, product defects, personal injury, 
        death or property damage; or (d) any other party's access or 
        use of the Services with your account information.
    No Warranties. WE PROVIDE THE SERVICES ON AN ``AS IS'' AND ``AS 
AVAILABLE'' BASIS, AND YOUR USE OF THE SERVICES IS AT YOUR OWN RISK. TO 
THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, WE PROVIDE THE SERVICES 
WITHOUT WARRANTIES OF ANY KIND, WHETHER EXPRESS OR IMPLIED (INCLUDING, 
WITHOUT LIMITATION, WARRANTIES OF MERCHANTABILITY, FITNESS FOR A 
PARTICULAR PURPOSE, OR NONINFRINGEMENT). WITHOUT LIMITING THE 
FOREGOING, WE DO NOT WARRANT THAT THE SERVICES (AND OUR WEBSITE): WILL 
OPERATE ERROR-FREE OR THAT DEFECTS OR ERRORS WILL BE CORRECTED; WILL 
MEET YOUR REQUIREMENTS OR WILL BE AVAILABLE, UNINTERRUPTED OR SECURE AT 
ANY PARTICULAR TIME OR LOCATION; ARE FREE FROM VIRUSES OR OTHER HARMFUL 
CONTENT. WE DO NOT ENDORESE, WARRANT, GURANTEE OR ASSUME RESPONSIBILITY 
FOR ANY PRODUCT OR SERVCE OFFERED OR ADVERTISED BY A THIRD PARTY 
THROUGH THE SERVICES OR THROUGH OUR WEBSITE, AND WE WILL NOT BE A PARTY 
TO NOR MONITOR ANY INTERACTIONS BETWEEN YOU AND THIRDPARTY PROVIDERS OF 
PRODUCTS OR SERVICES.
    Limitation of Liability. IN NO EVENT WILL WE BE LIABLE TO YOU OR 
ANY THIRD PARTY FOR ANY DIRECT, INDIRECT, SPECIAL, INCIDENTAL, 
CONSEQUENTIAL, EXEMPLARY OR PUNITIVE DAMAGES OR ANY LOSS, THEFT, 
DISAPPEARANCE, OR DAMAGES FOR LOST PROFITS, LOST REVENUES, LOST DATA OR 
OTHER INTANGIBLE LOSSES THAT RESULT FROM THE USE OF, INABILITY TO USE, 
OR UNAVAILABILITY OF THE SERVICES, REGARDLESS OF THE FORM OF ACTION AND 
WHETHER OR NOT WE KNEW THAT SUCH DAMAGE MAY HAVE BEEN INCURRED. IN NO 
EVENT WILL WE BE LIABLE TO YOU OR ANY THIRD PARTY FOR ANY DAMAGE, LOSS 
OR INJURY RESULTING FROM HACKING, TAMPERING, VIRUS TRANSMISSION OR 
OTHER UNAUTHORIZED ACCESS OR USE OF THE SERVICES, YOUR BITPAY ACCOUNT, 
OR ANY INFORMATION CONTAINED THEREIN. IN NO EVENT WILL OUR LIABILITY 
FOR ANY DAMAGES ARISING IN CONNECTION WITH THE SERVICES EXCEED THE FEES 
EARNED BY US IN CONNECTION WITH YOUR USE OF THE SERVICES DURING THE 6 
MONTH PERIOD IMMEDIATELY PRECEDING THE EVENT GIVING RISE TO THE CLAIM 
FOR LIABILITY. THE FOREGOING LIMITATIONS OF LIABILITY SHALL APPLY TO 
THE FULLEST EXTENT PERMITTED BY LAW IN THE APPLICABLE JURISDICTION.
Miscellaneous.
        Taxes. You are responsible for determining any and all taxes 
        assessed, incurred, or required to be collected, paid, or 
        withheld for any reason in connection your use of our software 
        and services (Taxes). You also are solely responsible for 
        collecting, withholding, reporting, and remitting correct Taxes 
        to the appropriate tax authority. We are not obligated to, nor 
        will we determine whether Taxes apply, or calculate, collect, 
        report, or remit any Taxes to any tax authority arising from 
        any transaction.

        If in a given calendar year you receive (i) more than $20,000 
        in gross amount of payments and (ii) more than 200 payments, 
        BitPay will report annually to the Internal Revenue Service, as 
        required by law, your name, address, tax identification number 
        (such as a social security number, or employer identification 
        number), the total dollar amount of the payments you receive in 
        a calendar year and the total dollar amount of the payments you 
        receive for each month in a calendar year.

        Privacy Policy. Please see our Privacy Policy for information 
        regarding how we collect and use information. The Privacy 
        Policy is part of these Terms, so please make sure that you 
        read it.

        Assignment. You may not transfer or assign these Terms, or any 
        rights granted by these Terms. You agree and acknowledge that 
        we may assign or transfer these Terms.

        Severability. Should any provision of these Terms be determined 
        to be invalid or unenforceable under any law, rule, or 
        regulation, such determination will not affect the validity or 
        enforceability of any other provision of this Agreement.

        Waivers. Our failure to assert any right or provision in these 
        Terms shall not constitute a waiver of such right or provision, 
        and no waiver of any term shall be deemed a further or 
        continuing waiver of such or other term.

        Entire Agreement. These Terms, including the Privacy Policy 
        referenced herein, represent the entire understanding between 
        us and you with respect to the matters discussed. Headings are 
        included for convenience only, and shall not be considered in 
        interpreting these Terms.

        Notices. You agree to accept communications from us in an 
        electronic format, and agree that all terms, conditions, 
        agreements, notices, disclosures or other communications that 
        we provide to you electronically will be considered to be ``in 
        writing.''

        Governing Law; Arbitration. These Terms will be governed by and 
        construed in accordance with the laws of the State of Georgia 
        without reference to conflict of law or choice of law 
        provisions, and applicable Federal law (including the Federal 
        Arbitration Act). If a disagreement or dispute in any way 
        involves the Services or these Terms and cannot be resolved 
        between you and us with reasonable effort, the disagreement or 
        dispute shall be resolved exclusively by final and binding 
        administration by the American Arbitration Association (AAA), 
        and will be conducted before a single arbiter pursuant to the 
        applicable Rules and Procedures established by the AAA. You 
        agree that the arbitration shall be held in the State of 
        Georgia, or at any other location that is mutually agreed upon 
        by you and us. You agree that the arbiter will apply the laws 
        of the State of Georgia consistent with the Federal Arbitration 
        Act, and will honor and agree to all applicable statutes of 
        limitation. You agree that, unless prohibited by law, there 
        shall be no authority for any claims to be arbitrated on a 
        class or representative basis, and arbitration will only decide 
        a dispute between you and us. Arbitration proceedings must be 
        initiated within 1 year after the disagreement or dispute 
        arises. If any part of this Arbitration clause is later deemed 
        invalid as a matter of law, then the remaining portions of this 
        section shall remain in effect, except that in no case shall 
        there be a class arbitration.

        Amendment. We may update or change these Terms from time to 
        time. Except as otherwise provided in these Terms, we will 
        notify you of any changes by electronic mail or by posting a 
        link to the amended Terms on our Web site. If you continue to 
        use the Services after we provide notice of such changes, your 
        continued use constitutes an acceptance of the amended Terms 
        and an agreement to be bound by them. If you do not agree to 
        the amended Terms, you must close your BitPay account and 
        discontinue your use of the Services.

        Force Majeure. Neither you nor we will be liable for delays in 
        processing or other nonperformance caused by such events as 
        fires, telecommunications, utility, or power failures, 
        equipment failures, labor strife, riots, war, nonperformance of 
        our vendors or suppliers, acts of God, or other causes over 
        which the respective party has no reasonable control; provided 
        that the party has procedures reasonably suited to avoid the 
        effects of such acts.

        Survival. The provisions of Sections 2.2, 3.3, 3.4, 4.2, 5, 6, 
        7, 8.1, 8.5, 8.7, 8.8, 9 (including all subsections), 11, 12, 
        13, and 14.7 shall survive the termination of these Terms.

    You agree that the person signing below has the authority to sign 
the Terms and to bind you, and you acknowledge and agree that you: (a) 
have read and understand the Terms; (b) intend to form a legally 
binding contract; and (c) will abide by all the Terms.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR KIRK FROM JENNIFER 
                         SHASKY CALVERY

Q.1. I want to start off with a question about the Silk Road. 
In the case of the Silk Road, it was the FBI that was able to 
target, and eventually bring down the major players in the 
case. I have been told that a new ``Silk Road'' emerged just a 
month after the former Silk Road was shut down. In fact, the 
site administrator of this new site who goes by the moniker, 
``Dread Pirate Roberts'' wrote, ``It took the FBI two and a 
half years to do what they did . . . but 4 weeks of temporary 
silence is all they got''.
    Can you tell me what, if anything FinCen can and does 
provide to law enforcement in monitoring illicit actors such as 
those using the Silk Road? Is there coordination between 
FinCen, other financial regulators and law enforcement in these 
cases?

A.1. As mentioned in my written testimony, shortly after we 
issued our March 2013 guidance on virtual currency, FinCEN also 
issued a Networking Bulletin on crypto-currencies to provide a 
more granular explanation of this highly complex industry to 
law enforcement and assist in following the money as it funnels 
between virtual currency channels and the U.S. financial 
system. Among other things, the Bulletin addresses the role of 
traditional banks, money transmitters, and exchangers that come 
into play as intermediaries by enabling users to fund the 
purchase of virtual currencies and exchange virtual currencies 
for other types of currency. The Networking Bulletin has proved 
especially useful in the context of Silk Road because, as the 
Department of Justice has alleged, customers of Silk Road were 
required to pay a decentralized virtual currency to help both 
the operator of Silk Road and its sellers evade detection and 
launder hundreds of millions of dollars. Beyond the Networking 
Bulletin, FinCEN delivers its expertise to law enforcement on 
an ongoing basis by directly collaborating on criminal 
investigations, producing an ongoing series of analytical 
reports, and conducting training on the evolution in thevirtual 
currency sphere.
    Equally important to our ongoing efforts to deliver 
expertise to our law enforcement partners is FinCEN's 
coordination with our regulatory counterparts to ensure they 
are kept apprised of the latest trends in virtual currencies 
and the potential vulnerabilities they pose to traditional 
financial institutions under their supervision. In addition, 
FinCEN plans to work with our law enforcement partners to 
produce a Webinar on FinCEN requirements for the virtual 
currency community.

Q.2. Is there or should there be a task force within the 
Administration or between Federal financial regulators to 
determine what risks are posed by virtual currencies and to 
contemplate possible coordination and collaboration of efforts?

A.2. While not labeled ``taskforces,'' the Administration has 
established a number of high level virtual currency working 
groups that encompass the entire spectrum of regulatory and law 
enforcement agencies with technical expertise in virtual 
currency benefits, risks, threats, and vulnerabilities. The 
various working groups studying virtual currencies all approach 
the topic from different perspectives, which brings together a 
diversity of mandates, skill sets, and operational concerns on 
the subject matter. This approach fosters strong coordination 
and collaboration, and positively challenges opinions and 
informs the outcome of each working group's findings and 
deliverables. To help foster this interagency synergy, FinCEN 
continues to maintain a strong nexus with its external partner 
agencies in sharing multi-faceted knowledge bases and 
observations.

Q.3. Who do you see as taking the lead role in the U.S. 
Government in monitoring and reporting illicit activities being 
done through virtual currencies?

A.3. Since the issue of virtual currency is an Administration 
priority, the Administration itself is already taking a leading 
role by providing the necessary guidance and direction to 
ensure all relevant departments and agencies are maximizing 
their abilities and resources to safeguard the U.S. financial 
system from illicit activities posed by this emerging payment 
method. Through this guidance, those agencies at the 
operational level, such as FinCEN, leverage their equities and 
expertise to disrupt illicit activities conducted through 
virtual currencies.

Q.4. Knowing that a new ``Silk Road'' emerged just a month 
after the former Silk Road was shut down is there a way to 
ultimately bring down a particular site such as the Silk Road--
and to eliminate users from creating another?

A.4. Since the circumstances surrounding the Silk Road matter 
are primarily a law enforcement concern, I would have to defer 
to my colleagues at the Departments of Justice and Homeland 
Security for their perspectives on permanently shutting down 
such criminal enterprises. However, for our part, FinCEN uses 
its existing regulatory authorities to disrupt and dismantle 
virtual currency exchanges in relation to and in conjunction 
with criminal investigations. Such was the case in May 2013, 
when FinCEN named Liberty Reserve--a Web-based virtual currency 
provider specifically designed and frequently used to 
facilitate money laundering in cyber space--as a financial 
institution of primary money laundering concern under Section 
311 of the USA PATRIOT Act. FinCEN also strives to stay current 
on how money is being laundered in the United States, including 
through new and emerging payment systems like virtual currency 
and what investigative resources may be available, so that we 
can share this expertise with our many law enforcement partners 
to positively contribute to ongoing and future investigations. 
We meet this obligation by drawing from the knowledge we have 
gained through our regulatory efforts, use of targeted 
financial measures, analysis of the financial intelligence we 
collect, independent study of virtual currency, outreach to 
industry, and collaboration with our many partners at all 
levels of Government.

Q.5. There are some academics & policymakers that have 
suggested that the ``Know your Customer'' rule should apply to 
virtual currencies. What are your thoughts on this?

A.5. FinCEN's Customer Identification Program (CIP) rule 
applies to specific types of financial services providers, 
including depository institutions and securities broker-
dealers. Because these entities originate and maintain what can 
be long-term relationships with their customers, it is 
imperative that they know who their customers are and the types 
of transactions that are consistent with their profile. 
Moreover, we believe that this current CIP rule already acts as 
an important choke point for virtual currency providers, since 
as my written statement illustrates, banks are oftentimes 
either the originating or terminating point for virtual 
currency transactions.
    FinCEN works hard to strike the correct balance between 
smart regulation and industry burden, and at this time we 
believe mandating a CIP rule for virtual currency providers 
would be problematic, both from a privacy and cost/benefit 
perspective. It would require information collection and 
retention from every customer, even for one-time transactions, 
without generating the net tangible benefits realized from CIP 
obligations borne by other financial institutions.

Q.6. Just last week, the Federal Election Commission seriously 
considered letting candidates and committees accept bitcoins as 
in-kind contributions. Do you think since this is a Federal 
agency, that it gives legitimacy to our Government recognizing 
this virtual currency--or at least bitcoins, as a valid 
currency?

A.6. Since FinCEN's mission and mandate falls outside the scope 
of monetary policy, as a practical matter we do not offer 
opinions or perspectives on the validity or legitimacy of 
Bitcoin or any other virtual currency. However, as a store of 
value with funds transmission capabilities, FinCEN does focus 
on Bitcoin's potential to be exploited for money laundering or 
terrorist financing, and our focus on these vulnerabilities 
will continue to grow in concert with virtual currency's 
popularity, acceptance, and expanded use both domestically and 
internationally.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR KIRK FROM PAUL SMOCER

Q.1. Ms. Tunstall notes in her testimony that ``virtual 
currencies could be attractive to large financial institutions 
if the fees associate with virtual currency transactions, 
including the exchange fees, are lower than the fees 
accompanying other payments (i.e., interchange fees). What do 
you anticipate would give mainstream financial service 
providers and other electronic payment systems the comfort to 
enter into the digital currency space?

A.1. At this time, we are not seeing financial institutions 
moving to digital currencies. This can mostly be attributed to 
the number of potential fraud and security risks due to the 
lack of oversight of the entities participating in this space. 
Once the currencies are able to prove their ability to operate 
in a safe environment with the ability to mitigate their risks, 
we may see a move to virtual currencies.

Q.2. Do you believe that, as with mobile payments and other new 
technologies, companies will become more comfortable with 
digital currencies in other countries before working to adopt 
them in the United States?

A.2. Often the reason these new technologies are adopted in 
other countries is their lack of banking and consumer 
protection regulations. This allows companies to experiment 
more with new technologies. Given the mature regulatory 
environment in the United States, we are likely to see a delay 
in the adoption of these types of technologies. Though, by 
having this delay, we will be able to make sure technologies 
protect consumers and ensure the safety and soundness of our 
financial markets.

Q.3. Where do you think the financial services industry is in 
terms of its own understanding, appreciation or lack thereof 
for virtual currencies?

A.3. The financial services industry has watched this market 
grow since its inception, so I think there is an understanding 
of virtual currencies. We continue to identify ways to leverage 
the currency meet consumer needs while ensuring appropriate 
protections. This we are still trying to understand and will 
require much more time to make sure we get it right.

Q.4. Is there a working group, taskforce or public-private 
group that industry is participating with to develop best 
practices or standards? Do you think there is a willingness of 
industry to participate with Government on such taskforces to 
study and better understand how to promote the good within the 
industry and further hamper the bad?

A.4. I am not aware of any existing efforts to develop best 
practices or standards. The sector would be willing to 
participate with the Government as this area expands. We'd be 
happy to facilitate any discussion that may need to take place.
                                ------                                


 RESPONSE TO WRITTEN QUESTION OF SENATOR KIRK FROM SARAH JANE 
                             HUGHES

Q.1. In your testimony, you recommend that we retain the 
current division of regulation between the States and the 
Federal Government--with prudential regulation of the 
nondepository providers of new payments systems with the States 
and retaining the anti-money laundering, anti-terrorism and 
economic sanctions regulations with the Federal Government. How 
do States ensure that they are coordinating the oversight of 
these new developing industries with other States and also that 
the Federal Government is able to track the illicit activities 
in new technologies such as virtual currencies?

A.1. Thank you, Senator Kirk, for this interesting question.
    I remain persuaded that the current division of regulatory 
authority between the States and Federal Government that I 
mentioned in my testimony is the correct alignment of 
responsibilities for licensure, supervision and examination of 
nondepository providers, including providers of virtual 
currencies. Looking back at the record that FinCEN has had over 
the past decade in connection with the regulation of emerging 
payments systems for AML purposes, FinCEN has shown a careful 
development and articulation of standards for stored value 
devices and, more recently, for virtual currencies. I certainly 
think, and FinCEN Director Jennifer Calvery Shasky did not 
dispute, that FinCEN has all of the authority it needs to 
continue to monitor, supervise and issue guidance for virtual 
currencies consistent with its mandate from Congress. Although 
no representative from OFAC testified at the November 19, 2013 
hearing, based in part on my knowledge of and confidence in 
OFAC's remarkable staff, I would think OFAC also has all of the 
authority it would need to handle the enforcement of economic 
sanctions against any virtual currency provider or exchange 
that violated U.S. economic sanctions law.
    The prudential regulation of nonbank providers of financial 
products and services has long been the province of the States. 
The States generally assign responsibility for prudential 
regulation and supervision of nonbank providers to the same 
agency or department that serves as the prudential regulator 
for State-chartered banks and credit unions, as well as 
nondepository providers. In Illinois, the Department of 
Financial & Professional Regulation has responsibilities for 
all of these providers. In Indiana, the Indiana Department of 
Financial Institutions performs these functions. And, in New 
York, the newly renamed Department of Financial Services, has 
these responsibilities, as well as prudential regulation and 
supervision of insurance companies.
    These departments and agencies have powers--not unlike 
those of Federal bank regulators--to examine the books and 
records of the providers they license and to impose corrective 
action measures on their licensees that are comparable to the 
powers exercised by Federal bank regulators. They also tend to 
have more ``boots on the ground'' and regular contact with 
nondepository providers than a Federal agency is likely to 
provide. This was made clear to me early in my career when I 
worked for the Federal Trade Commission, which had jurisdiction 
over 1.5 million nondepository providers of consumer credit 
products, including a far more decentralized consumer credit 
reporting industry than today, and about 20 attorneys 
nationwide to handle their compliance with Federal consumer 
credit protection laws.
    The various State regulators work bilaterally and 
regionally with each other and have for many decades, including 
their regional compacts that presaged interstate banking and 
branching in the 1980s. At the national level, the widely 
regarded Conference of State Bank Supervisors with which 
Members of the Committee are familiar provides a variety of 
services to State bank supervisors. Prominent among their more 
recent services is a multi-State licensing service, in response 
to the Secure and Fair Enforcement of Mortgage Licensing Act of 
2008 (SAFE Act), that handles licensing of mortgage originators 
and additional types of nondepository providers at the request 
of the States. States have been joining this service in the 
past year, and not only for mortgage originators but also for 
other nondepository providers. With the type of successes this 
program has had, I am firmly of the view that Congress should 
not fix what is not broken.
    Moreover, and thinking specifically about virtual 
currencies, without a widespread adoption of a payment system--
and virtual currencies are not yet widely adopted--it is too 
early to add regulatory requirements for them. A more measured 
approach, such as FinCEN has taken with respect to its guidance 
to virtual currency participants in 2013 and 2014, has the 
benefit of addressing emerging areas of concern in a new 
payment mechanism and allowing suitable innovations to occur. 
The current approach--of registration with FinCEN and licensure 
from the States--is more than adequate regulation of the 
emerging field of virtual currencies at this time in my 
opinion. FinCEN's work is complemented by State ``money 
transmitter'' licensing and prudential regulation for providers 
of virtual currencies, mobile payments, and PayPal, just to 
name a few examples with which readers of the hearing's 
proceedings are likely to be familiar.
    Several reporters have pressed me for ideas about what 
types of ``consumer protections'' Congress should adopt for 
virtual currencies. I have told each what I said in my prepared 
testimony: that it is early days for regulating virtual 
currencies for consumer protection purposes beyond the FinCEN 
and State-based regulations already in place. I would expand my 
prepared testimony to highlight that ``early days'' 
occasionally last a long time. For example, travelers' checks 
were first issued about 100 years ago. Only in the 1980s did 
the States begin to include them under State payments law, 
their versions of Article 3 of the Uniform Commercial Code. 
Similarly, ``wire transfers'' closely followed the advent of 
the telegraph but were not governed by law--as opposed to 
bilateral contracts or system rules until the 1980s.
    Additionally, so far, we have few examples of problems with 
bitcoins transactions. This was truer 6 months ago than it is 
today--following announcement of exchange closures or 
disappearances, or of freezes on withdrawals for customers by 
exchange operators.
    In the United States, and also elsewhere in the world, 
governments have decades of examples of ways to regulate 
payments, including electronic payments. So, I would like to 
see us use existing laws and frameworks, including system 
rules, bilateral contracts, and State law prudential regulation 
as well as the steps FinCEN has already taken before we write 
new rules for currencies that, like those of the mid-1990s, 
might sound great today and be gone tomorrow.
    Last, if the United States were to move beyond our current 
mix of registration with FinCEN and compliance with licensure 
and prudential regulation by the States, and whatever bits of 
``law'' in the United States cover the type of problem being 
seen, we may have to recognize that a domestic solution may not 
suffice in an arena that includes significant players abroad. 
With more than 50 percent of the bitcoins held in exchanges 
whose ``locations'' are abroad, domestic consumer protections 
could prove too difficult for consumers to enforce, but their 
expectations of enforcement help would have been raised.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR KIRK FROM ANTHONY 
                            GALLIPPI

Q.1. Is BitPay synonymous with a Paypal but for Virtual 
Currency?

A.1. BitPay is strictly a merchant service, so a better analogy 
would be the ``First Data'' or the ``Authorize.net'' of virtual 
currency. BitPay does not have any consumer facing products. 
The company only clears and settles payments for merchants who 
want to accept virtual currency as a payment option.

Q.2. Is BitPay registered as a Money Service Business (MSB) 
with FinCen?

A.2. FinCEN's guidance that ``virtual currency'' is a type of 
money and should be treated like ``real currency'' is a step in 
the right direction. We have always worked under the impression 
that virtual currency is money, so we are glad that FinCEN now 
agrees with that position.
    The heart of FinCEN's guidance recommends that activities 
which are classified as Money Services Businesses (MSB) or 
Money Transmission Businesses (MTB) should be applied equally 
to both real currency and virtual currency. Therefore 
activities such as remittance and check cashing would be 
regulated whether the type of money is real or virtual.
    We should pay close attention to footnote #10 of the March 
2013 FinCEN guidance, which states:

        10 FinCEN's regulations provide that whether a person 
        is a money transmitter is a matter of facts and 
        circumstances. The regulations identify six 
        circumstances under which a person is not a money 
        transmitter, despite accepting and transmitting 
        currency, funds, or value that substitutes for 
        currency. 31 CFR  1010.100(ff)(5)(ii)(A)-(F).

    Looking up the six exemption circumstances in 31 CFR  
1010.100(ff)(5) will return the following:

  (ii) LFacts and circumstances; Limitations. Whether a person 
        is a money transmitter as described in this section is 
        a matter of facts and circumstances. The term ``money 
        transmitter'' shall not include a person that only:

    (A) LProvides the delivery, communication, or network 
        access services used by a money transmitter to support 
        money transmission services;

    (B) LActs as a payment processor to facilitate the purchase 
        of, or payment of a bill for, a good or service through 
        a clearance andsettlement system by agreement with the 
        creditor or seller;

    (C) LOperates a clearance and settlement system or 
        otherwise acts as an intermediary solely between BSA 
        regulated institutions. This includes but is not 
        limited to the Fedwire system, electronic funds 
        transfer networks, certain registered clearing agencies 
        regulated by the Securities and Exchange Commission 
        (``SEC''), and derivatives clearing organizations, or 
        other clearinghouse arrangements established by a 
        financial agency or institution;

    (D) LPhysically transports currency, other monetary 
        instruments, other commercial paper, or other value 
        that substitutes for currency as a person primarily 
        engaged in such business, such as an armored car, from 
        one person to the same person at another location or to 
        an account belonging to the same person at a financial 
        institution, provided that the person engaged in 
        physical transportation has no more than a custodial 
        interest in the currency, other monetary instruments, 
        other commercial paper, or other value at any point 
        during the transportation;

    (E) LProvides prepaid access; or

    (F) LAccepts 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.

    We have highlighted exemptions (B) and (F) which describe 
the activities performed by BitPay. The IRS has defined rules 
for classifying Payment Processors, or Payment Settlement 
Entities (PSE) in 2008 with the Internal Revenue Code 6050W. 
This ruling and others clearly state that Payment Processors 
and Payment Settlement Entities are not Money Transmitters.
    BitPay has a contractual agreement with our sellers for 
transaction processing, clearance, and settlement of funds that 
arrive for a given merchant account. BitPay does not have any 
contractual agreement with any sender of funds, and does not 
engage in any activities that would be considered Money 
Transmission activities.

Q.3. You are obviously on the forefront of these technologies--
do you think that it is the anonymity or the privacy that is so 
attractive to virtual currencies? Would it not make more sense 
to ensure privacy (account information, etc.) but not grant 
total anonymity? Where is the industry heading on the issue of 
anonymity?

A.3. Bitcoin transactions and the Bitcoin network operate 
differently than traditional banking products. With a 
traditional banking product, the user expects a level of 
privacy where their bank is not broadcasting all of the users 
transactions to the outside world. With Bitcoin, every 
transaction is broadcast to the whole world, and remains public 
record on the Bitcoin blockchain indefinitely. The public 
blockchain is the cornerstone of Bitcoin.
    Because every transaction is public record, users of 
Bitcoin must maintain their privacy. This is important for both 
individuals and businesses. For example, if a company is paying 
one of their suppliers with bitcoin, the company will not want 
their competitor to be able to reverse engineer their funds 
flows. Another example is an employee that receives payment 
from his employer in bitcoin has an expected level of privacy 
where his employer cannot see where the money is spent.
    Given all of the benefits of bitcoin and virtual 
currencies, we think that the anonymity is not the main factor 
driving its adoption (because it is not really anonymous). All 
of our businesses clients prefer bitcoin because it is a far 
lower risk and lower cost form of payment, compared to credit 
cards and the other options they have today.

Q.4. Ben Lawsky, the Superintendent of the NY Department of 
Financial Services was recently interviewed talking about the 
hearing that his department planned to hold on reviewing 
interconnection between money transmission regulations and 
virtual currencies and possibly considering a ``BitLicense'' 
specific to virtual currency transactions and activities. While 
he said that he did not think that this license and regulation 
would kill the industry he also noted that it was not his 
intent. Do you think that this is something that would 
potentially kill or severely impede this industry?

A.4. Money Transmission activities are currently regulated by 
the States. I think the existing laws are adequate. If a 
company is doing Money Transmission or Money Service 
activities, they need a license. If they are not doing those 
activities, they do not. The key criteria to determine whether 
an activity is considered money Transmission, as outlined by 
FinCEN and the States, covers two requirements: 1) is the 
consumer at risk of loss? and 2) is the product coming out the 
other end a form of money or currency? In addition, I feel that 
any type of license that would be discriminatory toward one 
type of business would probably impede the industry.

Q.5. While Tor was created by the U.S. Government and has been 
used in the past for good purposes--such as anonymizing 
financing of revolutions against tyrannical oppressive regimes, 
do you believe that it (Tor) is still necessary?

A.5. We believe Tor has a right to exist and people have the 
choice to use that product or use a different Web browser.

Q.6. Just a little over a week ago, there was a report from an 
Australian man that he had 4,100 bitcoins, worth more than $1.1 
million, stolen from him. This alleged theft is one of the 
largest since Bitcoin was created 4 years ago. I know that 
Bitcoin developers and others have worked to put into place 
safe guards and have worked to prevent incidents such as this--
but with this recent event can you tell us how progress on that 
front is going?

A.6. The security around Bitcoin is extremely important. New 
features such as multi-signature transactions will greatly 
reduce the risk of thefts. With a multi-signature transaction, 
funds are locked with a minimum of 3 keys (could be more) and a 
minimum of 2 keys are required to move the funds. If a hacker 
were to gain access to one private key, they could not steal 
the funds. We believe the technical solution of multi-signature 
will solve this problem, and I expect its use to be more 
widespread in 2014, reducing thefts.

Q.7. Is there a working group, taskforce or public-private 
group that industry is participating with to develop best 
practices or standards? Do you think that there is a 
willingness of industry to participate with government on such 
taskforces to study and better understand how to promote the 
good within the industry and further impede the bad actors?

A.7. We share the Committee's goals to develop best practices 
and prevent the bad actors from using our service. Many lessons 
and practices from the banking and credit card industry apply 
to virtual currencies, and those practices are being adopted. 
There are several groups that are working to bring these 
experiences into the startup companies: The Bitcoin Foundation 
and DATA are two that our company is involved with. I believe 
the many years of experience that our banks and processors have 
in compliance and antimoney laundering policies will greatly 
assist the startup companies.

              Additional Material Supplied for the Record


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


