[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
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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
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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.
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\1\ http://www.dailymail.co.uk/news/article-2492813/Bitcoin-site-
hacked-1million-virtual-currency-stolen.html.
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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\
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\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.
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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.
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\2\ Federal Deposit Insurance Corporation Statistics on Depository
Institutions, Report Date June 30, 2013.
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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\
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\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.
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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\
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\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.
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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.
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\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.'').
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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.
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\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.
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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.
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\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/.
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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\
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\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.'').
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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.
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\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.
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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.
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\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.
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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.
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\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.
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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.
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\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.
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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.
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\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.
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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.
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\23\ P.L. 110-289. Codified at 12 U.S.C. 5101 et seq.
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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.
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\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).
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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\
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\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.
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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.
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\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.
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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.
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\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.
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\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).
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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\
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\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).)
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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.
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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.
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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
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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.
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