Compliance Issues in Operating a Digital Asset Exchange in the U.S.
United States: Federal and State Oversight of Virtual Currency Exchanges
To date, U.S. law has not provided for direct, comprehensive federal oversight of virtual currencies or virtual currency spot markets. Instead, U.S. regulation of virtual currencies and the spot markets has evolved into a multifaceted, multi-regulatory approach due to divided opinions of how to properly define virtual currency. Currently the several federal agencies that have been actively regulating the emerging spot markets, derivative markets, or the underlying virtual currencies are:
1) FinCEN and MSB: Financial Crimes Enforcement Network (FinCEN), a division of U.S. Department of Treasury
On March 18, 2013, to further implement The Bank Secrecy Act of 1970 (BSA), FinCEN issued guidance on the “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies ” and demanded that all virtual currency exchanges and ICO issuers were subject to money service business (MSB) registration, reporting, and recordkeeping regulations.
In April 2018, immediately following BitMart’s official launch, the BitMart team duly registered under FinCEN as an MSB. This initial registration with FinCEN is not costly, but it means BitMart’s compliance team undertakes the responsibility of recordkeeping and reporting every single suspicious transaction that might run afoul of anti-money laundering laws (AML). Through this, BitMart is subject to FinCEN’s constant scrutiny through its annual renewal system. Most importantly, however, registering as an MSB in the U.S. signifies BitMart’s expansion into the global market, and proves that BitMart is ready to embrace the most stringent regulations.
2) State Money Transmitter Laws
In addition to FinCEN requirements, virtual currency exchanges are also subject to regulation from each individual state where the exchange operates. Each state’s opinions on virtual currency also deeply divided but can be broadly categorized into four definitions:
a. States that updated their money transmission laws or issued agency guidance's and required virtual currency exchanges to obtain requisite licenses:
· North Carolina (House Bill 229)
· Oregon (Senate Bill 277)
· Washington (Senate Bill 5031)
· Connecticut (House Bill 6800)
· Hawaii (agency memo)
· New York (BitLicense)
*It should be noted that NYSDF (New York State Department of Financial Services) established a regulatory framework that any exchange that provides virtual currency transmission services needs apply for a BitLicense. If the exchange also engages in fiat transactions, then the application of a separate New York Money Transmitter license is also mandatory.
b. States that define virtual currency as “money” but have not expressly required virtual currency exchanges to obtain a money transmission license:
· Pennsylvania (House Bill 850)
· Vermont (House Bill 182)
c. States that either do not have laws passed or expressly exempted virtual currency exchanges from money transmitter law regulations:
· New Hampshire (House Bill 436)
· Kansas (agency guidance)
· Illinois (agency guidance)
· Tennessee (agency guidance)
· Texas (agency guidance)
· Virginia (agency notice)
· West Virginia
· Rhode Island
· South Dakota
· North Dakota
· New Jersey
· New Mexico
d. States that do not have their own money transmitter laws:
*Note that all above regulations are pertaining to those exchanges that only provide crypto-crypto services. If the exchange provides fiat transaction service, then it is mandatory in all and every state, except Montana (Montana does not have its own money transmission law), to obtain the state’s Money Transmitter license.
3) The U.S. Securities and Exchange Commission (SEC) and Alternative Trading Systems (ATS)
The SEC has long stated that virtual tokens are securities. The Securities Exchange Act of 1934 regulates the secondary trading of those securities between persons, through brokers, or dealers.
Therefore, virtual currency exchanges, particularly those with spot trading, are subject to The Securities Exchange Act of 1934. In their March 7, 2018 announcement “Statement on Potentially Unlawful Online Platforms for Trading Digital Assets”, the SEC further clarified that all virtual currency exchanges should register with the SEC as a “national securities exchange” or alternative trading system (ATS), which is an exemption to the national securities exchange registration requirement.
To comply with Regulation ATS, an ATS must, among other things, register as a broker-dealer and file an initial operation report with the SEC, via Form ATS, before commencing operations. Thereafter, an ATS must file amendments to Form ATS to provide notice of any changes to its operations, and must file a cessation of operation report on Form ATS if it ceases operations. The requirements for filing reports using Form ATS can be found in Rule 301(b)(2) of Regulation ATS.
* Currently several top exchanges, including Coinbase and Gemini, have announced that they are moving forward with the ATS application, but no such applications have been granted by the SEC to date.
*Also note, that even though the SEC refused to recognize utility tokens, that is to say they view them as securities, the agency did reconcile with other regulators (i.e., The CFTC) in implying that certain coins, namely, Bitcoin, are not securities.
4) State Securities Regulation
Needless to say, virtual currency exchanges are also subject to each individual state’s own securities regulation each state that it operates. After the SEC registration, the exchange should also considering registering with local securities regulators.
5) Commodity Futures Trading Commission (CFTC) and CFTC Exchange
Unlike the SEC, the CFTC regulates derivative markets instead of spot markets. Within the limits and parameters of the current self-certification process, CFTC staff have engaged in a “heightened review” for extensive visibility and monitoring of markets for virtual currency derivatives including underlying settlement reference rates.
Exchanges that provide derivative products need to register under CFTC as a CFTC Exchange or Designated Commodity Market (DCM) under The Commodity Exchange Act of 1936 (CEA).
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