The US Treasury’s Office of
Foreign Assets Control's (Ofac) decision to blacklist
cryptocurrency addresses could backfire and drive investors to
smaller, less transparent exchanges.
The agency's new March 19 guidance
adding digital currencies to the Specially Designated Nationals
and Blocked Persons List (SDN) in the same way as fiat
currencies is intended to reduce money laundering and fraud.
But this decision could lead investors to riskier
The SDN list includes individuals,
groups and companies owned by targeted countries or acting on
behalf of targeted countries, named specially designated
nationals. Their assets are blocked and US persons are
generally prohibited from dealing with them. The list also
includes individuals, groups and entities designated under
programmes that are not necessarily country-specific. This is
widely expected have wide repercussions for exchanges and the
cryptocurrency sector itself. Blackrock chief executive Larry
Fink previously branded bitcoin an index of money
The changes are yet another layer of
regulatory scrutiny that cryptocurrency exchanges will have to
navigate. This could, however, go against the
regulators’ aim of providing more investor
"People may not use the prominent
exchanges and could go underground where the investor risks are
even greater," said Linklaters partner Doug Davison.
The Ofac guidance presents yet another
hurdle for US exchanges to address. This new development is
particularly onerous because the SDN list is updated
constantly, requiring exchanges to frequently check the list to
see if any of their investors are included. This is a daunting
task, particularly for start-ups, which may already have to
file with the Securities and Exchange Commission
For many crypto-zealots, who tend to be very strong
advocates of privacy and banking away from state intervention,
this could drive them to less well-known cryptocurrencies that
offer greater privacy or to smaller exchanges that exist
outside of regulation. Most of the established exchanges are
said to already comply with much of the regulation enforced by
the various bodies that have stepped in -
the SEC, the Commodity Futures Trading Commission (CFTC)
and the IRS to name a few
- but smaller ones are less likely to do so.
The SEC has been on an aggressive
enforcement surge this year, penalising several cryptocurrency
exchanges for not registering with the regulator. Last month,
the CFTC was granted legal permission by a district court judge
regulate cryptocurrencies as commodities. As a
result, exchanges potentially have to comply with
commodities regulation, securities regulation and also rules
from state regulators.
Because of this confusion, IFLR has been
told that many exchanges are shunning the US because of the
lack of clarity. For initial coin offerings (ICOs) open to US
investors, the majority of exchanges are automatically
registering with the SEC even though they may not need to.
Whether a company needs to register with the SEC depends on if
they are offering digital tokens – those that have
their own, exclusive, underlying blockchain. Exchanges that
only offer bitcoin or alt-coins – those that are
issued on a bitcoin derived blockchain – currently do
not need to register with the SEC, but this could be subject to
change after the financial regulator finalises its
investigation into the sector.
- Ofac has said
cryptocurrency addresses will be added to SDN lists, meaning
that exchanges will need to constantly look at the list to
ensure investors are not on there;
- But this could lead
to investors switching to less transparent exchanges where
the investor risks are greater. The change could be
counter-productive to the regulators’
- In Europe, to combat
money laundering, watchdogs have extended existing AML rules
to cover cryptocurrencies.
Where does the market stand now?
This confusing regulatory outlook is unlikely to change
soon. It's expected there will be more actions by the state
regulators and the SEC will work alongside them. But as the SEC
expands its investigations, current regulation could be changed
again, particularly on ICOs that are said to be flouting
enormous growth in the crypto market, the SEC is almost
playing wack-a-mole trying to regulate the cryptocurrency
sector," Davison said. "As the market keeps changing they want
to be flexible with it and each regulator is trying to apply
existing terms of work."
"The changes are yet another
layer of regulatory scrutiny that cryptocurrency
exchanges will have to navigate"
As well as the decision to include cryptocurrencies under
the SDN list, the US Treasury said it was planning to review
the Financial Crimes Enforcement Network cryptocurrency
practices relating to money laundering and terrorism financing
"Regulatory bodies are going to work more
closely together," said
Orrick counsel Jason Somensatto. "We could potentially see
one body taking most of the responsibility in the future, but
which body depends on the legal definition."
The EU has extended the fourth AML
directive to include cryptocurrencies, meaning that exchanges
and wallet providers must comply with the directive just as a
conventional financial platform would. In Europe, much of the
existing rules on conventional financial instruments have been
extended to include cryptocurrencies and it appears that the US
will follow in the same direction.
But the risk in implementing greater
regulation for a sector that was established precisely because
it wanted to avoid regulation, is that investors will look
elsewhere. There will be no shortage of alternative options
that aim to avoid regulatory oversight.
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