Changes in U.S. encryption regulatory policies trigger legal dilemmas: wallets and DeFi developers may face greater challenges and coping strategies

Since 2013, the U.S. government’s policy has actually been clear that developers and users of cryptocurrency wallets are not money transmitters. But the recent decision by the Department of Justice to prosecute wallet developers for unauthorized currency transfers comes as a surprise, especially since these developers do not actually control the assets that users protect with their software.

Federal prosecutors have advanced this unprecedented explanation in two recent cases, the Samourai Wallet indictment unsealed on April 26 and the Tornado Cash case against Roman Storm unsealed the same day objection to the exclusion of evidence. At the same time, the FBI also issued a warning to crypto wallet users, saying that if they do not transfer their funds to a regulated institution, they may lose their funds as a result of criminal seizures and investigations.

1. Here is a brief review of existing money transmission policies and a detailed summary of recent events

The United States has a series of federal laws that regulate anti-money laundering (AML) for money transmitters, mainly based on is the Bank Secrecy Act and its amendments. These laws define the category "financial institution" and authorize the Secretary of the Treasury to redefine this category as necessary. Therefore, the enforcement rules under the Bank Secrecy Act actually specify who must or must not register as a money transmitter or other financial institution, comply with Know Your Customer (KYC) principles, submit reports to the government, and implement Other anti-money laundering controls.

These regulations define a money transmitter as:

• Any person who provides money transmission services, where "money transmission service" is defined as "the acceptance of money, funds, or funds from a person" or the value of other fungible currencies, and transmit the value of currency, funds or other fungible currencies to another place or person by any means;
• Any other person involved in the transfer of funds.

In the context of cryptocurrencies, there is some ambiguity in this definition as to whether cryptocurrencies are “currency, funds, or other values ​​that are fungible for currency.” If cryptocurrencies are considered “money,” then “anyone involved in the transfer” is a money transmitter. If cryptocurrencies are considered “money,” or “other values ​​that are fungible for currency,” then anyone who “accepts” and “transmits” cryptocurrencies is a money transmitter. Under a straightforward reading of the regulations, cryptocurrencies are considered alternatives to traditional currencies, so if a person commercially accepts and transmits the cryptocurrencies of others, he is a money transmitter. In other words, a person is a money transmitter if he or she has actual control over another person’s cryptocurrency and uses that control to transfer the cryptocurrency to another person or location. This law has been governing law since before the advent of cryptocurrencies and has never been modified or overturned by Congress, courts, or regulations.

This minor ambiguity about whether cryptocurrencies are currencies, funds, or fungible currencies will be resolved by FinCEN early in the regulatory history of cryptocurrencies.

In 2013, FinCEN issued its first “virtual currency” guidance. In this guidance, FinCEN confirms that cryptocurrencies (which they call virtual currencies) are "the value of a fungible currency" and are not "funds" or "money" per se (hence the term "virtual currency"). In a note, it also made clear that it does not consider virtual currencies to be “funds,” as such a definition would trigger some prepaid access rules that FinCEN believes do not apply to cryptocurrency activities.

FinCEN further explained that mere users of virtual currencies are not money transmitters, and found in a subsequent administrative ruling that software developers are not money transmitters either Transmitter: "The mere production and distribution of software itself does not constitute the acceptance and transmission of value, even if the purpose of the software is to promote the sale of virtual currencies."

In addition, FinCEN issued more clear guidance in 2019 It was pointed out that partial control over virtual currency is not enough to classify wallet developers as money transmitters, because those who participate in transactions and perform additional verification upon request of currency holders do not have full independent control over those values.

This guidance requires that only businesses hosting cryptocurrencies need to be licensed and subject to federal money transmission regulations. The law has always been clear: non-custodial cryptocurrency developers are not money transmitters.

2. Details and arguments of the case

On April 26, 2024, an indictment was made public, accusing the developers of Samourai Wallet (a Bitcoin wallet that uses CoinJoin transactions to enhance user privacy) of illegal Currency transmission and many other crimes. For the purpose of this discussion, we will not discuss the allegation of money laundering conspiracy, as such an allegation relies on specific facts and is not necessarily based on the developer providing managed services rather than unmanaged services. The defendants may have operated a centralized server to coordinate CoinJoin transactions, as alleged in the complaint. However, based on what we know so far, the Samourai Wallet does not give the developer or any third party truly independent control over a user’s Bitcoins secured through the wallet software. Under a straightforward reading of the regulations, especially given FinCEN's guidance and administrative rulings, the developers of Samourai Wallet do not have "completely independent control" of any user funds, and therefore they do not fall within the definition of a money transmitter.

And in Roman Storm’s Tornado Cash case, prosecutors responded to a previously filed motion to dismiss. They discussed a law called Section 1960, which says it is illegal to operate a money transmission business without a license. The prosecutor's response specifically emphasized that this legal definition is much broader than what we usually discuss.

Their main argument is that whenever the Tornado Cash software is used to request deposits or withdrawals, it causes cryptocurrency to move on the Ethereum blockchain, so they believe the developers of Tornado Cash should Responsible. This statement expands the scope of liability, meaning that by this logic, almost all cryptocurrency wallets and smart contracts are in the money transmission business, and all developers may be involved in illegal money transmission.

In terms of regulatory definitions, the prosecutors’ response ignored all previous guidance and interpreted “funds” in the law very broadly, defining it simply as anyone involved in the transfer. They even compared it to package delivery to try to illustrate that controlling money is not a requirement. This explanation ignores the previous statement of the US Financial Crimes Enforcement Network (FinCEN) that virtual currencies are not "funds", which is also very ridiculous.

If Tornado Cash is a package service, it’s clearly not just for criminals. Second, the prosecution's comparison actually proved the exact opposite of what they were trying to prove. A courier service that has no access to the contents of the packages it delivers is clearly not a money transfer service. First of all, if you can't open the package, how do you know what's inside? How could you be guilty of operating a money transmission without a license if you were told you were just shipping boxes of canned goods and couldn't open the boxes? Secondly, the Financial Crimes Enforcement Network (FinCEN) clearly stipulates that armored vehicle services that are limited to the safe transportation of currency are not money transmission service providers!

At the same time, the Federal Bureau of Investigation (FBI) issued a warning announcement regarding crypto wallets. The advisory reminds Americans not to use cryptocurrency transmission services that are not registered as a money services business (MSB) under U.S. federal law. The FBI also provides an official tool from FinCEN that allows users to check whether a company is registered as an MSB.

In light of the Tornado Cash and Samourai Wallet prosecution cases, if the Department of Justice takes the position that any act of moving cryptocurrencies from one place to another on the Ethereum blockchain (as stated in the Tornado Cash defense arguable) is a money transmitter, then every crypto wallet is a money transmitter, whether it’s software running on your phone, software running on your Trezor or Ledger USB drive, or Coinbase servers All software running on the Internet needs to register the WeChat currency service business. And of the three, only Coinbase is registered. Considering the recent prosecution cases, many wallet companies in the industry, including some decentralized wallets, are precedents that need attention.

It is unclear whether the Justice Department is deliberately changing long-standing policy through criminal enforcement or whether there is a serious relationship between the Justice Department and the Financial Crimes Enforcement Network (FinCen). of disconnection. But in any case, this approach undoubtedly seriously undermines the principle of the rule of law in the United States. Off topic, whether it is the passage of the TikTok bill or the recent uproar of the Anti-Semitic Awareness Act, we can feel that the United States is also tearing itself apart.

3. Uncertainty factors have brought about the withdrawal of crypto wallets from the US market

Paris-based Bitcoin company Acinq stated in a statement that the recent announcement by the US authorities has raised concerns about self-hosted wallet providers. , a Lightning service provider or even a Lightning node that has raised questions about whether it can be considered a money services business and subject to such regulation, Phoenix will remove its popular Lightning Network wallet Phoenix from the U.S. app store, citing regulatory uncertainty. Users are advised to close the channel and transfer funds before access is terminated on May 3, 2023

One day later, zkSNACKs announced that it would be shutting down access to its privacy-protecting Wasabi wallet in the United States, saying in a statement on April 27, “Following recent announcements from U.S. authorities, zkSNACKs is now strictly prohibited from use by U.S. users. its services".

4. Questions

1. If the wallet is not for US users, does it still need to obtain permission and registration?

If a cryptocurrency wallet or service is expressly not targeted at U.S. users and ensures that its services are unavailable to U.S. users, it generally does not need to obtain a U.S. money transmitter license or register as a money services business (MSB). U.S. laws and regulations apply primarily to businesses operating in the United States or serving U.S. residents.

However, even if a service does not directly target U.S. users, it may still attract the attention of U.S. regulators if it operates through the U.S. financial system or if U.S. users find ways to use these services. Therefore, it may be difficult to completely avoid the risks of U.S. law, especially in a globalized and Internet environment.

To avoid potential legal risks, non-U.S. cryptocurrency service providers should take steps to ensure that their services are not accessed or used by U.S. users. This may include technical measures such as geo-blocking, IP address filtering, and an explicit statement in the terms of service that the service is not available to residents of the United States.

2. If it is impossible to avoid American users taking advantage of every opportunity to use it, what is the safe way?

• Register as a Money Services Business (MSB):
• In compliance with the requirements of the Treasury Department’s Financial Crimes Enforcement Network (FinCEN), any person or company that provides money transmission services must register as a money transmitter Register as a service business (MSB). This includes submitting necessary registration forms and updating information on any significant changes.
• Compliance with the Bank Secrecy Act (BSA):
• Businesses registered as MSBs are required to comply with the provisions of the Bank Secrecy Act and its amendments, including but not limited to Anti-Money Laundering (AML) regulations and submissions Suspicious Activity Reports (SARs).
• Implement Know Your Customer (KYC):
• Money transmission services are required to implement Know Your Customer, a customer identity verification process designed to prevent identity theft, financial fraud, and money laundering.
• Obtain State Level License (MTL License):
• In addition to registering at the federal level, most states require money transmission services to obtain a state level license. Specific requirements may vary from state to state, so you will need to apply for appropriate licenses based on the specific state in which your business operates.
• Maintain Compliance Records and Reports:
• Comply with all recordkeeping requirements and regularly report large transactions and suspicious activity to FinCEN. These records may need to be provided as part of a review or inspection.
• Capital and Insurance Requirements:
• Depending on the scale of operation and type of transaction, certain capital preparation and insurance coverage requirements may be required to ensure the safety of customer funds.

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