$250,000 fines possible for some virtual currency sales

(Image courtesy epSos.de via Flickr.)

(Image courtesy epSos.de via Flickr.)

In this article I want to address the application of the regulations of the Office of Foreign Assets Control (“OFAC”) to businesses dealing with virtual currencies.

This aspect of regulations is often overlooked or ignored, but the fines are very real. This spring, PayPal was fined $7,658,300 because they allowed transactions with Iranian and Cuban nationals, for example.

OFAC has authority to impose civil liability of either $250,000 or twice the amount of the underlying transaction. It is an office of the US Department of the Treasury and is tasked with enforcing economic and trade sanctions against foreign countries and certain foreign nationals.

Laws and regulations enforced and promulgated by the OFAC apply to banks and money services businesses alike. And since back in 2013 the Treasury Department designated administrators and exchangers of virtual currencies as money service businesses, most likely OFAC regulations will apply to them as well. Thus a business owner dealing with virtual currencies should be aware of all possible regulations that may affect the bottom line.

When imposing sanctions, the US Government can target either the entire country, region, organization or individual.

When the entire county, such as North Korea, is targeted by sanctions, it is the virtual currency company’s responsibility to block any account or property belonging to any citizen of that country.

Blocking or “freezing” of property means that a country or an individual is denied any kind of access, administration or control of their property without authorization from OFAC.

Banks have developed software that is designed to interdict certain illicit fund transfers  to targeted regions or individuals. It is unclear whether a comparable software exists for virtual currencies.

OFAC treats failure to block illicit transfers as a strict liability. According to this guidance, OFAC has imposed millions of dollars in civil penalties to banks who failed to block illicit transfer involving a targeted individual or a country.

The PayPal announcement shows that money services businesses are just as liable under OFAC’s regulations as the banking sector. And there is no indication that virtual currency operators will be treated any different in case of non-compliance.

Every time an account has been blocked or a transaction has been rejected, the financial institution – or a virtual currency business — has an obligation to make a report within ten business days. The report must identify, among other things, the owner, the property, the property’s location, estimated value and date it was blocked.

When it comes to Bitcoin or similar virtual currency that may be problematic, because of the nature of the cryptocurrency.

In addition, every time it comes to OFAC’s attention that an illicit transaction has occurred without being blocked or rejected, OFAC sends out an administrative demand for information requesting information on how the transaction was processed. Once the financial institution has responded to the demand, a civil penalty may be imposed. The financial institution — or a virtual currency operator — then has 30 days to present an explanation why a penalty should not be imposed or lessened. OFAC will look at any mitigating circumstances.

This is just an example of another way existing regulations can apply to virtual currency based businesses.

Alex Kadochnikov

Alex Kadochnikov is a partner at Gill & Kadochnikov. His primary focus is on commercial litigation, counseling start-up entrepreneurs, and employment-based immigration. He is also an expert on the rise and proliferation of virtual currencies and their effect on the legal and financial landscape.

9 Responses

  1. rt66@wanadoo.fr' Yichard says:

    Important question:
    Is a virtual world using an internal currency targetted by such regulations?
    Actually, anybody, using the internet, can subscribe an account in a virtual world, without the managing company being aware of who is this person, that he is on a ban list, or lives in an ostracized country. To be aware of this needs 1) that the virtual world knows the physical identity of the person, or at least the country of origin 2) that the virtual world knows the list of banned persons.

    The least that we can say is that it is not realistic to ask a small company, for instance Inworldz, do take care of this. This is one of the reasons why these companies rely instead on money businesses like Paypal and others.

    Side note 1: that innocent individuals are targetted by generic measures against a whole country is… politics. I hope that the recent easing of things in this domain will end all discriminations against Cubans or Iranians. As to Koreans… well North Korea has no Internet, so they do the discrimination themselves.

    Side note 2: we still have a confusion on the expression “virtual currency”, used to designate two very different things: 1) a convenience in virtual world, with a fixed exchange rate and transparent accounting, and 2) speculation money with a variable change rate and secret working. Clearly not the same regulations apply. But how can the law spare the innocent, if they are named the same as the guilty?

    • Alexander Kadochnikov says:

      Yes, according to the way regulation is structures, a virtual world using an internal currency must abide by the regulations. As an example, Second Life – a business that registered as an Money Services Business with FinCEN. Regulations applying to virtual currencies apply equally to centralized virtual currencies, like the Linden Dollar and decentralized ones, like Bitcoin. Does it seem fair that there is a blanket regulation of all virtual currency, without regard to the size and the type of currency one deals with? No. But the regulations are relatively new – as is the virtual currency world itself, and it can take a while to catch up. Hopefully there will be some tweaks to existing laws in the future

      As far as reliance on companies like PayPal, bank and other non-bank financial institutions. Already there are businesses operating with virtual currencies that have hard time getting a bank accout. In my opinion, that is because banks would know that they could be potentially liable for cross-border transactions of their clients and they do not want to risk being liable for activites of their client’s client. Someone who is not even an account holder with them.

      • rt66@wanadoo.fr' Yichard says:

        I hope things move in this way, and that there appear some distinction between simple money and speculation money. Today laws lead to absurd results: if I change dollars for, say, Linden dollars, and get them back into dollars, then this casing out is taxed like an income!

        There is still a lot of confusion about what virtual life is. After the accusations of pedophilia, come the accusations of virtual worlds being used to evade taxes or smuggle drug money. And once again ignorant politicians castigate virtual life at a whole, for things done by a small minority only.

        But on our side, there is a lot of naivety too, to put on the same footing people who want a better world with a better economy, and people who want to make some totally unregulated hyper-capitalism. And Linden Lab opened this way, when they held their ambiguous “hippie” speech, while imposing a roleplay of money speculation and land speculation.

  2. geir.noklebye@dayturn.com' XMIR Grid says:

    Another reason not to place grids with currencies on US servers.

    • sonichedgehog_hyperblast00@yahoo.com' Mircea Kitsune says:

      I find that the US is evil with some things, whereas other places (such as Europe) are evil with others. There’s really no safe location to place a server on this world… except maybe the top of some unclaimed mountain, if satellite internet works there.

  3. Frank Corsi says:

    When the funding source for a virtual currency is paypal, then the burden is placed on paypal, since they exchange the real money.

  4. sonichedgehog_hyperblast00@yahoo.com' Mircea Kitsune says:

    Hands off currencies like Bitcoin, government. Your nose doesn’t belong in this one…

  5. greatcanadiangrid@yahoo.com' Roddie Macchi - GCG says:

    Virtual Currency under the FINTRAC of Canada does not apply, though the MSB will be a part of the currency License for The GCG when it does. The sad part is most grids don’t do their homework when deciding to do all this. It’s a real fact that sooner or later they will be asking for either the taxes or licenses for money transmitting just like money mart. I have said this repeatedly to many grid owners and well..hopefully they listened. Another reason why I am lucky in a way being in Canada and also using a third party provider for currency. Do your homework for everything..even streaming music on a grid that isn’t licensed is illegal due to copyrighted material for music. Again we have that also called SOCAN. Just be careful k…cheers!