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Swift Institute: Problems And Progress Regulating Cryptocurrencies

Last Updated March 4, 2021 4:45 PM
Lester Coleman
Last Updated March 4, 2021 4:45 PM

As cryptocurrencies have expanded as a medium of exchange, governments worldwide have struggled with how best to regulate them. While one of the draws of cryptocurrencies is that they are less regulated than traditional currencies, problems associated with these currencies (such as financial crimes and terrorist financing) have encouraged governments to develop regulations.


A recent report by the SWIFT Institute summarizes regulatory initiatives to date and identifies some of the problems that governments encounter in attempting to regulate cryptocurrencies.

The 77-page paper, titled “The Evolution of Third Party Payment Providers and Cryptocurrencies Under the EU’s Upcoming PSD2 and AMLD4,” summarizes legislative developments and new payment methods in Europe, the U.S. and Asia. The institute, based in La Hulpe, Belgium, seeks to extend understanding of current practice and future needs in global financial services.

PSD2 stands for Second Payment Services Directive while AMLD4 stands for Fourth Anti-Money Laundering Directive.

Focus On The European Union

While the paper offers an extensive summary of regulatory efforts on three continents, much of the focus is on The EU, which has attempted to improve and clarify regulation of payment systems in response to the expansion of electronic money (e-money).

The report’s objectives were to 1) analyze which third party payment providers are covered by PSD2 and AMLD4, and 2) to analyze the potential regulation of cryptocurrency in relation to money laundering and terrorist financing.

In comparing the regulatory activities in Europe, The U.S. and Asia, the paper concludes that the U.S. regulatory agencies have classified virtual currencies as money transmitters and have therefore taken a more aggressive regulatory approach.

Focusing first on Europe, the paper notes The EU’s Payment Services Directive is an attempt to improve market access for non-credit institution actors to provide a level playing field and create more competition in national markets. It notes third party payment services have emerged but are not covered under the directive. Hence, the EU has proposed new rules called Second Payment Services Directive (PSD2) to cover these services.

The EU has also adopted its Fourth Anti-Money Laundering Directive (AMLD4) that could impact third-party payment services.

European Directives Vague On Cryptocurrency

The status of cryptocurrencies under these directives remains problematic as neither the PSD2 or AMLD4 specifically refer to cryptocurrencies.

Service providers engaged in cryptocurrencies, mostly in the form of exchanges, have proven untrustworthy and are often mired in “dubious activities,” the paper notes.

The PSD2’s objective is to develop an integrated European payment market that fosters security, innovation and competition, taking into account new services. The most significant PSD2 change is extending its scope to cover third-party payment service providers (TPPs).

Problematic areas in regulating TPPs include provisions on authentication including security credentials, liability allocations in cases of defective or unauthorized payment services and transition periods.

The allocation of liability under PSD2 also needs clarification, the paper notes. PSD2 states each service provider is liable for their respective parts in the payment service, but the account servicing payment service provider remains the first point of contact for a payment user in cases of unauthorized access.

The EU’s Payment Services Directive cannot regulate the emission of cryptocurrency since it aims to regulate only the service providers and not the issuers of the funds. “Funds” is defined as “banknotes and coins, scriptural money and electronic money as defined in Article 1(3)(b) of Directive 2000/46/EC.” While a broad interpretation of “funds” could allow for cryptocurrencies, the scope of the directive’s exceptions rule out its application to cryptocurrencies.

The European directive covering “e-money” indicates e-money must be considered as a prepaid good. Hence, the directive would not cover cryptocurrencies.

European Banking Authority Seeks Change

The European Banking Authority issued an opinion to include cryptocurrencies under the EU’s anti-money laundering directive. This proposal could provide a short-term solution to protect regulated financial services from virtual currency schemes. The European Commission also indicated it could include virtual currencies under AMLD4.

While the EU is beginning to pay more attention to cryptocurrencies, several member states have taken actions on their own. Most of the state discussion of cryptocurrencies focuses on the taxing of transactions. Some countries have decided that virtual currency transactions are subject to value added taxes.

The situation is different in the U.S.

Third parties in the U.S. are increasingly offering competitive services to traditional financial institutions and providing services that bypass the traditional payment chain. Special mention is given to PayPal, which allows users to link a bank account with a PayPal account for verification purposes, along with Google, Square and Amazon.

TPPs in the U.S. are regulated primarily as money transmitters on a state-by-state basis, making the regulatory landscape less uniform.

All U.S. money transmitters are required to register with the Financial Crimes Enforcement Network (FinCEN) under the Bank Secrecy Act.

In U.S., FinCEN Has Teeth

In the U.S., FinCEN published a guidance document stating that it considers virtual currencies as exchange media that can operate as a currency but not possessing the attributes of real currency, such as being legal tender. FinCEN considers virtual currency exchangers as money service businesses (MSBs) when they accept and transmit convertible virtual currencies or buy or sell convertible virtual currencies.

Hence, virtual currency administrators and exchangers have to register as an MSB and follow anti-money laundering control rules.

FinCEN has enforced the rules. The Department of Homeland Security seized accounts that belonged to a U.S.-based Mt. Gox subsidiary based on its not being registered as an MSB.

FinCEN also acted against Liberty Reserve based on the USA Patriot Act.

More recently, FinCEN required Ripple to register as an MSB. FinCEN fined a Ripple subsidiary $700,000 for not implementing an anti-money laundering program and not conducting reporting duties.

U.S. states have also initiated legislation to regulate virtual currency. The paper notes actions by New York, California, Florida, North Carolina and Connecticut.

The New York and California measures are similar to the EU legal framework on payment services, the paper notes. A service provider – the virtual currency business in the U.S. and the payment service provider in the EU – has to be authorized to conduct business. In both cases, the service providers must meet capital requirements.

U.S. Differs From EU And Asia

The key difference between the EU and U.S. approaches is that in the U.S., FinCEN has included virtual currencies under its definition of a money transmitter. In the EU, such inclusion is limited.

In addressing Asia, the paper notes that most Asian countries still place virtual currencies outside the scope of the law. The Asian approach perpetuates legal uncertainty f or users of virtual currency for legitimate purposes and complicates regulatory oversight over the use of virtual currency for illegal purposes.

Hence, Asia follows an approach more similar to the EU, where member states have not developed a concerted action regarding AML and CFT for virtual currencies.

Image from Shutterstock and SWIFT.