If you already own bitcoin and/or other crypto assets or think you might in the coming months, it is worth understanding FinCEN’s (Financial Crime Enforcement Network, part of the Treasury Dept) proposed reporting rule changes. These changes were proposed on Dec 18th, 2020 with a surprisingly short 15-day comment period, which included both Christmas and New Year’s Eve holidays. To quote one of the formal responses below, “ it is clearly a politically motivated piece of midnight rule making….” It’s baffling to me why a lame duck government would try to hastily ram through regulation on an enormously complicated issue/technology.
The tweet below, from a crypto legal expert, provides further insights on the hasty comment period.
Several lawmakers asked Treasury Secretary Mnuchin to extend the comment period to the normal 60 days. You can read more about the request here. That did not happen as the comment period closed on Jan 4th. Expect litigation on the curtailed 15-day comment period if FinCEN pushes ahead with the revised rules.
What does the new rule propose? The rule essentially requires US-based regulated entities like exchanges, custodian and other financial firms that touch crypto assets to verify, report and store information on transaction with self-hosted wallets above a certain threshold. The proposed rules impact crypto financial entities directly, but will indirectly impact most bitcoin/crypto users. The regulated entities are required to collect and hand over data that includes your NAME and physical ADDRESS to the government.
As someone entrusted to manage clients’ retirement wealth, I am most worried by the security implication of this proposal: Bitcoin (all crypto) is a bearer asset. That means the bitcoin you own is NOT linked to your name but is instead controlled via a private cryptographic key, which is secured by a string of 12 or 24 words, called a seed-phrase. In many instances people keep this seed-phrase at home, which means they are storing their bitcoin wealth at home. If someone steals this seed-phrase then the thief controls the bitcoin. Combing this bearer asset aspect of bitcoin/crypto with a central government database of crypto owners’ personal data creates an unacceptably high risk for law abiding citizens. Layering in a society with 300m+ firearms in circulation further raises the risk.
This is how Chainalysis, the crypto data analysis and AML firm, articulates the above risk in the official response to Treasury. A link to the full response is at the bottom of this article.
Where can I find the details of the proposed rules and what are the key issues? The official responses from industry participants helped me investigate the issues thoroughly. I list below a few of those official responses to Treasury/FinCEN.
Let’s start with Chainalysis’ explanation of the proposed rules. This is NOT their official reply, which is shown at the bottom of this report. It’s worth noting that Chainalysis, in a static environment, is likely to benefit from tighter regulations. Yet, Chainalysis thinks the proposal is a bad idea for many reasons.
Here’s the FinCEN proposal. It is 72 pages
Objections to the rushed 15-day comment period is universal, as you’ll see in the links below. Coin Center, the industry body, provided the first official comments on Dec 22nd to provide a lead to the industry. Read it here
Many of the industry participants posted their comments just before the January 4th deadline, taking a few more days to investigate the impact/feasibility of the proposed rules. As many say, they have not had the time to fully investigate some of the potential issues and impacts.
This is Kraken’s (crypto exchange & soon to be a custodian) comment. Surprisingly Coinbase, the largest exchange in the US, has not released a detailed official response on their website. The CEO encourage industry participants to respond directly to the Treasury Department in this Dec 30th blog post and the company previously released this brief statement on Dec 21st.
Here is an articulate statement to FinCEN from Ben Davenport, co-founder of BitGo, one of the earliest and largest Institutional digital asset custodians.
This is Square’s (NASDAQ:SQ) comment
Here is the formal response from Chainalysis.https://www.linkedin.com/embeds/publishingEmbed.html?articleId=9048176816359321801
I will be keeping a close eye on how this issue develops. Perhaps the incoming administration decides that there are more pressing issues for the Treasury Department to tackle or at the very least obtains a more thorough response. This is a relatively new industry undergoing rapid innovation and evolution. It would be a bad outcome if the globally decentralized blockchains end up fracturing into US compliant coins and ex-US coins. That’s a complicated subject for another time!