January 26, 2024

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Good morning and happy Friday. This week, we look at a letter from Rep. Maxine Waters (D-CA) pushing back against Meta's possible expansion into the crypto space, and concerns raised against FinCEN's proposed rule regarding crypto mixing.

Top Points

Rep. Maxine Waters, the top Democrat on the House Financial Services Committee, sent a letter to Meta CEO, Mark Zuckerberg, expressing concern about the company's recent trademark applications that suggest the company is looking to expand into the digital asset space.
Industry firms and policy groups filed comment letters urging FinCEN to significantly narrow or withdraw a proposed rule that would impose new reporting requirements for transactions suspected of involving crypto "mixing."

HFSC Ranking Member Rep. Maxine Waters Sends Letter to Meta

On Monday, Ranking Member Maxine Waters sent a letter to Meta voicing concerns that the company may be looking to pursue crypto-related projects. The letter cites Meta's recent trademark applications related to "various digital asset services and blockchain technology" as the basis for the letter.

At the heart of Rep. Water's concerns are fears that allowing firms to mix commerce and banking activities may lead to a dangerous concentration of economic power at Big Tech, which, in turn, could lead to user privacy, financial stability, and cybersecurity concerns.

Rep. Waters also suggests Meta's trademark applications contradict recent communications between Meta and Democrat Financial Services Committee staff in which Meta indicated that it was not pursuing any blockchain-based products or stablecoins.

The letter traces Rep. Water's concerns back to 2019 when she opposed Facebook's plans to create its own cryptocurrency called Libra and a wallet called Calibra.

Given these concerns, the letter asks Meta to answer a series of questions, including:

whether Meta plans to pursue any projects related to web3, digital assets, or digital wallets;
to what extent Meta is conducting R&D into pilot programs, future stablecoin projects, or partnerships with stablecoin issuers;
whether Meta plans to launch a payments platform that supports cryptocurrency; and
how is Meta's technology is enabling the creation, mining, storage, transmission, or settlement of cryptocurrencies in its related platforms, including its Metaverse?

So What?

Ranking Member Waters has raised concerns with allowing tech firms to mix commerce and banking activities at previous Congressional hearings on stablecoins. She also issued a statement in August of last year in opposition to PayPal launching a stablecoin despite there being no Federal stablecoin regulation:

So while the concerns outlined above are not new, the letter shows Rep. Waters is unlikely to support Big Tech expanding into crypto any time soon - or at least until stringent federal regulations and oversight are in place.

Notably, the Clarity for Payment Stablecoins Act (which passed HFSC in July of last year) would allow nonbank entities to engage in stablecoin activities, but also includes a section that would limit permissible activities of all issuers to those directly supporting the work of issuing and redeeming stablecoins. § 4(a)(6).

Industry Pushes Back Against FinCEN's Proposed Rule Re: Mixing

Background

On October 23, FinCEN published a "Proposed Rule" that would:

(1) designate transactions involving "CVC Mixing" of primary money laundering concern, and
(2) require "covered financial institutions" to record and report transactions to FinCEN that they "know, suspect, or have reason to suspect involve CVC mixing within or involving jurisdictions outside the United States." NPRM at 72702.

CVC stands for Convertible Virtual Currency, which the Proposed Rule defines as: "a medium of exchange that either has an equivalent value as currency, or acts as a substitute for currency, but lacks legal tender status" (and includes Bitcoin). § 1010.662(a)(1).

Covered financial institutions include banks, crypto asset service providers (e.g., exchanges), and all money services businesses. See Proposed Rule at 72714.

FinCEN issued the rule pursuant to section 311 of the USA PATRIOT ACT which authorizes the Secretary of Treasury to direct U.S. financial institutions to take "special measures" when it finds a class of transactions is of primary money laundering concern. 31 U.S.C. § 5318A(a). One of those special measures is to impose additional recordkeeping and reporting requirements on domestic financial institutions and agencies. § 5318A(b)(1).

FinCEN says the rule is necessary because criminals all over the world use CVC mixing for money laundering, sanction evasion, and illicit darknet marketplaces. Proposed Rule at 72702. So, here, "imposing additional recordkeeping and reporting requirements would assist in mitigating the risks posed by" crypto transactions involving mixing. Id.

Comment Period

The period to submit public comments ended on January 22. So this week, industry firms and policy groups filed comment letters outlining their key concerns and recommendations.

TLDR: While industry shares FinCEN’s concern for combatting illicit finance, it believes the proposed rule’s expansive scope would do more harm than good by sweeping in commonplace, lawful transactions, creating reporting redundancies and privacy concerns, and ultimately driving crypto activity offshore, where U.S. law enforcement would have less, not more, visibility into illicit finance activity.

Recommendations proposed include significantly narrowing the Proposed Rule's definitions, establishing a minimum threshold (e.g., only transaction over $10,000 must be reported), and withdrawing the rule entirely.

Here's a closer look at some of the key concerns raised:

Overly Broad:

The Proposed Rule defines CVC mixing as: "[T]he facilitation of CVC transactions in a manner that obfuscates the source, destination, or amount involved in one or more transactions, regardless of the type of protocol or service used." Proposed Rule § 1010.662.
In addition, the proposed rule lists several examples of the types of transactions captured by this definition, including, for example: "pooling or aggregating CVC" and "exchanging between types of CVC or other digital assets." Id.
Industry comment letters argue this overly broad definition would sweep up commonplace, lawful transactions, and ones that have not historically been considered "mixing." Accordingly, industry comment letters call for FinCEN to significantly clarify and narrow its scope to focus more acutely on mixing activity that is more likely to pose illicit finance risks.

Duplicative and Overburdensome:

Under the Bank Secrecy Act, financial institutions are already required to file "Suspicious Activity Reports" for transactions they suspect involve illicit activity. FinCEN recognizes this in their proposed rule, but says the additional reporting requirements would help fill surveillance gaps, as SARs are not always reported directly to FinCEN. See Proposed Rule at 72707 (snip below).

Conversely, industry argues the new reporting requirements would add marginal and questionable benefits to U.S. law enforcement, while undoubtedly imposing significant compliance obligations on entities subject to the rule.
Accordingly, many of the comment letters recommend improving the existing reporting frameworks, rather than impose the new, expansive requirements in the Proposed Rule.

Privacy:

The Proposed Rule would require covered financial institutions to collect a broad swath of user’s personal information - including wallet addresses involved in transactions, the customer’s name and address, and the amount and type of crypto involved in the transaction. See Proposed Rule § 1010.662 for full list.
Industry comment letters argue the broad reporting requirements will result in unnecessary intrusions into the privacy of customers – even those engaged in perfectly lawful transactions.
Relatedly, several letters argue FinCEN failed to adequately consider the legitimate reasons why someone might engage in mixing to protect their financial privacy. Here’s a snip from Blockchain Association’s letter further elaborating on this concern:
- “[T]o the extent a user is deanonymized, anyone can see the core components of every transaction that the user has ever executed—the sender’s public key, the receiver’s public key, and the amount, type of asset, and time transmitted. This is akin to publishing an individual’s entire credit card transaction history online. Tools like CVC mixers allow users to reclaim privacy that would be available as a matter of course in the traditional financial system, while retaining the benefits that come with blockchain technology. BA Letter at 5 (emphasis added).

Undermines Efforts to Combat Illicit Finance

As noted above, FinCEN says the rule is necessary to combat the increasing use of CVC mixing by criminals to hide illicit activity. According to FinCEN, the reporting requirements "will assist law enforcement with identifying the perpetrators behind illicit transactions and preventing, investigating, and prosecuting illegal activity, as well as rendering such transactions—through increased transparency—less attractive and useful to illicit actors." Proposed Rule at 72702.
But at least one industry letter argues the Proposed Rule may ultimately undermine its purported objective. Polygon Labs & DELV's comment letter states:
- "[T]he Proposed Rule is so broad that covered financial institutions likely will refuse to process or otherwise engage in any transactions that it 'knows, suspects, or has reason to suspect' involves CVC Mixing. In practice, this means that no U.S. covered financial institutions subject to the BSA would engage in transactions involving CVC Mixing....Moving all CVC mixing transactions to off-shore, non-U.S. VASPs would remove any visibility into CVC mixing activity for FinCEN, and for U.S. law enforcement and the intelligence community. This would thwart the purpose of the BSA’s recordkeeping and reporting requirements – i.e., to allow U.S. law enforcement to detect, investigate and prosecute potential illicit actors." Comment Letter at 23-24.

For those looking to dive deeper on the full range of issues, concerns, and recommendations raised throughout the comment letters, here are some links:

What's Next?

FinCEN will now review the comments and then may either withdraw the rule, publish an amended rule, or finalize the Proposed Rule as written. Based on the comment letters, failure to address some of the concerns in a final rule, particularly with respect to narrowing its scope, would likely result in legal challenges in the courts.

Look Ahead

Tuesday, January 30, 2024 - 10am HFSC:
- Hearing: "Better Investment Barriers: Strengthening CCP Sanctions and Exploring Alternatives to Bureaucratic Regimes."
Wednesday, January 31, 2024 - 10AM HFSC:
- Hearing: "Rules Without Analysis: Federal Banking Proposals Under the Biden Administration."

Quick Hits

Illicit Finance

GAO issued a blog post (1.16.24) highlighting a GAO report from last year (12.13.23) that analyzed how digital asset growth may impact the effectiveness of economic sanctions. The blog post concluded:

Senator Elizabeth Warren (D-MA) used the blog post as a jumping off point to promote her Digital Asset Anti-Money Laundering Act.

But see: Senator Warren's post was quickly community noted:

Crypto in the Courts

Custodia Bank, Inc. v. Board of Governors of the Federal Reserve System

Blockchain Association filed an amicus brief on behalf of Custodia Bank arguing the Fed's assertion that it has complete discretion to deny master accounts undermines the strength of America's dual banking system.
- Brief.

SEC v. Binance

U.S. District Court in D.C. heard oral arguments in SEC v. Binance, where the parties debated similar arguments raised in SEC v. Coinbase, but the judge seemed less sympathetic to arguments that an investment contract requires a contract or some enforceable right against the issuer.
- "SEC finds more favorable judge in DC as Binance tries to dismiss lawsuit" (Casey Wagner; Blockworks).

Tornado Cash

"Why Tornado Cash Remains the Most Pivotal Legal Case in Crypto" (Opinion, Ben Schiller; CoinDesk).

Thank you for reading and please enjoy your weekend.

Sincerely,

GSL

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Cap Hill Crypto

*All information contained in this newsletter is for informational purposes only and should not be considered legal or financial advice. You should conduct your own research, and consult an independent financial, tax, or legal advisor before making any investment decisions. The author may own cryptocurrencies discussed herein.*

Cap Hill Crypto

Letter to Meta & CVC Mixing - 1.26.24