FinCEN’s New Proposed Rule Targets CVC-Mixed Cryptocurrency: Could Your Exchange Be Impacted?

At a glance:

• The main takeaway: FinCEN has proposed a new rule intended to help improve AML enforcement in transactions that might involve CVC mixing of cryptocurrencies.
• The impact on your business: If the proposed rule will apply to your business and its operations it would be a good idea to start planning how to implement the new reporting and recordkeeping requirements as soon as you can.
• Next steps: Determine whether your business would be affected by the new rule and, if so, start making plans for dealing with the new requirements now.

Schedule a consultation with Aprio’s AML Specialists today.

The full story:

The Financial Crimes Enforcement Network (FinCEN) released a notice of proposed rulemaking (NPRM) on October 23, 2023 concerning a relatively new and reasonably worrisome technique known as convertible virtual currency (CVC) mixing. The window for commenting on the proposed rule is open until January 22, 2024, which means financial institutions will have until then to provide questions or comments to FinCEN regarding this NPRM. Until then, it’s always a good idea to stay abreast of any new regulatory developments.

Keep reading for a quick overview of the proposed rules, what they cover, and how they may impact your business. And remember to contact Aprio with any questions and concerns you might have about your Anti Money Laundering (AML) program. 

Convertible Virtual Currency

It’s a lot easier to understand the proposed rule and its implications if you understand what’s being regulated in the first place. This rule has to do with a technique/technology called CVC mixing, so let’s start with the first part: CVC.

CVC stands for convertible virtual currency. It’s a broader term that encompasses any virtual media of exchange that can operate like and be converted to and from a state-backed fiat currency. Or, as FinCEN puts it: “CVC is a type of virtual currency that either has an equivalent value as a currency or acts as a substitute for currency and is therefore a type of ‘value that substitutes for currency.”’

Their “CVC” label covers digital currencies, cryptocurrencies, cryptoassets, and digital assets, most of which operate on a blockchain-based architecture.

CVC Mixers

Most CVCs work based on some form of blockchain, meaning every transaction and change of ownership they experience is recorded on a publicly-available ledger. These ledgers are inherent and integral parts of all blockchain-based cryptocurrencies and cryptoassets – they’re the main mechanism preventing crypto counterfeiting, not to mention the only way to trace where any given unit of any given crypto has been.

In other words, they help keep the crypto world as honest as a decentralized web of mostly anonymous actors can be, and they make it possible for AML teams to trace the transaction/ownership path of crypto assets before they hit their own books.

There’s just one problem that FinCEN is concerned about: Some people don’t like having their activities publicized – even on blockchain ledgers – so they’ve started taking additional measures to ensure their privacy. Those measures are collectively known as CVC mixers.

CVC Mixing Methods

FinCEN lists several different methods by which owners of CVC can obfuscate their transactions:

• Pooling: Combining CVC from two or more people into one wallet or contract and obfuscating the identity of the parties involved by decreasing the probability of determining both intended persons for each unique transaction.
• Splitting and transmitting: Splitting a single transaction into multiple, smaller transactions to make them blend in with other unrelated transactions on the blockchain occurring at the same time, making it harder to determine both intended persons for each transaction.
• Algorithmic or programmatic: Using software that coordinates transactions together to obfuscate the individual transactions by providing multiple potential outputs from a single coordinated input.
• Peel chain: Creating multiple decoy accounts, single-use wallets, and addresses, then using them to filter the CVC through a chain of unnatural transactions, making it that much harder to trace the original source and destination of the funds.
• Chain hopping: Exchanging two or more types of CVC or other assets multiple times between and within transactions and moving the funds to at least one different service or platform to make it harder for investigators to trace.
• Technological time delays: Using some kind of technology to programmatically delay transactions, making it harder to connect transactional inputs and outputs.

Legal Uses of CVC Mixers

Observers with a passing familiarity with AML would be forgiven for wondering why CVC mixers are legal in the first place. After all, cryptocurrency is a potent vehicle for illegal transactions on its own, so why would methods and technologies designed to further obfuscate the nature, origin and destination of illicit funds be allowed to proliferate?

The reasons are twofold: First, even FinCEN acknowledges that there are legitimate reasons why responsible actors might want to pursue transactions with greater anonymity than is possible with standard blockchain ledgers attached to CVC. Some people might want more privacy for privacy’s sake, and others might require greater privacy because they live under repressive regimes. Technically there are licit, reasonable uses for CVC mixers.

The second reason is that FinCEN and other US regulators have no way to police or prevent the use of CVC mixers outside the US. That’s the reality: FinCEN has no way of stopping CVC mixing outside the country, and that’s a problem.

Illegal Uses of CVC Mixers

The potential illegal uses of CVC mixers are basically what you would expect from a set of technologies/methods used to obfuscate transactions made in CVC. Black market participants, ransomware operators, international criminal organizations, participants in CVC heists, and even state-backed criminal enterprises from places like North Korea and Russia all use CVC mixing to hide their activities from law enforcement, and their numbers seem to be growing. FinCEN estimates that the amount of CVC processed through mixers rose by 62.78% between 2021 and 2022 – and that’s only including the transactions they could actually trace.

Proposed Special Measure One

The NPRM acknowledges that most of the ideas FinCEN came up with would be ineffective, impractical, overly burdensome or some combination of the three. It lands on only one proposed special measure, the details of which have yet to be formalized.

The proposed special measure one is summed up at the top of the document as: “…requiring covered financial institutions to implement certain recordkeeping and reporting requirements that covered financial institutions know, suspect, or have reason to suspect involve CVC mixing within or involving jurisdictions outside the United States.”

Any formal version of special measure one would require recordkeeping and reporting of biographical and transactional information related to transactions involving CVC mixing. The document notes that most or all of the information the special measure would require to be collected and reported is already being captured in the normal course of business.

FinCEN also notes that the reporting obligations would only apply to covered financial institutions that directly engage with CVC transactions, such as crypto exchanges, and do not encompass direct fiat transactions by covered US financial institutions.

The Bottom Line

FinCEN’s most recent notice of planned rulemaking is just that. It is unknown what the actual rule(s), if any, will look like once they’ve passed the comment period, been formally drafted, reviewed and finally implemented.

There’s no guarantee that a rule will be implemented at all, but it would still be wise to keep the potential for new recordkeeping and reporting requirements in mind as you move forward, especially if it sounds like your exchange or operations would fit FinCEN’s criteria.

It isn’t always easy to stay on top of these developments, and it certainly isn’t easy to discern exactly what that might mean for your business. Aprio’s AML specialists are here to answer your questions, help you strategize and make achieving and maintaining compliance with regulations as easy as possible.

Related Resources:

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An Independent Review of Coinbase’s AML Process Could Have Saved Them $100 Million

Safeguarding Financial Institutions: What Are Transaction Lookback Reviews and Can They Be Prevented?

The Red Flags of AML – Part 1