FinCEN Rules Commodity-Backed Token Services are Money Transmitters

The Financial Crimes Enforcement Network (FinCEN) has issued a new ruling applicable to US businesses seeking to tokenize commodities for blockchain-based trading.

Despite being a response to a specific inquiry by an unnamed company, the letter could be read as broadly applicable to startups seeking to both custody physical assets and issue a digital asset for use in trading. Under such business models, FinCEN suggests startups would need to be licensed in all 50 states.

The letter describes the company behind the submission as one that provides an “Internet-based brokerage service” that connects buyers and sellers of precious metals; buys and sells precious metals on its own account; holds precious metals for clients and issues “digital proof of custody” in the form of a token on the bitcoin blockchain.

In this specific instance, FinCEN argues the company in question does not fall under an electronic currency or commodities trading exemption as it allows “unrestricted transfer of value from a customer’s commodity position to the position of another customer or a third-party”.

The ruling reads:

“FinCEN finds that, as the company is going beyond the activities of a broker or dealer in commodities and is acting as a convertible virtual currency administrator (with the freely transferable digital certificates being the commodity-backed virtual currency), the company falls under the definition of money transmitter.”

The statement is the latest from FinCEN to clarify which types of US bitcoin services it considers money transmitters following similar declarations for bitcoin processors, escrow services and miners, among other groups.

Exceptions

Notably, FinCEN did offer guidance as to how such business models could be crafted should the company in question want to avoid the requirements associated with being categorized as a money transmitter in the US.

In particular, FinCEN referenced a 2011 decision in which it carved out an exemption to entities that only provide “the delivery, communication, or network data access services used by a money transmitter to supply money transmission services”.

The letter reads:

“To the extent the only type of brokerage services offered by the company are those in which the buyer makes payment directly to the seller, the company would meet this exemption and FinCEN would not deem the company a money transmitter.”

FinCEN further called back to 2008 guidance in which it stated that broker-dealers in commodities or currencies are money transmitters if they transfer funds between a customer and a third party that is not part of the transactions.

“Such transmission of funds is no longer a fundamental element of the actual transaction necessary to execute the contract for the purchase or sale of the currency or the other commodity,” it said.

The agency also nodded to its past rulings on virtual currencies to suggest such a definition could be used to capture tokens meant to represent items with a real-world value.

“This type of virtual currency either has an equivalent value in real currency, or acts as a substitute for real currency,” it said.

Interpretations

Risk and compliance specialist Juan Llanos, who has formerly worked with such firms as Bitcoin Foundation and Bitreserve, suggested the ruling should be read as broadly applicable to businesses seeking to issue blockchain-based assets.

Llanos told CoinDesk:

“The broader statement is that issuing a certificate of ownership (whether paper, digital or even a statement) and allowing the unrestricted transfer of value is what makes a broker or dealer (or any other company, for that matter) a money transmitter.”

Llanos suggested the interpretation could extend to many parts of the bitcoin ecosystem, even services like bitcoin wallet provider Blockchain, which has argued that it provides only the software necessary for users to hold bitcoin.

“The government could argue that a wallet service, by providing an ‘account’ or a representation of value via the software, is in fact ‘issuing’ a certificate of ownership or representing the ownership of value electronically,” he suggested.

Ultimately, Llanos inferred that the ruling would increase the number of companies in the space that fall under the definition of money transmission and would thus be governed by Bank Secrecy Act regulations.

Paperwork image via Shutterstock