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From Banking and Finance Law Daily, March 19, 2014

Virtual currencies need regulation to reach full potential, Treasury official says

By Richard A. Roth, J.D.

Virtual currencies cannot obtain mainstream acceptance without effective regulation that brings about financial transparency, according to Treasury Under Secretary David S. Cohen. Regulation does not need to stifle virtual currency innovation, Cohen argues; it can instead “bring stability to the virtual currency market and security to its users and investors,” he says in remarks prepared for delivery on March 18, 2014.

Those who use or invest in virtual currency are exposed to risks that don’t affect national currencies, Cohen points out. The anonymity and irrevocability of transactions in virtual currencies expose users to fraud and theft, and virtual wallets do not benefit from any deposit insurance. Investors are unprotected as well, he adds.

“There is no question that improved consumer and investor protections are sorely needed, and will be crucial to the long-term viability of virtual currency,” according to Cohen. However, “Nor is there any question that the long-term viability of virtual currency depends on addressing the risk that virtual currencies can be used to facilitate illicit finance,” he says.

Current risk. U.S. regulators do not currently see that virtual currencies are being used in a widespread manner to finance terrorism or evade sanctions on foreign transactions, Cohen says. This is because of the volatility of virtual currencies and the limitations on their use to buy goods and services in the real world. However, virtual currencies could become an increasingly attractive way for persons engaged in illegal activities to transfer value anonymously, he warns.

Regulatory response. Virtual currency bans such as those implemented in China and Russia are not the best response, Cohen believes. In the United States, both state and federal regulators have taken steps to regulate virtual currencies in ways that leave room for innovation.

The need is for transparency, Cohen says. Transparency in virtual currency transactions, as in other transactions, requires financial institutions to:

  • know who their customers are;

  • understand their customers’ normal, expected financial activities; and

  • keep records and make reports that will allow the authorities to take action against abuses of the financial system.

In response to criticisms of government regulatory efforts, Cohen draws a parallel to financial system regulation after the depression, which—despite dire warnings—did not push innovation and progress to foreign markets.

The Financial Crimes Enforcement Network’s current regulatory focus is on persons who “facilitate the entry and exit into a convertible virtual currency system,” according to Cohen. The agency is concerned when virtual currency is exchanged for “real” money, or the reverse. Persons who simply use virtual currency for their own transactions are not now subject to regulatory requirements.

Moreover, there is no currency transaction reporting requirement for virtual currencies, Cohen observes. This might change if virtual currencies become sufficiently widely accepted to allow users to avoid the need to exchange them for national currencies, he warns.

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