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CRS report raises privacy concerns regarding digital wallets
On April 18, the Congressional Research Service released an overview of digital wallet technology and related cybersecurity, data privacy and consumer protection policy considerations. Digital wallets are software applications that store payment or account details to facilitate traditional payments using bank and credit card details, and also cover transfers from consumers’ bank accounts to retailers and peer-to-peer and cryptocurrency transactions. One issue the report identified is that companies that offer digital wallets and payment companies often collect information about users and may share data with affiliates and nonaffiliates unless users opt out. As previously covered by InfoBytes, the CFPB is developing proposed rulemaking around sharing consumer financial data, but it remains unclear whether the rules would apply to digital wallet companies. The report also stressed that because funds stored on digital wallets are not deposits, digital wallets are generally not covered by deposit insurance. And while credit, debit, or prepaid cards stored on a mobile wallet are covered by the EFTA and TILA (and implementing Regulations E and Z), those statutes do not currently cover cryptocurrency wallets. The report explained that “[c]ryptocurrency transactions are not subject to Regulation E primarily because these are not bank products and also because cryptocurrencies are not typically used for consumer payments.”
Hsu discusses stablecoins, pushes for crypto banks
On April 8, acting Comptroller of the Currency Michael J. Hsu discussed stablecoin policy considerations in remarks before the Institute of International Economic Law at Georgetown University Law Center. Hsu called for the establishment of an “intentional architecture” for stablecoins developed along the principles of “[s]tability, interoperability and separability,” as well as “core values” of “privacy, security, and preventing illicit finance.” According to Hsu, one way to mitigate blockchain-related risks would be to “require that blockchain-based activities, such as stablecoin issuance, be conducted in a standalone bank-chartered entity, separate from any other insured depository institution [] subsidiary and other regulated affiliates.” Hsu also emphasized the need to evaluate whether stablecoin issuers should be required “to comply with a fixed set of safety and soundness-like requirements (as is the case with banks)” or be allowed to pick from a range of licensing options.
Additionally, Hsu raised the question about how separable stablecoin issuers should be. “Blockchain-based money holds the promise of being ‘always on,’ irreversible, programmable, and settling in real-time,” he explained. “With these benefits, however, come risks, especially if commingled with traditional banking and finance.” Specifically, Hsu cited concerns that a bank’s existing measures for managing liquidity risks associated with traditional payments “may not be effective for blockchain-based payments,” which could conceivably accumulate over a weekend and “outstrip a bank’s available liquidity resources.” Hsu also raised concerns related to the current “lack of interoperability” should stablecoins expand from trading to payments, and stressed that “[i]n the long run, interoperability between stablecoins and with the dollar—including a [central bank digital currency]—would help ensure openness and inclusion.” He added that this “would also help facilitate broader use of the U.S. dollar—not a particular corporate-backed stablecoin—as the base currency for trade and finance in a blockchain-based digital future.”
FDIC instructs banks to provide notification when engaging with crypto assets
On April 7, the FDIC released FIL-16-2022, titled “Notification of Engaging in Crypto-Related Activities,” instructing banks that intend to engage in, or that are currently engaged in, any activities involving or related to crypto assets (also referred to as “digital assets”), to notify the FDIC of their intent and to provide “all necessary information that would allow the FDIC to engage with the institution regarding related risks.” The FDIC noted that, though it “supports innovations that are safe and sound,” the agency is “concerned that crypto assets and crypto-related activities are rapidly evolving, and risks of this area are not well understood given the limited experience with these new activities.” According to the FDIC, crypto-related activities “may pose significant safety and soundness risks as well as financial stability concerns,” digital asset activities “present risks to consumers,” and insured depository institutions “face risks in effectively managing the application of consumer protection laws and regulations” related to these “new and changing crypto-related activities.” The letter also specified that a bank should promptly "notify the appropriate FDIC Regional Director” of “information necessary to allow the agency to assess the safety and soundness, consumer protection, and financial stability implications” of digital asset activities. The FDIC will review the information and provide relevant supervisory feedback.
Yellen sets out principles for regulating digital assets
On April 7, Treasury Secretary Janet Yellen outlined a broad set of principles for regulating digital assets during remarks delivered at American University’s Kogod School of Business Center for Innovation. Yellen said that the approach she described largely reflects priorities outlined in an Executive Order issued by President Biden last month, which presented a “whole-of-government” strategy to coordinate a comprehensive approach for ensuring responsible innovation in digital assets policy (covered by InfoBytes here). Emphasizing that “regulatory frameworks should be designed to support responsible innovation while managing risks—especially those that could disrupt the financial system and economy,” Yellen cautioned that regulatory frameworks must appropriately reflect these risks as banks and other traditional financial firms enter this space. Moreover, she added that “new types of intermediaries, such as digital asset exchanges and other digital native intermediaries, should be subject to appropriate forms of oversight.”
During her remarks, Yellen discussed the risks and benefits to consumer protection and financial stability associated with the growth in digital assets. While Yellen did not provide specific instructions, she outlined general principles that she believes should guide the creation of a new framework for regulating digital assets. Stressing that regulations should be “tech neutral” and “based on risks and activities, not specific technologies,” Yellen explained that consumers and businesses should be protected from fraud regardless of whether assets are stored on a balance sheet or a distributed ledger. She also stressed the importance of ensuring that the growth of digital assets does not disproportionately impact vulnerable communities or exacerbate social, racial, or economic inequities. Yellen stated that, over the next six months, Treasury will collaborate with the White House and other agencies to produce reports and recommendations addressing opportunities and challenges posed by these emerging technologies.
DFPI concludes MTA licensure not required for digital asset trading platform
On March 23, the California Department of Financial Protection and Innovation (DFPI) released a new opinion letter covering aspects of the California Money Transmission Act (MTA) related to a digital asset trading platform. The redacted opinion letter examines whether the inquiring Company (a registered money services business) requires licensure under the MTA. The Company requesting an interpretive opinion operates a software platform that allows retail and institutional investors to buy and sell digital assets, including cryptocurrency, and access related services, within the platform. The letter explains that U.S. customers must fund an account on the Company’s platform prior to purchasing cryptocurrency with either fiat currency (U.S. dollars) or cryptocurrency. The letter also describes, among other things, how customers can buy from and sell to the Company cryptocurrencies on one or more cryptocurrency exchanges using the platform. In these transactions, the Company would sell or buy cryptocurrency from the customer at the selected price and settle the trade using fiat or cryptocurrency held in its own accounts. Simultaneously, the Company would execute a trade for its own benefit on the exchange offering the price selected by the customer. Customer funds would not be used to buy or sell cryptocurrency from or to the exchange. After executing a transaction, a customer may choose to withdraw all or part of the customer’s fiat or cryptocurrency from the platform, or may choose to maintain a balance to execute future transactions.
The DFPI stated that it “has not concluded whether a wallet storing cryptocurrency constitutes a form of monetary value representing a claim against the issuer and accepted for use as a means of redemption for money or monetary value or payment for goods or services.” As such, the DFPI will not require the Company to be licensed under the MTA to provide customers with an account via a proprietary software platform to transfer and store cryptocurrency in order to execute trades directly with the Company.
OCC’s Hsu discusses managing tail risks
On March 31, acting Comptroller of the Currency Michael J. Hsu spoke before the American Bankers Association Risk 2022 Conference to discuss managing low probability, high impact risk events, or tail risks. In particular, Hsu highlighted the connection between Russia’s invasion of Ukraine and heightened tail risks associated with geopolitical risk, cyber risk, and inflation risk. Hsu warned that multiple possible events stemming from the conflict, including cyber-attacks from Russia, broader conflict in Europe, and increased inflation could materialize simultaneously increasing the chances that tail risks materialize that could trigger a recession. Hsu noted that the increase of sanctions to oil and gas would put upward pressure on fuel prices, and “Ukraine’s role as a producer of wheat, neon, platinum, and palladium is also beginning to affect global prices in certain markets.” Despite the elevated risks, Hsu noted that enhanced stress testing has positioned large banks to absorb a range of shocks, but warned that “nonetheless, greater caution and risk management vigilance is warranted today, perhaps more than any time in recent memory.” Hsu also singled out risks associated with crypto assets and said that the OCC is collaborating with other agencies on “how to maintain a consistent, careful and cautious” approach to bank involvement in cryptocurrency. Hsu cautioned that in light of “limited or unreliable price histories” of crypto-assets, financial institutions should “carefully consider” the tail risks associated with factoring cryptocurrency positions into the overall risk management process. Hsu discussed his worry regarding the potential for crypto derivatives to create “wrong-way risk” in which a leveraged party use trades to “double-down” at the same time it is experiencing financial stress. Hsu stated that the OCC has engaged with government agencies in the U.K. and U.S. on “how to maintain a consistent, careful, and cautious approach to bank involvement in crypto.”
DFPI addresses MTA licensing requirements
Recently, the California Department of Financial Protection and Innovation (DFPI) released new opinion letters covering aspects of the California Money Transmission Act (MTA) related to a digital currency trading platform and the referral of customers to financial institutions. Highlights from the redacted letters include:
- Digital Currency Trading Platform. The redacted opinion letter examines whether the inquiring Company requires licensure under the MTA. The letter describes that the Company’s customers would transfer digital currency into the account they have with the Company, with the balance being reflected in the customer’s wallet issued by the Company. The letter further explains that the Company would provide California residents access to its digital currency trading platform to buy, sell, or hold digital currency and provide liquidity services. The letter also describes, among other things, how customers could use the platform, transfer digital currency into the account, and transfer fiat currency by transferring it from their own bank account or by debit or credit card to the Company. Customers would not be able to send fiat or digital currency to others, except in the context of a sale. DFPI concluded that while the Company’s wallets holding fiat currency meet the definition of stored value, licensure under the MTA was not required because the Company offered fiat currency wallets to customers solely to facilitate the trade of digital currency. DFPI also noted that the Company does not require licensure under the MTA to perform Platform trading services or to issue wallets holding digital currencies.
- Referral of customers to financial institutions. The redacted opinion letter examines whether the inquiring Company’s referral service is subject to the MTA. The letter describes that under this service, the Company would refer customers to banks, trust companies, and other entities which are either licensed as money transmitters in California or exempt from licensure. Under the proposed referral service, customers would be re-directed to a financial institution’s website where they could set up and fund an account. Customers wishing to buy, sell, or exchange cryptocurrency or fiat currency could do so from the Company’s website and use a third party’s software platform to input their order details. The platform would check to make sure that the customer has sufficient assets in the customer’s account with the financial institution to purchase the cryptocurrency. The financial institution would be the only party to hold, receive, or transmit all cryptocurrencies in the customer’s account. DFPI concluded that the referral service does not meet the definition of money transmission because the service entails connecting customers with financial institutions from which customers can buy, sell, or exchange cryptocurrency. Further, DFPI noted that the transactions between customers and financial institutions are also not money transmission because the customer would simply exchange cryptocurrency directly with the financial institution. Accordingly, DFPI held that licensure under the MTA is not required because the Company will not sell or issue payment instruments, sell or issue stored value, or receive money for transmission by offering the referral service.
OCC’s Hsu discusses improving crypto literacy
On March 8, acting Comptroller of the Currency Michael J. Hsu spoke before the Financial Literacy and Education Commission’s (FLEC) Public Meeting to discuss and commend FLEC’s efforts to improve crypto literacy and crypto education. In his remarks, Hsu described that a “younger, more financially vulnerable” population makes up a large portion of crypto owners, and that the risk of scams and hacks are increasing. He also argued that “it is hard to find neutral, trusted sources of information on crypto,” calling it “nearly impossible to find neutral information about something as simple as fees.” Describing “an urgent need for improved crypto literacy and education,” Hsu urged the commission to make available neutral, trusted educational materials to educate the public on crypto. He added that “consumers are left with an information landscape dominated by a lot of hype, jargon, attractive yields, and only boilerplate disclaimers about the risks they could face.”
Special Alert: Latest developments in OFAC sanctions against Russia
Beginning February 21, the U.S. Department of the Treasury’s Office of Foreign Assets Control has issued significant sanctions in response to the Russian Federation’s military invasion of Ukraine and its recognition of Ukraine’s separatist regions.
Since Buckley’s last update on February 25, there have been a number of developments in the sanctions against Russia, which include:
- A prohibition on the importation into the United States of Russian crude oil and certain petroleum products, liquified natural gas, and coal
- A ban on new investment by U.S. persons in the Russian energy sector
- The imposition of asset blocking sanctions on Vladimir Putin, Sergei Lavrov, numerous oligarchs and families with ties to Putin, and Russian-backed disinformation services
- Sanctions targeting Russia’s U.S. foreign reserves by prohibiting all dealings with Russia’s Central Bank, National Wealth Fund, and Ministry of Finance
- The issuance of the Russian Harmful Foreign Activities Sanctions Regulations, which codify the prohibitions imposed under Executive Order 14024, discussed below, and include several interpretations and general licenses
- The issuance of a general license that exempts “transactions related to energy” from certain prohibitions imposed under Executive Order 14024
OFAC, DOJ measures aim for stronger compliance with Russian sanctions
On March 2, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) and the DOJ announced new measures to strengthen compliance with Russia-related sanctions in response to the situation in Ukraine. OFAC observed that in the past few days, Russia has taken measures “to use exporters to act as their agents and help them raise resources to prop up their currency and fund their priorities.” In response, OFAC reiterated that such actions taken on behalf of Russia’s Central Bank are prohibited. Newly issued and updated frequently asked questions address enhanced sanctions compliance measures and further explain recent sanctions, including prohibitions imposed pursuant to Directive 4 under Executive Order (E.O.) 14024, “Prohibitions Related to Transactions Involving the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, and the Ministry of Finance of the Russian Federation.” (Covered by InfoBytes here.) Additionally, the updated FAQs clarify, among other things, that energy payments can and should continue. As explained in OFAC’s announcement, General License (GL) 8A permits “U-turn transactions” so that energy payments may be processed through non-sanctioned, third-country financial institutions to allow the continuation of transactions that support the flow of energy to the market. OFAC also issued new FAQs and general licenses (see GLs 9A, 10A, 13, and 14) related to E.O. 14065, “Blocking Property of Certain Persons and Prohibiting Certain Transactions With Respect to Continued Russian Efforts to Undermine the Sovereignty and Territorial Integrity of Ukraine” to further clarify the stipulated prohibitions.
The same day, the DOJ launched Task Force KleptoCapture, “an interagency law enforcement task force dedicated to enforcing the sweeping sanctions, export restrictions, and economic countermeasures that the United States has imposed, along with allies and partners,” in order to “isolate Russia from global markets.” “The Justice Department will use all of its authorities to seize the assets of individuals and entities who violate these sanctions,” Attorney General Merrick B. Garland stated. The Task Force will be staffed with DOJ prosecutors, agents, analysts, and professional staff with expertise in sanctions and export control enforcement, anticorruption, asset forfeiture, anti-money laundering, tax enforcement, national security investigations, and foreign evidence collection. According to the announcement, the Task Force will use data analytics, cryptocurrency tracing, foreign intelligence sources, and information from financial regulators and private sector partners to investigate and prosecute violations of new and future sanctions (both those related to the Ukraine invasion as well as those imposed for prior instances of Russian aggression and corruption), and “combat[] unlawful efforts to undermine restrictions taken against Russian financial institutions,” including prosecuting persons who attempt to evade know-your-customer and anti-money laundering measures. The Task Force will also target efforts to use cryptocurrency to launder foreign corruption proceeds and sanctions evasion and “us[e] civil and criminal asset forfeiture authorities to seize assets belonging to sanctioned individuals or assets identified as the proceeds of unlawful conduct.”