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Cryptocurrencies and anti-money laundering: the shortcomings of the fifth AML Directive (EU) and how to address them

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Abstract

Virtual currencies pose a serious threat to be used for money laundering, weakening the European Union’s financial system. Directive (EU) 2018/843 (the fifth anti-money laundering Directive) intends to mitigate these risks by introducing a definition of virtual currencies within Union law. Some service providers connected to virtual currencies are made subject to anti-money laundering law. Member States are required to transpose this Directive into national law by January 2020. Consultations on national level are currently ongoing. This article analyses how the Directive applies to current forms of cryptocurrencies, their adjacent services and intermediaries. It highlights the Directive’s imprecise wording as well as its limited scope. If Member States transpose it verbatim, they will create legal uncertainty and loopholes for relevant entities. Therefore, this article seeks to contribute to the national consultations of Member States by providing concrete legislative recommendations on how to fix the Directive’s shortcomings.

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Notes

  1. For example, see Financial Action Task Force (FATF). (2018) FATF Report to G20 Finance Ministers and Central Bank Governors, July, at p. 2, paras. 7–8, www.fatf-gafi.org/media/fatf/documents/reports/FATF-Report-G20-FM-CBG-July-2018.pdf, accessed 21 January 2019; HM Treasury and Home Office. (2017) National risk assessment of money laundering and terrorist financing, October, at p. 40, paras. 5.8–5.12., www.assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/655198/National_risk_assessment_of_money_laundering_and_terrorist_financing_2017_pdf_web.pdf, accessed 21 January 2019, stating that the risk for money laundering is growing; Keatinge, T., Carlisle D. and Keen, F. (2018) Virtual currencies and terrorist financing: assessing the risks and evaluating responses. Brussels, BE: Policy Department for Citizen’s Rights and Constitutional Affairs. PE 604.970, May, at p. 27 et seqq., www.europarl.europa.eu/RegData/etudes/STUD/2018/604970/IPOL_STU(2018)604970_EN.pdf, accessed 21 January 2019; Teichmann, F.M.J. (2018) Financing terrorism through cryptocurrencies—a danger for Europe? Journal of Money Laundering Control 21(4): 513–519.

  2. Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU (hereinafter AMLD5).

  3. For example, the UK’s Financial Conduct Authority (FCA) will hold a consultation on regulating further entities beyond AMLD5, see HM Treasury, FCA & Bank of England. (2018) Cryptoassets Taskforce: final report, October, at pp. 41–42, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/752070/cryptoassets_taskforce_final_report_final_web.pdf, accessed 21 January 2019; likewise, the German Federal Ministery of Finance is already preparing the respective national laws of AMLD5 (for which it normally then holds consultations), see Deutscher Bundestag. (2018) Drucksache 19/6034, at p. 2, http://dip21.bundestag.de/dip21/btd/19/060/1906034.pdf, accessed 21 January 2019.

  4. The term is not meant to be accompanied by any legal or other connotation. There are several other terms used, e.g. the distinction between cryptocurrencies and tokens; or cryptoassets, see, for example, Houben, R. and Stevens, A. (2018) Cryptocurrencies and Blockchain—Legal context and implications for financial crime, money laundering and tax evasion. Brussels, BE: Policy Department for Economic, Scientific and Quality of Life Policies. PE 619.024, July, at p. 23–24, www.europarl.europa.eu/cmsdata/150761/TAX3%20Study%20on%20cryptocurrencies%20and%20blockchain.pdf, accessed 21 January 2019; EY (2018) IFRS—Accounting for crypto-assets, March, at pp. 2–9, eyfinancialservicesthoughtgallery.ie/wp-content/uploads/2018/03/EY-IFRS-Accounting-for-crypto-assets.pdf, accessed 26 March 2019). In contrast to ‘cryptocurrency,’ these are not as suitable to be used as generic terms.

  5. In academic literature, the term ‘coin’ is used in the term ‘Initial Coin Offering,’ see infra at note 8; however, all units of cryptocurrencies are referred to as tokens to clarify that their origin is a Blockchain, see, for example, Bodó, B., Gervais, D. and Quintas, J.P. (2018) Blockchain and smart contracts: the missing link in copyright licensing?. International Journal of Law and Information Technology 26(4): 311–336, at 4 et seq.; Swiss Financial Market Supervisory Authority (FinMa) (2018) Wegleitung für Unterstellungsanfragen betreffend Initial Coin Offerings (ICOs), February, at p. 3; www.finma.ch/de/news/2018/02/20180216-mm-ico-wegleitung/, accessed 26 March 2019.

  6. Maume, P. and Fromberger, M. (2019) Regulation of Initial Coin Offerings: Reconciling US and EU Securities Laws. Chicago Journal of International Law 19(2): 548–585, at 558.

  7. Ibid.

  8. Maume P. and Fromberger, M. (n 6); Rivero, A. (2018), Distributed Ledger Technology and Token Offering Regulation, at 5 et seq., available at www.ssrn.com/abstract=3134428, accessed 21 January 2019; Klöhn, L., Parhofer, N. and Resas, D. (2018) Initial Coin Offerings (ICOs). Zeitschrift für Bankrecht und Bankwirtschaft 30(2): 89–106, at 99; Barsan, I. (2017) Legal Challenges of Initial Coin Offerings (ICO). Revue Trimestrielle de Droit Financier (RTDF) (3): 54–65, at 56–60 (identifying only two token categories: ‘currency like’ and ‘security like’); Rohr, J. and Wright, A. (2018) Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets. University of Tennessee Legal Studies Research Paper No. 338. Cardozo Legal Studies Research Paper No. 527, at 14–26, available at www.ssrn.com/abstract=3048104, accessed 21 January 2019, distinguishing between ‘app tokens’ and ‘protocol tokens’; FINMA (Swiss Financial Supervisory Authority (2018) Wegleitung für Unterstellungsanfragen betreffend Initial Coin Offerings (ICOs), 16 February, at p. 2–3, www.finma.ch/de/~/media/finma/dokumente/dokumentencenter/myfinma/1bewilligung/fintech/wegleitung-ico.pdf, accessed 21 January 2019.

  9. See, for example, Verge, Monero or Bitcoin as decentralised tokens, based on decentralised Blockchains.

  10. Maume, P. and Fromberger, M. (n 6) at 559; Investopedia. (2018) Cryptocurrency. 10 December, https://www.investopedia.com/terms/c/cryptocurrency.asp, accessed 21 January 2019.

  11. Maume, P. and Fromberger, M. (n 6) at 559.

  12. Barsan, I. (n 8) at 57.

  13. The term ‘security’ is defined legally Art. 4(1)(1) MiFiD II; investment tokens can fulfil the prerequisites of securities (see ESMA Securities and Markets Stakeholder Group (2018) Advice to ESMA – Own Initiative Report on Initial Coin Offerings and Crypto-Assets, ESMA22-106-1338, 19 October, https://www.esma.europa.eu/sites/default/files/library/esma22-106-1338_smsg_advice_-_report_on_icos_and_crypto-assets.pdf, accessed 26 March 2019; Maume, P. and Fromberger, M. (n 6) at 572 et seqq.); if so, they are also commonly referred to as security tokens, see, for example, Mendelson, M. (2019) From Initial Coin Offerings to Security Tokens: A U.S. Federal Securities Law Analysis. Stanford Technology Law Review 22(1): 52–94; Moran, J.D. (2018) The Impact of Regulatory Measures Imposed on Initial Coin Offerings in the United States Market Economy. Catholic University Journal of Law and Technology 26(2): 213–258.

  14. De Filippi, P. and Wright, A. (2018) Blockchain and the Law: The Rule of Code. Cambridge, MA: Harvard University Press, at p. 101; Maume, P. and Fromberger, M. (n 6) at 559.

  15. So-called crypto-to-crypto exchanges, see infra Chapter on ‘Cryptocurrency exchanges’.

  16. De Filippi, P. and Wright, A. (n 14) at p. 100.

  17. Maume, P. and Fromberger, M. (n 6) at 560.

  18. See www.sia.tech/about/, accessed 19 January 2019.

  19. Maume, P. and Fromberger, M. (n 6) at 558.

  20. For an overview of the ICO market in 2017 and the development of token prices until December 2018, see Haffke, L. and Fromberger, M. (2018) ICO Market Report 2017. Performance Analysis of Initial Coin Offerings. 27 December, available at www.ssrn.com/abstract= 3309271, accessed 21 January 2019.

  21. See Moran, J.D. (n 13) at 219; Noonan, A.K. (2015) Bitcoin or Bust: Can One Really ‘Trust’ One’s Digital Assets? Estate Planning & Community Property Law Journal 7(2): 583–625, at 593.

  22. Haffke, L. and Fromberger, M. (n 20) at 12; Kastelein, R. (2017) What Initial Coin Offerings Are, and Why VC Firms Care. Havard Business Review, 24 March, https://hbr.org/2017/03/what-initial-coin-offerings-are-and-why-vc-firms-care, accessed 21 January 2019.

  23. Technically speaking, the term ‘mining’ is too narrow as it only refers to Blockchains based upon the proof-of-work concept.

  24. See Werbach, K. (2018) Trust, But Verify: Why Blockchain Needs the Law. Berkeley Technology Law Journal 33(2): 489–552, at 503.

  25. For example, creating a new Bitcoin block is rewarded with 12.5 Bitcoins.

  26. Of course, these exchanges could also be referred to as crypto-to-fiat exchanges.

  27. For example, the US Financial Crimes Enforcement Network (FinCEN) explained that all cryptocurrency exchanges will be considered Money Transmitters and therefore Money Service Businesses (MSB) under US Law, irrespective of whether they are a fiat-to-crypto or a crypto-to-crypto exchange, see FinCEN (2013) Guidance FIN-2013-G001, 18 March, https://www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf, accessed 26 March 2019.

  28. De Filippi, P. and Wright, A. (n 14) at p. 27.

  29. See https://www.coinbase.com, accessed 25 March 2019.

  30. See, for example, at CoinMarketCap. (2019) All Cryptocurrencies, www.coinmarketcap.com/all/views/all/, accessed 21 January 2019.

  31. See Binance, www.binance.com, accessed 21 January 2019.

  32. See Houbi, www.huobi.com, accessed 25 March 2019.

  33. Small, S. (2015) Bitcoin: The Napster of Currency. Houston Journal of International Law 37(2): 581–641, at 588 (comparing the public key to an email address).

  34. Nakamoto, S. (2008) Bitcoin: A Peer-to-Peer Electronic Cash System. Satoshi Nakamoti Institute, 31 October, https://nakamotoinstitute.org/bitcoin/, accessed 21 January 2019; Small, S. (n 33) at 588; De Filippi and Wright (n 14) at p.16.

  35. See Small, S. (n 33) at 588 (comparing the private key to a personal identification number (PIN) for a debit card).

  36. Moran, J.D. (n 13) at 218.

  37. Rosenberger, P. (2018) Bitcoin und Blockchain—vom Scheitern einer Ideologie und dem Erfolg einer revolutionären Technik. Berlin, DE: Springer, at p. 22 et seqq.

  38. Ibid.

  39. See, for example, MyEtherWallet, available at https://www.myetherwallet.com/, accessed 21 January 2019.

  40. An example is ‘MyEtherWallet’ which provides users both with an interface to interact with the Etherum Blockchain and with optional service to generate a pair of public and private key (and therefore to create a wallet).

  41. It depends on the respective Blockchain whether this is the case or not.

  42. Under some rare conditions, these transactions can still be traced back to the original wallet; see Goldfeder, S., Kalodner, H., Reisman D. and Narayanan, A. (2018) When the cookie meets the blockchain: Privacy risks of web payments via cryptocurrencies. Proceedings on Privacy Enhancing Technologies (4): 179–199.

  43. See Werbach, K. (n 24) at 526; Grzywotz, J. (2019) Virtuelle Kryptowährungen und Geldwäsche. Berlin: Duncker & Humblot, at p. 99; see also supra Chapters ‘Introduction’, ‘Wallets and wallet providers’ and ‘Tumbler services’.

  44. See Atik, J. and Gerro, G. (2018) Hard Forks on the Bitcoin Blockchain: Reversible Exit, Continuing Voice. Stanford Journal of Blockchain Law and Policy 2(1), available at https://stanford-jblp.pubpub.org/pub/hard-forks-bitcoin, accessed 26 March 2019; Bodó, B., Gervais, D. and Quintas, J.P. (n 5) at 313 et seqq.; Grzywotz, J. (n 43) at p. 98.

  45. See Grzywotz, J. (n 43) at p. 100; Bodó, B., Gervais, D. and Quintas, J.P. (n 5) at 314, 336; Werbach, K. (n 24) at 524 (‘global currency,’ ‘cross-border’).

  46. See CipherTrace (2019) Cryptocurrency Anti-Money Laundering Report, 2018 Q4. CAML-20190127, January, at p. 6, https://ciphertrace.com/crypto-aml-report-2018q4/, accessed 26 March 2019.

  47. See, for example, Bitcoinist. (2018) Pure Bit Bamboozles Investors in $2.7 Million ICO Exit Scam, 13 November, https://bitcoinist.com/pure-bit-bamboozles-investors-in-13000-eth-ico-exit-scam/. Accessed 26 March 2019; Marinoff, N. (2018) Exit Scam or Hack? Canada’s MapleChange Loses $5 Million of Customer Funds, 30 October, https://blockonomi.com/maplechange-hacked-scam/, accessed 26 March 2019; CipherTrace (n 46) at p. 7 et seqq.

  48. See CipherTrace (n 46) at p. 9.

  49. Ibid at p. 11.

  50. It is beyond the scope of this paper to analyse the specific requirements and legal consequences for obliged entities within the Blockchain environment.

  51. See European Commission. (2018) Strengthened EU rules to prevent money laundering and terrorism financing—Fact Sheet. 9 July, www.europa.eu/rapid/press-release_STATEMENT-18-3429_en.htm, accessed 21 January 2019.

  52. See AMLD5 Rec. 8; Houben, R. and Stevens, A. (n 4) at p. 62.; Vandezande, N. (2018) Virtual Currencies: A Legal Framework. Cambridge: Intersentia, at pp. 286, 298-303 and 309-310, also citing the view of the European Commission.

  53. AMLD5 Rec. 8.

  54. AMLD5 Recs. 8 and 9.

  55. AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(g) in its amended version.

  56. AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(h) in its amended version.

  57. AMLD5 Art. 1(2)(d); AMLD4 Art. 3(18) in its amended version.

  58. AMLD5 Rec. 9.

  59. AMLD5 Art. 1(41); AMLD4 Art. 65(1) third sentence in its amended version.

  60. AMLD4 Art. 5 specifically allows for stricter national provisions; it remained unchanged by AMLD5.

  61. AMLD5 Rec. 10.

  62. In very specific cases, some utility or payment tokens might already hold the status of ‘electronic money’ within the meaning of Art. 2(2) of Directive 2009/110/EC; however, these constitute rare exceptions.

  63. AMLD 5 Art. 1(2)(d); AMLD4 Art. 4 (18) in its amended version.

  64. To be technically precise: Actually, it is only the private key that is stored. Tokens are part of the Blockchain. They cannot be stored elsewhere.

  65. Maume and Fromberger (n 6) at 574.

  66. AMLD5 Rec. 10; Vandezande, N. (2017) Virtual currencies under EU anti-money laundering law. Computer Law & Security Review (33)(3): 341–353, at 351.

  67. It appears that this view was taken by the European Central Bank (ECB). The ECB specifically recommended the use of the term ‘means of exchange’ to cover all possible uses of virtual currencies, see ECB. (2016) Opinion on a proposal for a directive of the European Parliament and of the Council amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and amending Directive 2009/101/EC. OJ C 459/3, 12 October, at p. 3, para. 1.1.3.

  68. Rabin, A.A. (2004) Monetary Theory. Cheltenham: Edward Elgar, at pp. 22–24; Mishkin, F.S. (2009) The Economics of Money, Banking and Financial Markets. Boston: Pearson, pp. 54-55; Moritz, K.-H. (2012) Geldtheorie und Geldpolitik. Munich: Vahlen, at pp. 6–7; Holtenmöller, O. (2008) Geldtheorie und Geldpolitik (Neue ökonomische Grundrisse). Heidelberg: Mohr Siebeck, at pp. 25–26.

  69. Duffy, J. and Ochs, J. (1999) Emergence of Money as a Medium of Exchange: An Experimental Study. The American Economic Review 89 (4): 847–877, at 847; von Mises, L. (2013) The Theory of Money and Credit. New York: Skyhorse Publishing, at p. 31.

  70. Duffy and Ochs (n 69) at 847.

  71. Ostroy, J.M. and Starr, R.M. (1990) The Transactions Role of Money. In B.M. Friedman and F.H. Hahn (eds.), Handbook of Monetary Economics—Volume 1. Amsterdam: North Holland Publishing pp. 3–62, at pp. 26-27; Yang, B.Z. (2007) What is (Not) Money? Medium of Exchange ≠ Means of Payment. The American Economist 51(2): 101–104, at 101.

  72. AMLD5 Rec. 10.

  73. AMLD5 Rec. 10 (emphasis added).

  74. See, for example, Claassen, E.M. (1980) Grundlagen der Geldtheorie. Berlin: Springer, at pp. 37 et. seqq., who uses the German term ‘Zahlungsmittel’ (means of payment) to describe the phenomenon of a ‘Tauschmittel’ (means of exchange); likewise Mishkin, F.S. (n 68) at p. 54, who uses the phrase ‘is used to pay for goods and services’ to explain the term medium of exchange.

  75. See, for example, Issing, O. (2011) Einführung in die Geldtheorie. Munich: Vahlen, at p. 1; Duwendag, D., Ketterer, K.-H., Kösters, W., Pohl, R., and Simmert, D.B. (1999) Geldtheorie und Geldpolitik in Europa. Berlin: Springer, at p. 72.

  76. HM Treasury, FCA & Bank of England. (n 3) at p. 11, para. 2.12.

  77. This has not changed since the Directive’s proposal was first issued, see Vandezande, N. (n 52) at 10–13, who criticises the Directive’s imprecise scope.

  78. AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(g) in its amended version.

  79. See Coinbase, https://www.coinbase.com, accessed 21 January 2019.

  80. For example, ‘HitBTC’ is a decentralised crypto-to-crypto exchange, see www.hitbtc.com, accessed 26 March 2019, which charges a transaction fee. This is likewise possible for fiat-to-crypto exchanges.

  81. AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(g) in its amended version.

  82. For an explanation of crypto-to-crypto exchanges, see supra Chapter on ‘Cryptocurrency exchanges’.

  83. AMLD5 Art. 1(2)(d); AMLD4 Art. 3(18) in its amended version.

  84. AMLD5 Rec. 8 (emphasis added).

  85. The European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) agree with this recommendation to include crypto-to-crypto exchanges as obliged entities, see ESMA. (2019) Advice – Initial Coin Offerings and Crypto-Assets. ESMA50-157-1391, 9 January, at p. 36, paras. 168-169, www.esma.europa.eu/file/49978/download?token=56LqdNMN, accessed 21 January 2019; see EBA. (2019) Report with advice for the European Commission on crypto-assets. 9 January, at pp. 20–21, paras. 46–50, https://eba.europa.eu/documents/10180/2545547/EBA+Report+on+crypto+assets.pdf, accessed 21 January 2019. See also the recommendations of the FATF. (2018) Regulation of virtual assets. 19 October, www.fatf-gafi.org/publications/fatfrecommendations/documents/regulation-virtual-assets.html, accessed 21 January 2019.

  86. AMLD4 Art. 3(2)(a).

  87. See supra at note 1.

  88. Interestingly, Binance, a crypto-to-crypto exchange (see n 31), is already voluntarily conducting KYC checks, see www.binance.vision/glossary/know-your-customer, accessed 26 March 2019.

  89. As found in AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(g) in its amended version.

  90. See supra Chapter on ‘Crypto-to-crypto exchanges’; it is unclear when providers of so-called multisig wallets (that require several keys) are covered by the term. See, for example, Vandezande, N. (n 52) at 350, in particular footnote 103.

  91. While this is technically possible, it takes away the ease of usage of a custodian wallet. In contrast, this argument does not apply to crypto-to-crypto exchanges as analysed above because they are not used as often as wallets (which are meant to be used for day-to-day payments or transfers).

  92. See supra Chapter on ‘Tumbler Services’.

  93. See also CipherTrace (2019) (n 46) at p. 11 (without further explanation).

  94. Interestingly, the EBA specifically recommended to also make those providers subject to AML law that engage in the exchange of virtual currencies into the ‘one or more other forms’ of virtual currencies. This must include tumbler services; see EBA. (n 85) at p. 20, para. 46. The ESMA, on the other hand, was not as specific and recommended to regulate ‘exchange services between crypto-assets and crypto-assets’ with regard to AML; it is unclear whether they meant to include Tumbler services, see ESMA. (n 85) at p. 36, para. 169.

  95. As found in AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(g) in its amended version.

  96. AMLD5 Art. 1(1)(c); AMLD4 Art. 2(1)(3)(g) in its amended version; see also supra Chapter on ‘Cryptocurrency exchanges’.

  97. See supra Chapter on ‘Initiators/issuers of cryptocurrencies’.

  98. See supra Chapter on ‘Suggested Amendments’ (concerning the defintion of virtual currencies).

  99. Maume, P. and Fromberger, M. (n 6) at 560.

  100. See supra Chapter on ‘Types of cryptocurrencies’.

  101. Barsan, I. (n 8) at 56; Maume, P. and Fromberger, M. (n 6) at 558 et seq.

  102. The ESMA and the EBA both recommend that providers of services for ICOs should become obliged entities, see ESMA. (n 85) at p. 36, para. 169 and EBA. (n 85) at p. 20–21, paras. 46–50; see also the recommendations of the FATF. (n 85).

  103. For example, if an activity connected with mining (e.g. operating a mining pool) can be considered to be a financial service, then the entity is a financial institution within the meaning of Art. 3(2) AMLD4, see Terlau in Möslein/Omlor, FinTech-Handbuch, 2019, §20, Rn. 162.

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    Lars Haffke, Mathias Fromberger & Patrick Zimmermann

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Haffke, L., Fromberger, M. & Zimmermann, P. Cryptocurrencies and anti-money laundering: the shortcomings of the fifth AML Directive (EU) and how to address them. J Bank Regul 21, 125–138 (2020). https://doi.org/10.1057/s41261-019-00101-4

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