Treasury Proposes Groundbreaking Regulatory Response to Crypto-Mixing Epidemic

With the cryptocurrency market now viewed as the vehicle of choice by various global terrorism organizations for both raising and laundering funds, last week the United States Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed a new rule that would change the way the certain developing aspects of these markets are managed by domestic financial institutions moving forward – most notably with respect to crypto mixers. The very premise of mixing operations is to decrease transparency and further boost privacy for individuals making transactions in a space that is already notorious for clandestine activity.  Convertible currency mixers (CVCs), also commonly referred to as tumblers or blenders, are generally third-party services that receive identifiable cryptocurrency funds of varying legitimacy from a source user and pools these funds with coins contributed by countless other users in private allotments before ultimately transferring the original amount designated to the address of their intended recipient(s), effectively anonymizing the origins of these funds and making them far more difficult for the proper authorities to trace.

With mainstream adoption and investment into various crypto options such as Bitcoin, Ethereum and other Altcoins continuing to grow over the past decade, as has the use – and often misuse – of crypto-mixing services. As such, mixers have become major tools for financial criminals and terror organizations seeking to keep their identities concealed, with these services accounting for the processing of upwards of 25% of all illicit Bitcoin transactions made each year.² Altogether, CVC mixing offers critical services that allow financial criminals, militant organizations such as the Hamas and ISIS, malicious cyber actors, and even politically exposed periods (PEPs) the opportunity to fund their unlawful activities and obfuscate the flow of ill-gotten gains. According to the U.S. Treasury, the risks essentially promoted by mixing services vastly outweigh any potential benefits. FinCEN’s evaluation of crypto mixers culminating in the proposed new rule ultimately confirmed their belief that money laundering and terrorist financing activity through CVC’s remains a potent threat to the U.S. financial system. To their credit, they did acknowledge the situations where anonymity is beneficial, stating, “in addition to illicit purposes, CVC mixing may be used for legitimate purposes, such as privacy enhancement for those who live under repressive regimes or wish to conduct licit transactions anonymously.”¹

However, they went on to list several of the major downsides. These include the fact that crypto mixing services almost never provide to regulators or law enforcement the resulting transactional chain or information collected as part of the transaction. FinCEN is also primarily concerned with the fact that crypto mixing makes “CVC flows untraceable by law enforcement and makes potentially suspicious transactions unreportable by responsible financial institutions—thereby fostering illicit activity.”¹ In their report, FinCEN cites multiple examples of illicit activity at the international level, including hacks and ransomware attacks perpetrated by actors from North Korea, where a high volume of funds were allegedly laundered through mixers. FinCEN also acknowledges that that the percentage of CVC mixing activity attributed to illicit activity is increasing, though these figures cannot be truly quantified because of the lack of available transactional information available, also limiting their ability to determine the percentage of activity seen across various mixers that is being utilized for legitimate business purposes.¹

Given this general propensity to be used to facilitate potentially destabilizing activities however, as well as the tense geopolitical climate, the Treasury has decided to address this issue in a big way, exercising its authority under Section 311 of the USA PATRIOT Act. More specifically, the proposed rule will designate transactions with cryptocurrency mixers and mixing services as a “Primary Money Laundering Concern”, which would permit FinCEN to order financial institutions regulated by the Bank Secrecy Act (BSA) to take “special measures” over and above the anti-money laundering (AML) program controls the BSA already requires.³ This will include staunch record-keeping and reporting requirements for any financial transactions involving the use of mixers used both domestically and abroad. The move is significant, as never before has FinCEN designated an entire class of transactions under said sub-section, with this practice historically being reserved for specific entities or jurisdictions. They have also never appealed to Section 311 to require financial institutions to file reports and maintain records, which many have viewed as a step in the right direction towards maintaining the integrity of the international financial system. All told, the newly proposed regulation will seek to enhance transparency in the crypto space, setting the regulatory bar a step higher for American financial institutions who engage in transactions related to CVC mixing.

The Biden Administration had already initiated the crackdown on the criminal use of crypto mixers, recently charging two key players in a multinational underground mixing operation known as Tornado Cash with laundering over $1 billion in criminal proceeds. OFAC also sanctioned the mixer, leading to its ultimate demise which proved a major boon for anti-money laundering efforts worldwide. In spite of these positive developments, there remains significant work to be done to limit the illicit activity proliferating through these platforms given that there are countless options of both the centralized and decentralized variety seen around the world. And while some of these enterprises do operate by the book, it is safe to say that a rather large portion are involved in moving the proceeds of criminal activity in some way. The task of reigning in the multitude of platforms operating illicitly is more than daunting, and with their new proposal the U.S. government appears to be shifting the onus onto financial institutions to pick up the slack moving forward. FinCEN’s Notice of Proposed Rule Making (NPRM) seeks to build on prior actions taken by the Treasury to target illicit finance through the crypto realm, and time will tell whether these efforts prove fruitful. Written comments on the NPRM must be submitted for review prior to January 22^nd, 2024 before advancing to a potential final ruling.

Citations

1. “Proposal of Special Measure Regarding Convertible Virtual Currency Mixing, as a Class of Transactions of Primary Money Laundering Concern.” Financial Crimes Enforcement Network, Department of the Treasury, Oct. 2023. 
2. Singh, Onkar. “What Is a Cryptocurrency Mixer and How Does It Work?” Cointelegraph, Cointelegraph, 27 Mar. 2022. 
3. Stier, David, and Eric Hall. “Treasury Proposes Designating Transactions with Cryptocurrency Mixers a ‘Primary Money Laundering Concern.’” DLA Piper, 30 Mar. 2023.