While advocates of virtual currency may be disappointed such an innovation hasn’t yet replaced mainstream currencies, the need for international money transmitting services may breathe new life into the sector.
Some virtual currency companies, now officially categorized as money services businesses (MSBs) by the US Treasury, are capitalizing on a market that needs to send money abroad, but is increasingly finding that difficult to do.
These virtual currency firms are now in direct competition to steal a growing pool of unhappy customers that are seeing many of their go-to remitters close up shop, mostly due to the inability of these operations to keep their accounts at large domestic and international banks, a critical prerequisite to access the international payment system.
Moreover, even for the MSBs that have remained open, virtual currency firms are saying they are still a better route, advertising as being cheaper, faster and, ostensibly, just as safe in terms of money reaching the desired destination, though sidestepping the question of what anti-money laundering (AML) protocols are being followed, a required duty due to being under the rubric of MSB.
In addition to having registration requirements which imply government-mandated controls, virtual currency companies that were betting on catching fire are dealing with dramatic ups and downs that have tarnished the illusion of bitcoin as a replacement for the dollar or Euro.
In 2013, the value of one bitcoin was more than $1,200. At the time of writing, one bitcoin was worth around $230.
Bitcoin daily transactions are hovering around 62,000, according to Coinmetrics. That compares with daily transactions at Visa, Inc. of 212.6 million and Paypal at 7.7 million, making Bitcoin a small blip on the radar of transactional activity.
Virtual currency companies are hoping this redirection of services will save them before Bitcoin continues to plunge in value. Virtual money transmitter startups with giant venture capital valuations are also hoping that is true.
But the sector just announced some good news, buoying enthusiasm and potentially snaring past jaded customers who fear for the security of their deposits. Just this month, Bitcoin wallet operator Coinbase, originally founded in 2012, opened its first regulated US exchange for the digital currency.
Banks believe Bitcoin exchanges, as MSBs, are high risk
However, these companies may find themselves staring down the barrel of the same problem plaguing MSBs today: the inability to get or keep their bank accounts due to being dubbed as too “high risk.”
For nearly a decade, federal regulators have been branding MSBs at being at a higher risk for financial crime, and by proxy, giving the banks holding their accounts significantly more scrutiny to determine if these institutions are properly and accurately calibrating and mitigating those risks.
Jorge Guerrero, the founder and former president of the National Money Transmitters Association (NMTA), has been working with MSBs to solve the banking issue, and is now being approached by virtual currency companies that want to be compliant but face the same problem
“The Achilles heel of the MSB industry has been getting a bank account,” said Guerrero, who owns Optima Consulting, Inc..
“In reality, when we created the NMTA it was for the sole purpose of addressing the issue, which we saw could threaten the industry even back then and we’re talking about 17 years ago.”
Guerrero said that the banking issue, exorbitant fees and inconvenience may allow Bitcoin to be posed as the future’s remittance system.
Tradition vs. Innovation
The current traditional foreign money transfer process works like this:
- A small business in a foreign country will need to send money over to a supplier in another foreign country.
- The currency dealer will go to a bank and find that the rates are too high or it takes too long so they will go to a currency exchange house and the currency exchange house will take the order.
- The currency exchange house has to know their client, know that they have a good compliance program, verify that they are in fact a legitimate business, and implement anti-money laundering (AML) know-your-customer (KYC) controls.
- The dealer hopefully has the US dollar account in the US to be able to transfer checks received from the US then send money to deposit into the currency dealer’s account.
- The currency dealer will have the funds waiting, so when the supplier comes in looking for the money, it will be available.
- In order for them to effect a payment that will be received in the other country, they have to issue a payment from their account to the bank account of the supplier.
- That requires as many as a half-dozen steps, assuming that everyone is compliant, they are legitimate businesses, and that all parties are following AML protocols.
For virtual currency, you only need to have a currency backed by government regulation or law, called a fiat currency, at the beginning when the client goes to send the transaction at a digital currency dealer. This can be simply a person with a bank account, who cares little to nothing about the origin of funds or risk of the person giving them the money. The money is then exchanged, either in person or at a bank of the exchange’s choosing, for virtual currency to the other foreign currency.
This route skips several steps, including standard due diligence, because the individual doesn’t have to go to an actual currency dealer or remitter or worry that the operation can’t send funds across borders or that the funds won’t arrive at their specified destination. In many cases, though, if the transaction is below customer identification thresholds, the customer would not be asked for identification.
Guerrero said that if virtual currency transfer systems are only a two-step process versus a six-step process for traditional remittance services, then virtual currency is creating a revolutionary opportunity for expedient and cheap movement of funds internationally.
There are potential pitfalls, though.
“The flip side of that is that there could be the opportunity for money laundering, that if the parties involved in doing the transactions are not regulated, are not compliant, then it’s the perfect opportunity to launder and to export or import funds or value all over the world, and that’s risky,” Guerrero said.
Traditional money transmitters becoming too costly, too time-consuming
According to the International Association of Money Transfer Networks, remittances were estimated at $404 billion in 2013, up 3.5 percent compared with the year before. The demand is expected to grow significantly over the next three years, raising flows to $516 billion by 2016.
For developing countries, remittances remain a staple for the influx of external financial resources, exceeding international aid and more stable than private debt and portfolio equity flows.
However, though the market for money transfers and remittances is growing, the channels for cheap and convenient money flow are drying up.
As US banking regulators send mixed signals – first signaling money services businesses (MSBs) are high-risk customers throughout the mid to latter 2000s, then telling banks in recent years to stop the categorical slashing of MSB bank accounts to lower risk profiles – customers have been the ones to bear the burden of fewer currency transmission options.
Bank accounts are crucial to the operations of money transmitting firms, and without them, in many cases, they are forced to shut down or stop servicing certain regions.
Dominic Thorncroft from the UK National Money Transmitters Association, says regulation of MSBs in Britain has been “incredibly inefficient.”
“The wholesale account discontinuance is a global phenomenon. From a UK perspective, the whole thing is amiss really,” Thorncroft said.
“The MSBs are regulated by several agencies but the banks don’t recognize that and obviously in the cash MSB sector, there are only about 15-20 firms in the UK that are able to offer cash directly to the client.”
Those compliance issues are magnified when a purported high-risk entity, the MSB, also services a region known to be at a high risk for certain crimes, like terrorism.
In 2013, Barclays in the United Kingdom decided to close 250 bank accounts in the money remittance area, 75 percent of the institution’s MSB account portfolio. Those accounts were instrumental in sending remittance dollars to Somalia.
In the US, Somalian families also struggled to find appropriate channels to send money that would go towards school, food, water, medicine, and other essentials for family living in Somalia.
In November 2014, the Governor of the Central Bank of Kenya expressed his concern over the uneconomical costs of remittances. Njunguna Ndung’u said the challenge for regulators is to ensure that remitters can send funds to their recipients conveniently, safely and at a reasonable cost.
Kenyans who work abroad and send money to their families back home sent $1.3 billion in 2013, making remittances a vital part of the Kenyan economy, comparable to that of other developing nations.
Compliance costs narrowing the field: only the fiscally strong survive
The need for money remitters who can operate in developed and developing countries is clear.
But there seems to be a fracturing of the industry when it comes to which ones can actually convince banks to hold their accounts, chiefly by illustrating to these institutions they are spending more on compliance controls.
The two largest money remitters, MoneyGram and Western Union, typically have annual revenues in the tens and hundreds of millions of dollars, making them more able to absorb the costs of stronger AML controls and meet the demands of regulators and investigators. Both operations, though, have been hit with large penalties and are remediating compliance programs.
However, the smaller firms that don’t have the capital to apply the extensive financial crime controls required by banks and regulators will find it difficult to keep a bank account.
As a result, clients will find it harder to get services that banks have deemed “legal and compliant,” regardless of the conclusions by applicable state and federal examiners.
David Landsman, the president of the US-based NMTA, said customers will satisfy their needs where the services are available, potentially pushing them out of the compliant MSB sector and into unregulated channels.
“The other thing is that companies are dealing with it in different ways, but one thing you can be sure of is that more than half, 75 percent of everybody’s time in this business is spent on maintaining bank account relationships and on fixing compliance internally to accommodate those banks,” he said.
Virtual Currency as an alternative money transmitter
Not surprisingly, MSBs would not pleased that virtual currency exchangers are trying to horn in on their at-times frustrated customer base.
Many money services businesses would be loath to hear the newest campaign for up-and-coming virtual currency businesses: “send your money abroad immediately, and for FREE.” At first glance, it would appear that virtual currencies like Bitcoin are the panacea for the woes of MSB clients who suddenly find their go-to firm has been shut down or raised prices due to higher compliance expectations.
The Paris-based Financial Action Task Force (FATF), which sets global counter-financial crime program standards, even recognized the potential for virtual currencies to take over traditional payment systems in their June 2014 guidance.
A key takeaway from the report is that virtual currencies could also provide a potent new weapon for criminals, terrorist financiers and other evaders of the law to move and store illicit funds outside the watchful eye of law enforcement and regulatory authorities.
So there are legitimate concerns from banks and investigators that the migration to virtual currencies as a global payment mechanism would not just include individuals supporting far-flung family members. The ease of money movement, and potential lack of due diligence checks and related transaction monitoring for suspicious activities are all main draws for criminals.
And, due to its general nature, Bitcoin can be traded and exchange anonymously and skirts traditional criminal and regulatory oversight and enforcement. By design, it is a decentralized system which has no central server or service provider and therefore cannot be overseen by any law enforcement authority. Bitcoin addresses have no names or customer identification attached, which would seem to stymie basic AML controls.
The warnings that Bitcoin can be used to fund criminal enterprises are not unwarranted.
Last year, the once-largest Bitcoin exchange in the world, Mt. Gox, shut down after $500 million worth of bitcoins belonging to users and the company mysteriously evaporated, potentially at the hands of the company’s own chief executive, Mark Karpeles.
This month’s trial of the operator of Silk Road, Ross Ulbricht, also had defense attorneys pointing the finger at Karpeles as the true mastermind behind the dark web marketplace, which sold everything from illicit drugs to assassination services, with the preferred payment mechanism as Bitcoin. Ulbricht is charged with money laundering, hacking and drug trafficking.
Future unclear for virtual currencies replacing money remitters
Regulators have tried to box in the virtual currency industry, despite the lack of a clear legal framework around the currency.
In March 2013, the US Treasury’s Financial Crimes Enforcement Network (FinCEN) published guidance on Bitcoin, stating that exchanges would be treated as MSBs, but simply holding bitcoins or engaging in incidental trading would not invoke the classification and its required four-pronged AML program.
Marco Santori, the Chairman of the Bitcoin Foundation’s Regulatory Affairs Committee, said that was Bitcoin’s “watershed moment, because of its clear, unequivocal positive message: Bitcoin is not illegal. The negative consequence, though, was just as obvious: many Bitcoin business models are illegal.”
Landsman said virtual currency companies are in an uncomfortable position, much like MSBs.
“I don’t think anybody prefers virtual currency these days because of a lack of fees or convenience although there are those two factors,” Landsman said.
“The unfortunate regulatory situation is forcing the industry along similar lines that I just described of the MSB and money transmitter industry in general. That is large virtual currency companies that have deep pockets will get bank accounts and smaller companies will not.”