Regulation of Virtual Currency: Consultation Paper.

STATES OF JERSEY

REGULATION OF VIRTUAL CURRENCY: CONSULTATION PAPER

Presented to the States on 10th July 2015 by the Chief Minister

STATES GREFFE

2015   Price code: D  R.80

Regulation of Virtual Currency

The creation of a business-friendly framework that encourages innovation, jobs and growth in both the financial services and digital sector is a priority for the Government of Jersey. Virtual Currency systems can be significant building  blocks  of  a  modern  digital  economy.  The  introduction  of  an appropriate and proportionate regulatory regime in this area is intended to encourage confidence and innovation in the sector.

This Consultation Paper highlights the most prominent money laundering and  terrorist  financing  risks  that  the  Government  of  Jersey  believe  are associated with virtual currencies in their current form. It goes on to present a number of options for regulating virtual currency activity. In forming these

options, the consultation paper has regard to the approach of a number of other  jurisdictions  and  papers/policy  documents  produced  by  leading organisations. It also considers whether there is a case for adopting a standard for distributed ledger technology and the possibility of potential future pan-Channel Island work in this area.

Date published:  Closing date: 9 July 2015   7 August 2015

How we will use your information

The information you provide will be processed for the purpose of consultation. The Chief Minister's Department will use your information in accordance with the Data Protection (Jersey) Law 2005 and the Freedom of Information Jersey) Law 2011. Please note that we may quote or publish responses to this consultation but we will not publish the names and addresses of individuals. If you do not want any of your response to be published, you should clearly mark it as confidential. Confidential responses will be included in any summary of statistical information received and views expressed.

Outline of Consultation  

Virtual currency[1] systems represent new and empowering technology. They incorporate both new payment systems and new virtual currencies.

Whilst governments are keen to embrace the potential offered by the virtual economy  there  is  also  a  need  to  introduce  measures  to  tackle  virtual economy-based  money  laundering  and  financing  of  terrorism  ("ML/FT"), including giving regulators and law enforcement agencies the necessary powers and resources.

Should  virtual  currencies  accomplish  the  necessary  levels  of  user acceptance  and  market  penetration  in  the  future,  both  legitimate  and nefarious users may achieve full independence in acquiring, transferring and spending virtual currencies within the virtual economy.

The inherently decentralised, distributed, implicitly anonymous and versatile nature of virtual currency systems (often boosted with extensions, protocols and further developments which grant even greater anonymity) make virtual currency systems attractive to cybercriminals, online-based traditional crime perpetrators, money launderers and terrorist financiers.

Accordingly, the Government of Jersey considers that, whilst governments should embrace the potential offered by the virtual economy, there is also a need to introduce measures to tackle virtual economy-based ML/FT.

The Government of Jersey believes that by putting in place an appropriate and proportionate regulatory environment, the jurisdiction will be protected from unacceptable risk. At the same time, a modern digital economy can be fostered  with  a  business  friendly  framework  therefore  encouraging innovation and growth in the virtual currency arena.

The  consultation  paper  highlights  current  risks  that  the  Government  of Jersey believes are associated with virtual currencies in their current form and presents a number of options for regulating virtual currency activity. In forming these options, the consultation paper has regard to the approach adopted  by  a  number  of  other  jurisdictions  and  papers  and  policy documents produced by leading organisations.

The paper also considers whether there is a case for setting a Distributed ledger  technology  standard  and  explores  the  possibility  of  pan-Channel Island work in this area after a series of initial meetings with the other Channel Islands.

This consultation paper has been prepared in conjunction with the Jersey Financial Services Commission (the "JFSC"), the Joint Financial Crimes Unit of the States of Jersey Police, the Law Officers' Department, Jersey Finance Limited ("JFL") and Digital Jersey ("DJ").

Who should respond and ways to respond

The  Government  of  Jersey  is  interested  in  receiving  responses  from individuals or businesses that interact with virtual currency or are likely to interact  with  virtual  currencies.   The  Government  of  Jersey  would particularly encourage both those in the financial services and the digital communities to respond to the consultation paper.

Seminar

The consultation paper is supported by a consultation seminar that will occur on 3 August 2015 at from 12noon - 2pm at The Town Hall , York Street, St Helier, Jersey. The consultation seminar will act as a forum to explore some of the topics raised in this paper in more detail and will serve as an open forum for feedback to the questions asked in this consultation paper.

The event is free to attend if a ticket is obtained through registration at the below website link:

http://www.eventbrite.com/e/regulation-of-virtual-currency-consultation- seminar-tickets-17632915525

Online submission

You can also respond to the consultation paper online at the following link: https://www.surveymonkey.com/r/5QZFQJW

Writing

Should you wish to respond in writing you may submit responses directly to the following address:

Regulation of Virtual Currency Consultation 5th Floor, Cyril Le Marquand House

The Parade

St Helier

JE4 8QT

Telephone:  +44 (0) 1534 448839

E-mail:  g.pearmain@gov.je

Further Questions

Should you have any questions about the paper and wish to speak to an individual in an organisation that has been involved in the preparation of this

consultation paper, contact details are listed below:

Government contacts:

George Pearmain - Lead Policy Adviser: Private Wealth and Financial Crime

Telephone:   +44 (0) 1534 448839 Email:   g.pearmain@gov.je

Lloyd Adams – Lead Policy Adviser – Digital Strategy

Telephone:   +44 (0) 1534 440726 Email:   l.adams@gov.je

Jersey Financial Services Commission contacts: Andrew Le Brun - Director - Financial Crime Policy

Telephone:   +44 (0) 1534 822065 Email:   a.lebrun@jerseyfsc.org  

Vladimir Jizdny – Senior Manager – Financial Crime Policy

Telephone:   +44 (0) 1534 822023 Email:   v.jizdny@jerseyfsc.org  

Digital Jersey Contact: Andrew Jarrett – Director

Telephone:   +44 (0) 1534 789333 Email:   andy.jarrett@digital.je

Jersey Finance Contact:

Thomas Cowsill – Senior Strategic Projects Manager

Telephone:   +44 (0) 1534 836029

Email:   thomas.cowsill@jerseyfinance.je  

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This consultation paper has been sent to the Public Consultation Register.

Feedback on this consultation  

We value your feedback on how well we consult or seek evidence. If you have any comments on the process of this consultation (as opposed to the issues raised) please contact Communications.Unit@gov.je

Part 1: Introduction

1. A currency is according to its economic definition something which operates as:

1. a medium of exchange;
2. a unit of account; and
3. a store of value

2. For the purpose of the consultation paper, currencies divide into two categories:

1. Fiat currencies, which mean money issued (whether physical or electronically) by the government of a country or territory. This is money as is ordinarily understood, and is legal tender in at least one country or territory.
2. Virtual  currencies,  which  may  have  one  or  more  of  the characteristics of a currency amongst user groups. However, they are not legal tender in any country or territory, which may to a greater or lesser extent, affect how far they are treated as a medium of exchange, unit of account or store of value.

3. Virtual currency is often confused with electronic money. A virtual currency is  not  electronic  money.  According  to  the  ECB[2],  virtual currency systems are not full forms of money as defined in economic literature nor are they money or currency from a legal perspective. Whereas virtual currencies will always be held in digital form, fiat currencies may also be held in digital form (so the terms "virtual" and "digital" are not interchangeable).
4. The virtual currencies referred to in this paper:

1. are  online  value  transfer  systems  that  utilise  a  decentralised consent mechanism (Bitcoin3 and the like); or
2. provide  for  a  decentralised  debt  issuance  and  settlement mechanism (e.g. Ripple).

These  systems  are  decentralised  (no  centrally  controlled  and maintained  payment  ledger)  and  their  native  currencies  are convertible (they have an equivalent value in, and can be exchanged for, fiat currency. They are often crypto-graphically protected (and referred to as crypto-currencies).

5. For  the  avoidance  of  doubt,  this  paper  does  not  apply  to centralised  virtual  currencies  (which  will  have  a  single administrator that controls the system, issues the currency and maintains a central payment ledger).
6. Virtual currency systems have substituted and are able to further substitute banknotes and coins in certain payment situations. Since the usage of virtual currency as a currency for payments remains limited at present (Bitcoin worldwide transactions per day currently represent 0.03% of non-cash retail payment transactions made in the EU). Accordingly, the ECB in its analysis further argues that there is not yet a material risk that virtual currencies can undermine price stability, financial stability and integrity of the real economy nor the smooth operation of payment systems.
7. Bitcoin is  the  most  prominent  and  most  widely  accepted  virtual currency with current market capitalisation fluctuating around US$ 3 billion.   There  are  currently  a  little  over  14  million  Bitcoins  in circulation, transactions varying between 90,000 and 130,000 per day, more than 3.5 million My Wallet[3] users and on average 250,000 unique Bitcoinaddresses used every day[4].  
8. Despite  this,  virtual  currency systems  are  yet  to  accomplish  the necessary  market  penetration  and  user  acceptance  levels  to  be considered substantially used across the global economy[5].
9. Until such levels of use are reached, the need for interaction between virtual  and  conventional  systems  will  persist  and  the  level  and intensity of interaction between such systems is likely to be driven, at least in the short term, by the pace at which new virtual currency businesses achieve acceptance and recognition, and the pace of integration  of  the  technology  into  the  existing  financial  services environment.

10. Should virtual currencies accomplish the necessary levels of user acceptance and market penetration in the future, both legitimate and nefarious  users  may  achieve  full independence  in  acquiring, transferring  and  spending  of their  virtual  assets  within  the  virtual economy. This will reinforce the need for governments to tackle virtual economy-based ML/FT.
11. The inherently decentralised,  distributed, implicitly anonymous and versatile  nature  of  virtual  currency systems  (often  boosted  with extensions,  protocols  and  further  developments  granting  even greater  anonymity)  make  virtual  currency systems  attractive  to cybercriminals,  online-based  traditional  crime  perpetrators,  money launderers and terrorist financiers.
12. The potential for money launderers and terrorist financiers to exploit virtual currency systems for nefarious purposes is amplified by the fact that the main entry and exit points between the conventional and virtual systems are often represented by unregulated interfaces that are not subject to any requirements to counter ML/ FT.

Part 2: Background – main types of virtual currencies

Bitcoin

1. Bitcoin is the most prominent  decentralised virtual currency that provides  for  online  value  transfers  between  peers  by  utilising  a distributed and  decentralised  consent  mechanism.   In  this distributed network,  private  keys and  public  keys are  used  to transfer  Bitcoins from  rightful  owner  to  intended beneficiary  and each transaction must be cryptographically signed. Individual users connect with one another through an unencrypted TCP[6] channel over the Internet. The underlying architecture that underpins Bitcoin protocol is designed in a way that no central control or oversight of the network is needed.
2. Miners are responsible for adding and ordering transactions into a block which forms part of a block-chain (block-chain is a distributed ledger utilised by Bitcoin. Miners gather transactions, check their validity (using algorithms) and include them in a new block. Miners who wish to add a newly created block (which records changes in ownership) to the chain must demonstrate that they have solved a computationally difficult mathematical problem (known as "proof of work").

3. All Bitcoin transactions are irrevocable and irreversible; they can only be refunded by the beneficiary of the transaction.

Ripple

4. Ripple is a  virtual currency system that functions as an on-line, universal  and  decentralised  debt  settlement  network  with  a centrally-issued native currency called Ripple ("XRP").
5. At  its  core,  Ripple  is  a  physical  and  decentralised  network  of computers running a common open-sourced software which allows network participants to interact with one another according to the rules set by the Ripple protocol. The protocol provides a set of rules for transaction clearing and settlement. These rules govern the way ownership of any supported item of value or currency (both fiat and virtual-currency) is changed. Ripple protocol is not built to interface directly with consumers which stands in contrast to other, solely peer-to-peer networks (e.g. Bitcoin).  
6. Ripple operates globally, and is a fast, cheap, secure and asset neutral network that supports, besides its native currency, transfer of almost any fiat currency, virtual currency or other assets of value (e.g. frequent flyer miles, mobile minutes).
7. A asset of value not held in XRP are represented as "issuances" (digital representation of real assets) that can be sent and traded through the Ripple network without a need to convert them to XRP (though this may be necessary when there is not otherwise a market for trade) .  
8. Ripple relies on financial institutions to function as:

1. gateways into and out of the Ripple network,
2. market makers to provide liquidity for currency conversion and trading.  

The primary function of a Ripple gateway is to provide access to the Ripple network by accepting cash deposits, creating digital balances in user accounts and redeeming cash for digital balances stored in accounts. Market makers on the other hand provide liquidity to the network by holding funds in multiple currencies and by competing for foreign exchange trades.  

9. The settlement process utilised by Ripple is based on consensus that must be reached amongst the network's participants in order for any transaction to be included into the network's ledger.  
10. Whenever a transaction involves users that do not have a trusted relationship established between themselves, the system tries to find  a  path  between  the  users  where  each  link  of  the  path  is between two users (typically a bank, money service business or OTC market) that have a trusted relationship. This mechanism is called "rippling" and is believed to be a digital version ofHawala.  
11. In order to access Ripple, a user must first purchase a nominal amount of XRP. It is worth noting that Ripples Labs, the Ripple software provider, is currently implementing additional requirements for the use of the software requiring any new user of a Ripple Trade account[7] to upload customer identification information.  

QUESTION 1:

Is there any other type of virtual currency that does not fit any of the two currently prominent systems and which should be considered at this point in time when considering Regulation of Virtual Currency for Jersey?  

Part 3: Risk of ML/FT

1. The ML/FT vulnerabilities identified as the most prominent requiring the attention of respective government agencies are:

• Inherent pseudonymity' of virtual currency ownership - with no requirement  to  attach  true  names  to  the  currency  owned  and transacted.
• Problematic traceability of transactions - which is a function of the implicit anonymity of ownership, address disposability and fluid structure of transactions.
• Use  of  additional  technology-enabled  anonymisation  and encryption  protocols  and  extensions  and  stealth  currency emulations - that add an extra veneer of secrecy to the already pseudo-anonymous nature of ownership and its traceability.
• Decentralised  architecture  –  no  trusted,  central  currency issuing authority administering and controlling virtual currencies and that can assist law enforcement and other government agencies for investigative or asset seizure purposes. This is aggravated by the fact that virtual currencies exist in a digital universe entirely outside the reach of any particular country.
• Non-existent  regulatory  framework  -  with  no  statutory requirements to prevent and detect ML/FT applicable to businesses acting  as  the  interface  between  virtual  currencies  and  the conventional financial system.
• Secure technology – where law enforcement may not have the requisite  IT  skills,  forensic  expertise  and  knowledge  needed  to effectively  target  virtual  currency  related  ML/FT  and  deprive criminals of their virtual currency denominated criminal gains.

2. These  vulnerabilities  will  attract  specific  user  categories  (e.g. cybercriminals, drug dealers). They will be attracted also by the relative  instantaneous  manner  of  borderless  and  irreversible transactions.
3. The  FATF in  its  report[8] providing  an  initial  assessment  of  risk associated with virtual currencies argues that, at least in the near

term, only convertible virtual currencies are likely to present ML/FT risks that stem predominantly from their anonymity, inherent non- face-to-face nature and existence outside the reach of any country.

4. Despite every transaction being publicly logged and unalterably and permanently stored in a block-chain, Bitcoin10 addresses are not associated  with  the  identity  of  their  users/holders  and  so transactions (unlike wire transfers) are not identifiable to a particular person. Furthermore, in order to achieve greater anonymity and security, Bitcoin users can use a new address for each transaction in order to avoid transactions being linked to a common owner.

QUESTION 2:

Are there any other material ML/FT risks associated with virtual currencies that should be considered for the purpose of an effective and suitable framework for preventing and detecting ML/FT?

Part 4: Existing local framework

1. In  Jersey,  respective  authorities  have  already  taken  a  proactive approach in embracing virtual currencies.

Consumer protection

2. Jersey's Trading Standards Office has issued a general guide[9] permitting  virtual  currency prices  to  be  displayed  alongside  fiat currency prices. The advice given by the Office applies to business- to-consumer contracts only and not business-to-business contracts.

Tax

3. In respect of crypto-currency treatment, Jersey's Tax Office has published guidance[10]. The Tax office has advised that, while crypto- currencymining on a small or irregular scale will not be regarded as a  trading  activity  (and  so  will  not  constitute  a  taxable  event), exceptions may occur where mining activities are accompanied by trading in crypto-currencies on a sufficiently commercial scale.

4. As  regards  business  activities  involving  exchanging  virtual currencies to and from fiat currencies, these will be liable to income tax only when the principles of trading are met.[11]
5. When a virtual currency is used to purchase goods or services, the value  of  the  supplied  goods  or  services  must be  converted  to pounds sterling for GST purposes at the date of the transaction. No GST will be due where virtual currencies are exchanged for sterling, other fiat currencies or other virtual currencies.

Regulatory legislation

6. In  July  2014,  the  JFSC  authorised  the  first  Bitcoin collective investment fund. In funds where Bitcoins are an asset class, the key  ML/FT  risks  will  stem  from  the  provenance  of  Bitcoin and potential for investors to launder illicit proceeds through the fund.
7. These risks are able to be mitigated by imposing conditions on the licensing of a fund, for example, a requirement to only obtain Bitcoin from a licensed exchange.
8. Other businesses have outlined plans to the JFSC to launch and operate virtual currency activities in Jersey involving Bitcoin vending machines  and  various  business  models  of  a  Bitcoin exchange, whereby fiat currencies are exchanged for virtual currencies.
9. Activities relating to the exchange of or sale of Bitcoins are currently not  regulated.   They  are  not considered  to  be  money  service business  (defined  in  Article  2(9)  of  the  Financial  Services  Law because, as explained in Part 1 above, Bitcoins are not a currency or money as ordinarily understood. This means that:

• The business of exchanging any  fiat currency into a  virtual currency is not a bureau de change activity.

• The business of exchanging one virtual currency for another is not a bureau de change activity.
• The  exchange  only  service'  (i.e.  exchange  between  fiat currency and virtual currency and nothing more) does not fall under "engaging in money transmission services".

10. In instances where a composite transaction' service that consists of  both  the  exchange  of  fiat  currency for  virtual  currency and services for the onward use of both as a means of payment is provided, then this activity is considered to be engaging in money transmission  services  in  accordance  with  Article  2(9)(d)  of  the Financial  Services  Law, where  the  two  services  form part  of  a continuous (i.e. composite) whole.
11. However, other business activities related to services provided in relation to virtual currencies will be covered by the existing statutory framework  in  Jersey.   If  undertaken  by  way  of  business,  these include activities set out under Paragraph 7, Part B, Schedule 2 to the  Proceeds  of  Crime  Law, in  particular  business  activities involving:

• lending services to third parties, including consumer credit, where virtual currency is the type of asset lent;
• investing, administering or managing virtual currency funds on behalf of third parties; and
• providing safe custody of virtual currencies.

QUESTION 3:

Are there other key areas where you consider that virtual currency activity is caught by the existing statutory framework?

Part 5: Jurisdictional positions

1. Approaches  taken  to  address  virtual  currency risks  vary  from country  to  country.  In  order  to  inform  respondents  to  the consultation, an outline is provided below on the approaches taken so far by various jurisdictions to regulation of virtual currency[12].
2. The emergence of virtual currencies has attracted attention not only from  technologists,  speculators  and  crypto-anarchists,  but  from public  authorities  too.  Politicians,  regulators,  law  enforcement agencies, tax collectors and trading standard agencies around the globe have been developing their thoughts concerning the most effective  and  suitable  definition,  classification  and  subsequent treatment of Bitcoin and other virtual currencies.
3. Politicians  and  regulators  in  several  countries  have  held  public hearings  to  gain  a  comprehensive  understanding  of  the  newly emerged virtual currencies in order to:

• determine and design a suitable and proportionate regulatory framework for virtual currencies and thus maximise the potential offered by the very potent, yet possibly disruptive technology;
• ensure ongoing stability in financial markets; and
• protect businesses and their customers from illegal activities.

4. Examples of public hearings include Bitcoin inquiries conducted by the Canadian Senate Committee on Banking, Trade and Commerce and Australian Senate's Economics References Committee. Both inquiries  sought  to  examine  and  gauge  the  potential economic impact of virtual currencies across various industries, both nationally and internationally, and consider best tax, trade, digital commerce and AML/CFT treatment of virtual currencies.
5. Particular  focus  in  both  inquiries  was  placed  on  a  suitable  and effective  regulatory  regime  that  would  encourage  innovation, promote  competition,  protect  consumers  and  protect  against unlawful activity and behaviour. The following key success factors were identified for an effective regulatory framework:

• Thorough understanding of virtual currencies and their key attributes,  including  the  technology  and  protocols  that  underpin these systems;
• Major risks clearly identified and effectively managed; and
• Effective cooperation and collaboration between public and private sectors.

6. In the European Union, the EBA [13] has asserted that, in order to manage/mitigate  risks  comprehensively,  a  substantial  body  of regulation would be needed. The regulatory framework would need to  encompass  governance  requirements  for several  market participants, the segregation of client accounts, capital requirements etc. Since this is acknowledged to be almost impossible to achieve in  the  medium-term,  the  EBA has  recommended  that  national supervisory authorities in Member States should discourage credit institutions,  payment  institutions  and  e-money  institutions  from buying, holding or selling virtual currencies.
7. This approach has been, to some extent, echoed in Canada which, as a result of a recent regulatory reform, has prohibited banks from opening and maintaining correspondent banking relationships with businesses dealing in virtual currencies that are not registered with FINTRAC, Canada's financial intelligence unit.
8. Other countries have either intentionally decided not to take any proactive  steps  or  decided  to  wait  and  follow  suit,  whilst  other countries have embarked upon a process of determining the most effective regulatory response to the emergence of virtual currencies.

Australia

9. In a format similar to the inquiry conducted by the Canadian Senate, the  Australian  Senate's  Economics  References  Committee  has organised  public  hearings  with  public,  private,  and  academia representatives  (including  the  international  community)  on  virtual currencies.   The  hearings  took  place  in  November  2014  and  a report produced by the Committee is expected to be presented to the Senate (after an extension was granted) by 10 August 2015.

The inquiry was set up to:

• establish how to develop an effective regulatory system for virtual currencies;
• gauge the potential impact of digital currency technology on the Australian economy;
• consider how Australia can take advantage of digital currency technology to establish itself as a market leader in this field; and
• cover any other related matters[14].

There were, in total, 44 written submissions to this inquiry comprising

submissions made by individuals, private organisations (e.g. Ripple Labs Inc.), trade associations (e.g. Australian Bankers' Association), and  public  authorities  (Australian  Taxation  Office,  Attorney- General's Department and Australian Securities and Investments Commission).

10. The Australian Securities and Investments Commission concluded in their submission to the digital inquiry that virtual currencies do not fit within the existing definitions of a financial product in Australia. This is based on the fact that contracts between parties are settled immediately and there is no delay between the entry and delivery of digital currency that would make the contract meet the definition of a derivative.   In  support  of  this  conclusion,  the  Commission  also asserts that virtual currencies do not afford the holder any rights to make payments using the digital currency (no legal tender status or to rights to redeem virtual currency for cash).
11. Venture  capital  markets  and  OTC  markets that  allow  virtual currencies to be bought and sold have also been the subject of a review conducted by the Commission. It concluded that trading platforms through which offers to buy and sell virtual currencies are matched or facilitated are not financial markets as virtual currencyis not regarded as a financial product.
12. The submission of the Australian Attorney-General's Department explains that the Department commenced a review in December 2013  of  Australia's  AML/CFT  regime  in  order  to  examine  the operations  of  the  regime,  consider  issues  raised  by  regulated businesses  and  government  agencies,  and  determine  any enhancements.   The main  ML/FT  concerns  observed  are  the perceived anonymity and security of virtual currencies and the fact that these features will be exploited and abused to facilitate the laundering of proceeds of crime and the purchase of illicit goods and services.

13. In  order  to  proactively  address  the  emerging  risks  of  virtual currencies that are exploited for criminal purposes, the Australian Crime  Commission  has  launched  an  investigation  into  crypto- currencies and their links with organised crime. An example of this initiative is a Project codenamed Longstrike which aims to gather intelligence on organised crime groups that make use of Darknets to harbour trading in illicit commodities, where Bitcoin and other virtual currencies have become the currency of choice/the sole currency for  both  cybercriminals  and  for those  who  engage  in  internet enabled-traditional crime.
14. According  to  the  Australian  Crime  Commission,  the  current unregulated environment and anonymity of transactions render the technology and virtual currencies attractive to criminals.

Canada

15. Canada  is  keen  to  lead  in  promoting  virtual  currencies  and introduced a new Bill C-31 which became law in June 2014. The law extends the application of the Canadian Proceeds of Crime (Money Laundering) and Terrorist Financing Act to persons and entities that deal in virtual currencies.
16. Consequentially,  the  definition  of  money  services  business  now includes an entity that is engaged in the business of dealing in virtual currencies, as defined by regulation. In order to meet the definition of money service business, the entity has to either have a place  of  business  in  Canada;  or  has  to  provide  money  service business to its customers in Canada.
17. Whilst  the  omnibus  C-31  bill  amended  Canada's  AML/CFT legislation and brought business dealing in virtual currencies under the AML/CFT supervisory framework, the term dealing in virtual currencies'  was  not  defined.   The  implementation  of  the amendments to the AML/CFT legislation depends upon adoption of regulations that will define the term dealing in virtual currencies'. It

is expected that the definition will cover virtual currency exchanges, but not individuals or businesses.

18. In addition to the extended definition of money service business and a requirement subjecting dealers in virtual currencies to register with FINTRAC (Canada's financial intelligence unit), banks are, under the  C-31  Bill,  prohibited  from  opening  and  maintaining correspondent banking relationships with  digital currency dealers that are not registered with FINTRAC as a money service business.
19. The Canadian Senate's Banking, Trade and Commerce Committee has undertaken an extensive special study on the use of  digital currencies and held a series of public hearings with representatives of both public and private sector. The Senate Committee in its final report  entitled  Digital  Currency:  You  can't  flip  this  coin!' recommends i)  digital currency exchanges to be defined as any business that allows customers to convert state–issued currency to digital  currency  or  vice  versa  and  ii)  the  government  to  require digital  currency exchanges,  with  the  exclusion  of  business  that solely provide wallet services, to meet the same requirement as money service businesses.

United States (US)

20. The New York Department of Financial Services (NYDFS) is the only known regulator to have created a bespoke comprehensive framework, known as a BitLicense' for regulating virtual currency firms. The framework issued on 03 June 2015 (the third and final version of the framework) incorporates key consumer protection, anti-money laundering and cyber security rules tailored to virtual currency firms.
21. The  NYDFS's  BitLicense  is  designed  to  capture  financial intermediaries  only,  with  no  intention  to  regulate  software developers. The activities considered to be virtual currency business activity  and therefore  captured  by  the framework  are  set out  in Section 200.2 of the BitLicense.
22. Alongside the BitLicense, the NYDFS has developed a transitional BitLicense'  -  a  two-year  transitional  tailored  licence  issued  to businesses that are unable to satisfy all of the requirements of a full licence.

23. California is home to approximately 40% of all Bitcoin jobs in the US and almost half of all Bitcoin related venture capital. It is the first US state to pass a bill (AB-129) which ensures that Bitcoin and other alternative currencies such asdigital currency, points, and coupons do not violate the law when used for the purchase of goods and services or transmission of payments.
24. FinCEN, the US financial intelligence unit, issued an interpretative guidance  paper  on  18  March  2013  clarifying  the application  of regulations to persons administering, exchanging, or using virtual currencies. Whilst a user of a  virtual currency is not a money service business, an administrator or exchanger is considered to be a  money  transmitter,  therefore  carrying  on  a  money  service business.
25. The Internal Revenue Service issued a notice n. 2014-21 on 25 March 2014 providing information on federal tax treatment and tax implications of transactions involving virtual currencies. The notice provides that a virtual currency is treated as property for federal tax purposes and not as a currency for the purposes of foreign currency gain or loss.
26. In  June  2013,  the  Securities  and  Exchange  Commission  fined Trendon  Shavers  US$  40  million  for  defrauding  investors  in  a Bitcoin Ponzi scheme. Shavers was the operator of Bitcoin Savings and Trust and fraudulently accumulated 700,000 Bitcoins in funds. In order to establish whether Bitcoin could be considered as money and their use constitute an offence of running a Ponzi scheme, a Texas magistrate court ruled that Bitcoin can be used as money, used to purchase goods or services, exchanged for fiat currencies, and therefore is a currency or form of money.

France

27. The French Senate's Committee of Finance issued a report[15] in August 2014 following a joint meeting held between the Senate, Treasury, Customs, Central Bank and TracFin (France's financial intelligence unit).
28. The report considers different attributes of virtual currencies, e.g. legal status, tax treatment, approaches taken by foreign authorities on  regulation  of  virtual  currency transactions  and  exchange platforms as well as virtual currencies' innovative potential. The report calls for continued analysis of developments in this area and for work to be undertaken on adopting a regulatory framework at European level in order to be truly effective.  

Germany

29. Germany's federal regulator, BaFin, has assessed Bitcoin and its characteristics  and  published  a  guidance  note[16] on  its  website clarifying regulatory treatment of Bitcoin.
30. According to the note, BaFin takes the view that Bitcoin and the likes qualify as financial instruments under the respective provisions of the German Banking Act. Bitcoin is thus effectively regarded as a private means of payment, similar to, but not qualifying as, a foreign currency, and without a legal tender status.
31. While  the  ordinary  activities  of  mining,  purchasing  and  selling Bitcoins  in  an  existing  market  are  not  subject  to  authorisation requirements, there are instances where, if an additional service to ordinary activities is provided, authorisation will be required.

These activities include:

• Principal  broking  services  –  anyone  buying  and  selling Bitcoins for commercial purposes in their own name for the account of  third  parties  engages  in  principal  broking  services  and  these services are subject to authorization requirements;
• Multilateral trading systems  – brings together multiple third party buying and selling interests in financial instruments within the system and in accordance with pre-defined provisions in a way that results in a contract in respect of the financial instruments; and
• Broking  and  proprietary  trading  –  "offering  regionally structured commercial web lists consisting of persons who buy or sell Bitcoins at their place of residence" qualifies as investment and contract broking. Currency exchange offices are regarded by BaFin as proprietary traders.

32. The assessment concludes that the need to regulate businesses that seek to engage in trading in  Bitcoins (financial instruments) stems from the fact that there are a number of factors (loss, theft, negligent  conduct,  and  ML)  that  elevate  the  inherent  risk  level presented by Bitcoin to its users.

Hong Kong

33. The Government of Hong Kong in their response to a question from a member of the Legislative Council of Hong Kong set out that Bitcoins  are  not  a  legal  tender  in  Hong  Kong,  have  not  been accepted widely as a medium of payment and their circulation as a medium of exchange in Hong Kong is limited.
34. Bitcoin and  other  kinds  of  virtual  currencies  are  regarded  as commodities  or  virtual  commodities  for individual  speculative activities. Given the very limited market penetration and small scale circulation, the Government of Hong Kong in its statement issued in March, 25, 2015[17] did not consider it necessary to introduce new legislation to regulate trading in virtual currencies or prohibit people from participating in such activities.

Singapore

35. The Monetary Authority of Singapore asserts that virtual currencies will have a role to play in the future but is doubtful about their potential to replace fiat currencies entirely. In order to address ML/FT  risks  presented  by  virtual  currencies,  the  Authority announced  in  March  2014[18] that  it  will  introduce  rules  that  will require  virtual  currency businesses  acting  as  intermediaries (definition of intermediaries includes operators of Bitcoin exchanges and  Bitcoin vending  machines)  to  implement  CDD and  other measures to prevent and detect illegal activities.
36. This public commitment forms a part of overall efforts to preserve and  further  enhance  Singaporean  prominence  in  anticipating technology driven changes in financial services.

United Kingdom (UK)

37. The  UK  is  home  to  some  of  the  world's  most  popular  Bitcoin products and services. HM Treasury has run a consultation (ended on 3 December 2014) on virtual currencies with the aim of enabling the  government  to  examine  the  potential  benefits  that  digital currencies may  bring  to  consumers,  businesses  and  the  wider economy,  and  identify  potential  barriers  that  virtual  currency businesses face when trying to establish themselves in the UK.
38. As a result of this consultation, the UK Government announced in March  2015  its  response  to  the  call  for  information  on  Digital currencies[19]. The next steps listed by the UK are:

• The  government  intends  to  apply  anti-money  laundering regulation  to  digital  currency  exchanges  in  the  UK,  to  support innovation and prevent criminal use. The government will formally consult  on  the  proposed  regulatory  approach  early  in  the  new Parliamentary session.
• As  part  of  this  consultation  on  the  proposed  regulatory approach,  the  government  will  consider  how  to  ensure  that  law enforcement bodies have effective skills, tools and legislation to identify and prosecute criminal activity relating to digital currencies, including the ability to seize and confiscate digital currency funds where transactions are for criminal purposes.
• The  government  will  work  with  BSI  (British  Standards Institution) and the  digital currency industry to develop voluntary standards for consumer protection.
• The government is launching a new research initiative which will bring together the Research Councils, Alan Turing Institute and Digital  Catapult  with  industry  in  order  to  address  the  research opportunities and challenges for digital currency technology, and will increase research funding in this area by £10 million to support this.

39. HM Revenue & Customs published a brief in March 2014 setting out the position on the tax treatment of income and charges made in connection with Bitcoin activities. It does not consider the exchange

of Bitcoin or other virtual currencies for fiat currency to be activity that  is  within  the  scope of  UK's  Money  Laundering  Regulations 2007, as Bitcoin is not recognized as money in the UK.

40. In one of its quarterly bulletins (Q3, 2014), the Bank of England asserts that although the monetary aspects of  digital currencies have  attracted  considerable  attention,  the  distributed ledger underlying  their  payment  systems  is  a  genuine  technological innovation'. It continues positing that the interest in and the adoption of  virtual  currencies  appears  to  be  driven  by  three  key  factors; ideology, financial return and pursuit of lower transaction fees. The Bank of England concludes, that the presently too small total stock of  digital  currencies does  not  pose  a  threat  to  financial  and monetary  stability,  but  it  is  conceivable  that  in  time,  this  could change.

Isle of Man

41. In 2014, the Isle of Man's Department of Home Affairs conducted a consultation on changes to be made to Schedule 4 of the Proceeds of Crime Act which included a proposal to cover persons carrying on virtual currency business.
42. The  activities  included  in  the  proposal  encompass  the  issuing, transmitting,  transferring,  providing  safe custody  or  storage  of, administering,  managing,  lending,  buying,  selling,  exchanging  or otherwise  trading  or  intermediating  convertible  virtual  currencies, including crypto-currencies or similar concepts where the concept is accepted by persons as a means of payment for goods or services, a unit of account, a store of value or a commodity. The Proceeds of Crime Order came into force on 1 April 2015.
43. The  proposal  also  includes  introducing  a  1,000  occasional transaction threshold for convertible virtual currency activities into the  Isle  of  Man's  Anti-Money  Laundering  and  Countering  the Financing of Terrorism Code.
44. In addition to the above, an opinion of the Isle of Man Attorney General's Chambers in relation to the regulatory status of a virtual currency business model concludes that, where a Bitcoin company acts  as  an  intermediary  between  a  merchant  and  its  customer (making payments in Bitcoins for goods or services purchased from a  merchant),  it  would  be  construed  as  money transmission/remittance.   Consequently,  this  activity  would constitute a regulated activity if carried on in or from within the Isle of Man. This is in line with Jersey legislation.

Part 6: Options for regulation of virtual currency

1. In considering options for regulation of virtual currencies, it is helpful to refer to the four "guiding principles" set out in Article 7 of the Financial Services Commission (Jersey) Law 1998. In particular the need to counter financial crime both in Jersey and elsewhere must be of paramount importance when considering the introduction of, or amendment to, any regulatory regime.  
2. Factors that need to be considered in determining what form of regulation maybe appropriate include:

• the  way  virtual  currencies  manifest  themselves,  and  their specific terms;
• the nature and scale of the risks identified;
• the  need  to  preserve  the  integrity  and  stability  of  existing financial services;
• the  need  to  prevent  businesses  and  their  customers  from engaging in criminal activity; and
• the need to promote innovation by enabling technology driven changes to traditional financial products and services and further development of the digital economy.

3. As mentioned earlier in this paper, some activities involving virtual currencies are already subject to regulation and supervision. For example, existing legislation captures:

• Persons engaged in the business of money transmission on a "composite" basis - who fall under the definition of money service business (Article 2(9)(d) of the Financial Services Law).
• Persons engaged in lending in virtual currencies (Paragraph 7(1)(b) of Part B of the Schedule to the Proceeds of Crime Law).

• Persons  engaged  in  safe  custody  of  virtual  currencies (Paragraph 7(1)(m) of Part B of the Schedule to the Proceeds of Crime Law).
• Persons  engaged  in  the  business  of  otherwise  investing, administering  or  managing  virtual  currencies  on  behalf  of  third parties  (Paragraph  7(1)(n)  of  Part  B  of  the  Schedule  to  the Proceeds of Crime Law).

4. However,  reliance  on  existing  provisions  is  unlikely  to  focus on activities that will most effectively address the risks identified in this paper.
5. It is also worth noting that, by electing to regulate and supervise virtual currency operators for AML/CFT purposes only, customers and wider industry participants may incorrectly assume that a robust and comprehensive prudential and conduct of business regime is in place, including customer protection schemes.
6. Options A to C below consider regulation for AML/CFT purposes only. Option D proposes regulation for prudential and conduct of business purposes. The options are presented as alternatives to each  other,  but  are  not  mutually  exclusive  and  some  could  be implemented together.
7. Brief preliminary discussions have occurred between authorities in the Channel Islands regarding potential advantages to developing a joint Channel Island standard for Regulation of Virtual Currency. If it is  felt  that  this  could  be  advantageous,  further  discussion  on  a standard for Regulation of Virtual Currency could be raised between the  Channel  Island  authorities.  If  these  discussions  resulted  in agreement on such a standard, it could then be for each of the Islands  to  implement  the  standard  within  their  own  respective legislative regimes.
8. It  has  been  suggested  that  a  clear  and  unified  position being advanced by the Channel Islands to the outside world may have a greater  impact  and  therefore  create  confidence  in  the  approach adopted by the Channel Islands.

Option A – regulate all virtual currency activities

9. Option  A  is  to  add  the  following  activities  to  the  definition  of "financial services business" in Schedule 2 to the Proceeds of Crime Law:

"Activities covering issuing, transmitting, transferring, providing safe

custody or storage of, administering, managing, lending, buying, selling,  exchanging  or  otherwise  trading  or  intermediating convertible virtual currencies, including virtual currencies or similar concepts where the concept is accepted by persons as a means of payment for goods or services, a unit of account, a store of value or a commodity."

10. This change could bring a significant number of additional activities connected with virtual currencies within the scope of the  Money Laundering Order, including activities occurring exclusively within the virtual ecosystem with no interaction between real and virtual economy. Given that virtual currencies are considered to still be in their experimental stage, this definition may be too wide. Also, some  activities,  e.g.  lending  and  safe  custody,  will  already  be covered by Schedule 2 to the Proceeds of Crime Law (i.e., there will be duplication).
11. Under this option, Article 4 of the Money Laundering Order would require identification measures to be applied to any one-offvirtual currency transaction of 1,000 (or equivalent) or more.

Option B – regulate interface with fiat currencies

12. In line with the approach likely to be adopted by the FATF, option B is to add the following activity to the definition of "financial services business" in Schedule 2 to the Proceeds of Crime Law:

"Acting as an interface between legacy financial systems and virtual

currencies,  e.g.  virtual  currency  exchanges  and  Bitcoin  ATM operators."

13. This is also the approach announced by the Monetary Authority of Singapore in March 2014 which is yet to be implemented.  This change focuses on "gatekeepers": those businesses that exchange fiat currencies for virtual currencies (and vice versa).

14. Under this option, Article 4 of the Money Laundering Order would require identification measures to be applied to any one-offvirtual currency transaction of 1,000 or more.

Option C – extend meaning of cash and money

15. Option C is to extend a number of existing provisions so that they will  be  read  as  applying  to  virtual  currencies,  where  this  is  not already the case.
16. A definition of "bureau de change" would be amended ino Schedule 2 of the Proceeds of Crime Law, so that it would also include any case  where a  fiat  currency is  exchanged for  a  virtual  currency, virtual currency is exchanged for a fiat currency, and virtual currency is exchanged for a virtual currency.
17. The definition of "high value dealers" contained in Schedule 2 to the Proceeds of Crime Law would be amended to include:

"Persons who, by way of business, trade in goods when they receive,

in respect of any transaction, a payment or payments in  virtual currency of at least 15,000 (or equivalent) in total, whether the transaction is executed in a single operation or in several operations which appear to be linked."

18. The definition of "issuing and administering means of payment" set out in Article 7(1)(e), Schedule 2 to the  Proceeds of Crime Law would be amended to include:

"Any operator of a virtual currency."

19. Regulation  of  virtual  currency operators  may prove  to  be unworkable,  in  particular  for decentralised  virtual  currencies,  as there is no central authority that issues currency.
20. Under this option, existing one-off transaction thresholds would be retained.

Option D – extend meaning of investment

21. Option D is to amend the definition of "investment" in the Financial Services Law to treat virtual currencies and similar concepts as a type of investment. The effect of this would be to capture any person:

• Dealing in virtual currencies, that is buying or selling either as principal or as agent;
• Undertaking  discretionary  management,  that  is,  the  person decides as agent to buy or sell virtual currencies;
• Gives advice in respect of virtual currencies.

22. This  option  bears  some  similarities  with  the approach  taken  by Germany's financial services regulator.
23. The regulatory scope of this option would be closest to option A. However,  whereas  option  A  would  regulate  operators  only  for AML/CFT purposes,  option  D  would  also  apply  prudential  and conduct of business rules.
24. Such an approach may be considered to be premature. It could also have the effect of pushing business away from Jersey (on the basis  that  most  other  jurisdictions  are  likely  to  regulate  virtual currency activities only for AML/CFT purposes).
25. However,  it  could  also  be  argued  that  such  an  approach  may encourage operators to establish themselves in Jersey on the basis that they could present themselves as regulated and supervised by the JFSC. A full regulatory regime would undoubtedly also help to manage risk more effectively, and encourage the use (or greater use) of virtual currencies by more risk-averse users.

QUESTION 4:

Which option (or combination of options) do you consider represents the best approach for Jersey to take in respect of regulation of virtual currency?

And why?

QUESTION 5:

Do you consider that any other regulatory options should be considered to prevent and detect ML and TF in respect of virtual currencies?

QUESTION 6:

Do you consider that it would be advantageous to agree a Channel Islands standard for Regulation of Virtual Currency?

Part 7: Distributed ledger technology standard

1. Some brief and preliminary discussion between the Channel Islands has occurred  regarding  whether  regulation  of  the  underlying  "distributed ledger"[20] technology would be advantageous in providing confidence to the marketplace that the Channel Islands are suitable jurisdictions in which to conduct "distributed ledger" technology based business. A standard might involve registration, inspection, certification and periodical checking of the underlying  "distributed ledger"  technology  system  sitting  behind  any particular business that would use, develop or provide "distributed ledger" technology[21].
2. When considering  a  technical  quality  standard  for  distributed ledger" technology, consideration should also be given to whether this should be mandated  by  legislation  or  whether  it  should  be  voluntary.  Voluntary application would allow those who wished to obtain the status of meeting the "distributed ledger" technology standard' to apply to be registered.

QUESTION 6:

Do you consider that a technical quality standard for "distributed ledger" technology would be advantageous, and, if so, should it be voluntary or compulsory?

QUESTION 7:

Do you consider that a common technical quality standard for "distributed ledger" technology could be implemented and administered by one Channel Island body as a joint Channel Islands Standard or should it be a common standard administered by separate jurisdictional bodies?

Summary of Consultation Paper Questions

1. Is there any other type of virtual currency that does not fit anyof the  two  currently  prominent  systems  and  which  should  be considered at this point in time when considering Regulation of Virtual Currency for Jersey?
2. Are there any other material ML/FT risks associated with virtual currencies  that  should  be  considered  for  the  purpose  of  an effective and suitable framework for preventing and detecting ML/FT?
3. Are  there  other  key  areas  where  you  consider  that  virtual currency activity is caught by the existing statutory framework?
4. Which  option  (or  combination  of  options)  do  you  consider represents the best approach for Jersey to take in respect of regulation of virtual currency? And why?
5. Do you consider that any other regulatory options should be considered to prevent and detect ML and TF in respect of virtual currencies?
6. Do  you  consider  that  a  technical  quality  standard  for "distributed ledger" technology would be advantageous, and, if so, should it be voluntary or compulsory?
7. Do you consider that a common technical quality standard for "distributed ledger" technology could be implemented and

administered by one Channel Island body as a joint Channel Islands Standard or should it be a common standard administered by separate jurisdictional bodies?

[END OF PAPER]

Appendix 1 - Glossary of Terms