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Fighting money laundering online

Why regulating against the illicit use of virtual currencies won't be easy.


The federal government has made a bold pronouncement towards regulating the shady changing-of-hands of money online.

The trouble is, nobody is quite sure how it is going to do it.

Indeed, enforcing the regulation of decentralized digital currencies is no easy task, particularly when the government has to juggle with international gambling law, a world full of anonymous hackers, and the thorny field of First Nations' ancestral rights.

Of cryptocurrencies...

Much has been written about cryptocurrencies — Bitcoin being the star among them.  They’ve been described as everything from bizarre novelty and nefarious cloak used to hide illegal online transactions, to legitimate methods of payment.

The premise of a cryptocurrency is certainly ingenious, if not unusual: The creators of Bitcoin (as well as its many copycats, now denoted broadly as 'bitcoins') introduced a system based on a digital mining mechanism – not dissimilar to resource extraction, which creates Bitcoins and distributes them among currency holders in the Bitcoin economy. Through crowdsourcing, the currency supply is kept in check without the intervention of a central regulator.

Given the unorthodox and unprecedented means by which the value of Bitcoins is assigned, their value has been known to fluctuate wildly, making it a gold rush for smart speculators. That hasn’t stopped a growing number of businesses from accepting the currency.  Even Bitcoin ATMs have popped up worldwide — including in Ottawa, Toronto, Vancouver, Winnipeg and Montreal.

But the legal challenges are dizzying. Though each Bitcoin transaction is logged, each transaction creates a unique address. For incorporated stores, who can require clients to enter personal information to complete a transaction, that isn't a huge problem. But transactions between individuals, especially in the backchannels of the off-the-grid internet, are harder to trace.  And that proves problematic for law enforcement.

Not impossible, however. Authorities in the U.S. recently arrested two owners of a Bitcoin trading site for alleged money laundering, after illicit online black market site Silk Road was shut down earlier this year.

But the difficulty is enough to push the Canadian government into acting. That's why Ottawa is looking to subject digital currencies to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. (PCMLTFA)

Easier said than done, perhaps.

Currently, the Canada Revenue Agency has asserted that bitcoin transactions are subject to the same tax laws as any other transaction. Beyond that, the government has few tools at its disposal to do much else.

"What I expect one option could be is that the Department of Finance promulgates regulations that say: funds, as set out in the regulations, include crypto-currencies. They could shoehorn bitcoins under the money-service business rules, which is somewhat similar as what has been done in the States. That's one approach," says Stuart Hoegner, a specialist on digital currencies, and the founder of Gaming Counsel, a law boutique focused on the needs of the international gaming and betting sector.

That approach would lump bitcoins in with money lenders and foreign currency exchangers under the PCMLTFA, and place any business exchanging the digital currency under the watchful eye of the Financial Transactions Reporters Analysis Centre of Canada, more commonly known as FINTRAC. Most bitcoin trades exceeding $10,000 would have to be reported to the government-run centre.

It would also, ostensibly, clear up any confusion as to whether bitcoins should be treated as a currency under the law, or whether it is more aptly described as a derivative or a security.

Legal transactions between a customer and a business are one thing. These fall under FINTRAC’s oversight.  But what of anonymous online marketplaces such as the notorious Silk Road, nicknamed as for illegal drugs, which operated on the murky fringes of the internet?

When asked whether cramming bitcoin regulation into a regime built for brick-and-mortar institutions would lack oversight on some of the most critical issue surrounding the currency, Hoegner has this to say: "The short answer is yes, it will only apply to a part," he says. "I don't think that this is a silver bullet that's going to solve money laundering in this country."

If the government does go this route, regulating peer-to-peer exchanges online will have little impact. Also it says nothing about how we should regulate miners, who are a cross between stock market traders and programmers.

What’s more, bitcoins raises a whole host of security issues, highlighted by the failure of Japan-based Mt. Gox.  Originally an online trading post for a popular brand of trading cards, it became a huge bitcoin trader that ultimately succumbed to security breaches that produced losses of nearly $500 million worth of bitcoins. It declared bankruptcy last month.

Another approach, says Hoegner, would be to build from scratch a whole new regulatory regime for digital currencies, though that would be a tall order. Canada has taken the first step in that respect in the budget, targeting Paypal as something that ought fall under the Canadian Payments Act, which governs the clearing and settlement of payments in this country.

Documents obtained by the Wall Street Journal show that FINTRAC's first instinct was to "choke" the currency. But, as it became clear that the U.S. would be working to create a legal framework that legitimize digital currencies — with several of its politicians even accepting it for donations — a change in tact was in order.

Besides, Hoegner argues, the risks may be more histrionics than anything else.

"In terms of the practical amount of being laundered [globally], it's a drop in the ocean," he says. "I think there's a theoretical risk that needs to be addressed, and that properly advised operators are already addressing that risk."

The black sheep in the world of cryptocurrencies, at least in Canada, are already trying to conform to some semblance of rules. Hoegner points out that the Bitcoin ATM in Ottawa, Canada's first, puts a limit on the amount that users can deposit in a day, in line with caps on what the money-service industry face. It also collects a cellphone number for each user.

Anything introduced by the government, he figures, will offer some direction and clarity for those in the current regulatory vacuum.

... and online gambling

It’s a similar situation with regulating online gambling. In 2008, the Financial Action Task Force on Money Laundering (FATF), an inter-governmental task group that evaluates countries' financial regulatory regimes and recommends improvements, evaluated Canada and found its laws deficient in a number of areas, specifically around tackling money laundering on internet gambling sites.

Part of the problem is that Canada's online casinos are managed either under provincial jurisdiction, or on-reserve.

Currently, only British Columbia and Quebec run online casinos. Manitoba joined in a partnership to have its own, managed by BC, and Ontario has been developing its own system for some time. Those sites do not technically fall under FINTRAC, though their parent companies — provincial Crown corporations — do.

Christine Duhaime of Duhaime Law, which specializes in the laws around money laundering, says tackling the provincial gambling bodies could be Ottawa's plan of attack.

"It's one of two things. One, they're actually going to go and require every single online casino that has any business in Canada to register with them," says Duhaime. That option, she explains, could be costly and well outside FINTRAC's mandate.

If Ottawa puts its foot down, most corporations would likely refuse to incorporate in Canada and adhere to a second set of rules. That would ultimately put Canada in the awkward, and technically difficult, position of either blocking the websites, or trying to prosecute sites that don't adhere to Canada's regime, because they operate outside its borders. When the U.S implemented similar measures, in what came to be known as 'Black Friday,' they were able to serve warrants against the corporations that were actually based in that country, taking them offline until they adhered to financial-reporting laws.

Or, the intention is really only to get the BC Lotto Corporation and Loto-Quebec to report their online operations to FINTRAC. “It's one of those two options. I actually think they mean the second one," she says. A spokesperson for the Finance Department confirmed that, indeed, that will be part of the upcoming changes.

It's not clear if those changes will include Ontario's online horse-track betting system. Horse racing has a unique status in section 202 of the Criminal Code, meaning that its betting regime is wholly apart from traditional gambling systems. Horse racing, and its corresponding online betting system are both managed under the Canadian Pari-Mutuel Agency, which is a division of Agriculture Canada.

"Horseplayer Interactive is unregulated," says Duhaime. "So none of the online gaming that ever takes place on Horseplayer Interactive, which could take place anywhere in the world because it's an online regime, is registered with FINTRAC or gets reported, and that has huge susceptibility to money laundering."

Dealing with the provinces may be difficult, but it's feasible. There is a bigger, unregulated, market that poses a much more formidable challenge to bring under a national regime — First Nations reserves.

While provincial online casinos may be the most visible choice, the vast majority of online casinos in Canada are hosted on-reserve, mostly in the off-island Montreal reserve of Kahnawake. While they have their own set of regulations and rules for the casinos hosted there, the regulatory regime isn't as robust as FINTRAC's.

But if history serves as any indication, First Nations won't take kindly to Ottawa trying to force regulations onto their casinos — whether they be physical buildings or digital-only.

The Mohawks of Kahnawake have an especially salient defence, in that they can claim long-standing, pre-contact traditions of gambling, giving them a clear path to claiming ancestral rights, if the government were ever litigious enough to take it to court.

The only real case law to give direction on the issue is R. v. Pamajewon, where the Supreme Court of Canada ruled that two Ontario reserves did not have the right to host high-stakes gambling on their reserve. That 1996 case, however, contains as many similarities as it has differences to Kahnawake's context.

Even so, it might just not be worth it.

While some have singled out jurisdictions such as Kahnawake — which, in cooperation with an Isle of Man-based internet company, has come to host many of the internet's largest gaming sites — as being the conduit for much of the world's shady money movements, others aren't so sure.

"It's overblown," says Duhaime. She says that many of the sites that are hosted in Kahnwake aren't actually run from there, they're headquartered either in the U.S. or Western Europe, which have their own regulatory regimes. "They're being vetted one way or the other," says.

"It's overstated," says Hoegner. Because most payments are transacted through credit card companies and banking institutions, there's little chance that someone can discreetly transfer large sums.

While it's unclear if Ottawa's feasible and moderate steps — pulling bitcoins under existing regulation, and subjecting only provincial online casinos to FINTRAC — will be enough to satisfy the international regulators at FATF, there little doubt that it will only be tackling a part of the issue.