ICO/Cryptocurrencies: The 5th Money Laundering Directive

03 July 2018

Dr Michael Jünemann, Johannes Wirtz

Continuous digitalisation within the financial sector leads to accelerated competition and thriving innovation of technologies and financing tools. They facilitate access to payment services, loans and equity capital. However, just as any form of the New Economy, this acceleration is not free of risk or abuse but comes with inherent threats of money laundering and terrorist financing.

The rapid development, the innovative spirit of start-ups and incumbents and the enormous interest in virtual currencies and financial transfers are creating niches to exploit these market transformations. These niches may, however, provide safe places for money laundering of anonymously acquired funds and even hidden terrorist financing. To fight these risks, the European Parliament and the Council of the European Union has agreed to amend and expand existing anti-money laundering legislation. This will be the 5th Anti-Money Laundering Directive (AMLD5) and, among others, comes with a requirement for preventive responsibility by the crypto-currency market.

Application of AML legislation to crypto currency exchanges and wallets

Effective anti-money laundering legislation requires so called “obliged entities” to comply with extended due diligence obligations when establishing and performing business relationships.

Under the 5th Anti-Money Laundering Directive the criteria to qualify as an obliged entity remains as is and continues to include financial services institutions.

The new Directive will now encompass platforms for the exchange of virtual currency to fiat currencies (so-called crypto currency exchanges) and providers of electronic wallets for virtual currencies such as Bitcoin, Ether or Ripple throughout Europe as obliged actors. Additionally, the Directive requires the providers to register with the financial supervisory authorities. However, exchange platforms that only operate between different virtual currencies do not qualify as obliged entities under the Directive. For the first time AMLD5 provides a definition for virtual currency as 'digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically'.

While uniform AML regulation of the crypto market is entirely new to Europe, not much changes for some member states. Crypto currency exchanges in Germany, for example, are already required to obtain permission by the German Federal Financial Supervisory Authority (BaFin). BaFin has categorized crypto currencies, so-called currency tokens, as units of account. As this trade warrants permission, any holder of such permission is already obligated to comply under the current anti-money laundering legislation.

Consequences for the crypto currency market

The crypto currency market has long been attractive due to its inherent anonymity and low levels of regulation. The technological specifics of the blockchain technology were supposed to mitigate the issue and provide the necessary trust from within the market. However, neither Initial Coin offerings (ICOs) nor the secondary market have been able to build a sensible and effective AML compliance regime. With this new European initiative, the European crypto-currency market must now conform to applicable AML regulations like any other financial market participants.