Why the battle over FinCEN’s crypto wallet rule isn’t over

Wonk Talk recently sat down with Jerry Brito, executive director of think tank Coin Center, to talk about what the latest extension on FinCEN’s proposed rule means for 2021 (here’s some background on the rule itself and the unusual procedures that accompanied it).

WT: When the notice of proposed rule-making initially dropped, there was an unusually short comment period of 15 days. Agencies can do that in times of emergency, but as Coinbase pointed out in their letter, there seemingly was no emergency. Have you ever seen anything like this action before?

JB: Not that I’m aware of.

There are many agencies making lots of different rules over the course of the last hundred years, so maybe there's precedent for what happened, but what happened was very weird. You can kind of tell that what the [Treasury] secretary wanted to do was to put out what's called an interim final rule. An interim final rule means that there's an emergency or there's some situation where putting a rule out for comment would undermine the rule. And so when agencies are allowed to do under the Advisory Procedure Act (APA) is to publish the rule as final. So it's immediately the law is immediately binding and then you have a comment period. And at the end of that comment period, they'll look at the comments and typically to what they learn they can if they want to amend that initial rule. But on day one it's binding.

WT: Why does it seem like Treasury Secretary Steve Mnuchin intended to promulgate this as an interim final rule? How did that seem to affect the process?

JB: You can tell that that's what they want to do, because in order to take advantage of [the interim final rule], they have to cite an emergency or a circumstance where it basically would undermine the purpose of the rule if they sought the regular notice and commentary period. And it's clear that's what they wanted to do and that they got pushback internally...you can see that the compromise the secretary arrived at because he really wanted to get this out before he left office, which, by the way, is not a good reason to rush things under the APA.

So he said fine, we’ll publish it as normal rule-making, but we will give only 15 days. And so when you read the rule, it cites these kinds of emergencies. But you only would cite an emergency if you were giving no notice, if you're giving some notice it kind of undermines your argument because typically what you would say is we have to make a rule final because if we couldn't make it final immediately, bad things would happen if we gave a comment period. And what he's saying is I think the comment period is fine, but a 30 day would be just the end of the world, which makes no sense. I've never seen that where they cite the emergency provisions, but not for giving no notice, but for giving short notice.

I know it's all kind of academic at this point. If they had finalized a rule during the last administration, then all of that would have mattered a lot because it would have certainly been taken to court. At this point it's kind of water under the bridge. But it was completely weird.

WT: A number of entities, like the Blockchain Association and Coinbase, committed to challenging the rule if it took effect due to alleged procedural violations. If the rule does take effect after the new 60 day extension period, do you expect people would still challenge it based on the APA?

JB: Moving forward now, a lot of the process grounds people planned to challenge, now that they're following a normal process, kind of fall away. However, it’s still kind of the fruit of the poisonous tree, because a lot of people filed comments under duress. But at this point, I think it's kind of been cured by the fact that they're giving plenty of more time, etc..

On the constitutional questions, it depends on what the final rule is. If the final rule is as bad as I would have expected if Mnuchin had finalized it, then we will still challenge it. But I don't expect that anymore. He's gone. I think what we're going to get is going to be, I hope, a rule that's reasonable.

WT: When the administration changed over, the White House released a notice of regulatory freeze pending review, and many thought that meant the “Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets,” notice of proposed rule-making was frozen for good. Does an extension mean the Biden Administration is advancing it?

JB: When presidents take over, especially from a president of the opposite party, they will immediately on minute one of the administration put out a memo that freezes all ongoing rule-making to say ‘stop, let us take a look at what you're doing to decide if this is this important to the policy we want to continue to pursue.’

That's what Joe Biden did on minute one. And you would think that that meant all rule-making, including this one. There is a provision, of course, that basically says everything is frozen, unless the agency in charge says ‘we really need to keep this one going,’ especially if it's a national security or law enforcement related thing. Then the White House may decide not to freeze that one.

There was nothing said about this one in particular, so everybody assumed that it was frozen, but there was no notice put out saying that this particular one was frozen or was exempt. Then we got the 60-day extension notice that answers that question. And the answer is, whether it was frozen or not doesn’t really matter, it’s academic. The point is they reviewed it and they want to go ahead with it in the proper way.

WT: Coin Center and other commenters have specifically taken issue with the counterparty requirements outlined in the proposal. What are some of the legal ways they might be challenged?

JB: From a legal constitutional perspective, it requires financial institutions to identify people who are not their customers and who never agreed to give any of their information to that financial institution. So if you have a Coinbase account and you're going to pay me and I have no interest in personally using Coinbase, Coinbase would still have to identify me and my physical address and keep that on file. The Bank Secrecy Act, its constitutionality is premised on what's called a third-party doctrine, which means that you voluntarily gave information to the institution that the BSA requires to keep it. So that's one piece.

There are First Amendment rights to anonymous assembly issues here. The government can’t compile lists of nonprofits. In a way, with this rule, the government would be able to because of the counterparty ID requirements. The way it would ultimately work out, you would end up with a government collected list of Coin Center’s donors. So we would have challenged that way.

WT: What are some issues from a policy or technology standpoint? Why might the counterparty requirements make things more difficult for stakeholders?

JB: Also, this is not technology-neutral and FinCEN has been very good throughout history in basically saying, ‘we're going to apply the same rules to all financial institutions, regardless of what technology they use, regardless of how they do their business. We apply the same requirements.’ This, for the first time, would have separated out a particular technology for special treatment. And that's bad for policy reasons.

Technically, it can make it very difficult to transact. It's easy enough potentially to identify a counterparty, that kind of party as a human with the physical address. But if the counterparty is a smart contract it kind of becomes impossible. And so, in a way, you're banning the ability of institutions to interact with the smart contracts.

WT: Could this create a situation in which decentralized finance (DeFi) venues are negatively affected?

It would have really hurt the intersection between the onramps and off-ramps between exchanges and DeFi. You can say that you can always move funds from an exchange to your own software wallet where you’ve identified yourself and from their interact with DeFi, but that creates a lot of friction. To the extent that this wants to grow to not just sophisticated early adopters but for mainstream folks to use these things, the whole reason they’re using an exchange is because they don’t want to have their own software wallet.

That’s one piece, and then the other piece is put DeFi aside, there are all kinds of interesting things and services you might want to offer with smart contracts.

WT: Commenters lodged over 7,500 comments in the original 15 day comment period. Now that there’s a full 60 days set, what happens now?

JB: Because the counterparty part was so terrible and we had so little time that’s what everyone concentrated on. Now we can take the time to think through the currency transaction reporting (CTR) part of the proposal. If we have a CTR requirement, what is the most rational way to do that? And how can we provide FinCEN comments on that? So I think that's what people are thinking about now and that’s from an industry sense. In the community, I get the sense that the community thinks we’ve won and people are very happy about that. I hasten to say we haven't won yet. This rule is still pending. It still includes a proposal for a counterparty requirement. So we won the battle. We still have to land the plane.