The marijuana industry is a rapidly expanding sector that has proven profitable for licensed marijuana businesses and the financial institutions that serve them. These profits are often manifested by piles of cash that are costly and dangerous to handle. To solve this problem, some marijuana businesses have turned to crypto-currency as an alternative. However, crypto-currency only complicates the marijuana industry by exposing both crypto-currency users and the banks that serve them to liability for money laundering and tax evasion, thereby putting Washington’s entire legal marijuana industry at risk.
What is Crypto-Currency?
Neither paper nor plastic, crypto-currency is an anonymous and decentralized virtual medium of exchange. By using encryption techniques to regulate currency unit generation and verify fund transfers, crypto-currencies like Bitcoin, Coinye, Decred, Gulden, Gridcoin, Litecoin, MazaCoin, Monero, Namecoin, Nxt, Peercoin, PotCoin and Ripple operate independently of a central bank. To use and store crypto-currency, an individual creates a virtual “wallet” with a personalized username and password. Every wallet has a unique address, which is linked to its owner’s username. The wallet does not store personal information about its owner, granting the owner complete anonymity. To obtain crypto-currency, individuals can buy existing crypto-currency units or “mine” new ones. Mining is the process by which individuals can acquire undiscovered units of crypto-currency by solving mathematical equations. Unlike traditional currency, which has no finite limit and can be minted and multiplied as necessary, once the maximum number of a type of crypto-currency has been mined, no new amount of that crypto-currency can be created.
If this seems complicated, it is. In March 2014, the Internal Revenue Service (IRS) released Notice 2014-21 to explain “how existing general tax principles apply to transactions using virtual currency.” In Notice 2014-21, the IRS stated that while “in some environments, [crypto-currency] operates like ‘real’ currency… it does not have legal tender status.” In the last few years, the United States Securities Exchange Commission has charged numerous crypto-currency reliant companies with ongoing unlawful and fraudulent activities, citing that “[f]raudsters may…be attracted to using virtual currencies to perpetrate their frauds because transactions in virtual currencies…have greater privacy benefits and less regulatory oversight than transactions in conventional currencies.” SEC Pub. No. 153 (7/13).
Who Uses Crypto-Currency?
Crypto-currency’s anonymity and decentralization are especially convenient for drugs, arms and child pornography sellers. As illustrated by the Silk Road, one of the dark web’s most notorious marketplaces, crypto-currency allows these parties to anonymously engage in illicit transactions and avoid detection.
Illicit actors are not alone in recognizing crypto-currency’s advantages. Crypto-currency also appeals to state licensed marijuana businesses. Because of marijuana’s current status as a Schedule I controlled substance, many banks will not serve marijuana businesses. Consequently, these businesses rely heavily on cash, which is both cumbersome and extremely dangerous. To find a cash alternative, some marijuana businesses have turned to debit/credit card processing (swipe) machines that use crypto-currency.
What are the Dangers?
While crypto-currency may seem like a viable cash alternative, in reality, it allows marijuana licensees to launder money from illegal drug sales and avoid paying taxes. To minimize the risk, the Washington Liquor and Cannabis Board (LCB) has specified that marijuana businesses may only purchase marijuana with cash, checks, debit/credit cards, electronic funds transfers, prepaid accounts or via a licensed money transmitter. See, WAC 314-55-115. However, marijuana retailers are not banned from accepting crypto-currency as payment from consumers, exposing the banks that serve them to potential liability for the retailers’ illicit actions.
Swipe machines that allow consumers to pay marijuana retailers using crypto-currency could be used to facilitate money laundering in just a few simple steps. For example, a retailer sets up an account with the swipe machine provider and instructs the provider to send funds from crypto-currency transactions to a bank account not held in the retailer’s name. Once the swipe machine is set up, the retailer has a “strawman” purchase crypto-currency using a debit/credit card and reimburses the strawman using cash the retailer received from an illegal (black market) sale of marijuana. The retailer then sells the crypto-currency back to the swipe machine provider, which transfers the funds to the retailer’s designated bank account. At this point, the funds from the black market sale of marijuana have been effectively laundered.
Marijuana retailers could also use crypto-currency to sell marijuana that does not comply with state regulations and divert the funds from these sales to an unaffiliated bank account. Finally, if a marijuana retailer uses crypto-currency to divert funds from legal marijuana sales to an unrelated bank account, the business could under-report its gross income and thereby avoid paying income and excise taxes.
What are the Consequences?
Crypto-currency’s penchant for unlawful transactions threatens Washington’s legal marijuana industry. Under the guidelines outlined in Deputy Attorney General James M. Cole’s 2014 memorandum titled Guidance Regarding Marijuana Enforcement (the Cole Memorandum), the federal government will not use its limited resources to prosecute marijuana businesses that abide by their state’s regulations and do not implicate the memoranda’s eight enforcement priorities. These enforcement priorities include “preventing revenue from the sale of marijuana from going to criminal enterprises, gangs and cartels” and “preventing state-authorized marijuana activity from being used as a cover or pretext for…illegal activity.”
As illustrated above, use of crypto-currency could implicate the enforcement priorities from the Cole Memorandum by facilitating money laundering, tax evasion and the unlawful diversion of marijuana sale revenues. Consequently, crypto-currency’s use could lead to widespread federal prosecution of marijuana businesses and eviscerate Washington’s marijuana industry altogether.
What Can Banks Do?
To protect themselves, banks must vigilantly monitor their marijuana clients for crypto-currency use. Monitoring clients can be a timely and expensive task for banks. To alleviate these costs, banks can work with third party compliance companies like PayQwick, which ensure licensed marijuana businesses remain compliant and do not use crypto-currency.
No matter how banks monitor their clients, they should not accept funds that were ever held as crypto-currency and should further ensure that none of their marijuana clients use crypto-currency. Moreover, if a bank discovers that one of its clients has been using crypto-currency, the bank should take appropriate action.
Re-Published from CBW Winter Newsletter
By Kenneth J. Berke, PayQwick, LLC’s Co-Founder and CEO, and Sahar Ayinehsazian, PayQwick, LLC’s Manager of Regulatory and Governmental Affairs.
PayQwick is a federally registered money services business, licensed as a money transmitter in both Washington and Oregon. PayQwick provides BSA/AML and state law compliance, cash management and electronic payment services. For more information, contact Kenneth J. Berke at email@example.com, (818) 224-7776 ext. 710 or Sahar Ayinehsazian at firstname.lastname@example.org, (818) 224-7776 ext. 722.