Linden Lab’s New ToS, the Bank Secrecy Act, and You

Today, Linden Lab updated its Terms of Service. The updated Terms of Service “make it clear that trading of Linden dollars (L$) on exchanges other than the LindeX, Second Life’s official L$ exchange, is not authorized or allowed.” This change has a lot of people concerned, because many of those third party exchangers are popular.

Why has LL made this change, and what does it mean to you?

Here’s why LL has (probably) made the change: FinCEN changed stuff first.

In March, the Financial Crimes Enforcement Network (FinCEN), the federal agency charged with enforcing the nation’s laws against money laundering, issued new regulatory guidelines regarding virtual currencies. This new guideline applies the Bank Secrecy Act to virtual currencies and businesses that administrate and exchange virtual currencies.

The Bank Secrecy Act contains numerous anti-money laundering and anti-fraud provisions. These provisions place certain requirements on “Money Services Businesses” (MSBs) and money transmitters, including registration requirements; requirements to collect information on any potentially suspicions transactions and keep extensive records on users; and requirements to report suspicious transactions to the federal government. A regulatory change applying the Bank Secrecy Act to virtual currencies, as FinCEN’s did, has some significant effects on any business relying on virtual currencies.

Let’s take a closer look. What did this change do?

First, FinCEN had to define who was and was not subject to the regulations. FinCEN acknowledged that there were “users,” “exchangers,” and “administrators” of virtual currencies. Users are people who obtain virtual currency, and are not MSBs: they are not subject to the registration, reporting, and recordkeeping regulations. However, exchangers (who have the ability to exchange virtual currency for real currency) and administrators (who have the ability to issue or withdraw virtual currency) are MSBs. They are subject to strict regulation.

Next, FinCEN had to sort out different kinds of exchangers and administrators. It identified three: those who trade in e-currencies and e-precious metals; centralized virtual currencies; and decentralized virtual currencies. Let’s look at the last two, because those affect Linden Lab.

  • A centralized convertible virtual currency, as defined by FinCEN, is a virtual currency “banked” in a centralized repository, controlled by a centralized administrator. Any exchanger of currency provides its services through access granted by the administrator. A clear example of a centralized virtual currency is Facebook’s virtual money.
  • A decentralized convertible virtual currency has no central repository and no single administrator. Users may obtain it through their own computing or manufacturing effort. Users who create or obtain that virtual currency and transmit it to other users in exchange for real currency, funds, or different forms of virtual currency are acting as exchangers, and are subject to regulation. Bitcoin is a clear example of a decentralized virtual currency.
  • Okay. And it applies to Linden Lab how?

    Now things are a little more clear. As of this past March, Linden Lab is an MSB, regulated by FinCEN under the Bank Secrecy Act. It is subject to some strict reporting, registration, and recordkeeping requirements. Linden Lab is an administrator and an exchanger of a centralized convertible virtual currency.

    Have you been following along? Because here’s the payoff: Because of the very strict reporting, registration, and recordkeeping requirements placed on LL by the Bank Secrecy Act, LL has to distance itself from any exchangers it does not control. Those exchangers might not be paying attention to the new FinCEN laws. They might not be keeping records. They might not be reporting suspicious transactions. They might be permitting money laundering. LL has to make it very, very clear that those exchangers aren’t authorized; they’re not part of LL; and LL isn’t responsible for them.

    So what does this mean to you?

    That depends.

    It may mean nothing at all. The third party exchangers may truck right along and be just fine. They may comply with the new regulations and continue forward. They may fail to comply and skate along without anyone noticing. BUT. They may fail to comply and get shut down and have all their assets seized. I don’t know.

    Third party exchangers have always been a “use at your own risk” proposition. However, now the federal government is actively cracking down on administrators and exchangers of virtual currencies. It looks like Linden Lab is taking steps to make sure it’s in compliance. I don’t know if the others are.

    So…you know. Use at your own risk. Really.

    EDIT: Apparently, Linden Lab’s support team is telling people that LL is interpreting “not authorized” to mean “not permitted” rather than “not accredited.” I really wish LL would clarify this, because Section 5.3 of the Second Life Terms of Service pretty clearly states that other exchanges exist and that people exchange money there, and it only states that such transactions are “not authorized.” I draft terms of service pretty regularly, you guys, and if they’re intending “not authorized” in this section to mean “grounds for termination,” that’s some sloppy contract drafting. LL, you need to fix this. In the meantime, I strongly suggest that SL users stick to the Lindex exchange.

    May 8: One last comment. First, Inara Pey drew my attention to a post she wrote in April about this very issue. It’s well-written and worth a look. Now, it may be that Linden Lab is doing something completely different, like just trying to get more revenue off Linden sales, or just trying to consolidate its control over the Linden dollar. These regulatory changes do affect LL, though, and it’s more likely than not that LL had to respond to them and chose to do it this way.

    Regardless, I think LL has some big problems to deal with related to this move. As I see it, they announced this change yesterday, required users to re-establish agreement to the new Terms of Service yesterday, and implemented the changes yesterday (including revoking the third-party exchangers’ access to certain APIs that they needed to function). But as per LL’s own Terms of Service, material changes to the ToS aren’t effective until 30 days after users receive notice…and this is absolutely a material change. And that’s a problem. I’m not sure who’s sailing the ship right now, but they need to get it tightened down.


    About Vaki

    Seriously, Mega Shark v. Giant Octopus is a masterpiece of modern cinema. What? It has Deborah Gibson in it. And there's this one scene where...what? Oh, like there's something better than a mega shark leaping out of the ocean and biting a plane in half. Whatever.
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    28 Responses to Linden Lab’s New ToS, the Bank Secrecy Act, and You

    1. Pingback: 5/6 TOS change: the end of non-LindeX exchanges? - Page 2 - SLUniverse Forums

    2. Pingback: The New ToS Explained

    3. Thank you so much for blogging about this! I was wondering what the new TOS was about.

    4. JubJub says:

      Thanks for this post, i hope it helps stop the FUD

    5. Jadeclaw says:

      Thanks for the info. This explains a lot.
      Interestingly, the third party exchange I’m using (Eldexchange) is based here in Germany and
      operates under german and european money laundering prevention- and banking laws.
      Which are already quite tight, e.g. all transactions must be recorded and all records kept for
      atleast 10 years. Everything is traceable over here. Yes, the USA is late in the game here.

      • Is there no way that we can state that WE (the users) want to use Eldexchange at our own risk? I have been using Eldexchange for the past 5-6 years now and they have provided the best customer service. They surpass LL in service with a million points!

    6. Wolf Baginski says:

      I’ve been using one of the Europe-based L$ exchanges, just as Jadeclaw has, and I have also seen signs of European banks being a bit suspicious of card payments to Linden Labs. The last one I made may have triggered an email from my bank, reminding me I must tell them if I am travelling to the USA.

      So what’s a guy to do?

      I have seen reports that either Visa or Mastercard (or both?) in the USA were talking about charging a higher rate for transactions through Paypal, and their justification was of Paypal not giving them full data on the transactions. Some people were speculating about advertising, some about fundie Christian management objecting to porn, but it fits with this sort of regulation change too.

      In Europe, Mastercard, Visa, and Paypal, are all distinct companies from the US operations, and subject to EU banking law with all the record keeping.

      Comparing how LL handles card payments with how EU companies do, I can’t help feeling that LL is operating under a less secure regime. And I am not sure they are following the VAT rules properly. I am in the EU, and not a registered trader, and SL would not be a business expense anyway, so LL has to charge me VAT, and remit it to my national tax collectors. But I’ve done VAT accounting, and the transaction details they send me don’t meet the standards I was taught.

      On what I see, I am inclined to wonder whether the problem is their accounting system, or their web page coding. It would be pretty trivial to include their VAT Registration Number on the web page that is about VAT, but I haven’t yet found that number anywhere.

      • Vaki says:

        Really interesting points regarding EU regulations, Wolf. I’m not familiar with EU banking law or VAT requirements, so I can’t speak to those, but you’re right: there are a lot of things that LL does not do with its currency that it should, if Lindens are indeed a currency. Very curious to see where all this goes as US finance regulations get more stringent on virtual currencies.

        • Wolf Baginski says:

          I did a bit of checking. Some of the supermarkets in the UK put their VAT number on their till receipts, some don’t. But it’s pretty easy to find their VAT Number with Google. Linden Labs, on the other hand, doesn’t tell customers, and a similar Google search doesn’t find the number. That’s where things get dodgy. It’s not so much actual illegality as something that a tax inspector might take as a sign.

          And this particular aspect is about real-money transactions. The status of the L$ is irrelevant.

          I hope.

          Look at what the TOS is saying the L$ is: a license to use a service. Which is liable for VAT.

    7. Thomas says:

      Jadeclaw read again the text in english this time
      (…there will be no Eldexchange if that happens)

      • Jadeclaw says:

        I did read the text in english (I don’t use Google Translate for english texts). Fact is, all third party exchanges got an email from the Lab, ordering them to cease all trading in L$ and ordering them to remove all items connected to their exchanges.

        I had a mail exchange with Eldexchange, asking about LL’s “brain fart” and they wrote back, I quote: “This is not a brain fart, this is napalm…”. Eldexchange currently trades only in the currency Avination uses, they still hope, that trading in L$ can be resumed after clarification from the Lab. I’m seriously miffed, that I may have to deal with PayPal in the future instead.

        And something that really irks me here, the FinCEN-statement was from mid-March, now it is May, was it really that hard to give the exchanges the proper information in advance, so they could change the way they operate or allow to wind up the business properly? To me it looks like asshattery is currently the normal way the Lab operates.

    8. Well written! I have been trying to explain about BSA and the need LL now has to make sure that $L is not regarded as a currency for some time!

    9. Inara Pey says:

      I’d considered the FinCEN guidelines when I saw the LL blog piece, having written about it back in March myself. However, I’m not 100% convinced the FinCEN guidelines were the motivating factor behind the update. For one thing, there isn’t anything in the guidelines to suggest that LL would in any way be held accountable for any failure on the part of a third-party MSB than is currently the case.

      As such, I tend to go with this being more a move directed at further limiting the opportunities for frauduent actions involving SL users which may have an impact on the platform as a whole, rather than a direct result of FinCEN issuing a set of intrepretive guidelines.

      That said, I would add that where there is a potential overlap between the two (the FinCEN guidelines and the SL ToS change), inasmuch as by attempting to limit any exposure of L$ to third-party exchanges and confine trading to LL’s own mechanism (the LindeX), the Lab might be trying to strengthen their position that the L$ is a “gaming token” rather than a “virtual currency” – which cuts to the heart of the core difference in their interpretation of the Linden Dollar’s status, and how FinCEN might regard it.

      • Vaki says:

        Great article, Inara — I hadn’t seen that, and you’re absolutely right. LL describes the Linden as a “virtual token,” but it’s a virtual currency by FinCEN’s definition, and LL is an administrator (and an exchanger) of that currency, because LL does allow the exchange of Lindens for cash. And even if LL argues around it: one critical ambiguity in FinCEN’s guidelines is that it does not address whether or not the exchange of virtual currency for real cash must be authorized by the administrator (for instance, does WoW gold count as a virtual currency, even though it is absolutely not redeemable for cash value to Blizzard, but it is absolutely exchangeable for cash via third party exchangers?). I think that the guidelines anticipate that it does count as a virtual currency, but they don’t explicitly address it.

        I agree that LL wouldn’t be held accountable for failures on the part of a third-party MSB…unless the third-party MSB could argue that it was in some way the agent of LL, or was authorized by LL (note, for instance, that LL has for years provided APIs to third-party exchanges that make it possible for them to function). Which is why, as I see it, LL has to distance itself from third-party exchangers and make it clear that they are not authorized, that there is no business relationship between them and LL, and that LL has no sort of contributory liability for the actions of third-party exchanges.

        But you’re right: this may not be due to the FinCEN guidelines, and may just be a move by LL to strengthen its own control over the Linden.

        • Inara Pey says:

          I totally agree that the FinCEN document itself is ambigous, and that there is a pretty wide gulf between LL’s position that L$ is a “token” and theFinCEN’s criteria for it being a virtual currency – as you rightly point-out, the L$ does appear to tick all the boxes in the latter regard.

          However, perhaps the biggest ambiguity with the FinCEN guidelines is that while tey attempt to clarify, there is no underpinning change to the regulations for the BSA (none of the regulations appear to have been updated since 2011), as such there is a big question mark over how much legal weight the guidelines themselves have, as it could be argued (and has on some blogs) that the guidelines are seeking to change the rules without actually tightening / clarifying the regulatory acts.

          So a bit of a mix-up all ways round – and all certainly food for thought!

        • We are all feeling the huge sting of the recession and I cant help but feel that this is an effort from LL to get some more revenue

    10. I think that the issue here is to figure out what is LL’s intent, and if the bad wording of the ToS is just, well, bad wording. I mean, you pointed out correctly that one thing is defining what “authorized” means, the other is saying, on the very same ToS, that third-party exchanges exist (5.3. There are other exchanges that are operated by third parties on which Linden dollars are exchanged.)

      To me, this sounds pretty much lawyers screwing up, as they have so often done in the past. It’s like Google+ issues about using pseudonyms: they’re technically not allowed, unless you’re “famous”, but nobody knows how “fame” is defined, and it’s left deliberately vague.

      So either LL wants to turn the LindeX into a monopoly, and then they should rewrite 5.3 and simply state “Exchanging L$ for real currency outside the LindeX is strictly forbidden and your account will be terminated if you a) operate an exchange; b) transact with them”, or simply make clear that they only vouch for the LindeX and it’s caveat emptor elsewhere, which would be rather more reasonable.

      In my country, Multibanco/SIBS, a huge payment gateway (connecting all banks in Portugal and running the whole of the ATM network) also exchanges Euros for L$. It would be ironical that such a huge banking monster, which has a gazillion of permits to exchange money in all possible ways, would be denied access to L$/Euro transactions by a puny organisation somewhere in California which doesn’t even have good lawyers who knows how to spell things right 🙂

      In either case, some enterprising Germans have already put up a petition for LL to revise their ToS and write it correctly. Sadly the text of the petition is in German only (for now), but hopefully they add an English translation for the SL residents who are not fluent in German but also wish to sign the petition…

    11. Simone says:

      On my facebook account there is a translation for the petition

    12. NoName do Montijo says:

      Interesting discussion.. only time will tell whats about to happen in LaLa land. Sincerely hope that we all dont get limited to lindex when comes to exchange the precious virtual tokens. Limits, higher fees, paypal, usd bank conversions… blergh!

      Small note on the side… The multibanco/sibs in portugal doesnt run the exchange of lindens. Its run by a third party individual who makes usage of multibanco to issue automated payment details thus allowing people to pay through atm or homebanking in order to buy lindens almost instantly

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