New York Proposes Novel Regulatory Scheme for Virtual Currency
Diana Uhimov, October 3, 2014.
After close to a year of public hearings and other inquiries, on July 21, 2014, the New York Department of Financial Services (DFS) proposed a novel comprehensive virtual currency regulatory framework, making New York the first state to take steps to regulate virtual currency businesses. Virtual currencies are digital representations of value that are utilized as money and can be transferred, stored and traded electronically. They are not government-backed or pegged to any fiat currency, which is currency that a government has declared to be legal tender, but is not backed by any physical commodity. Virtual currency is obtained by accepting it as a payment for goods and services or by buying it from someone you know. It can also be purchased directly from an exchange with funds from your bank account. Once it is in your possession, it can be used to purchase goods and services from many merchants who accept virtual currency worldwide.
Bitcoin, which launched in 2009, is the most popular virtual currency, but it is not the sole virtual currency firm. As with many virtual currencies, Bitcoin transactions are anonymous, but there are public ledgers with records of the transactions. Despite recent setbacks in the virtual currency market, there are many indications that it is gaining momentum and will eventually stabilize and become more established. For example, in May 2014, a prominent Bitcoin investor disclosed plans to list a Bitcoin exchange-traded fund on the Nasdaq stock exchange, and in June 2014, the State of California repealed a state law prohibiting commerce using anything but U.S. currency, permitting California businesses to accept virtual currencies as a form of payment. There have also been announcements from a few major retailers stating that they will accept payment in the form of Bitcoin, and reports of significant real estate deals which have been closed using solely virtual currency.
Commonly referred to as the “BitLicense” due to the licensing requirement for virtual currency firms operating in New York, the goals of the DFS regulations are customer protection, minimizing criminal activity, and creating a hospitable environment for start-ups. The initially scheduled 45-day public comment period on the proposed legislation has been extended to October 21, 2014, in response to requests from industry members for more time to review and reply. The regulations have been positively received on the one hand, for their ability to prevent the use of virtual currency for illicit activity and provide consumer protection, while on the other hand criticized as overreaching, potentially reducing competition by placing too heavy a burden on small businesses, and disincentivizing innovation.
According to the proposed regulations, a BitLicense will be compulsory for entities conducting virtual currency activities involving New York or a New York Resident. However, BitLicenses will not be required for: (i) entities that are chartered under the New York Banking Law to conduct exchange services and which are approved by the DFS to engage in virtual currency business activities; and (ii) businesses or consumers that use virtual currencies only for the purchase or sale of goods or services.
DFS Superintendent Benjamin M. Lawsky has described the proposed regulatory framework as a “collision of banking regulations with new technology.” The detailed scope of the legislation subjects virtual currency firms to rules regarding consumer protections, capital requirements, anti-money laundering, and cyber security. The legislation is also far-reaching, adopting a widely-inclusive definition of what entities are considered “virtual currency businesses.”
Members of the virtual currency industry are concerned over the expansiveness of the DFS regulations. Several Bitcoin exchanges have submitted comments to the DFS that the scope of the proposed framework should be limited to cover only virtual currency businesses with a meaningful connection to New York, and other virtual currency businesses, including Bitcoin wallet and Xapo, intend to circumvent the BitLicense requirement by excluding New York customers.
If DFS decides to make significant revisions to the proposed framework, it will issue an updated framework for additional review. It is not yet clear how the proposed regulations will affect the use of virtual currencies either in New York or beyond. Further, if other states or the federal government release similar rules, the interaction of the rules will require examination. It is also important to note foreign regulations, since virtual currencies are utilized globally.