In June 2015, New York, through its Department of Financial Services (NYDFS), became the first state to adopt a detailed framework for regulating virtual currency businesses. Other states have sought to regulate virtual currency businesses through their money transmitter laws. For example, last week, North Carolina Governor Pat McCrory signed into law a Money Transmitters Act that applies to virtual currency businesses but is somewhat more business friendly than the New York regulation. This week, the Uniform Law Commission(ULC), an organization that works to develop legislation to promote uniformity and clarity among all states, considered the Uniform Regulation of Virtual Currency Business Act (the Act). This proposed statutory language, which all states will now have the option to adopt, is intended to “harmonize state-level regulation of virtual currencies in the absence of an overarching federal payments regulatory framework.” As set forth below, the Act improves upon the New York and North Carolina regulations by striking a balance that allows virtual currency businesses to innovate and grow, while also providing important consumer safeguards. Virtual currency businesses are currently unregulated in California, as proposed virtual currency regulations died in committee last year. Because the Act allows for innovation while also protecting consumers, California should work now to adopt it.
New York’s BitLicense Regulation
New York’s virtual currency regulation requires a virtual currency business to obtain a “BitLicense” in order to operate within the state. Because the BitLicense requirements are so cumbersome and costly, to date, New York has only issued two BitLicenses. One to Boston-based bitcoin startup Circle Internet Financial Inc. and one just this month to distributed ledger startup Ripple.
The BitLicense regulation includes a lengthy list of application requirements and has led to an exodus of companies out of New York. While some companies opted to make the investment to obtain a BitLicense, others decided to look elsewhere to pursue their business.
While we’re sure that the protection from New York law enforcement is valuable, it comes at a price that exceeds the market opportunity of servicing New York residents,” wrote the founders of Kraken, a San Francisco-based bitcoin exchange with $6.5 million venture capital. “Therefore, we have no option but to withdraw our service from the state.
Even the “simplified” application process in the final version of the regulation is not without significant risk or cost, namely $5,000 for the nonrefundable application fee. Additionally, the BitLicense requires each licensee to maintain capital in the amount and form determined by the superintendent as well as “a surety bond or trust account in United States dollars for the benefit of its customers in such form and amount as is acceptable to the superintendent.” There is also no way to guarantee that a BitLicense will be issued, as New York’s Superintendent of Banking possesses significant discretion as to whether to approve a BitLicense application. Upon receipt of a completed application, the Superintendent may determine whether “the applicant’s business will be conducted honestly, fairly, equitably, carefully, and efficiently within the purposes and intent of this Part, and in a manner commanding the confidence and trust of the community.” This subjective standard, in addition to no option for reciprocal or provisional licenses, leaves businesses without much guidance in terms of what is required to obtain a BitLicense, which undoubtedly has deterred many small business and start-ups from starting or operating virtual currency businesses in New York.
North Carolina’s Money Transmitters Act
The recently enacted North Carolina Money Transmitters Act takes a more business-friendly approach to regulating virtual currency businesses than the stringent New York BitLicense regulation to the extent that it defines virtual currency and many other necessary terms so that businesses have more guidance in navigating the legislation. Further, the list of exemptions is considerably longer than that of the BitLicense allowing many businesses to begin or continue operating in North Carolina without first obtaining a license.
While the Money Transmitters Act does make significant strides in enacting a more business-friendly regulatory scheme, it still poses difficulties for virtual currency businesses in North Carolina as there are cumbersome and costly requirements with no reciprocity or provisional licensing opportunities. The nonrefundable licensing fee is only a fraction of the BitLicense at $1,500 but comes with an additional amount to be paid for an annual assessment. This bill also requires applicants to maintain a minimum net worth not less than $250,000, which may be increased at the Commissioner’s discretion and also post a surety bond with the Commissioner for $150,000. This surety requirement will likely be an obstacle for virtual currency companies because of the cyclical nature and difficulty of obtaining such bonds in the marketplace.
The ULC Act Provides a Balanced and Comprehensive Regulatory Framework
The Act addresses many of the shortcomings in previous attempts to regulate virtual currency businesses, such as the rigid licensing requirements in New York and North Carolina. For example, both of those laws apply to all virtual currency businesses with the scope of the regulations, regardless of their size. In other words, well-capitalized established companies are treated exactly the same as start-ups and small businesses. The Act remedies this imbalance by providing for a provisional registration that functions as an “on-ramp” for start-ups to begin conducting business. Under this provision, a state adopting the Act will set an asset threshold, below which a company will qualify for a provisional registration that is much less cumbersome than the full licensing requirements. The company would have to file a notice with the regulatory department; pay a registration fee of $250; provide evidence of registration with FinCEN as a money services business; agree to not invest or pledge virtual currency in its custody or control on behalf of others or to engage in the exchange or transfer of legal tender; and prove its policies for reporting, disclosures, and compliance. The provisional registration expires when the business exceeds 75% of the value number of transactions or users listed in the initial notice; merges or is acquired, or after two years unless it has not exceeded the initially disclosed threshold.
The Act also minimizes burdens on start-ups and small businesses through a relaxed surety requirement. One of the biggest hurdles in applying for a full BitLicense or its counterparts in other states is the requirement that an applicant must provide a surety bond with its application. It is very difficult for small businesses and start-ups to obtain a surety bond in the marketplace before their license applications are approved. The ULC remedies this by requiring the surety bond after approval. This makes it much easier for small businesses and start-ups to continue to raise capital and develop their businesses while they are waiting for their license applications to be reviewed.
In addition to lessening some of the burdens for virtual currency companies seeking licensure, the Act still provides for solid consumer protection for all of the licensing options. Article 5 of the Act requires that companies disclose in a “clear and conspicuous manner” information the department deems reasonable in addition to the required disclosures including:
- Schedule of all fees and charges
- Whether the product or service is covered by a form of insurance or otherwise guaranteed against loss by an agency of the US
- Notice that transfer of virtual currency or digital units is irrevocable
- Notice describing the licensee’s liability for unauthorized, mistaken, or accidental transfers
- Notice that the date on which a transfer is made and the user’s account is debited may differ
- Whether the user has a right to stop a pre-authorized transfer of virtual currency and the procedures for doing so
- User’s right to receive a receipt
- User’s right to at least thirty days prior notice of any changes in licensure status
- Disclosure of the fact that virtual currency is not legal tender
Finally, the Act fosters innovation through uniformity and reciprocity. Any business that obtains a license in a state that adopts the Act will be able to quickly obtain a license in another state that adopts the Act. This will avoid the problem of small businesses and start-ups having to comply with inconsistent and costly registration requirements in order to conduct business in more than one state (or with the residents of more than one state). This greatly benefits consumers. As virtual currency transactions using cryptocurrency software rise, rules that seek to regulate virtual currency businesses geographically may be difficult to interpret and enforce. This means that consumers are likely to be unaware of what laws apply to their virtual currency transactions. Ideally, many or all states will, in the future, adopt the Act’s uniform set of rules, which provide consumers with the necessary protections regardless of where they and the virtual currency companies with which they do business are located.
California Should Adopt the Act Because it Provides Consumer Protection without Squelching Cutting-Edge Innovation
In February 2015, California Assemblymember Matt Dababneh introduced a bill to enact a Virtual Currency Actthat would have required virtual currency businesses to obtain licenses in California in order to engage in business in the state. The bill, which has been inactive since September 2015, was the last attempt to regulate virtual currency businesses in California.
The Virtual Currency Act was passed with some of the same burdensome licensing requirements as that of the BitLicense: a $5,000 initial application fee followed by annual assessment fees, a lengthy list of application requirements, no reciprocal licensing clause, and broad definitions for virtual currency and virtual currency business. It, however, did include the requirement for companies to use boilerplate consumer protection and transaction receipt clauses as well as the ability for low or no risk companies operating with less than $1,000,000 in outstanding obligations to pay a $500 application fee for a two-year provisional license that can then be renewed.
As more states begin to enact legislation regulating virtual currency businesses, those watching and working in this arena have begun to question whether California will make another attempt to enact virtual currency business regulation. While California has been taking a “wait-and-see” approach to virtual currency regulation, the Act provides compelling reasons for California to adopt it. As set forth above, as opposed to the stringent regulations in other states such as New York, and the bill proposed in the Assembly last year, which appear to deter companies from spending the time and money to pursue cutting-edge ideas, the Act appropriately balances the need for consumer protection with the desire to allow businesses to innovate. Thus, by adopting the Act, as opposed to the strict requirements of some other states, California will avoid pushing virtual currency start-ups and small businesses with limited resources out of California and into other states, and avoid hurting California’s well-deserved image as a sandbox that welcomes creativity and innovation. Additionally, California should be careful to avoid creating an environment where its residents do not have access to the useful services that virtual currency businesses can provide.
If California chooses to adopt its own virtual currency legislation, as opposed to the Act, it should still follow the UCL’s lead and create a framework that allows for regulation while also fostering innovation. At a minimum, California should allow for a provisional or short-term license or registration that would allow companies to come to market without having to meet the strict and costly requirements found in New York’s BitLicense and then allow them to apply for a full license later on if they want to continue doing business in California or with California residents. This would allow California to enact important consumer protections, such as the disclosure of material risks, the unpredictability of virtual currency price in relation to fiat currency, and consumer’s rights and remedies, without also immediately imposing harsh, costly licensing requirements. The State should also tie the licensing requirements to the size/experience of the business, such that small businesses or start-ups could obtain virtual currency licenses at a more reasonable cost. Again, the goal of any licensing regime should be to ensure that California provides a hospitable environment for virtual currency companies and that California remains at the forefront of virtual currency business development, while still providing solid consumer protection.