Consumer Protection

New York Issues Proposed Bitcoin Regulations

On July 17, the New York State Department of Financial Services (DFS) issued proposed regulations delineating a license process for certain businesses involved in Bitcoin and other virtual currencies (Proposed Rules).1 The Proposed Rules would require any business that engages in “virtual currency business activity” (Virtual Currency Firms) to obtain a license from DFS (BitLicense) and would require such businesses to adopt consumer protection, anti-money laundering and cybersecurity procedures and requirements.

A 45-day public comment period for the Proposed Rules commenced on July 23.2 The Proposed Rules may be revised and reissued by DFS following the review of the public comments.

Executive Summary Of Proposed Regulations
  • Any business that secures, stores, holds or maintains custody or control of virtual currency on behalf of others or engages in other delineated businesses is required to obtain a BitLicense.
  • Applicants for a BitLicense must provide disclosure about its operations and owners and provide detailed background information and fingerprints of such owners.
  • Applicants for a Bit License must maintain “adequate” capital based on the size and nature of the business and such capital must be invested in specified U.S. dollar-denominated accounts.
  • Applicants for a BitLicense must establish anti-money laundering and similar policies that are subject to the review and inspection of DFS.
  • BitLicense holders must maintain records for an extended period of time and periodically submit reports and financial statements to DFS.
Summary Of Bitcoin

As explained in our November 26, 2013, advisory3 Bitcoin is a type of digital asset that is based upon a peer-to-peer, decentralized, computer-generated, math-based and cryptographic protocol. Bitcoins may be converted to fiat currencies, such as U.S. dollars or other national currencies based on then-current exchange rates. Approximately 13 million bitcoins currently exist, and the maximum number of bitcoins that will ever be created is 21 million. Approximately 400 digital assets or “altcoins” have been launched, of which 10 have a market capitalization in excess of $10 million as of July 23, 2014, and many of which are based on protocols similar to or derived from the protocol and computer network that underlie bitcoin transactions (Bitcoin Network).

Scope Of The BitLicense Framework

The Proposed Rules require Virtual Currency Firms to apply for BitLicenses from the DFS prior to commencing operations.4 A Virtual Currency Firm refers to any person that engages in “virtual currency business activity,” which includes, among other things, (a) receiving “virtual currency”5 for transmission or transmitting it; (b) securing, storing, holding or maintaining custody or control of virtual currency on behalf of others; (c) buying and selling virtual currency as a customer business; and (d) performing retail conversion services (i.e., the conversion of virtual currency into fiat currency, or vice versa, or the conversion of a virtual currency into another virtual currency), provided that such activity involves the State of New York or a resident thereof.6

As drafted, it is possible that the Proposed Rules would require virtual currency exchanges, storage services such as online Bitcoin “wallets” and funds that invest in Bitcoin to obtain a BitLicense. However, the Proposed Rules exempt (a) banks and limited liability trust corporations chartered under the laws of the State of New York that are approved by DFS and (b) merchants and consumers that use virtual currency solely for the purchase or sale of goods and services.

Application Process

A prospective licensee (Applicant) must provide extensive information about its operations and its principal officers, equity owners and/or beneficiaries, including but not limited to (a) a description of the proposed, current and historical business of the Applicant; (b) detailed background information; and (c) an independently prepared background report for the Applicant and its owners and current financial statements for the Applicant and its owners.7 The Proposed Rules require DFS to approve or deny a completed application within 90 days of its filing, subject to an extension by DFS. The Proposed Rules require DFS to investigate the “financial condition and responsibility, financial and business experience, and character and general fitness of the [A]pplicant.” As such, DFS has broad discretionary authority in granting BitLicenses.

Licensee Requirements

The Proposed Rules subject Virtual Currency Firms to various regulations and requirements concerning their operations. Some of the most significant licensee requirements are summarized below.

Minimum Capital and Asset Custody Requirements

The Proposed Rules require each licensee to maintain minimum capital in an amount to be determined based on proposed operations. The minimum capital required is based upon the total assets and liabilities, the actual and expected volume of the licensee’s virtual currency business activity, the liquidity position of the licensee and the amount of leverage employed by the licensee. The Proposed Rules require earnings and profits to be stored in certificates of deposit issued by financial institutions regulated by a federal or state agency, money market funds, state and municipal bonds, U.S. government securities or U.S. government agency securities, provided that each of the foregoing is denominated in U.S. dollars and has a maximum maturity of one year.

In addition, licensees would be required to maintain a bond or trust account in U.S. dollars for the benefit and protection of their customers. Furthermore, if a licensee maintains custody or control, or otherwise secures or holds, virtual currency on behalf of customers, such licensee must hold in reserve an equal amount of virtual currency as being stored by the customers (e.g., a wallet that stores 50,000 bitcoin for its customers is required to maintain a “reserve” of 50,000 bitcoin that is not accessible by customers). The Proposed Rules prohibit licensees from selling, transferring, hypothecating, lending or otherwise using the customers’ virtual currency, thereby preventing a business from, among other things, operating a fractional reserve business operation or lending customer deposits.

Although the proposed BitLicense includes comprehensive rules, it represents the next step in the evolution and acceptability of Bitcoin and virtual currencies. By proposing rules to protect customers, DFS is creating a framework to ensure that businesses that operate in New York are legitimate and complying with applicable federal and state regulations. While there is no current indication that other states or foreign jurisdictions will follow the DFS's BitLicense framework (whether in its proposed or finalized form), the BitLicense framework may influence other jurisdictions' regulatory responses to virtual currencies.

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