There have been times, especially during the last several years, when it seemed like the American Congress was completely incapable of any action, let alone rapid action. They might need to take lessons in action from the New York State Department of Financial Services who, only seven months after holding extensive and highly publicized meetings on cryptocurrency regulations, has already released a draft of proposed rules for regulating virtual currencies.

Finance Department Superintendent Benjamin Lawsky released the surprisingly short 40-page draft explaining that it was intended only to put some sort of regulatory framework around digital currencies that were operating in New York State. The rules are set for official publication on July 23, 2014 and this will also begin a forty-five day public comment period. Lawsky said in the press release about the draft:

“We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity – without stifling beneficial innovation.  Setting up common sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets.”

The proposed rules will still have to be adopted but that does not seem to be a real problem. After the regulations come into effect, any business offering virtual currency services must apply for a license to do business in the state and meet the regulatory requirements - not only maintaining certain levels of capital and good bookkeeping but also comply with any FinCEN regulations concerning money laundering, fraud and cyber-security.  Bitcoin business would also have to agree to two year inspections by the Bureau of Financial Services (BFS).

Director Lawsky has taken the lead in New York as far as determining the fate of virtual currencies and has proven to be very open-minded on the issue, keeping as his main concern protecting the consumer while promoting innovation to strengthen these currencies, which will add another layer of consumer protection. During the earlier meetings he heard statements from some of the industries main leaders, including Litecoin creator Charles Lee, Coinbase co-founder Fred Ehrsam, Cameron and Tyler Winklevoss and SecondMarket’s Barry Silbert. Cameron Winklevoss said via email:

 “We are pleased that Superintendent Lawsky and the Department of Financial Services have embraced Bitcoin and digital assets and created a regulatory framework that protects consumers. We look forward to New York State becoming the hub of this exciting new technology.”

But the question is how well the rules will go down with people who actually use Bitcoin, especially people who got in at the beginning. These people, most commonly known as “cryptoanarchists” use Bitcoin precisely because of its decentralized, unregulated nature and many of these people are looking forward to opening a Bitcoin startup or a business accepting BTC. If the comments in at least one Reddit Feed are an example of the general attitude, the backlash is already here. Additionally, Erik Voorhees already made a blog post criticizing the move for essentially making financial privacy a crime.

Tim Byun, Chief Compliance Officer at BitPay, one of the world’s largest virtual currency payment processors, told Cointelegraph today that he commended both the DFS and Ben Lawsky for supporting innovation while at the same time ensuring balanced regulations. He said that the framework proposed by the Department of Financial Services corresponded to the department’s position:

  • Strong understanding of the Bitcoin ecosystem, including valuable services to consumers that would benefit from an emerging, efficient and cheaper payment system
  • Strong understanding of Anti-Money Laundering/Anti-Terrorist Financing and T Trade Sanction obligations, including existing Virtual Currency regulations and exemptions at the Federal level.
  • Ability to leverage the Bank Secrecy Act and the significant resources that are already expended by the Bitcoin ecosystem to comply with anti-money laundering and anti-terrorist financing requirements.
  • Openness in setting a standard in the next 45 days that will likely be followed by other states.

BitPay appreciates the comment period that the DFS has allowed from all shareholders, including those in the Bitcoin industry. The company says that if feels very strongly about both consumers and merchants having access to “innovation and the true potential for efficient, cheaper, faster payment systems.”

However, BitPay also noted three important potential problems that will need to be worked out:

  1. Reporting on virtual currency transactions, particularly with regards to purchases totalling over US$10,000, might create an unlevel playing field as purchases with credit/debit cards of under that amount are not required to be reported.
  2. Identification for large transactions might be reasonable if applied when exchanging Bitcoins for virtual currencies. It may however be unnecessary for the purchases of goods and services similar to commerce today.
  3. Cyber Security Program - having sound security controls is paramount; however, the requirements of annual penetration test and others may inhibit further innovation, as smaller ecosystem entrants would face significant costs. The framework may benefit from a more risk based program or establishing nominal thresholds that would enable innovation while ensuring controls or transparency to protect consumers.

But it’s good to see the issue moving forward even though there are still plenty of bugs to iron out. While national governments seem to be scratching their heads and dragging their feet on this issue, letting local jurisdiction’s handle the decision appears to be the most effective approach at this point to attract investment similarly to the EU ruling that member nations would have to regulate on a nation by nation basis.

Community commentary:

Moe Levin:

“I think that it needs a lot of work, but confirms that lawmakers and government officials have a skewed view of Bitcoin. It's our job to educate them and engage in an open (and patient) and smart dialogue.”

Lamar Wilson:

“As written, the “BitLicense” regulations draft still displays a basic misunderstanding of how crypto-currency technology works, and will more than likely drive a lot of crypto innovation away from the state of NY.  With that said, it's also been noted that they would like to hear feedback from the community as a whole to get a better grip on what will work. So everyone in the community should be collectively giving feedback through every source of media possible. Cryptocurrency technology is about freedom.  It's about gaining back control of our own financial future, without permission from anyone. The same way the internet liberated information, crypto currency has done that for money.  Thus, we should not fear this type of regulation, but look at it as a validation of the power of monetary freedom. The seed of change has been planted, and its crown is becoming more visible daily.”

Jeremy Gardner (College Cryptocurrency Network):

“When there is a weak or nonexistent regulatory environment for a financial innovation such as Bitcoin, it becomes a sort of Wild West. It's how Charlie Shrem and Ross Ulbricht ended up where they are now. Sure, there's a lot of amazing innovation when no guidelines are in place, but a lot of customers and businesses get screwed in the process. I applaud Lawsky's efforts to balance the need for consumer protection and the desire not to stifle innovation.”

Juan Llanos:

"Having been in the money transfer industry for over a decade, the prudential aspects do not come as a surprise at all. That is, the background checks on management, the capital requirements, the protection of assets; in short, the safety and soundness requirements.  That's supposed to be the primary reason to regulate. This is a known high-bar.  Even the fact that Bitcoin was not going to be allowed to be a permissible investment.  I actually wrote about it last January and argued that it was sufficient regulation.
    Where the NYS government has raised the bar in a disproportionate way, in my opinion, is in the requirement to fully identify both parties to a payment at dollar zero.  That's unprecedented and clearly technology-specific.  No other financial services product is subject to such a requirement, and the electronic version of cash (bitcoin) shouldn't either.And in the case of bitcoin, unworkable.  Lawsky know from the hearings and over six months of research that bitcoin has fundamental features that make it unique, one of which is the virtual impossibility of identifying the counterparty to a payment.  However, he's mandating that their identify be verified.
    Another aspect that is striking is who should be regulated, and in his opinion everybody should, including pass-through wallet services that don't have control of customers' private keys. That means that many companies that are not considered money transmitters at the federal level, will be at the state level, e.g.,
    Also, something that I had observed only in Arizona before, is that NY is basically creating a new anti-money laundering regime at the state level.  Money laundering laws are the prerogative of the federal state, however, he's creating additional reporting requirements that will be difficult to enforce, and will add additional complexity and expense to companies.
    In sum, as I said it yesterday via Twitter, I think the bottom line is that NY has set high-bar requirements that very few companies will be able to meet.  The proverbial barrier to entry, if this regulation is passed as is, the bar will be insurmountable for underfunded startups."


Will Pangman:

The BitLicense is unfeasible and does not take into account non-monetary uses of blockchain technologies. As written, the draft is vague and far overreaching beyond New York State. Bitcoin entrepreneurs need to stand up for this industry, call the suggested regulations what they are, and stop pandering to politicians and bureaucrats for their permission to innovate.

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