Will New York Be the First State to Regulate Bitcoin?

Will New York Be the First State to Regulate Bitcoin?

New York is poised to become the leading authority on virtual currency (generally referred to as “Bitcoin”) regulation. The New York State Department of Financial Services (“NYSDFS”) recently published a Notice of Proposed Rulemaking regarding the regulation of such virtual medium of exchange.

As noted in the NYSDFS proposal, the proposed regulation is intended to protect members of the public by imposing regulatory standards on virtual currency transactions and services that involve New York or New York residents, ensure the solvency, safety, soundness, and prudent conduct of persons or entities engaged in virtual currency business activity, and to foster the growth of the financial industry in New York by setting forth clear guidelines that will inspire confidence and allow for the establishment of legal virtual currency business activity.

Concerns about security and reliability are two key reasons why virtual currency is not yet a mainstream form of payment. In its early days, Bitcoin was often associated with nefarious activities, such as anonymously purchasing guns or drugs online. Even when used to make legitimate purchases, the lack of legal protections makes transactions more susceptible to fraud.

Ben Lawsky, Superintendent of Financial Services at NYSDFS, spearheaded New York’s effort to regulate virtual currency. While once an outspoken critic, Lawsky’s stance on Bitcoin softened greatly after talking to stakeholders in the industry, including lawyers, consumers, and business owners. While he once characterized the virtual currency as a “threat to national security,” he now sees the potential of the technology, albeit with proper safeguards in place.

Nonetheless, Lawsky acknowledged that crafting the new regulation was not easy. “Fashioning appropriate guardrails for virtual currencies presents challenging questions for regulators,” he stated at public hearings held in January. “Virtual currency is not easily categorized within the divisions we traditionally think about when it comes to the financial system (such as banks, insurers, or money transmitters). It’s neither fish nor fowl.”

Under the rule proposal, “virtual currency businesses” would have to obtain a license from NYSDFS. The definition encompasses a number of industry players, such as Bitcoin exchanges, digital wallet apps, and merchant service providers, but excludes consumers, retailers, and entities chartered under the New York Banking Law to conduct exchange services (and approved by the Superintendent of Financial Services at NYSDFS to handle Bitcoin transactions)..

Licensees would be subject to various compliance obligations, such as developing and enforcing anti-fraud, anti-money laundering, cybersecurity, and data security procedures. They would also be subject to capital requirements and biennial examinations.

The comment period on the proposed regulations runs through August 31, 2014.

If you have any questions about this post or would like to discuss the legal issues surrounding virtual currency, please contact me, Robert Marisco, or the Scarinci Hollenbeck attorney with whom you work.