The New York State Department of Financial Services (NY-DFS) released its highly anticipated proposed BitLicense regulatory framework last week which addresses many of the problems that have plagued the virtual currency in the media over the last year. The virtual currency industry has been waiting to see the NY-DFS’s proposed framework since Benjamin Lawsky, the Superintendent of the NY-DFS, oversaw regulatory hearings with digital currency experts this past January. The proposed regulations detail the steps that companies transacting with virtual currencies such as bitcoin in New York State will need to take in order to comply with the new BitLicense regulatory scheme. The proposed BitLicense framework is open for comment until September 6, 2014. A full copy of the proposed BitLicense framework can be found here.

  1. Who needs a BitLicense?

The proposed BitLicense framework will require any company engaged in any Virtual Currency Business Activity to obtain a BitLicense unless it is chartered under the New York Banking Law to conduct exchange services and is approved to engage in Virtual Currency Business Activity. The proposed rules explain that “Virtual Currency Business Activity” means “conduct of any one of the following types of activities involving New York or a New York Resident:

  1. receiving Virtual Currency fortransmission or transmitting the same;
  2. securing, storing, holding, or maintaining custody or control of Virtual Currency on behalf of others;
  3. buying and selling Virtual Currency as a customer business;
  4. performing retail conversion services,including the conversion or exchange of Fiat Currency or other value into Virtual Currency, the conversion or exchange of Virtual Currency into Fiat Currency or other value, or the conversion or exchange of one form of Virtual Currency into another form of Virtual Currency; or
  5. controlling, admisntering, or issuing a Virtual Curreny."

Title 23, Chapter I, Part 200.2(n). Nonetheless, bitcoin miners as well as companies who simply accept payment in bitcoins will not need a BitLicense to operate in New York.

  1. What Does Compliance with the BitLicense Framework Require?

The BitLicense regulations address three major areas of concern over virtual currencies, and bitcoin in particular, that have been raised by regulators and consumer protection advocates:

  1. anti-money laundering
  2. consumer potection
  3. cybersecurity

Many of the proposed regulations would bring reporting on digital currencies in line with existing requirements that are already in place for the rest of the US financial system. For instance, companies operating under a BitLicense would be required to report suspicious activity, verify a customer’s name and physical address, and submit quarterly and annual audited financial reports. The proposed BitLicense framework also requires licensed companies to record the identity and physical address of both parties to all bitcoin transactions, which would prohibit use of bitcoin as a pseudonymous means of exchange, and also prohibits business from working with foreign shell entities. Additionally, BitLicensees will be required to meet certain capital requirements and maintain a bond or trust account on behalf of their customers. However, unlike traditional banks, which can loan out more money than they owe to customers, BitLicensees who secure, store, hold or maintain custody or control of virtual currencies on behalf of another party will be required to hold virtual currency of the same type and amount as that which is owed to the third party.

  1. Timing—When Must a Company File a BitLicense Application?

While a BitLicense will be required to engage in any Virtual Currency Business Activity once the rules are finalized, the proposed rules will permit existing companies to file for a BitLicense within 45 days following the release of the final regulations. Existing companies who file within this 45- day window will be given preliminary approval to operate, which will remain in force unless and until the NY-DFS reviews the company’s BitLicense application and finds fault with it, at which point the BitLicense can be revoked, forcing the company to immediately cease all Virtual Currency Business Activity in New York. Failing to apply for a BitLicense within 45 days following release of the final regulations by a company already engaged in Virtual Currency Business Activity in New York could result in criminal prosecution.

  1. How Is a BitLicense Obtained?

BitLicense applicants will be required to submit a written application under oath that lists all of the applicant’s affiliates and includes for each individual applicant, each officer and for certain stockholders and beneficiaries, inter alia, (a) biographical information, (b) a background report prepared by an independent investigatory agency, (c) fingerprints and photographs and (d) a current financial statement. Applicants are also required to submit a description of their past, current and proposed business, details of all banking arrangements, all written policies and procedures, an affidavit describing any action or threatened action against them, a copy of any insurance policies, and an explanation of how it will calculate the value of Virtual Currencies in Fiat Currency. A nonrefundable application fee will also be required.

Once a complete application is received by the NY-DFS, a decision approving or denying the application will be made within 90 days, although this time period can be extended at the discretion of the NY-DFS. However, once a BitLicense is granted, it will remain in effect until it is either surrendered by the BitLicensee or revoked or suspended by the NY-DFS after providing the BitLicensee with notice and a hearing.

Once a complete application is received by the NY-DFS, a decision approving or denying the application will be made within 90 days, although this time period can be extended at the discretion of the NY-DFS. However, once a BitLicense is granted, it will remain in effect until it is either surrendered by the BitLicensee or revoked or suspended by the NY-DFS after providing the BitLicensee with notice and a hearing.

*           *           *

While the BitLicense regulations are not yet finalized, and therefore are not yet mandatory, they provide guidance as to how New York will regulate bitcoins in the very near future. Companies in the virtual currency industry should begin preparing to comply with the BitLicense regime now so that they will not be caught off guard once the rules are finalized.