In an extraordinary public sparring match through Coindesk’s daily blog on April 18, 2019, the New York State Department of Financial Services provided further insight into why, two weeks ago, it suspended Bittrex, Inc. from operating in New York as a cryptoasset exchange and denied it a BitLicense and money transmitter license. In response on the same blog post, Bittrex attacked the DFS for “overstepping its regulatory authority and changing rules and guidelines on the fly.” 

(Click here for details of DFS’s action against Bittrex, and Bittrex’s public response at the time in the article “New York State Department of Financial Services Revokes Crypto Exchange’s Safe Harbor to Operate Without BitLicense” in the April 14, 2019 edition of Bridging the Week.) DFS’s principal office is in New York City.

In an article by Shirin Emami, the DFS’s Executive Deputy Superintendent for Banking, the agency castigated Bittrex’s defense of its conduct in a press statement on April 10, 2019. Ms. Emami claimed that Bittrex’s defense “continues to misstate the facts and it presents a misleading picture about the denial.” Ms. Emami said that Bittrex’s initial applications for licenses contained “many deficiencies” although NY DFS “repeatedly” advised Bittrex of regulatory requirements and how it could address its applications’ weaknesses. Ms. Emami claimed that DFS’s suggestions were generally rejected. According to Ms. Emami, “Bittrex made promises and representations to obtain virtual currency and money transmitter licenses in New York, was given every opportunity by DFS to meet the required regulatory requirements and was denied because it failed to deliver.”

Bittrex passionately disputed DFS’s new allegations, and concluded that “[t]he actions of the NY DFS show that it was focused on retribution rather than consumer protection.” In particular, Bittrex claimed that DFS’s criticism that its transaction monitoring system was manual was disingenuous; under applicable rule, noted Bittrex, transaction monitoring may be automated or manual. (Click here to access Rule 504.3(a) of the NY DFS Superintendent’s Regulations related to transaction monitoring.)

In other regulatory and legal developments involving cryptoassets:

  • FinCEN Sanctions Peer-to-Peer Virtual Currency Exchanger for Licensing and AML Violations: The Financial Crimes Enforcement Network of the US Department of Treasury brought and settled an enforcement action against Eric Powers for failing to register as a money service business (MSB), having no written anti-money laundering or related policies or procedures, and not reporting suspicious transactions and certain currency transactions, all as required by applicable law. 

According to FinCEN, Mr. Powers failed to adhere to applicable requirements when, from December 6, 2012 through September 24, 2014, he acted as an exchanger of virtual currency by buying and selling bitcoin to and from others, and conducted over 1,700 transactions as a money transmitter. FinCEN claimed that Mr. Powers continued to act as an unregistered money transmitter even after it published guidance on March 18, 2013 warning that persons in the business of exchanging convertible virtual currencies are money transmitters and must register as MSBs (click here to access the relevant FinCEN guidance). FinCEN also indicated that, during the relevant time, Mr. Powers “processed transactions that bore strong indicia of illicit activity” without reporting such activity. This included activity with customers doing business on the darknet website Silk Road – a location associated with illegal drug sales.

To resolve his enforcement action, Mr. Powers consented to pay a fine of US $35,000 and never to engage in activity that would constitute a money service business.

  • Cryptoassets Among FCA Top Priorities for Upcoming Year: The UK Financial Conduct Authority said in its 2019/2020 business plan issued last week that sometime during the upcoming year, it will publish a feedback summary and issue finalized perimeter guidance in response to its consultation paper on cryptoassets issued earlier this year.

In the relevant consultation paper, the FCA observed that, while security tokens fall within its regulatory perimeter, cryptocurrencies (which the FCA labels “exchange tokens”) and utility tokens are likely outside its oversight. Notwithstanding, the FCA noted that certain payment tokens pegged to fiat currency (e.g., stablecoins) may be subject to UK requirements related to e-money and that under some circumstances, stablecoins pegged to fiat currencies, other commodities or assets (e.g., gold), or baskets of other cryptoassets may constitute securities if they resemble funds or a derivative. (Click here for details on the FCA’s prior consultation paper in the article “UK Financial Conduct Authority Proposes Guidance Regarding Cryptoassets; Says Cryptocurrencies and Utility Tokens Generally Outside Regulatory Perimeter” in the January 27, 2019 edition of Bridging the Week.)

In its business plan, the FCA said that, during the upcoming year, it will also provide technical guidance to Her Majesty’s Treasury regarding extending the regulatory perimeter to capture exchange and utility tokens, as well as to extend anti‑money laundering requirements to certain unspecified activities involving cryptoassets.

In addition to dealing with cryptoassets, the FCA also disclosed that its top priorities for 2019/2020 included continuing to help enhance financial services firms’ culture and governance; working to promote operational resiliency at regulated firms (e.g., cybersecurity), including “setting clear expectations on outsourcing to third party service providers;” and enhancing the FCA’s own anti-money laundering capabilities. During the upcoming year, the FCA plans to continue to support a “smooth” post-Brexit transition.

My View: The case for a single federal regulator of cryptocurrency exchanges is overwhelming. Today, jurisdiction over such entities is practically divided among FinCEN (which generally requires exchangers of virtual currency to be registered as money service businesses), the states (many of which require such entities to register as money transmitters or in an equivalent manner, or in the case of New York, also mandate such entities to obtain a so‑called “BitLicense”) and the Commodity Futures Trading Commission (which exercises anti-fraud and anti-manipulation authority over transactions involving spot virtual currencies but does not functionally regulate such transactions day-to-day). (Click here for a general discussion of federal and state jurisdictional issues involving cryptoassets in the article “Digital and Digitized Assets: Federal and State Jurisdictional Issues” by the American Bar Association Derivatives and Futures Law Committee (March 2019).)

Although most states view cryptocurrency exchanges’ activities as implicating their requirements for money transmitters, many states do not. (Click here, e.g., for background in the article “Cryptocurrency Exchange Not a Money Transmitter Says Pennsylvania” in the January 27, 2019 edition of Bridging the Week.) Moreover, except for New York, none of the states or FinCEN regulate cryptocurrency exchange activities as traditional exchange conduct. As a result, requirements for such entities tend to emphasize anti-money laundering and US government sanctions’ compliance and cyber security protections, as well as capital and bonding, as opposed to monitoring and protecting against manipulative trading.

To me, this hodgepodge approach is a big problem waiting to happen and creates a too-high barrier to entry for legitimate firms that wish to provide innovative cryptoasset trading solutions.