Many Crypto Exchanges May Now Need Colorado Licenses
Law360, (September 25, 2018)
Ever since cryptocurrencies appeared on the scene, states have scrambled to determine whether their money transmission laws and licensure requirements apply to cryptocurrency exchanges. Fewer than half of the 56 states and U.S. territories provide clear direction to virtual currency firms about whether moving cryptocurrencies between virtual wallets requires a money transmitter license. Last week, on Sept. 20, 2018, Colorado joined the minority of jurisdictions with clear guidance on the issue.
Colorado's Division of Banking, through its interim regulatory guidance, stated that a license is required when a cryptocurrency exchange is capable of taking government-backed money (known as "fiat currency"), converting it to cryptocurrency, and then permitting the transfer of that cryptocurrency from one person to another, either of whom resides in Colorado. While an exchange may have some transactions that, at times, do not complete the entire circuit of fiat-in to fiat-out, if a cryptocurrency exchange is capable of transferring money between persons through the cryptocurrency medium, the exchange is subject to licensure.
Patty Salazar, the state bank and financial services commissioner, explained that the guidance is meant to support business in Colorado. Salazar said, "In an effort to support attracting and retaining innovative technology in Colorado, the Division of Banking, within the Department of Regulatory Agencies, is pleased to provide regulatory clarity regarding how cryptocurrency does and does not fit within the Colorado Money Transmitters Act."
This guidance is important to most virtual currency firms that operate in the United States, not just those that base their business in the Rocky Mountain state. Licensure in Colorado is required whenever a Colorado consumer is part of the transaction. Colorado has the third-highest concentration of tech workers in the United States. These are precisely the type of tech-savvy consumers that the cryptocurrency firms target.
Even with cryptocurrency values at their current low levels, the overall market is valued at about $200 billion total capitalization. State banking and finance regulators have seen a marked increase in requests for money transmitter licenses, including from tech companies like Apple Payments and Google Payments. To the detriment of these businesses engaged in money transfers, state regulators have responded slowly to these requests. Sometimes businesses must wait years before obtaining a license.
For example, since New York issued its regulations in 2015, only 11 companies have successfully secured a license, while many others have left the market altogether. New York has some of the strictest licensing requirements for any cryptocurrency firm doing business in the state. New York does not seem to be pulling back either. Just last week, the
state attorney general issued a report titled the "Virtual Markets Integrity Initiative" that illustrates the need for more regulatory oversight on cryptocurrency exchanges.
Under New York's regulatory framework, businesses must obtain a license known as "BitLicense" before taking part in any "virtual currency" business activity. New York defines "virtual currency" as any digital unit of exchange, whether centralized or decentralized. Any digital unit of exchange that can be created and obtained through computing efforts therefore falls under New York's regulations. Thus, entities that transmit virtual currencies, store them on behalf of others, buy and sell virtual currencies, or exchange and issue virtual currencies must obtain licenses.
Colorado's approach is less stringent than New York and will rely on the state statutory requirements necessary for traditional money transmitters. The Colorado Money Transmitters Act is a licensing statute that requires persons engaged in the business of "money transmissions" to obtain a license from the state banking board. The act defines "money transmission" as follows:
The sale or issuance of exchange or engaging in the business of receiving money for transmission or transmitting money within the United States or to locations abroad by any and all means including but not limited to payment instrument, wire, facsimile, or electronic transfer.
In other words, money transmission means either (1) the "sale or issuance of exchange" or (2) "engaging in the business of receiving money for transmission or transmitting money within the United States or to locations abroad by any and all means[.]"
Interpreting "[t]he sale or issuance of exchange[,]" the division found that the term "exchange" is limited to negotiable instruments such as checks, drafts or money orders because they constitute payments for a fixed amount and are payable at a definite time to a particular person. Because cryptocurrency is not a negotiable instrument, it is instead a digital asset not recognized as a legal tender; a person in the business of buying or selling or facilitating transfers of cryptocurrencies does not need to obtain a license.
On the other hand, a person "engaging in the business of receiving money for transmission or transmitting money within the United States" is required to obtain a license. Cryptocurrency exchanges allow users to link their bank accounts to fund their exchange accounts with fiat currency, which then allows users to purchase and transfer cryptocurrencies. Therefore, the guidance concludes that if a person engages in the business of transferring money from one customer to the other within an exchange through the medium of cryptocurrency, "that act would constitute money transmission and would be subject to licensure under the Colorado law."
Cryptocurrency firms that relied on previous guidance that exchanges operating in Colorado did not require a license will need to reconsider their positions. Unlike New York's requirements, Colorado law does not cover each and every type of business activity related to cryptocurrencies. However, if a business has the ability to transfer fiat currency between persons through the medium of cryptocurrency, that business should consider contacting the Division of Banking to determine whether the business should have a license.
Correction: An earlier version of this article misstated the number of New York BitLicenses issued since 2015. The error has been corrected. Sarah Auchterlonie is a shareholder at Brownstein Hyatt Farber Schreck LLP. She is a former attorney with the U.S. Department of the Treasury's Office of Thrift Supervision and a former acting deputy enforcement director with the Bureau of Consumer Financial Protection's Office of Enforcement. Emily R. Garnett is an associate and Tony Arias is a law clerk at the firm. Disclosure: Auchterlonie is an at-large member of the Colorado State Banking Board, which is the policy and rule-making authority for the state's Division of Banking and released the guidance discussed here. The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.