On March 11, the New York State Department of Financial Services issued an Order announcing that that it “will consider formal proposals and applications in connection with the establishment of regulated virtual currency exchanges operating in New York.” While the Order itself is silent on timing, an accompanying press release makes clear that the NYDFS will begin accepting applications from exchanges “immediately.” The press release also makes clear that while exchanges can begin submitting applications at any time, approved applicants will ultimately be required to adhere to the proposed “BitLicense” regulatory framework, which the NYDFS promised would be announced no later than the end of the second quarter of 2014.
Following the Bitcoin hearings held in January 2014, NYDFS Superintendent Benjamin Lawksy had previously set a timeline of the end of the year for finalizing a new “BitLicense” regulatory framework for Bitcoin and other virtual currency businesses. Both the acceleration of the timetable for adoption of the BitLicense framework and the announcement that the NYDFS will begin accepting applications from exchanges immediately are consistent with the NYDFS’s increased interest in bitcoin and in attracting virtual currency firms to New York, as evidenced by statements made by Superintendent Lawsky during and after the NYDFS bitcoin hearings.
While the Order addresses only exchanges, the press release says that NYDFS expects to begin considering applications “for other types of virtual currency firms beyond exchanges” in the “near future.” This raises the question of what kinds of virtual currency businesses other than exchanges will be regulated under the BitLicense regime, and the closely related question of what exactly the NYDFS means by an “exchange.”
Neither the Order nor the press release defines what the NYDFS considers to be a “virtual currency exchange.” Presumably, virtual currency firms engaging in activity that involves traditional money transmitter functions will be regulated as such, especially in light of the fact that FinCEN classified exchangers of virtual currency as money transmitters in its virtual currency guidance issued a year ago. However, the sections of the New York Banking Law that the NYDFS cited as authority for the Order do not relate to money transmitters, but rather to trust companies and insurance of deposits. This raises the question of whether the NYDFS intends to regulate virtual currency firms that never hold user assets in custody (e.g., those performing a contemporaneous exchange of fiat currency for virtual currency or vice versa, with instant remittance of proceeds to a user’s account) with the upcoming BitLicense regulatory proposal. This is an issue virtual currency firms should monitor closely, as the Order’s separation of exchanges from “other types of virtual currency firms” may signal that separate treatment is appropriate in light of the type of activity involved or the type of financial service provided.
Since no application form or due diligence list was issued with the order, virtual currency exchanges should presumably use existing application materials for New York money transmitters as a starting point. In light of the NYDFS’ request for “applications and proposals,” however, it is likely that applicants will need to propose modifications to the forms and requirements for the NYDFS’s consideration. Further, the announcement makes clear that NYDFS remains unsure of what substantive content should be required of virtual currency exchanges in the realm of consumer, cyber-security and anti-money laundering protections. Therefore, firms that submit a proposal should be prepared to enter negotiations with the NYDFS regarding the specifics of their compliance programs and be flexible enough to implement any changes required for licensure.
While the latest NYDFS statements leave a lot of unanswered questions and do not provide a clear path forward for virtual currency firms, it appears on balance to be a step forward for those virtual currency exchanges seeking licensure in New York. The continued interest of the NYDFS in virtual currencies and in moving the regulatory process forward is encouraging to virtual currency businesses. However, the ultimate regulatory structure applicable to the virtual currency industry in New York remains generally unclear. As such, firms seeking licensure under the Order should remain cautious in light of the fact that any entity licensed before the new BitLicense structure is finalized will be expected to submit to the new regulations.