The New York Department of Financial Services riveted the attention of the virtual currency world (and just about everyone else involved with digital financial services), with its July 17 proposal to issue licenses for Virtual Currency Business Activities. The so-called BitLicense proposal features broad coverage; open ended capital and bonding requirements; personal investigation of founders, investors and even employees; and prior regulatory approval of new products and activities.

These and other aspects of BitLicensing beg the question: will licensing protect the public and investors? Or just drive Bitcoin participants out? (If they leave, they may find roadblocks elsewhere; days before New York’s announcement, France’s Ministry for the Economy and Finance, for example, proposed regulating Bitcoin.) Opportunistic locales for virtual currency operators are already being identified, such as the Isle of Man, a self-governing British Crown Dependency, whose Financial Supervision Commission says it is “not the appropriate time” to introduce a regulatory regime, while warning there is no consumer protection in the digital currency market. Think about this: Tiny Delaware is a corporate legal haven, Switzerland created an international bank haven, and a virtual currency haven may be next. Regulatory exercises like New York’s could advance that option.

Founders of virtual currency startups (as well as other more traditional emerging payment businesses generally) aren’t keen to disclose personal financial information and fingerprints, and aspects of the NY bitlicensing rule such as the requirement to keep consumer complaints on file for 10 years, and limitations on permissible investments for licensees’ retained earnings have created a torrent of online backlash. BitLicensees could not introduce new products or materially change their activities without approval of the NY superintendent of financial services, with no timeline for approval. Prior approval of business activities in this fast-paced industry troubles high-tech innovators, who worry that their products aren’t well understood. The anticipated cost of the NY BitLicense, regulatory compliance programs, and required audit and reporting are also perceived as dampers on a fledgling industry.

Despite new regulatory proposals, the virtual currency industry is gaining ground, as evidenced by groups including the North American Bitcoin Conference (NABC), UK Digital Currency Association, Bitcoin France Bureau, Bitcoin Association of Australia, Australian Digital Currency Commerce Association and the newly formed Chamber of Digital Commerce. First stop is lobbying in Washington, with demands for “smart regulation,” followed by media outreach by the industry’s public affairs people.

Virtual currencies will eventually be regulated, because AML and worldwide counter-terrorism priorities demand it, but I’m not sure BitLicenses will prevent Mt. Gox-like meltdowns. We represent clients in many financial services industries, and despite elaborate licensing rules, investors lose money, providers lose traction, and things go wrong occasionally. Requirements for managing electronic data and transaction risk didn’t prevent breaches at Target or Neiman Marcus, despite their robust (and expensive) systems. Outsized regulatory reporting requirements increase costs, which startups are keen to control. Moreover, realigning limited regulatory resources toward virtual currency regulation could mean less oversight of other, also important controls, with unhappy consequences. New York is trying to strike the right balance between creating a regulatory structure to aid in the legitimacy of the new medium while not stifling its growth or pushing it to friendlier regulatory environments. However, is it too much too soon?