After multiple proposals and significant industry comment, the NYDFS has released a final “BitLicense” framework that establishes a comprehensive licensing and regulatory regime for New York businesses engaged in activities related to Bitcoin and other virtual currencies.
In a speech on June 3, Superintendent Benjamin Lawsky of the New York Department of Financial Services (NYDFS) announced its release of the final rules for businesses that engage in activities related to Bitcoin and other virtual currencies in New York (the Final Rules or the Rules). The Rules will apply to both persons located in New York that engage in activities related to virtual currency and persons located outside New York that engage in activities related to virtual currency with persons located in New York. The Final Rules define a “person” as an individual, partnership, corporation, association, joint stock association, trust, or other entity, however organized. Although the Final Rules have been issued by the NYDFS, their effective date has not been announced.
This “BitLicense” framework is the first comprehensive licensing framework in the United States specifically designed to regulate virtual currency firms and has been closely followed by industry participants. In adopting the Final Rules, the NYDFS declined to place virtual currency firms under the existing money transmitter rules. Instead, it opted for a more stringent and substantive scheme specifically tailored to virtual currencies and more closely resembling the licensing and regulatory regime for banks. The NYDFS originally proposed virtual currency rules in July 2014 and subsequently issued significantly revised rules in February 2015 after receiving comments from thousands of market participants and other interested parties. The Final Rules feature only one substantive change from the February 2015 proposed rules—a clarification of the circumstances under which virtual currency firms will need to receive prior approval from the NYDFS for certain material business changes.
The BitLicense Framework
Under the Final Rules, any person that engages in “Virtual Currency Business Activity” (a licensee) must obtain a license from the NYDFS prior to engaging in such activity. “Virtual Currency Business Activity” is defined broadly in the Final Rules to include any person that (1) transmits or receives virtual currency for transmission for financial purposes; (2) stores, holds, or custodies virtual currency for others; (3) buys and sells virtual currency as a customer business; (4) converts fiat currency into virtual currency or vice versa as a customer business; or (5) controls, administers, or issues a virtual currency.
In addition to a nonrefundable $5,000 fee, a license application must include, among other things, (1) information about the licensee and its affiliates, including business descriptions, a projected customer base, and specific marketing targets; (2) detailed biographical information, an independent investigatory agency background report, and a set of completed fingerprints for each principal of the licensee; (3) a current financial statement for the licensee and each principal; (4) details of the licensee’s banking arrangements and insurance policies; (5) a copy of written policies and procedures related to the Final Rules; and (6) an explanation of the methodology used to calculate the applicable virtual currency’s value in fiat currency. The Final Rules establish a 90-day application review period, subject to extensions at the discretion of the superintendent. The Rules also establish a 45-day transition period from their effective date for potential licensees to submit their applications. During this transition period, when an application is submitted, a licensee is deemed to be in compliance with the BitLicense requirements unless and until the licensee is notified that its application has been denied.
The Final Rules provide two exemptions from the BitLicense requirements. The first exemption is for persons that are chartered under the New York Banking Law and receive approval from the NYDFS to engage in Virtual Currency Business Activity. The second exemption is for merchants and consumers that use virtual currency solely to purchase or sell goods and services or for investment purposes. Superintendent Lawsky reiterated that the NYDFS does not intend to regulate software developers that do not have custody of consumer funds—rather, the Rules’ primary target includes financial intermediaries (and specifically nonbank institutions). Importantly, Superintendent Lawsky reiterated in his speech that licensees that want both a BitLicense and a traditional money-transmitter license will not have to go through the full application process twice.
The Final Rules also create a two-year “Conditional License” that may be issued to applicants that do not satisfy all of the Final Rules’ regulatory requirements upon licensing. Superintendent Lawsky has indicated that this was aimed to provide flexibility for start-ups that are required to obtain a license. The NYDFS has sole discretion in granting, renewing, imposing conditions on, suspending, or revoking a conditional license. Among the relevant factors that the NYDFS will consider in determining whether to grant a Conditional License are the volume of a firm’s anticipated business, the nature and scope of the risks that the business presents to consumers and financial markets, and whether the applicant is licensed or registered by any governmental or self-regulatory authority to engage in financial services or other business activities. The Conditional License application process and the specific rules and procedures that will apply are currently unknown. It is also unclear whether firms with existing regulatory oversight (e.g., those regulated by the Securities and Exchange Commission [SEC] or the Commodity Futures Trading Commission [CFTC]) will be able to obtain a Conditional License instead of submitting a comprehensive application.
Requirements for Licensees
In addition to granting the NYDFS examination authority of licensees, the Final Rules put in place a number of substantive requirements with which licensees must comply. First, each licensee must have a compliance program that ensures compliance with the Final Rules as well as with applicable federal and state laws and regulations. The compliance program must be reviewed and approved by the licensee’s board of directors and overseen by a designated compliance officer. The Rules impose capital and custody requirements on licensees (which may be held in virtual currency); the amount of capital required is left to the superintendent’s discretion based on a list of outlined factors. Additionally, the Final Rules require (1) books and records similar to those in place for most financial firms; (2) licensees to deliver quarterly financial reports to the superintendent; (3) superintendent approval for certain changes in control of the licensee (but not, unlike the proposed rules, approval of new rounds of venture capital funding, as long as investors remain passive); and (4) advertising, marketing, and consumer protection measures, including enumerated disclosures to customers of material risks and the delivery of confirmation receipts to customers after each transaction.
The Final Rules address one of the significant concerns related to virtual currencies by imposing strict anti–money laundering (AML) and cybersecurity requirements for licensees. In his June 3 speech, Superintendent Lawsky noted that there was significant overlap between the Rules dealing with AML issues and existing Financial Crimes Enforcement Network (FinCEN) regulations. As a result, FinCEN registrants that already file Suspicious Activity Reports (SARs) in compliance with FinCEN regulations will not need to duplicate their work by filing SARs with the NYDFS. This clarification addressed one of the concerns that market participants expressed with virtual currency regarding duplicative and potentially burdensome reporting requirements.
Finally, in the only substantive revision made to the proposed rules, the NYDFS narrowed the circumstances under which a licensee must obtain prior written approval from the NYDFS for certain corporate events. In response to industry comments, the Rules clarify that prior NYDFS approval is only required for material changes to a licensee’s products or business models. Superintendent Lawsky stated that material changes in this context do not include software or application updates.
The Final Rules create a new and comprehensive regulatory regime for persons that engage in virtual currency businesses far beyond what is currently required under federal or New York State law for money transmitters. The operational requirements regarding personnel, reporting, and capital may present a significant barrier to entry for persons that wish to engage in virtual currency activities in New York. The limited exemptions to licensing are also likely to present issues, particularly because the exemptions are much narrower than those that currently apply to entities that engage in money transmission or money services business. For example, FinCEN regulations specifically exempt from the definition of “money services business” “a person registered with, and functionally regulated or examined by, the SEC or the CFTC, or a foreign financial agency that engages in financial activities that, if conducted in the United States, would require the foreign financial agency to be registered with the SEC or CFTC.” The Final Rules do not include a similar exemption for federally regulated entities, notwithstanding commentators’ requests during the comment process to include one or more such exemptions.
Although the Final Rules provide a template for regulating virtual currency intermediaries, other states are taking different and generally less intrusive approaches to regulating virtual currency firms. For example, a bill pending in the California State Assembly would require virtual currency businesses to obtain a license more similar to a money transmitter license. Lawmakers in Pennsylvania and North Carolina have proposed amendments to their respective money transfer business laws that would bring transmitters of virtual currencies within the existing money transfer business regulatory scheme. Finally, the Connecticut legislature has passed a bill that, if signed into law, would give the Connecticut Department of Banking new power to oversee portions of the virtual currency industry in Connecticut. At this time, it is not clear whether other states will follow the New York regulatory model.
Superintendent Lawsky’s impending departure and the considerable amount of discretion granted to the superintendent in the Final Rules may create some uncertainty about the practical effects that the Rules will have on the conditional and definitive licensing requirements and time lines.